[author: Jeffrey H. Perry]
On August 22, a divided U.S. Securities and Exchange Commission (SEC) adopted final rules requiring (1) payment disclosures by resource extraction companies, and (2) companies to disclose their use of “conflict” minerals. The rulemakings, required by provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act, had been contemplated by the SEC for over two years. These rules apply to companies that file Form 10-K, 20-F, or 40-F annual reports with the SEC (“Issuers”).
In a departure from the Commission’s original proposals, Issuers must file (not furnish) the above disclosures in a new specialized disclosure report called Form SD. This change means that affected Issuers will be subject to potential liability under Section 18 of the Exchange Act for making knowingly false or misleading statements of material fact in their disclosures. Pursuant to Section 18, in instances when a false statement is “filed,” a private plaintiff who meets the elements of the statute including materiality, reliance, and damages, may assert a claim against any person who “made” the false or misleading statement, or “caused” it to be made.
Payment Disclosure Provisions
As required by Section 1504 of the Dodd-Frank Act, the SEC adopted rules requiring disclosure of payments by resource extraction Issuers. Specifically, companies engaged in the development of oil, natural gas, or minerals must disclose certain payments made to the U.S. or foreign governments.
Payments to governments
The rules require an Issuer to disclose payments made to a foreign government (including subnational governments) or the U.S. federal government that are:
made to further the commercial development of oil, natural gas, or minerals;
“not de minimis” (i.e., a single payment or series of related payments that equals or exceeds $100,000 during the most recent fiscal year); and
within the types of payments specified in the rules.
Payments made to a company that is at least majority-owned by a foreign government are covered under the rules, as are payments by Issuers to third parties that are to be paid to a government on the Issuer’s behalf.
Subsidiaries and controlled entities
The new disclosure requirements apply to domestic and foreign Issuers as well as to payments made by a subsidiary or another entity controlled by the Issuer. An Issuer is expected to make a factual determination as to whether it has control of an entity based on a consideration of all relevant facts and circumstances.
Commercial development activities
The rules define the “commercial development” of oil, natural gas, or mineral resources to include exploration, extraction, processing, and export, or the acquisition of a license for any such activity. The types of payments related to these commercial development activities that need to be disclosed and reported include:
Taxes (excluding consumption taxes such as value-added, personal income, and sales taxes);
Fees (including license, rental, and entry fees);
Bonuses (including signature, production, and discovery bonuses);
Dividends (excluding dividends paid to governments under the same terms as other shareholders but including any dividends paid in lieu of production entitlements or royalties); and
If an Issuer makes an in-kind payment of the types of payments required to be disclosed, the Issuer must disclose the payment and determine the monetary value of the in-kind payment.
Payments to be disclosed
The disclosures must not only be made in an Issuer’s Form SD filing, but must also be submitted to the SEC in an interactive data format whereby certain attributes are electronically “tagged”. This information will be made publicly available on the SEC website. Payment attributes to be identified are:
The type and total amount of payments made for each project;
The type and total amount of payments made to each government (not “each country”);
The total amounts 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 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 Issuer to which the payments relate.
The amount of payments made for each payment type, and the total amount of payments made for each project and to each government, during the reporting period must be made in either U.S. dollars or the Issuer’s reporting currency.
It is significant that these financial disclosures require not only summaries of expenses on a country-by-country basis, but also disclosure of payments at a project level of detail. The SEC has left the term “project” undefined in an effort to provide Issuers flexibility in applying the term to different business contexts. Disclosures at a project level could require companies to disclose commercially sensitive information, such as information indicating project production volumes, that it previously kept confidential.
Pursuant to Section 1502 of the Dodd-Frank Act, the SEC adopted rules requiring reporting companies to disclose publicly their use of “conflict minerals” that originated in the Democratic Republic of the Congo or an adjoining country (collectively, the “DRC countries”). Specifically, domestic and foreign Issuers must disclose their use of tantalum, tin, gold, or tungsten (the “conflict minerals”) if those minerals are “necessary to the functionality or production of a product” manufactured or contracted to be manufactured by an Issuer.
There is no exception to the disclosure requirements for the de minimis use of conflict minerals in a product, therefore even minute or trace amounts of a conflict mineral might trigger reporting obligations.
Manufactured or contracted to be manufactured
The rules do not define the term “manufacture” since the SEC believes that term is generally understood. It should be noted that an Issuer that only services, maintains, or repairs a product containing conflict minerals is not considered to be “manufacturing” that product.
An Issuer is considered to “contract to manufacture” a product if the Issuer has some actual influence over the manufacturing of that product. This is a determination that is based on an examination of the relevant facts and circumstances and should take into account the degree of influence that a company exerts over the product’s manufacturing process.
Process for determining where conflict minerals originated
The actual process of determining whether conflict minerals originated in the DRC or other covered countries contain escape clauses for Issuers that: (1) know that the minerals used did not originate in DRC counties or are from scrap/recycled sources, or (2) have no reason to believe that the minerals used may have originated in the DRC countries or may not be from scrap/recycled sources. Such an Issuer must only disclose its determination, provide a brief description of the inquiry it undertook, and the results of the inquiry on the Form SD.
If an Issuer’s inquiry otherwise determines both of the following to be true—(1) the Issuer knows or has reason to believe that the minerals may have originated in the covered countries, or (2) the Issuer knows or has reason to believe that the minerals may not be from scrap or recycled sources—then the Issuer must undertake “due diligence” on the source and chain of custody of its conflict minerals and file a Conflict Minerals Report as an exhibit to the Form SD.
Conflict Minerals Report
The Conflict Minerals Report requires certain due diligence measures to be undertaken and the Report must be audited by an independent auditor. There are various product classifications that reflect an Issuer’s due diligence determinations including: (1) DRC conflict free; (2) not found to be “DRC conflict free”; and (3) DRC conflict undeterminable.
The “DRC conflict undeterminable” category corresponds to a two-year temporary period (four-years for smaller reporting companies) during which an Issuer that is unable to determine whether the minerals in its products originated in DRC countries may describe its products as “DRC conflict undeterminable.”
Private Right of Action
In a departure from the Commission’s proposed rules that provided that the specialized disclosures would be “furnished’ in an Issuer's annual report, the SEC has directed that Issuers subject to these rules must file these disclosures utilizing the new Form SD. This development means that affected Issuers will be subject to potential liability under Section 18 of the Exchange Act if their disclosures contain knowingly false or misleading statements of material fact.
Section 18 provides a cause of action to any person who purchases or sells a security in “actual reliance” on a false or misleading statement of material fact included in any application, report or document filed pursuant to the Exchange Act, unless the person knew that such statement was false. 15 U.S.C. § 78r(a). Any plaintiff who meets the elements of the statute including materiality, reliance, and damages, may assert a claim against any person who “made” the false or misleading statement, or “caused” it to be made. See id.
This potential civil liability represents a significant departure from the proposed rules, which were of the “name and shame” variety and contained no real penalty provisions, and provides an avenue for the extension of liability to those individuals who “cause” a false statement to be made, even though they did not actually make the statement themselves.
Reporting dates and the Form SD
Both the Resource Extraction Payment and Conflict Minerals disclosures are to be made annually by filing a new specialized disclosure report with the SEC called the Form SD. A benefit of the Form SD is that the required disclosures will not be filed in an Issuer’s required annual report (e.g., Form 10-K). Therefore, the disclosures will not be covered by the CEO and CFO certifications under SEC Rule 13a-14 and will not be incorporated by reference into Securities Act registration statements, unless the Issuer affirmatively chooses to do so.
Resource Extraction Issuer Disclosure section
An affected Issuer is required to comply with the new rules for fiscal years ending after September 30, 2013. But only partial-year reporting would be required for the first year if the Issuer’s fiscal year began before September 30, 2013. Thus a calendar year-end company would first provide the information for the period beginning October 1, 2013 through December 31, 2013. An Issuer’s Form SD would be filed no later than 150 days after the end of the Issuer’s fiscal year, or by May 31st for calendar year-end companies.
Conflict Minerals Disclosure section
The Conflict Minerals disclosures cover an Issuer’s activities during the preceding calendar year. The first Form SD disclosures are to be filed with the SEC’s EDGAR system by May 31, 2014. In this regard, the first reporting period for all Issuers will be from January 1, 2013 to December 31, 2013. Issuers are not required to provide any information regarding conflict minerals that, prior to January 31, 2013, are located outside of the supply chain.
Although the instant disclosure obligations are limited to companies required to file annual reports with the SEC, the European Commission is considering similar rules and details are expected to be finalized over the coming months. 
Given these global developments, it would be advisable for all companies actively engaged in the commercial development of the oil, gas, and minerals, regardless of where they are currently operating, to factor payment disclosure obligations into their analysis when considering future projects. The same advice applies to companies that use conflict minerals “necessary to the functionality or production of a product” manufactured or contracted to be manufactured.
While the topics listed above do not form an exhaustive list of the provisions in which affected companies should be well-versed, they may serve as a starting point for an evaluation of an Issuer’s potential disclosure obligations and may provide a basis for any measures ultimately implemented to satisfy the SEC’s rules.