August 23, 2012
The Securities and Exchange Commission ("SEC" or "Commission") on August 22, 2012 adopted final rules regarding disclosure and reporting requirements with respect to the use of "conflict minerals" to implement Section 1502 of the Dodd-Frank Act. The final rules were adopted by a vote of 3 to 2, with Commissioners Paredes and Gallagher dissenting.
The 356 page adopting release containing the final rules is available here. Gibson Dunn will issue a more extensive client alert in the near future with a more detailed discussion and analysis of the rules. However, from the discussion at the Commission meeting and a Commission briefing paper, we note a few significant points:
The final rules apply to any issuer that files reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934. There is no exception for foreign private issuers, emerging growth issuers or smaller reporting issuers. The rules will apply to all issuers on a calendar year basis, regardless of an issuer’s fiscal year. Thus, the rules will apply to all covered issuers commencing on January 1, 2013.
The final rules adopt the same three-step analytical process contemplated in the proposed rules, but include significantly modified mechanisms for carrying out certain steps of the process. Those three steps involve: (1) determining whether conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the issuer; (2) if so, conducting a reasonable country of origin inquiry to determine if the issuer knows or has reason to believe that such minerals may have originated from the Democratic Republic of the Congo (DRC) or an adjoining country (the "covered countries") and are not from scrap or recycled sources; and (3) if so, conducting supply chain due diligence and issuing a Conflict Minerals Report.
The final rules, like the proposed rules, apply to products an issuer "manufactures" or "contracts to manufacture" if a conflict mineral (generally, gold, tin, tungsten or tantalum) is "necessary to the functionality or production" of the products. The final rules do not define any of these quoted terms, but the adopting release provides interpretive guidance on them. In determining whether an issuer "contracts to manufacture" a product, the standard will focus on the degree of influence the issuer exercises over the product’s manufacturing. An issuer would not be deemed to have influence over manufacturing if it merely: (1) affixes its brand, marks, logo, or label to a generic product manufactured by a third party; (2) specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product; or (3) services, maintains, or repairs a product manufactured by a third party.
The final rules, unlike the proposed rules, do not apply to issuers that mine conflict minerals or to issuers that contract to mine conflict minerals.
In contrast to the proposed rules, disclosures under the conflict minerals rules will not be included in or as an exhibit to an issuer’s annual report on Form 10-K, but will be made on a new, specialized Form SD. All issuers that manufacture or contract to manufacture a product for which a conflict mineral is necessary to the functionality or production of the product will be required to file the Form SD on May 31 with respect to their conflict minerals use in the prior calendar year. Thus, all issuers will file their first disclosure report on May 31, 2014 for the 2013 calendar year.
Also unlike the proposed rules, the final rules provide that the disclosure report on Form SD is to be filed, rather than furnished. This means that issuers will be subject to liability under Section 18 of the Exchange Act for any "false or misleading" statements in their Form SD, subject to a defense if the issuer acted in good faith and did not have knowledge that the report was false and misleading. The Form SD is not required to be accompanied by the officer certifications that apply to Forms 10-K and 10-Q, and is not incorporated into an issuer’s registration statements under the Securities Act of 1933, unless the issuer so specifies.
If, after conducting its reasonable country of origin inquiry, an issuer knows that the conflict minerals in its products did not originate from a covered country, or has no reason to believe that they may have originated in a covered country, then the issuer’s Form SD only has to disclose its determination and provide a brief description of the inquiry it undertook. These same disclosures are required on Form SD if an issuer determines that the conflict minerals in its products are from scrap or recycled sources, or has no reason to believe that they are not from scrap or recycled sources.
If, after conducting its reasonable country of origin inquiry, an issuer cannot reach one of the foregoing conclusions, then it must conduct due diligence on the source and chain of custody of its conflict minerals, and its Form SD must include a Conflict Minerals Report. The Conflict Minerals Report will reflect the issuer’s conclusion, based on its due diligence, on whether the issuer’s products are "DRC Conflict Free" or "Not DRC Conflict Free" and the report must be audited under a standard set forth in the final rules. However, in a departure from the proposal, the final rules include a temporary (two years, or four years for smaller issuers) reporting category for issuers who are unable to determine whether the minerals in their products originated in a covered country or financed or benefitted armed groups in the covered countries. The products of issuers falling into this category will be deemed "DRC Conflict Undeterminable." The Conflict Minerals Report for products that are DRC Conflict Undeterminable will be required to address much of the same information required when products are Not DRC Conflict Free, except that (1) it need not be audited, and (2) it must describe steps the issuer has taken or intends to take to reduce the risk that the conflict minerals contained in its products are benefiting armed groups in the covered countries.
As noted above, the Conflict Minerals Report, where required, generally must include an independent private sector audit. There are two exceptions to the audit requirement: (1) when the Conflict Minerals Report relates to products that are "DRC Conflict Undeterminable" during the temporary period described above; and (2) when the Conflict Minerals Report relates to certain recycled or scrap materials, as described in the next bullet. The proposed rules were unclear on the scope of the required audit; for example, whether the audit concerns an issuer’s due diligence process or the conclusions reached in the Conflict Minerals Report. The final rules specify a two-fold "audit objective." First, the audit must express an opinion regarding whether the issuer’s due diligence measures conform with a nationally or internationally-recognized due diligence framework. The only such framework currently available is the due diligence guidance adopted by the Organization for Economic Co-Operation and Development ("OECD Due Diligence Guidance"). Second, the required audit must express an opinion regarding whether the issuer, in fact, engaged in the due diligence according to the framework it adopted.
The final rules revise the SEC’s proposed treatment of recycled and scrap materials and provide that products containing conflict minerals originating from recycled or scrap sources do not automatically trigger an obligation to file a Conflict Minerals Report. Rather, products containing such materials are considered "DRC Conflict Free." There are, however, additional requirements for products that contain gold. In addition, in cases when an issuer must prepare a Conflict Minerals Report relating to tantalum, tin, and tungsten from recycled or scrap sources, a private sector audit is not required.
The SEC today also adopted final rules to implement Section 1504 of the Dodd-Frank Act. These rules, applying to approximately 1,100 issuers that are involved in exploration, extraction, processing or export of oil, natural gas or minerals, or acquiring licenses to conduct any of the foregoing activities, will require detailed disclosure of payments to governments by such issuers on a project by project basis. The disclosures likewise will be made on the new Form SD, and for calendar year issuers will first cover the period from October 1, 2013 through December 31, 2013.
This Client Alert was posted on the date the rules were adopted as a blog on the Gibson Dunn Securities Regulation and Corporate Governance Monitor, available at https://securitiesregulationmonitor.com. We encourage you to sign up at the Monitor website to receive email alerts when we post information on developments and trends in securities regulation, corporate governance and executive compensation.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you work, or any of the following lawyers:
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