By Maria Lokshin
Bloomberg BNA
The Securities and Exchange Commission Aug. 22 voted 3-2 to adopt a controversial rule under the Dodd-Frank Wall Street Reform and Consumer Protection Act that will require public companies to disclose their use of conflict minerals.
At the same time, the commission voted 2-1 to adopt a rule that will require resource extraction issuers to disclose payments they make to governments to further the commercial development of oil, natural gas, or minerals. SEC Chairman Mary Schapiro and Commissioner Troy Paredes recused themselves from that vote.
Conflict Minerals.
Section 1502 of Dodd Frank requires companies that use tantalum, tin, gold, or tungsten from the Democratic Republic of Congo and surrounding areas to disclose to the SEC the origins of those metals. The SEC issued a proposal in December 2010 (240 SLD, 12/16/10). but delayed taking action on a final rule, largely due to strong pushback from the industry. Many commenters cited compliance costs as the major problem.
“We incorporated many changes from the proposal that are designed to address concerns about the costs,” Schapiro said at the commission's open meeting Aug. 22. “I believe the rule we are considering today faithfully implements the statutory requirement as mandated by Congress in a fair and balanced manner.”
Under both the rule and proposal, issuers that use the covered metals are required to provide disclosures if the minerals are “necessary to the functionality or production” of a product that the company manufactures or contracts out to be manufactured. Issuers essentially would make tiered disclosures depending on what they learn about the sources of the minerals.
Departing from the proposal, companies that determine that the covered minerals come from scrap or recycled materials are exempted from providing further information to the SEC. Instead, the company must disclose its determination and a description of its inquiry.
However, if the company “knows or has reason to believe” that the metals “may have” come from the conflict areas, or that the minerals “may not be” from scrap or recycled materials, then the issuer must “undertake 'due diligence' on the source and chain of custody of its conflict minerals.” The company then would need to prepare a conflict minerals report and provide it to the SEC.
Also deviating from the proposal, the rule allows companies that cannot determine the origins of the minerals to designate those metals “DRC conflict undeterminable” for two years. For smaller companies, that period extends to four years.
The rule also creates a new form--Form SD--through which covered issuers are required to make their disclosures. The form is also required to be used for resource extraction issuers covered by that rule. The first disclosure is due to the SEC May 31, 2014.
First Impressions.
Commenting on the final rule, Mayer Brown LLC partner Mike Hermsen, who was formerly with the SEC's Corporation Finance Division, said the changes from the proposal may not be that significant. “My initial impression is that there were a few changes, but I just really don't think it will have a big impact for most companies,” he told BNA in a phone interview.
By contrast, Tom Quaadman, vice president of the U.S. Chamber of Commerce's Center for Capital Markets, said the SEC made “constructive and positive changes.” The Chamber has been lobbying for changes to the proposal.
For instance, he told BNA, the proposal required companies essentially to prove that they do not use conflict minerals--to “prove a negative.” The final rule now requires issuers to show that they do use the covered metals, he explained. “That could be a very significant change.”
Moreover, he noted that the Chamber “pushed” for the exclusion of recycled and scrap materials from the disclosure requirements. However, Quaadman said the group will need to review the adopting release when it is available before it gets into the “fine details.”
'Substantial' Costs.
In recommending the rule, Kathleen Hanley, deputy director and deputy chief economist for the Division of Risk, Strategy, and Financial Innovation, told the commissioners that compliance costs will be “substantial.” She estimated that the initial costs will be between $3 billion and $4 billion and continuing annual costs will range from $206 million to $609 million.
Hanley added that the rule's benefits and objective--to choke off funding to armed groups in the DRC and surrounding areas--was “difficult to quantify,” so the division undertook a qualitative evaluation.
The estimates represent a significant departure from the agency's previous projections. Initially, the SEC said compliance costs would be about $71 million--a figure that was challenged in a Tulane University study (209 SLD, 10/28/11).
However, the dissenting commissioners, Paredes and Daniel Gallagher, faulted the SEC for failing to analyze how the enhanced disclosures would advance that intent.
“The SEC's conflict minerals rulemaking suffers from an analytical gap that I cannot overlook-- namely, there is a failure to assess whether and, if so, the extent to which the final rule will in fact advance its humanitarian goal as opposed to unintentionally making matters worse,” Paredes said. “It is not enough to cite Congress's humanitarian goal or to assume that good results will follow without analyzing whether the final rule will in fact promote peace and security in the DRC.”
Gallagher echoed the view, saying that it is “incumbent on the commission” to analyze the benefits of any congressionally mandated rule.
Resource Extraction.
Meanwhile, the final rule for resource extraction disclosures--required by Section 1504 of Dodd-Frank--deviated in some ways from the proposal, which the commission issued in 2010. Resource extraction companies cried foul on the proposed rule, saying that it stood to hurt their competitiveness with foreign firms.
The rule requires that, among other points, issuers disclose payments that are “not de minimis”--a term the final rule defines as equal to or exceeding $100,000. It also requires that the companies provide information about the type and amount of payment related to a “project.”
However, the rule does not define the term “project.” Instead, the SEC said the release “provides some guidance on the Commission's view as to what a project would be.” Finally, the rule does not provide any exemptions where disclosures conflict with foreign law.
Companies are required to comply with the rule for fiscal years ending after Sept. 30, 2013.
On the costs, Hanley again said the expenditures would be “substantial.” She provided an estimate between $44 million and $1 billion for initial compliance costs and ongoing costs between $200 million and $400 million.
Dissenting, Gallagher again noted that the SEC's economic analysis was “incomplete.” He also contended that the commission took an overly burdensome approach in carrying out its Dodd-Frank mandate. Instead, he said, the SEC should have required a “compilation” of payments by country rather than by individual company and project.
“Nothing requires publicly linking … companies with the payments they make,” he said.
Moreover, he added that Section 23 of the 1934 Securities Exchange Act bars the SEC from issuing rules that stymie competition.
Legal Challenges Likely.
Christopher Guith, vice president of policy for the Chamber's Institute for 21st Century Energy, told BNA that the resource rule will put companies at a “huge disadvantage on a global competitive standpoint” and effectively will require them “to turn over their playbook for how they bid and compete.”
Though the SEC acknowledged that the rule will affect competition, Guith said it considered economic impact only from a qualitative standpoint. He said he will be “shocked” if legal challenges to the rule do not ensue. “It's something that we're very seriously considering,” he added.
For his part, Hermsen said he would not be “surprised” if a lawsuit challenged the conflict minerals rule. As to both rules, Hermsen said Gallagher and Paredes seemed to be making a case for a legal challenge in their dissents.
“It sounds like … those two commissioners were trying to lay out arguments that somebody could use as a basis for making a claim to try to overturn these rules,” he told BNA.