New rules bring added scrutiny to mining and energy companies

New rules passed by the United States Securities and Exchange Commission under the Dodd-Frank Act requiring resource extraction issuers, including Canadian companies listed on U.S. exchanges, to disclose payments made to governments could be putting competitiveness on the line.

On Aug. 22 the SEC passed by a 2-1 vote a rule saying any payment to a government that has to do with the commercial development of oil, natural gas, or minerals must be reported annually.

“Whether a Canadian company is an issuer or not this is going to be seen as part of a broader trend towards scrutiny over payments to government,” says John Boscariol, head of the international trade and investment group at McCarthy Tétrault LLP. “If a small Canadian mining or oil and gas company, many of which operate in questionable jurisdictions, haven’t already they should start to feel increasing pressure to start to pay attention to the corruption issues and put in place compliance programs and strategies for dealing with these issues.”

Companies engaged in the development of oil, natural gas, or minerals must disclose payment information annually by filing a new form with the SEC called Form SD. Any payments over $100,000 must be reported, and any series of related payments of $100,000 would be included.

Resource extraction issuers are required to comply with the new rules for fiscal years ending after Sept. 30, 2013.

Some companies, such as Barrick Gold Corp., say they already voluntary publish payments to governments.

The payments that must be reported now include taxes, royalties, bonuses, licence fees, dividends, and infrastructure improvements. One of the big concerns is that competitors who are not resource-extraction issuers — including state owned companies in the oil and gas industry from China and other countries — will have access to this information and glean information on strategies and profitability that they don’t have to disclose.

“If you think about it, you are making public some pretty sensitive information,” says Boscariol.

However, he concedes there is an equally strong argument for this kind of disclosure. It informs investors in these companies about the company’s exposure in developing countries as far as payments like this are concerned.

“One of the SEC commissioners who voted in favour of it said, ‘Sunlight is the best disinfectant.’ Shedding light on these things presumably brings an end to them. Like with conflict minerals, it’s all about disclosure. Through that process it may change behaviours,” he says.

There are also some concerns about changes to the payment-reporting rule as originally proposed. One has to do with whether the information resource extraction issuers have to provide is “furnished or filed.” If furnished, it’s not subject to lawsuits that can be brought under s. 18 of the Securities Exchange Act of 1934 in the U.S., which are investor suits for misstatements in securities documents.

“The original proposed rule said it would be furnished but it was changed in the final rule to say it would be filed. That means it can be subject to investor lawsuits,” says Boscariol.

There are also concerns that some countries have laws prohibiting the disclosure of information concerning payments to governments.

“There has been talk about legal challenges to it so this story isn’t over yet,” he adds.

Kevin Cramer, a partner with Osler Hoskin & Harcourt LLP in New York, suggests in-house counsel review all contracts pertaining to payments to see if there are any prohibitions on disclosure on any of the mandated information.

“Hopefully all contracts have a provision saying: ‘Unless required by law I won’t reveal this information.’ If they don’t have that provision they may have to think about negotiating with host countries about what they are going to have to disclose going forward,” says Cramer.

On the same day, SEC regulations were also passed requiring mining companies to track the origin of “conflict minerals” if they operate in Africa, either in the Democratic Republic of Congo or in another country.

The rules around conflict minerals will affect issuers that file reports under s. 13(a) or 15(d) of the Securities Exchange Act, including foreign and Canadian issuers.

It’s a rule that doesn’t prohibit a company from sourcing from Africa, it just insists they disclose whether it’s sourced from the region.

“Sophisticated clients are in the process of implementing systems to ensure [conflict minerals] simply won’t be in there and they’re spending a lot of money to do so,” says Boscariol.

In an effort to put pressure on rebels in the Congo, the U.S. passed a law in 2010 requiring the SEC to write rules forcing companies to prove minerals they derived from Congo are “conflict free.”

Originally expected in April 2011, the rules have been delayed due to opposition from companies and industry groups, creating uncertainty that has led some companies to stop purchasing materials from Congo. Many mines in the Congo are being abandoned, even for ones that are not funding military action.

“A lot of critics said it would happen and I think that might be coming to the fore,” he says. “But I think as companies invest more into their systems eventually we will get to a position where with these particular minerals it may be difficult to proceed with manufacturing certain products without actually sourcing them from that area.”

Major electronic companies knew it was coming for a long time and were in the process of putting systems in place.

“It is extremely onerous, but I think because companies perceived it as coming it wasn’t as much of a hit,” says Boscariol.

An exemption was made for retailers who have their private label products sourced, the theory being they don’t have as much knowledge about the origin of the materials used in the final product. Some retailers lobbied heavily for the exemption.

“The challenge was looking at eight or 10 different levels of the supply chain and working your way back to where the smelter sourced the conflict mineral,” says Boscariol. “I think if you asked most companies they would say, ‘OK, we won’t source it from there.’ In a world where even compared to 10 years ago the supply chain is so international and so multi-level it is very difficult to work through those issues.”

Cramer suggests companies that will be required to report on conflict minerals start reviewing their contracts with suppliers to see if they should be modifying them to include specific provisions mandating disclosure of information that will allow a company to comply.

“I’d also want to be talking to my IT people and asking if any information systems need to be modified to gather this data. Systems will have to be programed to capture the right kind of data,” says Cramer.

In-house counsel may also want to look at updating any risk factor disclosures they have in place.

“They should ask: ‘Am I going to have to put in a risk factor that we may have difficulty obtaining supplies that are no from the DRC in sufficient quantities and at competitive prices.’ Or they may have to indicate they could experience shipping delays or cancellations of orders, or suffer reputational damage if it turns out that they are using conflict minerals in products,” says Cramer.

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