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Proposed Conflict Minerals Disclosure Rules Will Create Reporting Challenges

(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)

March 20, 2011

Next month, the SEC is expected to adopt final rules under provisions of the Dodd-Frank Act requiring new disclosures of mineral-related activities, including the so-called “conflict minerals” disclosure requirement under Section 1502. The rules will affect companies in a broad range of industries if their products might utilize conflict minerals – gold and rare compounds mined in the Congo. These materials are used in electronic components, engine components, aerospace equipment, jewelry and other industries. Companies will be required to trace the source of raw materials in their products, or the components thereof, to determine whether conflict minerals are required and make the required disclosures, which must be audited.

The SEC issued proposed conflict minerals disclosure rules in December 2010, and under Dodd-Frank, final rules must be adopted by April 15, 2011. The SEC has received more than 150 comment letters, summarized in a recent article by Arielle Bikard, titled “No Shortage of Opinions on the SEC's 'Conflict Minerals' Proposal,” on the Compliance Week website (subscription required):

Congress originally included the legislation in the Dodd-Frank Act to discourage companies from using conflict minerals, which warlords in the Congo use to finance their operations. . . .

Commenters generally said that compliance with such a broad rule, with so many undefined terms, will be a challenge. ‘We believe that without additional clarity in the areas of objective, criteria, and evidence, there will be significant inconsistency and lack of comparability of information in issuers' Conflict Minerals Reports,’ Deloitte & Touche wrote in a letter to the SEC. In particular, Deloitte warned, if a company can't determine the origin of the minerals, an independent private-sector outside auditor might not be able to gather enough evidence to form an opinion.

Companies were hoping that the SEC would narrow the language of the rule in the proposal, but open questions still abound, says Brian Breheny, partner at the law firm Skadden, Arps, Slate, Meagher & Flom. For example, the current language doesn't clarify whether a retailer of electronic goods has any obligation to study conflict minerals in the items it sells. Companies must also determine whether the mineral is 'necessary' to the production or to the functionality of the product. What exactly does 'necessary' mean? The proposal doesn't specify. . . .

The SEC is required to pass its final conflict-mineral disclosure rule by April 15. . . . Plenty of letter writers took issue with the rule's taking immediate effect. . . .

Regarding the last point, although the statute provides that public companies must comply with the disclosure requirements for the first fiscal year beginning after the effective date of the rules, some of the commenters are requesting that the SEC exempt companies from the requirement for the first full year after effectiveness. Assuming this does not happen, manufacturing companies in a broad range of industries should be planning to quickly conduct the due diligence necessary to meet the reporting requirements.

Proposed Disclosure Rules for Resource Extraction Issuers Will Also Be Interesting

In the Compliance Week article, Bikard also touched on the SEC’s proposed rules (PDF) on disclosure by public companies engaged in resource extraction, requiring disclosure of the payments these companies make to foreign governments. This disclosure is required by Section 13(q) of the Securities Exchange Act of 1934, added under the Dodd-Frank Act. As with conflict minerals, the SEC has received many comment letters on its proposed rules on the payments by resource extraction issuers. Bikard asked for my commentary:

Industry voices such as Exxon and the U.S. Chamber of Commerce are pushing the SEC to limit the scope of the rules in a variety of ways, says Martin Rosenbaum, partner at the law firm Maslon Edelman Borman & Brand. For example, they suggest that the ‘annual report’ required by Dodd-Frank be confidential on an individual company basis, and that only the SEC's compilation be made public, he says. They also want broad exclusions from any requirements that would be inconsistent with non-U.S. laws, and blanket exclusions for smaller companies.

On the other side are institutional investors that push for socially responsible investing, which strongly oppose limits on the reporting requirements, Rosenbaum says. They have an interest in obtaining this information for policy reasons, he continues, and they also argue that transparency on an individual company basis will benefit investors.

Expect some interesting developments in the disclosure rules under the Dodd-Frank Act in the next few months.


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