Allens

International Business Obligations

Focus: New CONFLICT MINERALS AND EXTRACTIVE SECTOR PAYMENTS RULES

21 September 2012

In brief: The United States Securities and Exchange Commission has adopted new rules requiring companies to disclose their use of conflict minerals which originated in the Democratic Republic of the Congo or an adjoining country and to disclose payments made to the US Government or foreign governments for the commercial development of oil, natural gas or other minerals. Special Counsel Debra Counsell (view CV), Lawyer Dora Banyasz and Law Graduate Sheree Rubinstein report.

How does it affect you?

  • These rules will affect a large number of companies that are publicly trading in the United States across a broad range of industries. These companies should consider their obligations under the rules and how they will manage the reporting requirements.
  • The disclosure obligations relating to conflict minerals require a company to engage in a reasonable inquiry to determine whether any of the minerals it is using originated in the covered countries or are from scrap or recycled sources.
  • The disclosure obligations relating to the extractive industry require disclosure of payments equal to or exceeding US$100,000 that are made to the US federal government or foreign governments in relation to the commercial development of oil, natural gas or other minerals.
  • Both sets of disclosure obligations carry significant potential risk for companies – while there may not be any formal penalties, the court of public opinion has the potential to exact serious reputational consequences for those companies that report using conflict minerals or making payments to governments.

Background

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) was passed by the US Congress on 21 July 2010. The primary purpose of the Dodd-Frank Act was to address the causes of the 2008 global financial crisis and to restore public confidence in the financial services industry. Tucked away in the more than 800-page piece of legislation were two provisions particularly relevant to the extractive and manufacturing industries.

Section 1502 of the Dodd-Frank Act added a new section 13(p) to the Securities Exchange Act. The new section required the US Securities and Exchange Commission (the SEC) to enact rules requiring certain companies (issuers) which use conflict minerals that are necessary to the functionality or production of a product manufactured by that issuer, to disclose annually whether any of those minerals originated in the Democratic Republic of the Congo (the DRC) or an adjoining country (conflict minerals disclosure requirement). The motivation of Congress in passing this provision was to curb the connection between the trade and exploitation of conflict minerals in the DRC and the financing of armed conflict in the eastern DRC.

Section 1504 of the Dodd-Frank Act added a new section 13(q) to the Securities Exchange Act. This new section required the SEC to issue rules requiring resource extraction issuers to include, in an annual report, information relating to any payment made by the issuer (including its subsidiaries and controlled entities) to the US Government or a foreign government for the purpose of the commercial development of oil, natural gas, or minerals (extractive payments disclosure requirement). It was Congress' intention that these new rules would support the commitment of the US Government to promoting international transparency efforts within the extractive sector.

More than a year later, on 22 August 2012, the SEC finally adopted new rules as mandated by ss 1502 and 1504 of the Dodd-Frank Act.

We examine below some of the key aspects of each of these disclosure requirements.

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Conflict minerals disclosure requirement

This requirement applies to domestic and foreign companies that use tantalum, tin, gold or tungsten if:

  • a company files reports with the SEC under the Securities Exchange Act; and
  • the minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by a company.

A company is considered to be contracting to manufacture a product if it has some actual influence over the manufacturing of that product. This determination is based on facts and circumstances, taking into account the degree of influence a company exercises over the product's manufacture.

There are a number of layers of inquiry set out in the SEC rule governing this requirement.

Any company that uses the designated minerals is required to conduct a 'country of origin' inquiry. The inquiry must be designed to determine whether any of its minerals originated in the covered countries or are from scrap or recycled sources.

If the inquiry determines either that the minerals did not originate in the covered countries or are from scrap or recycled sources, or that there is no reason to believe the minerals may have originated in the covered countries, or may be from scrap or recycled sources, the company must report on the inquiry it undertook and the results of the inquiry in a form known as Form SD.

However, if the 'country of origin' inquiry determines that the company knows or has reason to believe either that the minerals may have originated in the covered country or that they may not be from scrap or recycled sources, the company must undertake due diligence on the source and chain of custody of its minerals. The company is also required to file a Conflict Minerals Report as an exhibit to the Form SD.

The due diligence measures must conform to a nationally or internationally recognised due diligence framework, such as the due diligence guidance approved by the OECD.

The content and audit requirements for the Conflict Minerals Report will depend on whether a company determines its products to be 'DRC Conflict Free', 'Not DRC Conflict Free', or 'DRC Conflict Undeterminable'.

There are additional special rules governing the due diligence and Conflict Minerals Report requirements for minerals from recycled or scrap sources.

The first reports under this rule will be due at the end of May 2014, covering the calendar year beginning 1 January 2013.

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Extractive payments disclosure requirements

These requirements will apply to a resource extraction issuer if the issuer:

  • is required to file an annual report with the SEC; and
  • engages in the commercial development of oil, natural gas or other minerals.

The disclosure requirements apply to both domestic and foreign resource extraction issuers, as well as small reporting companies that fall within the definition of 'resource extraction issuer'. The disclosure requirements also apply to payments made by a subsidiary or another entity controlled by the resource extraction issuer.

For disclosure to be required, the payment must have been made to the US Government or any other government and:

  • be made to further the commercial development of oil, natural gas or minerals, which includes exploration, extraction, processing, export and acquisition of a licence;
  • be equal to or exceed US$100,000 during the most recent financial year; and
  • fall within particular categories specified in the disclosure rules, such as taxes, royalties, fees, production entitlements, bonuses, dividends, and infrastructure improvements.

It should be noted that the SEC rejected adopting any exemptions from disclosure based on contractual confidentiality obligations or prohibitions on disclosure contained in foreign law.

Apart from disclosing the type and amount of payments for each project, a resource extraction issuer is required to disclose other information, including the type and total amount of payments made to each government, the total amount of the payments by category, the currency used to make the payments, and the project to which the payments relate.

To a large degree, what is required by this rule is consistent with what is required under the Extractive Industry Transparency Initiative (EITI). The EITI is a voluntary disclosure framework that sets a global standard for transparency around revenues from natural resources. The extractive payments disclosure requirement is designed to complement the EITI and only goes beyond it in a few areas where the SEC was of the view that the Dodd-Frank Act went beyond what is required by the EITI. For example, the definition of 'commercial development of oil, natural gas or minerals' is broader under the SEC rules, and includes processing and export.

Rather than making these disclosures in their annual report, companies subject to the extractive payment disclosure requirement are required to disclose payments annually with the SEC on the new Form SD. Companies that are caught by the rule will be required to report for financial years ending after 30 September 2013.

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Conclusion

Between the adoption of the Dodd-Frank Act and these new rules by the SEC, there was extensive debate between the business community and civil society groups over the nature and scope of the new requirements imposed by the rules.

Now that the rules have been adopted, the debate may continue but the reporting requirements are in place and companies will need to ensure that they understand what is required of them and are in a position to comply.

Compliance with the conflict minerals disclosure requirement is likely to be costly and difficult and may, for example, require the implementation of corporate risk management procedures to help identify and track conflict minerals. If companies find themselves in the position of having to prepare a Conflict Minerals Report, they may consider it prudent to seek alternative sources for the relevant minerals.

The extractive payment disclosure requirement is rigorous and will require companies to consider whether they have the processes and systems in place to access the kind of detailed information that is required.

The potential consequences for companies arising from these disclosure requirements are varied. The Form SD will be filed with the SEC, rather than furnished. This means that potential liability for making a false or misleading statement with respect to any material fact is enlivened under section 18 of the Securities Exchange Act. The costs of compliance will be significant, and foreign competitors who are not required to comply with the rules may acquire a competitive advantage by having access to the information that is disclosed. In addition to this, companies may experience considerable reputational damage depending on the content of their disclosures.

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