More Dodd-Frank Rules Proposed at SEC Open Meeting

By Cydney Posner

At an incredibly dull open meeting of the SEC this morning, the SEC voted to propose three sets of rules regarding disclosure and reporting obligations to implement provisions of the DFA:

• the use of conflict minerals (Section 1502);
• mine safety matters (Section 1503); and
• payments to governments made by resource extraction issuers (Section 1504).

None of commissioners had any questions about any of the proposals, nor, surprisingly, was there any soapbox speechifying about the appropriateness of the disclosure mandated by the DFA. Because of conflicts related to personal stockholdings (query why recusals are not more common?), the Chair recused herself from the vote on the Section 1504 rules and Commissioner Paredes recused himself from the vote on the Section 1503 rules. Chair Schapiro noted (admirably without sarcasm) that, because the staff does not have much expertise about these matters, the proposed rules were drafted "carefully to follow the direction of Congress." The staff also noted that it benefited greatly from advance public comments on these topics, especially since the rules were well outside the staff's normal purview. No releases have yet been posted, but if the staff is true to its most recent tradition, they should be posted quickly. It remains to be seen whether the releases contain more guidance than seemed to be indicated from the unusually cursory discussions at the meeting.

CONFLICT MINERALS (SECTION 1502)

The DFA requires annual disclosure by reporting companies of whether "conflict minerals" that are "necessary to the functionality or production of a product" manufactured by the company in the reporting year originated in the Democratic Republic of the Congo (the "DRC") or an adjoining country. The concern is that violent DRC groups are financing themselves with minerals such as gold and the "three T's" -- tin, tungsten and tantalum. Because some of these minerals are commonly used in laptops, cell phones, PDAs, DVD players, televisions, medical devices and other goods, these rules are expected to affect a broad swath of companies. (See my postings of 12/2/10 and 7/28/10.)

The proposed rules set up a three-step process:

1. Companies must determine if they manufacture using conflict materials. If not, no further action or disclosure is required. If they do, companies must undertake step 2.

2. These companies must conduct a reasonable inquiry to determine whether the conflict minerals used originated in the DRC or an adjoining country. If not, they must disclose that fact in their 10-Ks and post it on their websites, describing the inquiry conducted. These products may then be described as "DRC-conflict –free." If they did originate in the DRC or an adjoining country or if the company is unable to conclude that they did not originate there, companies must undertake step 3.

3. These companies must submit a Conflict Minerals Report to the SEC, filing it as an exhibit to their 10-Ks and posting it on their websites. The Report would include a description of the measures taken by the company to conduct due diligence on the source and chain of custody of the minerals, including a certified independent private sector audit of the Report, a description of the products manufactured or contracted to be manufactured that contain minerals that directly or indirectly finance or benefit armed groups in the DRC or an adjoining country (i.e., not DRC-conflict free), the entity that conducted the independent private sector audit, 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.

The proposal includes an interesting alternative that may be helpful for a number of companies. If the product uses minerals from recycled or scrapped material, then the product can be viewed as "DRC-conflict-free" because it would not be possible to trace the minerals. However, the company would be required to conduct due diligence to determine that it was from recycled or scrapped material and an auditor's report regarding the due diligence conducted would be required.

In her opening statement, Chair Schapiro announced that the release accompanying these proposed rules explores critical questions such as the meaning of "manufacture" and "contract to manufacture" a product, when a mineral is "necessary" to a product and the type of inquiry that would be required for the company to reach a country-of-origin conclusion. Those were not, however, discussed at the meeting, other than to indicate that the due diligence must be "reasonable." Hopefully, the release will provide some guidance as to steps that would be considered "reasonable." (In a memorable June column in The New York Times regarding conflict minerals and the tech industry  , it was reported that a group of companies led by Intel and Motorola is now developing a process to audit origins of tantalum in supply chains. Apparently, at present, some companies obtain certifications regarding conflict minerals from suppliers, but, because of the absence of any verification process, some have questioned the adequacy of these certifications.)

COAL OR OTHER MINE SAFETY (SECTION 1503)

Although this provision of the DFA is currently in effect and the SEC is not required to issue interpretive rules, the SEC is nevertheless proposing implementing rules. Under the DFA, public reporting companies that operate, or have subsidiaries that operate, coal or other mines are required to include in each periodic report filed with the SEC information regarding health and safety and other violations at each mine, including the total number of "flagrant violations" and " imminent danger orders," the total dollar value of proposed assessments for violations and the total number of mining-related fatalities. Operators also must file an 8-K regarding the receipt of an imminent danger order and other specified health and safety notices from the Mine Safety and Health Administration. (This requirement has led to some amusing 8-Ks, such as this one identified by Corporate Counsel, describing an imminent danger order resulting from the sighting of two coyotes in the vicinity of various shops and mine employees, the removal of employees from the vicinity of the coyotes, conduct of a related mandatory safety meeting and the company's attempt at a diplomatic conclusion: "While the Company prioritizes stewardship of the land and protection of wildlife, we will continue to work with an outside contractor to remove the coyotes and mitigate any potential safety hazard that such wildlife represents to our employees.")

The proposed rules rely on a number of definitions contained in the Federal Mine Safety and Health Act of 1977, such as the definition for a mine operator. The proposed rules would apply only to mines subject to the Mine Act and, therefore, only to mines in the U.S. The proposed rules would require disclosure regarding imminent danger orders and violations, the categories of violation involved, the amount of assessments during the period of time covered by the report plus any that remain outstanding, as well as a brief description of each of the categories to put the disclosure in context. The report would also need to disclose initiation of or material developments in legal action during the period, including the date, parties and mine locations. In addition, in any 8-K required under this rules, disclosure would be required regarding the type of order or notice, the date and location of the mine.

PAYMENTS BY RESOURCE EXTRACTION ISSUERS (SECTION 1504)

Under the DFA, each public "resource extraction issuer" is required to include in its 10-K information relating to any payment made by company, its subsidiary or any other company under its control to a foreign government (including companies owned by that government) or the Federal Government for the purpose of the commercial development of oil, natural gas or minerals, including the type and total amount of the payments made for each project and made to each government. Under the proposed rules, whether an entity is a subsidiary or other controlled entity would be determined based on the facts and circumstances and whether the entity's financial statements are consolidated with the company's. Ownership of companies by government would require majority ownership. Consistent with the DFA, "commercial development of oil, natural gas, or minerals" would include exploration, extraction, processing, export and other significant actions relating to oil, natural gas or minerals, or the acquisition of a license for any of those activities, although the SEC is requesting comment on whether further clarification is required. "Payment" would include any (non de minimis) payment made to further the commercial development of oil, natural gas or minerals, including taxes on profits, royalties, fees (e.g., license fees), production entitlements and bonuses, but not taxes on consumption, such as VAT. The proposal would require disclosure of the type and total amount paid for each product during the period covered, the government paid, the type of payment and the project to which the payment relates. The information, required under new Item 105 of Reg S-K, would be included in two new exhibits to Form 10-K, one of which would be in XBRL. In addition, companies would be required to include a statement in the text of the 10-K that the resource extraction information is included in these exhibits.

For those who are interested in swaps, the SEC also voted to propose a number or rules to implement Section 763(a) of the DFA, including Rule 3Cg-1 under the Exchange Act governing the exception to mandatory clearing of security-based swaps that is available to counterparties meeting certain conditions; the exemption for banks, savings associations, farm credit system institutions and credit unions; rule and form amendments to establish a process for the submission for review of security-based swaps for mandatory clearing; as well as other rules related to clearing agencies that are designated financial market utilities.