On December 15, 2010, the Securities and Exchange Commission (the “SEC”) proposed rules implementing (i) the “conflict minerals” disclosure requirements in Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), (ii) the mine safety disclosure requirements in Section 1503 of the Dodd-Frank Act and (iii) the disclosure of payments by issuers to foreign governments for the purpose of the commercial development of oil, natural gas, or minerals also required by Section 1503 of the Dodd-Frank Act.1
In Section 1502 of the Dodd-Frank Act, Congress aims to use public company disclosure requirements to shape public policy relating to the humanitarian situation in the Democratic Republic of the Congo and surrounding countries.2 The proposed rules are expected to impact a large number of public companies, as the conflict minerals targeted by the proposed rules are used in the manufacture of a broad spectrum of consumer goods.
Under the proposed rules, if conflict minerals are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by an issuer that files reports with the SEC under Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), such issuer will be required to disclose in the body of its annual report whether its conflict minerals originated in the Democratic Republic of the Congo or an adjoining country (the “DRC Countries”), based on its reasonable country of origin inquiry.
Regardless of the conclusion, the issuer would have to disclose the determination and the reasonable country of origin inquiry process it used in reaching this determination in the body of its annual report and make the report available on its website. Such issuer will be required to furnish, as an exhibit to its annual report, a separate report that describes, among other matters, the measures taken to exercise due diligence on the source and chain of custody of its conflict minerals (the “Conflict Minerals Report”).
The Conflict Minerals Report would have to include an independent private sector audit of the issuer’s report conducted in accordance with standards established by the Comptroller General of the United States. Any issuer furnishing such a report would be required to certify that it obtained an independent private sector audit of its report, provide the audit report, and make its Conflict Minerals Report available to the public on its website. Further, the Conflict Minerals Report must include a description of the products manufactured or contracted to be manufactured that are not “DRC conflict free,” the facilities used to process the conflict minerals, the country of origin of the conflict minerals, and “the efforts to determine the mine or location of origin with the greatest possible specificity.”
Covered Issuers: The proposed rules cover any issuer that files reports with the SEC under Section 13(a) or Section 15(d) of the Exchange Act (each a “Reporting Issuer”)3, for which conflict minerals are necessary to the functionality or production of a product manufactured, or contracted to be manufactured4, by that issuer. If an issuer does not meet this definition, the issuer would not be required to take any action, make any disclosures, or submit any reports. The statute and the proposed rule do not define what is meant by “necessary to the functionality or production” of a product.
- “Retailer” Issuers: With regard to issuers that are retailers, the SEC indicated that the proposed rules would apply to issuers that contract for the manufacturing of products over which they have any influence regarding the manufacturing of those products.
- “Mining” Issuers: Under the proposed rules, issuers that mine, extract, or contract for the mining or extraction of, conflict minerals will be considered to be manufacturing those minerals.
“Conflict Minerals”: Section 1502 defines “conflict minerals” as columbite-tantalite (coltan), cassiterite, gold, and wolframite or any of their derivatives. Because the proposed rules cover minerals used in the manufacture of metals commonly used in household products and jewelry, such as tin and tungsten, they will apply to a large number of companies.5
When Conflict Minerals are “Necessary” for a Product: The SEC did not provide guidance as to the meaning of the phrase “necessary to the functionality or production” and instead requested comment on whether this phrase should be defined and, if so, how. However, the SEC did note that if a mineral is necessary, the product is covered without regard to the amount of the mineral involved. Further, the SEC noted that it intends the proposed rules to include products if the conflict mineral is intentionally included in a product’s production process and is necessary to that process, even if that conflict mineral is not ultimately included anywhere in the final product. On the other hand, conflict minerals necessary to the functionality or production of a physical tool or machine used to produce a product would not be considered necessary to the production of the product even if that tool or machine is necessary to producing the product.6
The Reasonable Country of Origin Inquiry
Under the proposed rules, if an issuer is one for whom “conflict minerals are necessary to the functionality or production of a product manufactured by such person,” such issuer must determine after a reasonable country of origin inquiry whether its conflict minerals originated in the DRC countries. The proposed rules do not set forth what constitutes a reasonable country of origin inquiry. The reliability of any inquiry would be based solely on whether the information used provides a reasonable basis for an issuer to be able to trace the origin of any particular conflict mineral it uses. As an example, the SEC notes that it would not satisfy the proposed rules for an issuer to conclude that it is unreasonable for it to attempt to determine the origin of its conflict minerals solely because of the large amount of conflict minerals it uses in its products or the large number of its products that include conflict minerals. The SEC release indicated that one way of satisfying the reasonable country of origin inquiry requirement would be to receive a reasonably reliable representation from the facility at which its conflict minerals were processed that those conflict minerals did or did not originate in the DRC countries.
If the issuer determines that its conflict minerals did not originate in the DRC countries, the issuer will be required to disclose this determination and the reasonable country of origin inquiry it used in reaching this determination in its annual report and on its website, but would not be required to submit anything further to the SEC. The issuer would likewise be required to maintain reviewable business records to support its determination.
Otherwise, an issuer that determines that its conflict minerals did originate in the DRC countries, or an issuer that is unable to conclude that its conflict minerals did not originate in the DRC countries, would have to disclose this in the body of its annual report and disclose that the Conflict Minerals Report is furnished as an exhibit to the annual report.7 Such Conflict Minerals Report must contain, among other information, a description of any of the issuer’s products that originated in the DRC countries or that contain conflict minerals that it is unable to determine did not “directly or indirectly finance or benefit armed groups” in the DRC countries, or “DRC conflict free” products.
Content of the Conflict Minerals Report
As discussed above, the proposed rules would require issuers to exercise due diligence on the source and chain of custody of their conflict minerals and to describe those due diligence measures in their Conflict Minerals Reports, as well as include a certified independent private sector audit conducted in accordance with the standards established by the Comptroller General of the United States. Further, the Conflict Minerals Report must include a description of the products manufactured or contracted to be manufactured that are not “DRC conflict free,” the facilities used to process the conflict minerals, the country of origin of the conflict minerals, and “the efforts to determine the mine or location of origin with the greatest possible specificity.”
Under the proposed rules, an issuer that is required to furnish a Conflict Minerals Report because it is unable to determine that its conflict minerals did not originate in the DRC countries must also provide this information. Such issuer would be required to describe all of its products that contain such conflict minerals and to identify these products as not “DRC conflict free”8 since the issuer would not be able to establish that the minerals did not directly or indirectly finance or benefit armed groups in the DRC countries.
The proposed rules would require an issuer to furnish, as part of its Conflict Minerals Report, the audit report prepared by the independent private sector auditor and to specifically identify that auditor.
However, the Conflict Minerals Report would not be deemed to be incorporated by reference into any filing, except to the extent that the issuer specifically incorporates it by reference. As a result, an issuer that incorporates by reference its annual report into a registration statement would not be automatically incorporating the Conflict Minerals Report, or the audit report included therein, into the registration statement. Consequently, the independent private sector auditor would not assume expert liability and would not have to provide a consent unless the issuer specifically incorporates by reference the Conflict Minerals Report into the registration statement.
The proposed rules require each Reporting Issuer that is “an operator, or that has a subsidiary that is an operator, of a coal or other mine”9 located in the United States to disclose in their periodic reports filed with the SEC, information listed in Section 1503(a) of the Dodd-Frank Act regarding specified health and safety violations, orders and citations, related assessments and legal actions, and mining-related fatalities.10 Consequently, under the proposed rules, issuers that operate mines outside the United States would not have to disclose information about such mines. In addition, the proposed rules mandate the filing of a Form 8-K disclosing the receipt of certain orders and notices from the Mine Safety and Health Administration. Each periodic report must include disclosure “for the time period covered by such report.”
Location of Disclosure: The SEC proposes that issuers that have matters to report in accordance with Section 1503(a) include brief disclosure in Part II of Form 10-Q, Part I of Form 10-K and Forms 20-F and 40-F noting that they have mine safety violations or other regulatory matters to report in accordance with Section 1503(a), and that the required information is included in an exhibit to the filing containing detailed disclosure about specific violations and regulatory matters required by Section 1503(a).
Required Disclosure Items: Under the proposed rules, each issuer that is required under Section 1503(a) to provide this disclosure would be required to provide the following for each coal or other mine for the time period covered by the report:
- The total number of violations of mandatory health or safety standards that could significantly and substantially contribute to the cause and effect of a coal or other mine safety or health hazard under section 104 of the Federal Mine Safety and Health Act of 1977 (the “Mine Act”) for which the operator received a citation from the U.S. Labor Department’s Mine Safety and Health Administration (“MSHA”). The proposed disclosure requirement would mandate disclosure of any violation of a mandatory safety standard that is reasonably likely to result in a reasonably serious injury or illness under the unique circumstance contributed to by the violation (a “significant and substantial” violation).
- The total number of orders issued under section 104(b) of the Mine Act, which covers violations that had previously been cited under section 104(a) that, upon follow-up inspection by MSHA, are found not to have been totally abated within the prescribed time period, which results in the issuance of an order requiring the mine operator to immediately withdraw all persons (except certain authorized persons) from the mine.
- The total number of citations and orders for unwarrantable failure of the mine operator to comply with mandatory health and safety standards under section 104(d) of the Mine Act.
- The total number of flagrant violations under section 110(b)(2) of the Mine Act. The term “flagrant” with respect to a violation means “a reckless or repeated failure to make reasonable efforts to eliminate a known violation of a mandatory health or safety standard that substantially and proximately caused, or reasonably could have been expected to cause, death or serious bodily injury.”
- The total number of imminent danger orders issued under section 107(a) of the Mine Act. Such orders are issued under section 107(a) of the Mine Act if the MSHA inspector determines there is an imminent danger in the mine. The total dollar value of proposed assessments from MSHA under the Mine Act during the time period covered by the report, including the cumulative total of all proposed assessments of penalties outstanding as of the last day of the period covered by the report. The proposed rules would not prohibit the inclusion of additional information noting that certain proposed assessments of penalties are being contested to provide context to the required disclosure.
- The total number of mining-related fatalities, which must include all fatalities that are required to be disclosed under MSHA regulations, unless the fatality is determined to be unrelated to mining activity (or “non-chargeable” to the mining industry).
- A list of mines for which the issuer or a subsidiary received written notice from MSHA of a pattern of violations of mandatory health or safety standards that are of such nature as could have significantly and substantially contributed to the cause and effect of coal or other mine health or safety hazards under section 104(e) of the Mine Act.
- A list of mines for which the issuer or a subsidiary received written notice from MSHA of the potential to have such a pattern.
- Any pending legal action before the Federal Mine Safety and Health Review Commission (the “FMSHRC”) involving such coal or other mine.11 Under the proposed rules, the issuer must disclose any legal actions before the FMSHRC involving a coal or other mine for which the issuer or a subsidiary of the issuer is the operator.
- A brief description of each category of violations, orders, and citations reported. To facilitate investors’ understanding of the basis for the violations, orders or citations referenced, the proposed rules require issuers to provide a brief description of each category of violations, orders, and citations reported under new Items 106(a)(1) and 106(a)(2) of Regulation S-K.
Disclosure of Payments by Resource Extraction Issuers
Pursuant to Section 1504 of the Dodd-Frank Act, the proposed rule would require resource extraction issuers to include in an annual report information relating to any payment made by the issuer, or by a subsidiary or another entity controlled by the issuer, to a foreign government or the federal government for the purpose of the commercial development of oil, natural gas, or minerals.
The proposed rules apply to each resource extraction issuer that is a U.S. or foreign Reporting Issuer that engages in the commercial development of oil, natural gas, or minerals, regardless of the size or the extent of business operations constituting commercial development of oil, natural gas, or minerals. Likewise, the proposed rules would apply equally to companies that fall within this definition whether or not they are owned or controlled by governments.
The phrase “commercial development of oil, natural gas, or minerals” includes exploration, extraction, processing, export, and other significant actions relating to oil, natural gas, or minerals, or the acquisition of a license for any such activity, as determined by the SEC. The definition is intended to capture only activities that are directly related to the commercial development of oil, natural gas, or minerals, as opposed to activities that are ancillary or preparatory to such commercial development. In an example used by the SEC, a manufacturer of drill bits or other machinery used in the extraction of oil would not fall within the definition of commercial development.
A “payment” in the context of the proposed rule means one that:
- is made to further the commercial development of oil, natural gas, or minerals;
- is not de minimis; and
- includes taxes, royalties, fees (including license fees), production entitlements, bonuses, and other material benefits, that the SEC determines are part of the commonly recognized revenue stream for the commercial development of oil, natural gas or minerals.
Under the proposed rules, the resource extraction issuer will be required to disclose in its annual report filed on Form 10-K, Form 20-F or Form 40-F:
- the type and total amount of such payments made for each project of the resource extraction issuer relating to the commercial development of oil, natural gas, or minerals,
- the type and total amount of such payments made to each government; the total amounts of the payments, by category;
- the currency used to make the payments;
- the financial period in which the payments were made;
- the business segment of the resource extraction issuer that made the payments;
- the government that received the payments, and the country in which the government is located; and
- the project of the resource extraction issuer to which the payments relate.
Under the proposed rules, the Conflict Minerals Report would not be subject to liability under Section 18 of the Exchange Act, because it would be “furnished” to the SEC and not “filed.” However, failure to comply with the proposed rules, if adopted, would give rise to liability for violations of Sections 13(a) or 15(d), as applicable.
The proposed rules require issuers to provide their initial conflict minerals disclosure and, if necessary, their initial Conflict Minerals Report after their first full fiscal year following the promulgation of the final rules. Assuming that the SEC adopts the proposed rules prior to December 31, 2011, a December 31 fiscal year-end issuer would first have to provide conflict minerals disclosure or a Conflict Minerals Report after the end of its December 31, 2012 fiscal year.
Public companies would be wise to initiate diligence procedures throughout their manufacturing process and supply chain in order to determine whether the proposed disclosure requirements would apply to them and the extent of the potential exposure. If applicable, public companies should identify an independent auditor who will furnish a report to be included as part of their Conflict Minerals Report and prepare an auditor consent for a registration statement that specifically incorporates by reference the Conflict Minerals Report.12