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From Securities Regulation Daily, April 30, 2014

Conflict minerals compliance to be required with nod to unsettled First Amendment issues

By Mark S. Nelson, J.D.

The SEC’s Division of Corporation Finance (CorpFin) issued new guidance on how it expects companies to meet the requirements of the Commission’s conflicts minerals rule in light of the ongoing uncertainty about the rule’s status following an opinion by the U.S. Court of Appeals for the District of Columbia that upheld most of the rule, but found one provision ran afoul of the First Amendment. CorpFin Director Keith F. Higgins announced the guidance in a public statement late yesterday.

Companies to comply with bulk of rule. The CorpFin guidance makes clear that the SEC expects issuers to comply with most of the Commission’s conflicts minerals rule by the June 2, 2014 deadline. Said the guidance, “The Form SD, and any related Conflict Minerals Report, should comply with and address those portions of Rule 13p-1 and Form SD that the Court upheld.”

The guidance instructed companies that are not required to file a conflict minerals report to disclose their reasonable country of origin inquiry with a brief description of their inquiry. Companies that are required to file a conflict minerals report must describe their due diligence in the report.

Moreover, the guidance offers some flexibility regarding the use of the labels “DRC conflict undeterminable” and “not found to be ‘DRC conflict free.’” A company is not required to use these labels if its products are within the meaning of Items 1.01(c)(2) or 1.01(c)(2)(i) of Form SD, said the guidance. But the company “should disclose, for those products, the facilities used to produce conflict minerals, the country of origin of the minerals and the efforts to determine the mine or location of origin.”

Lastly, the guidance said that while companies are not required to describe their products as “DRC conflict free,” “not been found to be ‘DRC conflict free,’” or “DRC conflict undeterminable,” they may opt to make related voluntary disclosures. Specifically, a company that says its products are “DRC conflict free” in a conflict minerals report also must have obtained the required independent private sector audit (IPSA). But for now, an IPSA is not required for companies that do not make this voluntary disclosure.

Mandate withheld. Just over two weeks ago, a three-judge panel of the U.S. Court of Appeals for District of Columbia upheld much of the SEC’s conflict minerals rule, while also finding that a requirement in Exchange Act Sec. 13(p)(1)(A)(ii) and (E), and the SEC’s conflict minerals rule failed to satisfy the narrow tailoring required by the First Amendment. As a result, the court found these provisions to be constitutionally infirm to the extent the law and the SEC’s rule require a company to report to the SEC and state on its website that any of its products have “not been found to be ‘DRC conflict free.’” (National Association of Manufacturers, et al v. SEC, April 14, 2014, Randolph, A.; National Association of Manufacturers, et al v. SEC, July 23, 2013, Wilkins, R.).

Judge Srinivasan said in a separate opinion that he would have preferred that the court defer the First Amendment ruling pending the outcome of an en banc hearing in another case that raises a similar issue. It is still possible that the SEC or the courts may stay the conflict minerals rule, or the parties in the conflict minerals case could participate in the related case of American Meat Institute v. USDA, for which oral argument is scheduled on May 19, 2014.

The SEC’s guidance yesterday noted that the D.C. Circuit, on its own motion, decided to withhold its mandate in the conflict minerals case until seven days after disposition of any timely petition for rehearing, or for rehearing en banc. According to the guidance, that means the first reports under the conflict minerals rule are due to be filed by June 2, 2014, three days before the earliest date on which the court may issue its mandate (June 5, 2014).

Readying first reports with the guidance. The circuit court’s conflict minerals opinion left open many issues regarding how companies should prepare for their first reports. The CorpFin guidance may temporarily help to resolve some of those issues, although both the SEC and the courts may still act to further refine the scope of the conflict minerals rule.

Dynda A. Thomas, partner, Squire Sanders LLP, said CorpFin’s guidance clarifies what the SEC thinks companies should file by the June 2 deadline, with a nod to the D.C. circuit’s First Amendment holding. “By eliminating the requirement to provide product descriptions, the SEC seems to have tried to address the First Amendment concerns that were expressed in the Court of Appeals decision. The statement does state that due diligence must be described and that certain information about a company’s necessary conflict minerals must be included – although not connected to particular products.”

CorpFin’s guidance holds out the possibility that a company may voluntarily describe its products as “DRC conflict free.” This will require the company to obtain the required IPSA. Thomas said a company that opts to describe its products as “DRC conflict free” may face some pitfalls. For one, most first reports likely will not make this disclosure and a company that does is likely to draw attention to itself now, and its future actions may be eyed more closely. Another pitfall may be the need to update any disclosures because facts beyond the company’s control have changed. But according to Thomas, the IPSA would only be a pitfall due to the added lead time and costs of getting the audit.

Thomas also noted that while a few companies may consider themselves to be market leaders, and could file by early May, many others will likely wait for greater “clarity and finality” before filing their first reports nearer to the deadline.

Attorneys: Dynda A. Thomas (Squire Sanders LLP)

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