We continue to post oodles of resources in our “Conflict Minerals” Practice Area, but I thought it was worth highlighting these FAQs from Scott Kimpel and Brian Hager of Hunton & Williams since they address issues that I keep hearing about:
Why do the final rules leave so many terms undefined and create so many interpretive issues?
We believe a number of factors contributed to the tone and structure of the final rules. As a threshold matter, the final rules involve a diverse array of issues such as human rights, international relations, global politics, supply chain management, chemistry, metallurgy and manufacturing technology. These topics are far afield from the agency’s core experience and historical role as a securities regulator, and placed the Commissioners and agency Staff on a steep learning curve.
Second, though hundreds of commenters provided input and many multi-stakeholder groups were formed, commenters reached little consensus on many of the key issues. In the absence of consensus, the Commission was left having to make difficult choices on a topic in which it has little historical familiarity, and many of the underlying concepts of the rules defy easy explanation or simple definition.
Third, given the broad scope of the rules and their impact throughout the global supply chain, it simply was not possible or feasible to address every hypothetical situation involving every industry affected. Fourth, we believe the Commission sought to take a principles-based approach, rather than a rules-based one, to many of the interpretive questions so that over time industry and market practices would gain acceptance.
Finally, given the large number of human rights groups and other nongovernmental organizations that are closely monitoring issues concerning labor and supply chain issues generally, as well as the conflict minerals issue more specifically, we believe the Commission sought to use the influence of these groups to help shape emerging industry practices and to act as a counterbalance, were certain companies or industries to stray too far from emerging best practices.
Will the Commission or the Staff issue any further interpretive guidance?
The release accompanying the final conflict minerals disclosure rules is 356 pages in length. Some SEC officials initially stated that while the SEC has received numerous questions and requests for clarification regarding the final rules, the SEC Staff did not have any plans to issue additional guidance (e.g., FAQs) because the release accompanying the final rules provides extensive guidance to reporting companies.
Conversely, at an industry conference in November 2012, two senior officers from the SEC’s Division of Corporation Finance suggested that some guidance might indeed be forthcoming. Nevertheless, recent turnover in senior staff at the SEC and the nomination of a new SEC chairman call into question the imminence of any guidance from either the Commission or the Staff. Because the Commission chose to remain silent on many key issues, we question whether the Staff would be in a position to reopen issues when the Commission itself did not reach consensus on them.
Ultimately, the Staff’s guidance must have some legal basis, and it could be difficult to find that basis when the Commission has made a policy choice in favor of a principles-, as opposed to rules-, based approach on many of these issues. In the absence of further official clarification or direction on these questions, reporting companies should closely observe their peers and industry groups to keep abreast of any consensus or industry standards that begin to develop.
What about packaging?
The lack of a definition of “product” in the rules raises several related questions, including whether a product’s packaging is considered part of the product and, therefore, whether it is covered by the rule. As an example, if a reporting company sells a food product in a tin can, but the food product itself does not contain a conflict mineral, should the tin can be considered in the company’s conflict minerals analysis?
The SEC has not issued any guidance on this topic, and the adopting release for the final rule does not discuss packaging. Some commentators draw an analogy to the SEC’s exclusion of merely ornamental conflict minerals (e.g., gold embellishment) as not “necessary to the functionality” of certain products; however, others believe that a blanket exclusion of packaging would be too broad and could potentially undercut Congressional intent.
Unless the SEC issues further guidance, or an industry standard develops, reporting companies will be forced to rely on the facts and circumstances of a product and its packaging and make their own determinations. The critical question is whether the packaging is necessary to the functionality or production of the product. For example, if the tin in the can is necessary to prevent spoilage, then an argument could be made that the packaging is an integral part of the product. On the other hand, the availability of alternative packaging that does not include conflict minerals could also factor into the analysis.
Another consideration is whether the packaging itself has any intrinsic value. For example, disposable packaging presumably has little or no value, contrasted with a commemorative gold box that presumably does. A potential offshoot of this uncertainty is that reporting companies are likely to explore ways to replace conflict minerals in packaging (as well as in their core products).
How will the rules be enforced?
The SEC has not announced any particular enforcement program, and it is not yet clear how much of a priority the Staff will place on reviewing filings in 2014, but by analogy we can draw from the experiences surrounding other new disclosure regimes that have been implemented in recent years. In the absence of official guidance from the Commission or the Staff, it would not be uncommon for Commissioners or senior staffers to give speeches and presentations at industry events laying out their preferences and expectations for a new set of rules.
After the first wave of filings, it is possible that examiners in the Division of Corporation Finance could issue individual comment letters to specific registrants, or the Division as a whole may issue more comprehensive disclosure guidance highlighting best practices or areas where large numbers of registrants appear to have missed the mark. Given the two- and four-year transition periods contained in the final rules, the Staff’s process of providing feedback may occur more gradually than other recent amendments to public company disclosure rules, such as the rules on Compensation Discussion & Analysis, in which the Staff was very active in providing specific comments and publicizing its more general reactions after the first reporting cycle.
In all but cases involving egregious violations of the rules, we would not expect the Division of Corporation Finance to make a large number of enforcement referrals to the Division of Enforcement in the short to medium term. Over the longer term, it is possible that the Division of Enforcement will seek to bring enforcement cases against registrants that are perceived as materially flaunting the rules. As part of the Division of Enforcement’s recent reorganization, a special unit focusing exclusively on the Foreign Corrupt Practices Act has been formed.
This unit has been steadily improving working relationships with foreign regulators and developing increasingly sophisticated techniques for investigating transnational violations of the securities laws. These relationships and techniques would be readily transferable to future investigations of cases involving the conflict minerals rules. Outside of SEC enforcement, a private right of action exists under Section 18 of the Exchange Act for shareholders who perceive irregularities in the filed reports, and we should expect the advocacy and NGO community to also be very outspoken in publicly highlighting perceived violations of the rules.
After JOBS Act, Confidential Filers Rise
Last month, this WSJ article noted that nearly 75% of the companies that filed IPO registration statements between last April and the end of ’12 were deemed to be emerging growth companies. And 60% of these EGCs filed their registration statements through the EGC confidential process…
Meanwhile, Gunster’s David Scileppi blogs “SEC curtails JOBS Act broker registration exemption in recent FAQs“…
The Court Where Securities Law Rules Go to Die
Here is an interesting article about the US Court of Appeals for the DC Circuit, noting that no new judge have been appointed since 2006 due to Senate gridlock. There are 3 or 4 vacancies and if President Obama can get his two current nominees confirmed, Srikanth Srinivasan and Caitlin Halligan, the balance of power could be altered. Here is Sandra Day O’Connor’s take on one of the nominations…
– Broc Romanek