Last week, the SEC finally resolved two major rulemaking proceedings – the conflict minerals and the extractive industry payment rulemaking proceedings.  The business community vehemently opposed the new rules, citing the billions of dollars which businesses will have to spend to comply.  Nonetheless, the SEC adopted the new requirements with modifications to try and address specific business concerns.  The rules will be challenged in the appellate court and a decision on the rules will not be reached until sometime in 2013.

The SEC adopted the new controversial rules almost 18 months after the deadline included in the Dodd-Frank Act.  The Dodd-Frank Act directed the SEC to issue rules requiring resource extraction issuers to include in their annual reports information about any payment made by the issuer, a subsidiary of the issuer, or an entity under the control of the issuer, to a foreign government or the federal government for the commercial development of oil, natural gas, or minerals.

Extractive Industry Payments Rule

The purpose of the new extractive industry reporting requirement was to increase transparency in the hope that citizens in the countries which receive such payments will act to ensure that they receive their fair share of such payments from the recipient government.  The rules build on proposals made by a voluntary coalition of oil, natural gas, and mining companies, foreign governments, investor groups, and other international organizations dedicated to fostering and improving transparency and accountability in countries rich in oil, natural gas, and minerals through the publication and verification of company payments and government revenues from such resources.

Senator Lugar, one of the chief sponsors of this provision explained that the requirement “would help empower citizens to hold their governments to account for the decisions made by their governments in the management of valuable oil, gas, and mineral resources and revenues. . . The essential issue at stake is a citizen’s right to hold its government to account. Americans would not tolerate the Congress denying them access to revenues our Treasury collects. We cannot force foreign governments to treat their citizens as we would hope, but this amendment would make it much more difficult to hide the truth.”

For companies covered by the final rules, the rules  define “payment” to mean a payment that is made to further the commercial development of oil, natural gas, or minerals, is “not de minimis,” and includes taxes, royalties, dividends, payments for infrastructure improvements, fees (including license fees), production entitlements, and bonuses.   The SEC defined a de minimis payment as a single or series of payments that equals or exceeds $100,000 during the most recent fiscal year.

The Conflict Minerals Rules

The SEC also adopted new rules relating to “conflict minerals” — cassiterite, columbite-tantalite, gold, wolframite and other minerals determined by the U.S. government to be financing conflict in the Democratic Republic of Congo or adjoining countries.

Under the new rules, which are effective January 1, 2013, all reporting companies, including small businesses and foreign private issuers, would be required to make conflict minerals disclosures and conduct supply chain due diligence if they “manufacture or contract to manufacture” products that contain conflict minerals that are “necessary to the production or functionality of the product.”   The SEC originally proposed to require all issuers make conflict minerals disclosures and conduct supply chain due diligence if they “manufacture or contract to manufacture” products that contain conflict minerals.  The final rules do not explicitly define what it means to “manufacture” a product and  impose reporting requirements on companies that “contract to manufacture” products, or those that have some actual influence over the manufacturing of a product.  The SEC excluded companies from teh reporting requirements if they  “merely”  (1) affix its brand, marks, logo, or label to a generic product manufactured by a third party; (2) service, maintain, or repair a product manufactured by a third party; or (3) specify or negotiate contractual terms with a manufacturer that do not directly relate to the manufacturing of the product.

Impact of the New Rules

Federal prosecutors and SEC FCPA Enforcement Unit attorneys will use the extractive industry disclosures for intelligence purposes and as an additional prosecutorial tool.  Companies that are involved in the extractive industries will have another check on the accuracy of their books and records which could in turn provide valuable leads to the Justice Department and the SEC.

Both reporting requirements create risks in terms of accuracy – companies that make a material misstatement or omission could be subject to criminal prosecution under the False Statements statute, 18 USC Section 1001.

From the business side of the equation, the rules will certainly cost shareholders – the cost of compliance will fall somewhere between $10 and $20 billion.  Whether the benefit outweighs the cost, Congress already decided that issue when it imposed these requirements in Dodd-Frank.   

Foreign companies that are not subject to the rule will gain two competitive advantages – they will not incur the reporting costs and they will gain competitive information about payments made by their competitors to foreign governments.

The business community will continue to fight the rules and the issue will ultimately be decided by the US Court of Appeals for the District of Columbia Circuit.