Corporate Communicator - Summer 2013

by Snell & Wilmer
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Dear clients and friends,

In this issue of the Corporate Communicator, we are providing a short update concerning two recent reporting and governance matters affecting public companies. The first item is developments relating to a proposal by the NASDAQ Stock Market to require an internal audit function. Our second topic for this edition is a brief summary of recently issued Frequently Asked Questions by the Securities and Exchange Commission (SEC) concerning the SEC’s recently adopted conflict minerals disclosure rules.

We hope you enjoy the rest of your summer.

Very truly yours,

Snell & Wilmer L.L.P.
Business & Finance Group

NASDAQ Proposal to Require an Internal Audit Function

In February 2013, the NASDAQ Stock Market proposed a rule that would require that NASDAQ-listed companies establish and maintain an internal audit function to provide management and the audit committee with ongoing assessments of the company’s risk management processes and of internal control. The proposal makes clear that companies may elect to outsource the internal audit function to a third party service provider (other than its independent auditor), provided that the audit committee retains sole oversight responsibility over the internal audit function. As proposed, NASDAQ-listed companies must establish an internal audit function no later than December 31, 2013.  Through the end of the comment period, the SEC received 38 comments on the proposal.

On April 18, 2013, the SEC extended the time period for action on the proposal so that it has sufficient time to consider the NASDAQ proposal and the comments received. Thus, this proposal remains “on hold” at the current time.

Although many larger NASDAQ-listed companies already maintain a compliant internal audit function, such function is less common for smaller cap issuers. NASDAQ companies should continue to monitor developments concerning the proposal (and the related deadline for implementation) so that they can ensure they can implement an internal audit function timely if the NASDAQ proposal is ultimately adopted.

Conflict Minerals—The SEC Publishes Frequently Asked Questions

On May 30, 2013, the staff of the SEC published Frequently Asked Questions (FAQs) covering the SEC’s recently issued conflict minerals disclosure rules. The conflict minerals disclosure rules were adopted by the SEC as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Although the FAQs resolve some questions and provide useful guidance, the scope of the questions addressed in the FAQs, particularly in light of the complexity and novelty of the conflict minerals disclosure rules, is somewhat limited and many interpretive questions remain unanswered.  Following is a summary of the guidance provided in the FAQs.

  • All Filers Covered. The conflict minerals disclosure rules, including the requirement to file Form SD, apply to all issuers that file reports with the SEC under Exchange Act Sections 13(a) or 15(d), including voluntary filers.
  • Mining Activities Do Not Trigger Disclosure. Customary mining activities are not considered to be “manufacturing” and thus do not trigger disclosure on Form SD.
  • Consolidated Subsidiaries Included. Companies must apply the conflict mineral determination and disclosure rules to the reporting company and its consolidated subsidiaries.
  • Branding Generic Products Not Covered. A company that merely specifies that its logo, mark or brand be affixed to a generic product that is manufactured by a third party is not considered to be “contracting to manufacture” that product.
  • Generic Components Included in a Product Are Covered. Companies are required to conduct the reasonable country of origin inquiry for conflict minerals included in generic components included in the products the company manufactures or contracts to manufacture. The SEC stated “there is no distinction between the components of a product that an issuer directly manufacturers or contracts to manufacture and the ‘generic’ ones it purchases to include in a product.”
  • Packaging is NOT Part of the Product. Only conflict minerals contained in the product are considered “necessary to the functionality or production of the product.” The package or container is not considered part of the product and this is true even if a product’s package or container is necessary to preserve the usability of the product. The SEC did clarify the seemingly obvious point that to the extent the company manufactures and sells packaging or containers independent of the product, the packaging or containers are then considered products.
  • Manufacturing Tools and Equipment Not Covered. A company’s tools, machines or other equipment that it uses to manufacture products are not considered covered products. This is true even if the company later sells such items into the stream of commerce.
  • Equipment Used by Service Providers Not Covered. When a company manufacturers or contracts to manufacture equipment it uses in providing a service, such equipment is not subject to the conflict minerals disclosure rules even if it contains conflict minerals. The SEC cited the example of a cruise ship line not being required to file reports regarding any conflict minerals in the cruise ships it manufacturers or contracts to manufacture.
  • Product Descriptions on Form SD. The product descriptions to be included on Form SD (where its products have not been found to be Democratic Republic of Congo (DRC) conflict free or that are DRC conflict undeterminable) should describe the products based on the company’s own facts and circumstances. The SEC reasoned that the company is in the best position to know its products and describe them in terms commonly understood within its industry. A company is not required to use model numbers in describing such products.
  • Form SD and Audit Required Even When Products are Determined to be “DRC Conflict Free.” If a company determines that the products it manufacturers include conflict minerals that originated in the DRC or an adjoining country, it is required to file the Form SD and obtain an independent audit even where the products have been determined to be DRC conflict free. In such a situation, however, the company may omit certain disclosures such as descriptions of its products. Important Note: Because this FAQ only applies where a company’s products include conflict minerals that originated in the Democratic Republic of Congo or an adjoining country, it does not reach, for example, to a company that manufacturers products that contain conflict minerals that originate from some region or country other than the Democratic Republic of Congo or an adjoining country.
  • Phase In Period for IPO Companies. Where a company conducts an initial public offering, it may delay reporting until the first year that begins no sooner than eight months after the effective date of its initial public offering registration statement.
  • Form S-3 Eligibility. The failure to file a Form SD regarding conflict minerals does not cause an issuer to lose eligibility to use Form S-3.

The new conflict minerals disclosure rules are now in effect and for affected public companies and the first Form SD filing is due by May 31, 2014 for the calendar year ending December 31, 2013.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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