Recent judicial and Securities and Exchange Commission (“SEC”) developments may impact companies’ disclosure obligations regarding the use of conflict minerals and payments by resource extraction issuers. On July 2, 2013, the U.S. District Court for the District of Columbia vacated the SEC’s new resource extraction disclosure rule and remanded it to the SEC for further rulemaking. That same Court also heard oral arguments in a case related to the conflict minerals rule on July 1, 2013, which may call into question the validity of the controversial conflict minerals rule. In addition, the SEC recently issued Frequently Asked Questions to provide compliance guidance on the conflict minerals and resource extraction disclosure rules. This client alert summarizes these recent developments.
Last year, the SEC issued final rules1 concerning disclosure of (1) the use of conflict minerals (new Rule 13p-1, adopted under Section 13(p) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), and (2) payments made by resource extraction issuers to a foreign government or the U.S. federal government for the purpose of commercially developing oil, natural gas or minerals (new Rule 13q-1, adopted under Section 13(q) of the Exchange Act), as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). Under the new rules, a new Form SD (“Specialized Disclosure”) is required to be filed by issuers to report the use of conflict minerals and payments by resource extraction issuers to governments. Specifically, the SEC’s new rules require an issuer to submit a report on the new Form SD if it uses “conflict minerals” that originated in the Democratic Republic of the Congo (the “DRC”) or an adjoining country in the manufacture of its products. Similarly, the SEC’s new rule regarding resource extraction payments requires companies to file annual reports with the SEC on Form SD to report information describing any payments made by the issuer or an affiliate to a foreign government or the U.S. federal government related to the commercial development of oil, natural gas or minerals.
Issuers must assess whether they are “DRC conflict free” or subject to the required reporting for the calendar year beginning January 1, 2013, with the first reports due May 31, 2014 and annual reports due each May 31 thereafter. The new rules regarding resource extraction disclosures take effect for fiscal years ending after September 30, 2013.
Recent Court Proceedings
On July 2, 2013, the U.S. District Court for the District of Columbia vacated the resource extraction rule and remanded it to the SEC for further proceedings.2 The case, brought by the American Petroleum Institute and others, challenged the resource extraction rule on the grounds that it compelled speech in violation of the First Amendment and created various Administrative Procedures Act (“APA”) issues, including that the SEC erroneously read the Dodd-Frank Act to require public disclosure of resource extraction reports, that the SEC was arbitrary and capricious in failing to grant exemptions for countries that prohibit disclosure and that the SEC’s cost analysis was flawed, among other items. The Court did not address the plaintiffs’ First Amendment challenge or the majority of their APA challenges and ruled instead on the basis of “two substantial errors” by the SEC: (1) misreading of the statute to mandate public disclosure of the resource extraction reports and (2) its decision to deny any exemptions to the rule, which was arbitrary and capricious. The SEC has stated that it is currently reviewing the decision, and it remains unclear whether the SEC will appeal. Unless the SEC appeals and the rule is upheld on appeal, the SEC will be required to promulgate new resource extraction rules as the Dodd-Frank Act mandates that the SEC do so. This could mark yet another delay in the implementation of Dodd-Frank Act rules. For example, the SEC has yet to promulgate a new “proxy access” rule as mandated under the Dodd-Frank Act after the initial rule was struck down in 2011 upon challenge by the U.S. Chamber of Commerce and the Business Roundtable.
The conflict minerals rule, which was promulgated at the same time as the resource extraction rule, is also being challenged by three business trade groups in the U.S. District Court for the District of Columbia. Oral arguments in that case were heard on July 1, 2013. The outcome of that case is yet unknown, so companies should pay close attention for a ruling, as such may change the timing of or manner in which they seek to comply with the new disclosure rule.3
Conflict Minerals FAQs
Separately, the SEC recently issued Frequently Asked Questions that provide guidance on Section 13(p) of the Exchange Act, Exchange Act Rule 13p-1 and Item 1.01 of Form SD, relating to disclosure of the use of conflict minerals from the DRC or adjoining countries.4
The FAQs include 12 questions and answers and are summarized below. The full text of the release may be found here: http://www.sec.gov/divisions/corpfin/guidance/conflictminerals-faq.htm.
- Failure to Timely File Form SD and Form S-3 Eligibility. Failure to timely file a Form SD does not impact Form S-3 eligibility. (See FAQ # 12)
- Voluntary Filers. Rule 13p-1 and related required disclosures apply to all issuers that file reports under Exchange Act Sections 13(a) or 15(d), regardless of whether such filings are voluntary. (See FAQ # 1)
- Generic Components of Manufactured Products. An issuer must conduct a country of origin inquiry with respect to conflict minerals found in generic components included in products it manufactures or contracts to manufacture. There is no distinction between product components that an issuer directly manufactures or contracts to manufacture and generic components that the issuer purchases to include in a product. (See FAQ # 5)
- Product Packaging. A conflict mineral necessary to the functionality or production of a package or container that an issuer manufactures or contracts to manufacture that is used in the display, transport or sale of a manufactured product is not considered part of the product, even if necessary to preserve the product’s usability. Yet, if an issuer manufactures and sells packaging or containers independent of the product, the packaging or containers would be considered a product. (See FAQ # 6)
- Equipment Used in Providing Services. An issuer does not need to file a Form SD regarding conflict minerals in the equipment it manufactures or contracts to manufacture if that equipment is used in providing a service offered by the issuer and such equipment is retained by the service provider, required to be returned to the service provider or intended to be abandoned by the customer following the terms of the service (e.g., cruise ship manufactured by cruise line). (See FAQ # 7)
- Equipment Used in the Manufacture of Products. An issuer that manufactures or contracts to manufacture tools, machines or equipment that contain conflict minerals and are used in the manufacture of products, and such tools, machines or equipment are sold after use, is not required to file a Form SD regarding the conflict minerals in such equipment. (See FAQ # 8)
- “Conflict Free” Findings. An issuer that manufactures or contracts to manufacture products that contain conflict minerals that are determined to be “DRC conflict free” must still file a Form SD with a Conflict Minerals Report and obtain an independent private sector audit of such report; however, the issuer is not required to disclose the products containing conflict minerals in its report or provide certain other disclosures. (See FAQ # 10)
- Consolidated Subsidiaries. An issuer must make disclosures under Rule 13p-1 for itself and all of its consolidated subsidiaries. (See FAQ # 3)
- Etched Logos. An issuer that requires an identifier, such as a logo or serial number, to be etched into or otherwise marked on a generic product manufactured by a third party is not considered to be “contracting to manufacture” the product. (See FAQ # 4)
- Product Description. For products not found to be “DRC conflict free” or that are “DRC conflict undeterminable,” an issuer should describe in its Form SD the products based on its own facts and circumstances, describing them in terms commonly understood within its industry. An issuer does not need to reference model numbers but must specifically state that the products “have not been found to be ‘DRC conflict free’” or are “DRC conflict undeterminable,” as appropriate. (See FAQ # 9)
- IPOs. An issuer may wait to start Form SD reporting until the first reporting calendar year that begins no sooner than eight months after the effective date of its IPO registration statement. (See FAQ # 11)
- Mining. Form SD excludes all activities customarily associated with mining from Rule 13p-1 disclosures. (See FAQ # 2)
Disclosure of Payments by Resource Extraction Issuers FAQs
At the same time that the SEC issued Frequently Asked Questions on Section 13(p), it also issued Frequently Asked Questions that provide guidance on the disclosure of payments by resource extraction issuers as required in Section 13(q) of the Exchange Act, Exchange Act Rule 13q-1 and Item 2.01 of Form SD. As Rule 13q-1 was just struck down in U.S. District Court as discussed above, the value of these FAQs may be diminished unless the rule is upheld on appeal, if any. In the event that the SEC issues a revised rule, these FAQs may provide helpful guidance in complying with such rule to the extent it mirrors portions of the current rule.
The FAQs include 9 questions and answers and are summarized below. The full text of the release may be found here: http://www.sec.gov/divisions/corpfin/guidance/resourceextraction-faq.htm.
- Failure to Timely File Form SD and Form S-3 Eligibility. Failure to timely file a Form SD does not impact Form S-3 eligibility. (See FAQ # 9)
- Application of Rule 13q-1 to Holding Companies. A reporting issuer that is not directly engaged in the commercial development of oil, natural gas or minerals but whose subsidiary or other entity under its control is engaged in such activities is considered a resource extraction issuer subject to the disclosure requirement. (See FAQ #1)
- Definition of “Mineral”. Disclosure is required with respect to any material commonly understood to be a mineral, including materials for which disclosure is required under Industry Guide 7, “Description of Property by Issuers Engaged or to be Engaged in Significant Mining Operations,” notwithstanding any materiality test used in Guide 7. (See FAQ #3)
- Services Associated with the Exploration, Extraction, Processing and Export of Resources. A company that only provides services associated with the exploration, extraction, processing and/or export of a resource is generally not considered a resource extraction issuer. For example, neither a company that provides hardware and logistics related to the exploration or extraction of resources nor a company that is engaged by an operator to provide hydraulic fracturing services or drilling services is considered a “resource extraction issuer.” The SEC cautions, however, that where a service provider (such as the foregoing examples) makes a payment to a government on behalf of a resource extraction issuer, the resource extraction issuer must disclose such payment. (See FAQ #2)
- Transportation of Resources. Transportation activities where the issuer does not have an ownership interest in the resource are generally not included within the definition of “commercial development” unless the activities are directly related to the export of the resource. (See FAQ #4)
- Use of Government-Related Transportation Services. Payments made to a majority- owned government transportation service for transporting people or materials to an extractive job site are not covered by Rule 13q-1. (See FAQ #5)
- Penalties Imposed by Governments. Penalties and/or fines related to resource extraction that are paid to government agencies are not reportable as fees under Rule 13q-1. (See FAQ #6)
- Presentation of Payments on an Accrued Basis. Resource extraction issuers are not permitted to provide payment information on an accrual basis but must present payments on an unaudited, cash basis for the year in which payments are made. (See FAQ #7)
- Segregating Income Related to Resource Extraction. An issuer with multiple income sources in a given country that pays corporate level income tax on the consolidated amount is not required to segregate income from resource extraction activities and disclose taxes paid on that amount under Rule 13q-1. If the issuer does not segregate the income information, it may state that payments for purposes other than commercial development activities are included. (See FAQ #8)
Action Items; Contact
Companies should monitor recent developments concerning the resource extraction and conflict minerals rules as the requirements surrounding these rules and timing of implementation may change. At present, the resource extraction rule has been vacated, and it is unclear how the SEC will proceed and the timing of any new rules. Likewise, the future of the conflict minerals rule is up in the air until the District Court’s ruling – and, even then, both rulings may be appealed. Further, until any changes concerning the conflict minerals rule are known, companies should keep the recently issued FAQs in mind as they begin to prepare their first annual report on Form SD, which is currently required for the calendar year beginning January 1, 2013, with the first reports due May 31, 2014 and annual reports due each May 31 thereafter. These FAQs may impact the need to file a Form SD and the nature of disclosure.