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SEC Issues Proposed Rules Implementing Dodd-Frank Act – Reporting Obligations Regarding Conflict Minerals, Mine Safety and Payments by Resource Extraction Issuers

Author(s): Michael Budabin McQuown, Kate Coolican, Kevin D. Cramer, Matthew Sadofsky

Dec 23, 2010

On December 15, 2010, the U.S. Securities and Exchange Commission (SEC) proposed rules to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Act) dealing with new reporting obligations regarding use of conflict minerals originating in the Democratic Republic of the Congo and adjoining countries, mine safety, and payments to government entities in connection with the commercial development of oil, natural gas or minerals.1  This Update discusses key aspects of the proposed rules and highlights important questions regarding the proposed rules raised by the SEC for comment.  The deadline for persons wishing to submit comments to the SEC on the proposed rules is January 31, 2011.  Readers are encouraged to review our previous Update, New Reporting Obligations Imposed on Mining Companies Under the Dodd-Frank Act", for background on the statutory provisions of the Act.

Conflict Minerals

The proposed rules implementing Section 1502 of the Act require any issuer for which conflict minerals are “necessary to the functionality or production of a product manufactured, or contracted to be manufactured” by that issuer to disclose in its annual report whether its conflict minerals originated in the Democratic Republic of the Congo or an adjoining country (DRC countries).  If so, the issuer will be required to furnish a separate report as an exhibit to its annual report that includes a description of measures taken by the issuer to exercise due diligence on the source and chain of custody of its conflict minerals.

  • Conflict minerals consist of: 
    • columbite-tantalite (commonly used in electronic components);
    • wolframite (used to produce tungsten which is commonly used in metal wires);
    • cassiterite (tin); and
    • gold.
  •  The disclosure requirements apply even if only small amounts of such minerals are utilized. 

The proposed reporting requirements would apply to all issuers who file reports with the SEC, including foreign private issuers and smaller reporting companies.  It is important for mining companies to note that issuers would be considered to be “manufacturing” conflict minerals when they extract those minerals from mining facilities. 

  • An issuer would be considered to be “contracting to manufacture” a product if:
    • it has any influence over the product’s manufacturing; or  
    • it offers a generic product under its own brand name or a separate brand name, regardless of whether the issuer has any influence over the manufacturing specifications of the product, provided the issuer has contracted to have the product manufactured specifically for itself.   As proposed, a variety of retailers, not just manufacturers of jewelry or consumer electronic devices, would be subject to the rules. 

Issuer’s Inquiry

If an issuer determines through a “reasonable country of origin inquiry” process that the conflict minerals it uses did not originate in the DRC countries, it will be required to disclose this determination in its annual report and, until the issuer files its subsequent annual report, on its Internet website.  The proposed rules do not specify what constitutes a reasonable country of origin inquiry, but the proposing release states that obtaining reasonably reliable representations from the processing facility that the conflict minerals did not originate in DRC countries would satisfy the reasonable inquiry test.  The proposing release further states that this inquiry requirement is not meant to suggest that issuers would have to determine with absolute certainty whether their conflict minerals originate in the DRC countries.  Finally, the SEC notes that conducting the reasonable country of origin inquiry could be less exhaustive than the due diligence used in determining the source of custody of those conflict minerals that originate in the DRC countries (see discussion below).  An issuer would be required to: 

    • include brief conflict minerals disclosure in its annual report under a separate heading entitled, “Conflict Minerals Disclosure”;  
    • maintain reviewable records demonstrating that its conflict minerals did not originate in the DRC countries; and 
    • disclose the due diligence used in making its determinations, such as whether it used any nationally or internationally recognized standards or guidance for supply chain due diligence such as those being developed by the Organisation for Economic Cooperation and Development or the United Nations Group of Experts for the Democratic Republic of the Congo.

If an issuer either determines that its conflict minerals originated in the DRC countries, or cannot conclude that they did not originate in the DRC countries it would be required to:

    • disclose this information in its annual report (under the heading referenced above); 
    • furnish a report to the SEC (Conflict Minerals Report) as an exhibit to the annual report and post the Conflict Minerals Report on the issuer’s website until the subsequent report is filed with the SEC; and 
    • disclose the website address at which this exhibit is available.

Conflict Minerals Report

The Conflict Minerals Report would be required to include: 

    • a description of the measures taken by the issuer to exercise due diligence on the source and chain of custody of its conflict minerals, including a certified independent private sector audit conducted in accordance with standards established by the Comptroller General of the United States; 
    • a description of products that are not “DRC conflict free” (which the proposed rules define to mean a product which does not contain conflict minerals that directly or indirectly finance or benefit armed groups in the DRC countries), the country of origin of those conflict minerals, and the facilities used to process those minerals; 
    • a description of efforts and procedures taken to determine the mine or location of origin of the minerals with the greatest possible specificity;  
    • a certification by the issuer that it obtained an independent private sector audit of its Conflict Minerals Report; and 
    • the audit report and the identity of the auditor. 

The Conflict Minerals Report would not be deemed to be incorporated by reference into any filings under the U.S. Securities Act of 1933, as amended (Securities Act) or the U.S. Securities Exchange Act of 1934, as amended (Exchange Act), except to the extent that the issuer specifically incorporates it by reference.

Recycled and Scrap Minerals

The proposed rules allow for different treatment of conflict minerals from recycled and scrap sources than from mined sources due to the difficulty of looking through the recycling or scrap progress to determine the origin of the minerals. 

    • Issuers whose conflict minerals originated from recycled or scrap sources would be required to disclose in their annual report, under the “Conflict Minerals Disclosure” heading, that their conflict minerals were obtained from recycled or scrap sources and that they furnished a Conflict Minerals Report; 
    • Issuers would state in the Conflict Minerals Report that under SEC rules their recycled or scrap minerals are considered DRC conflict free; and 
    • Issuers would also need to describe the measures taken to exercise due diligence in determining that their conflict minerals were recycled or scrap. 

Timing

An issuer using conflict minerals that are necessary to the functionality or production of a product manufactured or contracted to be manufactured would be required to provide its first disclosures after its full fiscal year following the promulgation of the final rules.  Assuming the SEC adopts final rules in April 2011 (the deadline provided in the Act), a December 31 fiscal year-end issuer would first have to provide conflict minerals disclosure or a Conflict Minerals Report, as applicable, after the end of its December 31, 2012 fiscal year. 

Important Questions Raised For Comment By SEC 

            1.         Does the extraction of conflict minerals from a mine constitute “manufacturing” or “contracting to manufacture” a “product” such that mining issuers should be subject to the proposed rules? 

            2.         Alternatively, should a mining issuer not be viewed as manufacturing a product unless it engages in additional processes to refine and concentrate the extracted minerals into salable commodities or otherwise changes the basic composition of the extracted minerals? 

            3.         Should the SEC require issuers to provide the conflict minerals disclosure and reporting requirements mandated by the Act in Exchange Act annual reports filed, as applicable, on Form 10-K, Form 20-F and Form 40-F or should the SEC require or permit issuers to disclose the information in a separate annual report? 

            4.         Whether the disclosure requirements as proposed should apply to foreign private issuers and smaller reporting companies, or whether the rules should be adjusted in some fashion? 

            5.         Should the term “manufacture” be defined in a way that broadens or limits the scope of issuers for which the disclosure requirements would apply? 

            6.         Should a minimum level of influence, involvement or control over the manufacturing process be required before an issuer must comply with the proposed rules? 

            7.         Should the SEC provide additional guidance on how an issuer may satisfy a “reasonable country of origin” inquiry? 

            8.         Should the SEC provide additional guidance or a defined term for the phrase “necessary to the functionality or production” with respect to the use of conflict minerals? 

            9.         Should the independent audit certification be signed; who should be required to sign the audit certification and what liability should be assigned to the individual/firm that signs the certification? 

Mine Safety

The proposed rules implementing Section 1503 of the Act require issuers that are operators of a coal or other mine to disclose in their periodic reports with the SEC information regarding specified health and safety violations, orders and citations, related assessments, legal actions and mining-related fatalities.  They also require disclosure on Form 8-K following the receipt of certain orders and notices from the U.S. Mine Safety and Health Administration (MSHA)

    • The definition of “coal or other mine” in the Act is as defined in the Federal Mine Safety and Health Act of 1977 (Mine Act) and the Mine Act applies only to mines inside the United States.  Therefore, the new disclosure requirements would only apply to those mines inside the United States and an issuer operating mines both in the United States and Canada will only need to disclose information regarding its U.S. mines. 
    • Foreign private issuers and smaller reporting companies will have to comply with the periodic disclosure requirements, but under the proposed rules, foreign private issuers will not be required to comply with the requirement that receipt of certain orders and notices be disclosed on Form 8-K. 
    • Disclosure must be made for each distinct mine and grouping mines by project or geographic region will not be permitted.  In accordance with the plain language of Act, the SEC has rejected the use of any materiality thresholds. 

New Periodic Disclosure Requirements

Section 1503(a) of the Act lists new items to be disclosed in periodic reports, as we discussed in our previous Update, including, amongst others, violations that could significantly and substantially contribute to the cause and effect of a coal or other safety mine or health hazard under Section 104 of the Mine Act and the total number of mining-related fatalities. Besides those items listed in the Act, the proposed rules require a brief description of each category of violations, orders and citations included in other items required by Section 1503(a) so that investors can understand the basis for the violations, orders or citations referenced.

    • New periodic disclosure will be required for domestic issuers on Form 10-Q and Form 10-K, and for foreign private issuers on Form 20-F and Form 40-F. 
    • Each periodic report would cover disclosure for the time period covered by such report, so that a Form 10-Q, for example, would need to include disclosure for the quarter covered, and a Form 10-K would need to include disclosure for both the quarter and fiscal year covered. 
    • The proposed rules do not propose to allow issuers to exclude information about orders, violations or citations that were received during the time period covered by the report but subsequently were dismissed or reduced.  However, additional contextual information would not be prohibited. 
    • No particular presentation requirements for the new disclosure are being proposed by the SEC, but issuers are encouraged to use tabular presentations whenever possible if to do so would facilitate investor understanding. 

Form 8-K Filing Requirements

Section 1503(b) of the Act requires the disclosure on Form 8-K of orders and notices received by the operator of a U.S. mine from the MSHA.  While foreign private issuers would be required to comply with the new periodic disclosure requirements in connection with mine safety, foreign private issuers are not required to file current reports on Form 8-K.  Thus, under the proposed rules they would not be required to comply with the new Form 8-K disclosure requirements. 

    • The disclosure filed on Form 8-K would need to be filed again in the Form 10-Q for the quarter in which the Form 8-K was filed, and in the Form 10-K for the fiscal year in which the Form 8-K was filed.
    • Information required to be disclosed on Form 8-K would include:
      • the date of receipt of the order or notice;
      • the category of order or notice; and
      • the name and location of the mine involved.
    • The Form 8-K would need to be filed no later than four business days after the triggering event.

Timing

The disclosure requirements set forth in the Act are currently in effect.  Thus, Form 8-K must be filed for triggering events under Section 1503(b) as discussed above and appropriate disclosure on Form 10-Q, Form 10-K, Form 20-F and Form 40-F, as applicable, must be included for all periodic filings made after July 21, 2010.

Important Questions Raised for Comment By SEC

 

  1. Is it appropriate that the new disclosure requirements are only applicable to mines in the United States?  Will issuers that operate mines within the United States be at a competitive advantage or disadvantage compared to issuers that operate mines in other regions because of a lack of disclosure about non-U.S. mines?
  2. Should the periodic disclosure under Section 1503(a) apply to foreign private issuers as proposed?
  3. Should foreign private issuers be exempt from the Form 8-K disclosure requirements under Section 1503(b) as proposed?
  4. For issuers using domestic forms, should periodic disclosure be required in both Form 10-Q and Form 10-K, or only annually on Form 10-K?
  5. Is a separate disclosure requirement for each individual mine appropriate?  Could this approach produce such a volume of information that investors will be overwhelmed?
  6. Should disclosure be required for each project or geographic region?
  7. Should the new disclosure requirements apply to registration statements under the Securities Act as well as periodic reports?
  8. Should all mining fatalities at mines operated by companies that file periodic reports with the SEC be required to be reported rather than just fatalities at U.S. mines?
  9. Should the rules be revised in order to minimize duplicative disclosure such as by not requiring repetition of information previously reported?

 

Payments by Resource Extraction Issuers

The proposed rules implementing Section 1504 of the Act require each “resource extraction issuer” to include in its annual report information relating to any payment made by the issuer, a subsidiary of the issuer, or an entity under the control of the issuer to a foreign government or the U.S. federal government for the purpose of the commercial development of oil, natural gas or minerals.  Information would need to be provided regarding:

    • 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; and
    • the type and total amount of such payments made to each government.

The proposed rules would apply to domestic issuers, foreign issuers and smaller reporting companies that meet the definition of “resource extraction issuer”, regardless of size or the extent of business operations constituting commercial development of oil, natural gas or minerals.

Key Definitions

“resource extraction issuer”: the SEC adopted the statutory definition of “resource extraction issuer”, meaning an issuer that:

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

“commercial development”: the SEC also adopted the statutory definition of “commercial development of oil, natural gas, or minerals”. The proposing release notes that the proposed definition is intended to capture only activities that are directly related to the commercial development, and not activities that are ancillary or preparatory to such development. Therefore, the SEC would not consider a manufacturer of a product used in the commercial development of oil, natural gas or minerals to be engaged in the commercial development of the resource such as a manufacturer of drill bits or heavy equipment.

New Disclosure Requirements

The proposed rules would require a resource extraction issuer to submit the prescribed payment information using electronic tags that identify, for any payments made by a resource extraction issuer to a foreign government or the U.S. federal government:

    • the total amount 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.

The proposing release clarifies that disclosure will be required in connection with payments made to subnational foreign governments and that payments made to a “foreign government” include payments made to an entity that is majority-owned by a foreign government.  It also clarifies that the reference to the “federal government” refers to the U.S. federal government.

A resource extraction issuer would be required to provide the information annually in its Exchange Act annual report on Form 10-K, Form 40-F or Form 20-F, as applicable. Under the proposed rules the information would be included in two exhibits:

    • one exhibit that would be filed in text format, which would enable investors to easily read the disclosure about payment information without additional computer programs or software; and
    • a second exhibit filed in eXtensible Business Reporting Language (XBRL) format that would be readable through a viewer.

Definition of “Payment”

The proposed rules adopt the definition of “payment” from Section 13(q) of the Exchange Act. “Payment” means a payment that:

      • is made to further the commercial development of oil, natural gas, or minerals;
      • is not de minimus; 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.

The SEC emphasizes that these types of payments are consistent with the types of payments that the Extractive Industries Transparency Initiative (EITI), which was referenced in the statutory definition of payment, suggests should be disclosed.  Information regarding the EITI can be found at http://eiti.org.

Not de minimus”: the proposing release does not define this term.

Currency: under the proposed rules, disclosure would be required in the currency used to make the payments.

Payments by “a subsidiary…or an entity under the control of the resource extraction issuer”: under the proposed rules, resource extraction issuers are required to disclose payments by a subsidiary or other entity controlled by the issuer. The proposing release notes that the determination of whether an entity is under the control of an issuer will be based on consideration of the particular facts and circumstances. At a minimum under the proposed rules, payments made by a subsidiary or entity under the control of a resource issuer would be subject to disclosure if the issuer must provide consolidated financial information for the subsidiary or other entity in the issuer’s financial statements included in its Exchange Act reports.

Treatment of the Disclosure

In the proposing release, the SEC proposes that the required disclosure would be required to be “furnished” rather than “filed” and not be subject to liability under Section 18 of the Exchange Act. 

Timing

The Act provides that the final rules “shall take effect on the date on which the resource extraction issuer is required to submit an annual report relating to the fiscal year…that ends not earlier than 1 year after the date on which the [SEC] issues final rules”.  As the SEC must enact such final rules at the latest by April 15, 2011, the statute requires disclosure in an issuer’s annual report relating to the fiscal year ending on or after April 15, 2012.

Important Questions Raised for Comment by SEC

            1.         Should the SEC exempt certain categories of issuers, such as foreign private issuers or smaller reporting companies, from the proposed rules?

            2.         Should the SEC provide an exemption to allow foreign private issuers to follow their home country rules and disclose in their Form 20-F annual report the required home country disclosure?

            3.         Should the definition of “commercial development of oil, natural gas or minerals” include the activities of exploration, extraction, processing and export, as proposed?  Should the SEC exclude any of these activities?

            4.         As proposed, the definition of “payment” does not include payments resource extraction issuers make for infrastructure improvements, even if they are a direct cost of engaging in the commercial development of oil, natural gas or minerals.  Should the definition be expanded to cover such payments?

            5.         The proposed rules do not expressly include social or community payments made to improve a host country’s schools, hospitals or other social welfare activities within the definition of payments.  Are such payments part of the commonly recognized revenue stream for the commercial development of oil, gas or minerals?

            6.         Should the SEC adopt a definition of “not de minimis” that uses an absolute dollar amount as a threshold?  Should a payment be considered “not de minimis” if it meets or exceeds a percentage of expenses incurred per project for the year that is the subject of the annual report?

            7.         Should the SEC adopt a definition for the term “project”?  Should it adopt a definition of project that is substantially similar to the definition of “development project” under Rule 4-10(a)(B) of Regulation S-X?

            8.         Is the requirement to disclose payments by an entity under the control of the issuer even though the issuer does not consolidate the entity appropriate?

            9.         Should the SEC include an exemption to the requirement to disclose the payment information if the laws of the host country prohibit the resource extracting issuer from disclosing such information?

            10.       Should the SEC require, or permit, resource extraction issuers to provide the payment information in an annual report other than an annual report on Form 10-K, Form 20-F or Form 40-F?

Osler will continue to monitor developments involving the SEC’s proposed rules related to Sections 1502, 1503 and 1504 of the Act and update our clients as events warrant.  We would be pleased to discuss any aspects of the proposed rules and any comments you are considering making to the SEC in response to the proposed rules.

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1    Conflict Minerals, Exchange Act Rel. No. 34-63547 http://www.sec.gov/rules/proposed/2010/34-63547.pdf  (Dec.15 2010); Mine Safety Disclosure, Securities Act Rel. No. 33-9164 http://www.sec.gov/rules/proposed/2010/33-9164.pdf (Dec. 15, 2010); and Disclosure of Payments by Resource Extraction Issuers, Exchange Act Rel. No. 34-63549 http://www.sec.gov/rules/proposed/2010/34-63549.pdf (Dec. 15, 2010).

This publication is provided for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind. Recipients of this publication are advised to seek specific legal advice by contacting members of Osler regarding any specific legal issues. The information in this publication is current as of its original date of publication, but should not be relied upon as accurate, timely or fit for any particular purpose. Receipt of or use of this publication does not create a lawyer-client relationship.

 

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