The SEC today adopted final rules regarding disclosure and reporting requirements with respect to the use of “conflict minerals” to implement Section 1502 of the Dodd-Frank Act. The final rules were adopted by a vote of 3 to 2, with Commissioners Paredes and Gallagher dissenting. The 356 page adopting release containing the final rules is available here. Gibson Dunn will issue a client alert with a more detailed discussion of the rules in the near future. However, from the discussion at the Commission meeting and a Commission briefing paper, we note a few significant points:• The final rules apply to any issuer that files reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934. There is no exception for foreign private issuers, emerging growth issuers or smaller reporting issuers. The rules will apply to all issuers on a calendar year basis, regardless of an issuer’s fiscal year. Thus, the rules will apply to all covered issuers commencing on January 1, 2013. • The final rules adopt the same three-step analytical process contemplated in the proposed rules, but include significantly modified mechanisms for carrying out certain steps of the process. Those three steps involve: (1) determining whether conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the issuer; (2) if so, conducting a reasonable country of origin inquiry to determine if the issuer knows or has reason to believe that such minerals may have originated from the Democratic Republic of the Congo (DRC) or an adjoining country (the “covered countries”) and are not from scrap or recycled sources; and (3) if so, conducting supply chain due diligence and issuing a Conflict Minerals Report.• The final rules, like the proposed rules, apply to products an issuer “manufactures” or “contracts to manufacture” if a conflict mineral (generally, gold, tin, tungsten or tantalum) is “necessary to the functionality or production” of the products. The final rules do not define any of these quoted terms, but the adopting release provides interpretive guidance on them. In determining whether an issuer “contracts to manufacture” a product, the standard will focus on the degree of influence the issuer exercises over the product’s manufacturing. An issuer would not be deemed to have influence over manufacturing if it merely: (1) affixes its brand, marks, logo, or label to a generic product manufactured by a third party; (2) specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product; or (3) services, maintains, or repairs a product manufactured by a third party. • The final rules, unlike the proposed rules, do not apply to issuers that mine conflict minerals or to issuers that contract to mine conflict minerals.• In contrast to the proposed rules, disclosures under the conflict minerals rules will not be included in or as an exhibit to an issuer’s annual report on Form 10-K, but will be made on a new, specialized Form SD. All issuers that manufacture or contract to manufacture a product for which a conflict mineral is necessary to the functionality or production of the product will be required to file the Form SD on May 31 with respect to their conflict minerals use in the prior calendar year. Thus, all issuers will file their first disclosure report on May 31, 2014 for the 2013 calendar year.• Also unlike the proposed rules, the final rules provide that the disclosure report on Form SD is to be filed, rather than furnished. This means that issuers will be subject to liability under Section 18 of the Exchange Act for any “false or misleading” statements in their Form SD, subject to a defense if the issuer acted in good faith and did not have knowledge that the report was false and misleading. The Form SD is not required to be accompanied by the officer certifications that apply to Forms 10-K and 10-Q, and is not incorporated into an issuer’s registration statements under the Securities Act of 1933, unless the issuer so specifies.• If, after conducting its reasonable country of origin inquiry, an issuer knows that the conflict minerals in its products did not originate from a covered country, or has no reason to believe that they may have originated in a covered country, then the issuer’s Form SD only has to disclose its determination and provide a brief description of the inquiry it undertook. These same disclosures are required on Form SD if an issuer determines that the conflict minerals in its products are from scrap or recycled sources, or has no reason to believe that they are not from scrap or recycled sources. • If, after conducting its reasonable country of origin inquiry, an issuer cannot reach one of the foregoing conclusions, then it must conduct due diligence on the source and chain of custody of its conflict minerals, and its Form SD must include a Conflict Minerals Report. The Conflict Minerals Report will reflect the issuer’s conclusion, based on its due diligence, on whether the issuer’s products are “DRC Conflict Free” or “Not DRC Conflict Free” and the report must be audited under a standard set forth in the final rules. However, in a departure from the proposal, the final rules include a temporary (two years, or four years for smaller issuers) reporting category for issuers who are unable to determine whether the minerals in their products originated in a covered country or financed or benefitted armed groups in the covered countries. The products of issuers falling into this category will be deemed “DRC Conflict Undeterminable.” The Conflict Minerals Report for products that are DRC Conflict Undeterminable will be required to address much of the same information required when products are Not DRC Conflict Free, except that (1) it need not be audited, and (2) it must describe steps the issuer has taken or intends to take to reduce the risk that the conflict minerals contained in its products are benefiting armed groups in the covered countries. • As noted above, the Conflict Minerals Report, where required, generally must include an independent private sector audit. There are two exceptions to the audit requirement: (1) when the Conflict Minerals Report relates to products that are “DRC Conflict Undeterminable” during the temporary period described above; and (2) when the Conflict Minerals Report relates to certain recycled or scrap materials, as described in the next bullet. The proposed rules were unclear on the scope of the required audit; for example, whether the audit concerns an issuer’s due diligence process or the conclusions reached in the Conflict Minerals Report. The final rules specify a two-fold “audit objective.” First, the audit must express an opinion regarding whether the issuer’s due diligence measures conform with a nationally or internationally-recognized due diligence framework. The only such framework currently available is the due diligence guidance adopted by the Organization for Economic Co-Operation and Development (“OECD Due Diligence Guidance”). Second, the required audit must express an opinion regarding whether the issuer, in fact, engaged in the due diligence according to the framework it adopted. • The final rules revise the SEC’s proposed treatment of recycled and scrap materials and provide that products containing conflict minerals originating from recycled or scrap sources do not automatically trigger an obligation to file a Conflict Minerals Report. Rather, products containing such materials are considered “DRC Conflict Free.” There are, however, additional requirements for products that contain gold. In addition, in cases when an issuer must prepare a Conflict Minerals Report relating to tantalum, tin, and tungsten from recycled or scrap sources, a private sector audit is not required.The SEC today also adopted final rules to implement Section 1504 of the Dodd-Frank Act. These rules, applying to approximately 1,100 issuers that are involved in exploration, extraction, processing or export of oil, natural gas or minerals, or acquiring licenses to conduct any of the foregoing activities, will require detailed disclosure of payments to governments by such issuers on a project by project basis. The disclosures likewise will be made on the new Form SD, and for calendar year issuers will first cover the period from October 1, 2013 through December 31, 2013.
PCAOB Issues Release Providing Information for Audit Committees About its Inspection Process
On August 1, 2012, the Public Company Accounting Oversight Board (“PCAOB”) issued an informational report about its inspection process that is intended to serve as a guide for audit committees to learn more about the inspection process and offer questions the audit committee may ask the audit firm about its inspection results. The PCAOB issued the release with the goal of helping audit committees engage in more informative discussions with audit firms about the inspection process in order to aid audit committees in their oversight responsibilities related to financial reporting. PCAOB inspections of an audit firm examine both aspects of a limited number of audits performed by the firm (Part I of the inspection report) and elements of the firm’s overall system of quality control over its audit process (Part II of the inspection report, which is confidential). The release provides information about both parts of the PCAOB’s inspections and lists specific suggestions for initiating or enhancing discussions with audit firms about the inspection results.
SEC Approves NASDAQ Rule Change for Independent Directors
On July 19, 2012, the SEC approved a proposed change to NASDAQ’s rules regarding membership on a listed company’s audit, compensation and/or nominations committee. NASDAQ sought to modify an exception to its Rule 5605, which allows a non-independent director to serve on such committees “under exceptional and limited circumstances” for up to two years. The amendment provides an exception allowing a non-independent director to serve on a company’s audit, compensation and/or nominations committee, where the director has a family member serving as a non-executive employee of the company, so long as the listed company’s board concludes that the director’s membership on the relevant committee is “required by the best interest of the company and its shareholders.”The SEC’s release is available at here.
Glass Lewis Implements Changes to its Voting Analysis Model
GLass Lewis & Co. has announced that, effective for annual meetings taking place after July 1, 2012, it has implemented a number of revisions to its proprietary pay for performance quantitative model. Glass Lewis uses the quantitative model to analyze the degree of alignment between corporate performance and named executive officer compensation. When making voting recommendations to its subscribers on say-on-pay proposals, Glass Lewis analyzes both the quantitative analysis and a qualitative analysis of the company’s named executive officer compensation program.
FASB Votes Against Continuing Loss Contingency Disclosure Reform Project
At a July 9, 2012 meeting, the Financial Accounting Standards Board (“FASB”) voted against moving forward with its outstanding exposure draft to modify the accounting and disclosure requirements for loss contingencies. The FASB considered two alternatives at the meeting: (1) remove the loss contingency project from its agenda; or (2) continue to explore moderate changes to the loss contingency requirements. The FASB Staff recommended that the Board remove the project from its agenda. Chairwoman Seidman and Board members Buck, Golden, Schroeder and Smith voted to remove the project from the Board’s agenda. The majority agreed that the current requirements under Accounting Standards Codification Topic 450 are sufficient and that addressing any concerns with the adequacy of loss contingency disclosures is an issue of compliance and enforcement rather than standard-setting. Board members Linsmeier and Siegel dissented, with each noting that the project should continue with a focus on providing additional guidance on qualitative disclosures about loss contingencies.
UK Government to Require Mandatory Greenhouse Gas Emissions Reporting
On June 20, 2012, British Deputy Prime Minister Nick Clegg announced at the United Nations Rio+20 Summit that the UK will become the first country to require emissions data disclosure in companies’ annual directors’ reports. Pursuant to regulations to be made under the UK’s Climate Change Act 2008, which must come into force by April 2013, all UK “quoted companies” will be required to report their greenhouse gas emissions. (Quoted companies generally are UK companies whose equity share capital is included in the Official List, officially listed in an European Economic Area (EEA), or admitted to dealing on either the NYSE or NASDAQ.) In 2016, the British government will determine whether to extend this requirement to all large UK companies, including private companies.
Business Roundtable Publishes Principles of Corporate Governance 2012
Business Roundtable (BRT) today issued its Principles of Corporate Governance 2012, which update its April 2010 principles. The principles were updated to “reflect the new circumstances of Dodd-Frank Wall Street Reform and Consumer Protection Act implementation and the continuing evolution of best practices.” The new Principles of Corporate Governance include important updates in five key areas:
34 Questions Concerning the U.S. IPO Market
On June 19, the Committee on Oversight and Government Reform of the U.S. House of Representatives asked the Securities and Exchange Commission to answer 34 questions concerning the initial public offering market in the United States. The Committee’s inquiry came less than three months after the enactment of the JOBS Act, which, among other things, eased regulatory restrictions on initial public offerings by Emerging Growth Companies.
U.S. Securities and Exchange Commission Adopts Rules Implementing Dodd-Frank Requirements for Listing Standards Applicable to Compensation Committees
The SEC today adopted rules to implement Section 952 of the Dodd-Frank Act, requiring stock exchanges to adopt listing standards that:
- impose independence requirements on compensation committee members,
- authorize compensation committees to retain independent advisers, and
- require compensation committees to assess the independence of any consultant, legal counsel or other adviser that provides advice to the compensation committee, other than in-house counsel.
Risk Factors in IPO Registration Statements of Emerging Growth Companies
Nearly eight weeks after the Jumpstart Our Business Startups Act (“JOBS Act”) was signed into law, the first group of Emerging Growth Companies (each, an “EGC”), as defined in Section 101 of the JOBS Act, have publicly filed registration statements to the SEC that include EGC-specific risk factors. In a May 21, 2012 post on The Corporate Counsel blog, Broc Romanek identified nine such companies: