Securities Regulation Daily Wrap Up, PUBLIC COMPANY REPORTING AND DISCLOSURE—DC Bar Panelists Discuss Conflict Minerals, Resource Extraction Rules, (May 1, 2013)

By Amanda Maine, J.D.

The DC Bar hosted an event to examine the implementation of the Dodd-Frank Act’s disclosure rules relating to the use of conflict minerals from the Democratic Republic of the Congo (DRC) and to payments made to governments for oil, natural gas, and mineral extraction activities.

The panel discussion comes just a day after the National Association of Manufacturers asked the U.S. Court of Appeals for the District of Columbia to transfer its petition for review to the U.S. District Court for the District of Columbia in the wake of the D.C. Circuit’s opinion last week holding that it lacked jurisdiction to hear a similar challenge to the SEC’s resource extraction issuer rules. Compliance with both sets of rules is critical despite these ongoing court challenges.

Conflict minerals. Holly Smith of Sunderland Asbill & Brennan described Congress’ goal in passing the conflict minerals legislation as attempting to end armed conflict in the DRC by requiring companies to disclose whether products using conflict minerals originated from the DRC or in an adjoining country (“covered countries”). Under the new rules, which the SEC adopted on August 22, 2012, with a compliance date of May 31, 2014, for the 2013 calendar year, companies that are required to file reports with the SEC must disclose whether conflict minerals that are necessary to the functionality of a product manufactured or contracted to be manufactured by the company originated in the DRC or an adjoining country. The issuer must also disclose the process it undertook to make the determination and, in some cases, must conduct an independent private sector audit. The disclosures must be made on new Form SD and filed with the SEC.

Smith noted that the conflict mineral rules followed a long period of rulemaking at the SEC which generated more than 1,000 comments. The rules are extremely broad and affect almost every industry you can think of, Smith said, including the electronics, medical, jewelry, automotive, equipment, and clothing industries. She also noted that the National Association of Manufacturers, Business Roundtable, and U.S. Chamber of Commerce had filed suit against the SEC challenging the rules.

Elise Gautier of Deloitte and Touche described a three-part process in reporting conflict minerals use. A company must first determine if the rule applies to it by its use of named conflict minerals. If so, the issuer must perform a Reasonable Country of Origin Inquiry (RCOI) to determine the origin of the minerals. If the company determines that the conflict materials did not originate from a covered country or that they originated from scrap or recycled sources, the company must file a Form SD with the SEC to disclose this conclusion and a brief description of the steps it took to arrive at it.

If the company determines that it the minerals did originate from the DRC or a covered country, it must then categorize the minerals as “DRC conflict free” or “not found to be DRC conflict free.” The company is then subject to additional disclosures. Both conflict free and non-conflict free companies must engage an independent private sector auditor to evaluate the design and description of the issuer’s due diligence regarding its conflict minerals evaluation process. For an interim transition period, a company may also disclose that it is unable to determine whether or not it uses conflict-free minerals in its supply chain.

Smith pointed out that this undertaking is extremely complex. It extends down the supply chain to every single product manufactured by a company in order to determine whether it contains conflict minerals. She also noted that the SEC has stated that a private right of action under Securities Exchange Act Section 18 is available for shareholders who believe a company has disclosed misleading or inaccurate information on Form SD.

Resource extraction. Amy Pandit of Morgan Lewis & Bockius gave an overview of the SEC’s resource extraction rules. Under these rules, issuers who engage in the commercial development of oil, natural gas, or minerals and who file annual reports with the SEC must report payments they have made to a foreign government or the U.S. federal government for the commercial development of oil, natural gas, or minerals on a project-by-project basis on Form SD.

According to Pandit, Congress included the resource extraction requirements in the Dodd-Frank legislation to help empower citizens of resource-rich countries to hold their governments accountable for the wealth generated by these resources by increasing transparency about how much companies have paid to use the resources. Compliance with the rules begins on September 30, 2013. The rules have also been subject to litigation, with the U.S. Court of Appeals Court for the District of Columbia recently determining that it did not have jurisdiction over the matter and transferring it to district court.

Pandit noted that the rules do not specifically define what a “mineral” is, but the staff has unofficially listed several that are covered by the rules as “minerals,” including coal, copper, gold, iron, lead, limestone, salt, and silver. She also said that “payment” is broadly defined, and companies must look at all forms of payment including taxes, royalties, fees, production entitlements, and bonuses and that all situations should be examined as possibly being analogous to any of these categories. Likewise, “project” is not defined in the rules, and Pandit described the SEC’s view on the matter as a “when you see it you’ll know it” view.

Pandit also pointed out that the rules are controversial regarding confidentiality. Under the rules, resource extraction issuers are not allowed to omit disclosure of payments that are prohibited from disclosure under foreign law or by contract. This aspect of the regulation has been criticized as not giving enough respect to contracts or to the laws of foreign countries, according to Pandit.

Jeff Craft of Deloitte & Touche made several suggestions for companies implementing the resource extraction payment disclosure rules. One area of consideration should be organizational, he said. Companies must include not only their employees involved in financial and SEC reporting, but also representatives from their tax, legal, and technology divisions, he said. Companies must also determine how they will accumulate data and disaggregate payment records. The legislation initially required an independent audit like the conflict mineral rules, but this was eventually stricken from the bill. Data must still be validated within the organization because company disclosures will be examined and judged, Craft advised.

Craft also singled out company systems as an area for consideration in implementing the resource extraction rules. He said he has encountered clients requesting advice on how to move beyond Excel. While automation is not always possible or advised, he advocated automating as much as possible systems that track payments and government vendors.

RegulatoryActivity: DoddFrankAct FormsFilings PublicCompanyReportingDisclosure