Corporate Social Responsibility and the Law : Foley Hoag LLP

A coalition of 80 institutional investors sent a letter to Congress last week in support of the Business Transparency on Trafficking and Slavery Act (HR 2759).  As discussed previously, the proposed legislation would require companies to disclose efforts to identify and address the risks of human trafficking, forced labor, slavery, and the worst forms of child labor in their supply chains.

Modeled after the California Transparency in Supply Chains Act, which went into effect on January 1, 2012, the proposed federal legislation, unlike the California statute, is not limited to retailers and manufacturers. If enacted, the legislation would be applicable to any publicly-traded or private company currently required to submit annual reports to the Securities and Exchange Commission ("SEC"), as long as the company meets an established annual gross receipts threshold. Companies would be required to include the required disclosures in their annual reports to the SEC.

In a letter sent to Speaker of the House John Boehner and House Majority Leader Eric Cantor, members of the Interfaith Center on Corporate Responsibility and U.S. SIF: The Forum for Sustainable and Responsible Investment called for HR 2759 to be placed at the top of the legislative agenda in order to move "this important legislation forward in an expeditious manner.”  In urging Congressional leaders to prioritize the bill, the investors stated that the proposed legislation

reflects the realities of the marketplace, which increasingly requires that companies be sensitive to social and ethical issues, including human rights, in their operations and global supply chains, and create human rights policies, as well as due diligence processes to evaluate, monitor, and strengthen these policies.

Notably, the investors’ statement also argued that the U.N Human Rights Council’s unanimous endorsement of the Guiding Principles on Business and Human Rights in June 2011 established “a global norm for the ‘corporate responsibility to respect’ human rights and underscores the importance of public reporting by companies.”

When it was introduced in August 2011, HR 2759 was referred to the House Committee on Financial Services and currently sits with the Subcommittee on Capital Markets and Government Sponsored Enterprises. Given the contentious climate on Capitol Hill, and the upcoming presidential election, it is unlikely that the bill will move in 2012, but its introduction is reflective of shifting expectations regarding the responsibilities of companies to identify and account for the adverse human rights impacts of their operations.

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This post, authored by Sarah A. Altschuller and Gwendolyn W. Jaramillo, was originally published, in excerpted form, by The Elm Consulting Group.

The U.S. Securities and Exchange Commission (“SEC”) failed to issue a final rule on conflict minerals regulations before the end of 2011, and companies still await clear guidance on the scope of Section 1502 and the nature of the relevant reporting requirements. In an announcement regarding "upcoming activity" related to the implementation of Dodd-Frank, the SEC has now indicated that the final rule for Section 1502 will be adopted between January and June 2012. Notably, the SEC’s announcement indicates that “this is an estimated timeline and may be subject to change.” The final rule was originally scheduled to be issued no later than April 15, 2011.

The Conflict Minerals Report Requirement

Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires companies that utilize tin, tungsten, tantalum, and gold to conduct and disclose due diligence on their supply chains in order to identify whether the those minerals originated in the Democratic Republic of Congo (“DRC”) or adjoining countries. If an issuer either determines that its conflict minerals originated in the DRC countries, or cannot conclude that the conflict minerals did not originate in the DRC countries, the issuer will be required to disclose this information in its annual report. The issuer must then furnish a Conflict Minerals Report (“CMR”) as an exhibit to the annual report, and must disclose the Internet address at which this exhibit is available.

The CMR must describe the due diligence that the issuer conducted on the source and chain of custody of its conflict minerals. Issuers will be required to describe: products that are not "DRC conflict free"; the country of origin of those conflict minerals; the facilities used to process those minerals; and efforts taken to locate the mine or source of the minerals with the greatest possible specificity.

The Reporting Timeframe

Section 1502 requires impacted issuers to submit their first disclosures regarding their first full fiscal year which begins after the promulgation of the final rule. With a final rule now delayed again, issuers currently subject to the legislation must evaluate how to prepare for the future disclosure requirements.

Looking ahead, and based on previous experience, it is most likely that the SEC will introduce a phased approach for disclosures, whereby certain initial disclosures will be required in the first reporting year that will need to be augmented in subsequent years. Many stakeholders have urged the SEC to adopt a phased approach in comments to the proposed regulations issued in December 2010.

Groups calling for a phased approach include the U.S. Chamber of Commerce, the National Association of Manufacturers, and the House Financial Services Committee. This could logically take the form of requiring larger issuers to fully comply in the first year following the issuance of the final rule, while giving smaller issuers the benefit of more time to comply. This approach has been used in several prior instances, including: the requirement for the inclusion of XBRL (eXtensible Business Reporting Language) data files in corporate filings; and the requirement, pursuant to Section 404 of the Sarbanes-Oxley Act, for an independent auditor’s report on the effectiveness of internal controls over financial reporting (although the requirement for smaller companies was eliminated by Dodd-Frank).

If the rule is issued in the next few months, issuers with fiscal years beginning in March/April or June/July would be required to issue their first reports in early to mid-2013. Issuers may fear being required to report on due diligence efforts undertaken during a time period unguided by final regulations, but that appears unlikely based on the language of Section 1502. That said, however, issuers with fiscal years beginning soon should be prepared to hit the ground running and ideally will have identified appropriate internal groups or departments who would be charged with collecting the required information in order to facilitate full compliance.

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On August 1, Rep. Carolyn Maloney (D-NY) introduced H.R. 2759, the Business Transparency on Trafficking and Slavery Act (.pdf), a bill modeled after the California Transparency in Supply Chains Act.  The bill would require companies to disclose efforts to identify and address the risks of human trafficking, forced labor, slavery, and the worst forms of child labor in their supply chains. 

The requirements of the California statute, which goes into effect on January 1, 2012, have been described in several previous posts.  Similar to the California legislation, the proposed federal legislation would only apply to companies with annual worldwide gross receipts exceeding one hundred million dollars.  Notably, however, the federal legislation is not limited to retailers and manufacturers.  If enacted, the legislation would be applicable to any publicly-traded or private company currently required to submit annual reports to the Securities and Exchange Commission ("SEC"), as long as the company meets the annual gross receipts threshold. 

Specifically, H.R. 2759 would require companies to include, in their annual reports to the SEC, disclosures describing to what extent, if any, they:

• Maintain policies to identify and eliminate risks of forced labor, slavery, human trafficking, and the worst forms of child labor within their supply chains;
• Maintain policies prohibiting the use of company products, facilities, or services to obtain or maintain conditions of forced labor, slavery, human trafficking, and the worst forms of child labor;
• Engage in verification of product supply chains to evaluate and address risks of forced labor, slavery, human trafficking, and the worst forms of child labor;
• Ensure that audits of suppliers are conducted, including specifications as to whether audits are independent and unannounced;
• Assess the supply chain management and procurement systems of suppliers to verify whether suppliers have appropriate systems in place to address risks of forced labor, slavery, human trafficking, and the worst forms of child labor within their own supply chains;
• Require suppliers to certify that materials incorporated into products comply with the laws regarding forced labor, slavery, human trafficking, and the worst forms of child labor in the country or countries in which they are doing business;
• Maintain internal accountability standards, supply chain management and procurement systems, and procedures for employees or contractors that fail to meet company standards regarding forced labor, slavery, human trafficking, and the worst forms of child labor;
• Provide training to employees and management on forced labor, slavery, human trafficking, and the worst forms of child labor;
• Ensure that recruitment practices of all suppliers comply with company standards for eliminating exploitive labor practices that contribute to forced labor, slavery, human trafficking, and the worst forms of child labor; and
• Ensure that remediation is provided to those who have been identified as victims of forced labor, slavery, human trafficking, and the worst forms of child labor.

The bill is co-sponsored by Rep. Christopher Smith (R-NJ), Rep. Jackie Speier (D-CA), and Rep. Jim McGovern (D-MA).  Rep. Maloney and Rep. Smith are co-chairs of the Congressional Human Trafficking Caucus.

While the ultimate passage of this proposed legislation is uncertain at best, given the current Congressional climate, the introduction of the bill reflects increased attention to the issue of human trafficking by public policy leaders.  Looking ahead, it is likely that legislative and regulatory efforts to eradicate human trafficking and other human rights abuses will involve provisions seeking to engage companies in addressing these concerns.  As noted in a recent article in Ethical Corporation magazine,

[n]ew efforts to combat human trafficking and slave labour have placed growing pressure on larger companies throughout the world to work towards eradicating trafficked and forced labour from their supply chains....Companies worldwide are being increasingly presed to become more transparent about their efforts to eliminate all formes of forced labour.

H.R. 2759 has been referred to the House Committee on Financial Services for further consideration.  We will be tracking the progress of this legislation closely.

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On July 22, the D.C. Circuit Court of Appeals vacated Exchange Act Rule 14a-11, the proxy access rule that was approved by the Securities and Exchange Commission ("SEC") in August 2010. The rule sought to provide certain shareholders with the right to nominate corporate directors and have those nominations appear in corporate proxy statements. The rule was originally expected to be effective in November 2010, but it was stayed pending a request for judicial review by the U.S. Chamber of Commerce and the Business Roundtable.

The D.C. Circuit held (.pdf) that the SEC "acted arbitrarily and capriciously" in failing to adequately assess the economic effects of the new rule, including the costs that companies may incur in opposing shareholder nominees. The Court specifically noted the likelihood that "institutional investors with special interests" such as "unions and state and local governments whose interest in jobs may well be greater than their interest in share value" might seek to utilize the rule. The Court found that "by ducking serious evaluation of the costs that could be imposed upon companies from use of the rule by shareholders representing special interests...the Commission acted arbitrarily."

A separate rule issued at the same time as the proxy access rule, Rule 14a-8(i)(8), was not impacted by the Court's decision. This rule limits corporate capacity to exclude shareholder proposals seeking revisions to a company’s procedural requirements for shareholder director nominations.

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The Securities and Exchange Commission ("SEC") has delayed the release of final rules applicable to companies that source "conflict minerals" from the Democratic Republic of Congo ("DRC") and adjoining countries. Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires companies that utilize tin, tungsten, tantalum, and gold to conduct and disclose due diligence on their supply chains in order to identify whether the sourcing of these minerals is supporting the ongoing conflict in the Democratic Republic of Congo.

In an announcement regarding "upcoming activity" related to the implementation of Dodd-Frank, the SEC has indicated that final rules for Section 1502 will be adopted between August and December 2011. Final rules were originally scheduled to be issued no later than April 15.

Even as the federal rules on conflict minerals have been delayed, companies impacted by Section 1502 should pay attention to recent legislative activity in California. On April 12, the California State Senate passed a bill that would prohibit the state government from doing business with companies that fail to comply with federal regulations on conflict minerals. The California legislation, even if passed, is unlikely to impact many companies: it would apply only to companies against which the SEC has filed a civil or administrative enforcement action. That said, California's legislative activity reflects significant stakeholder concern, as well as advocacy activity, regarding the ways in which the sourcing of specific minerals may be contributing to the ongoing conflict in the DRC.

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Transparency International and Revenue Watch have released a report, Promoting Revenue Transparency: 2011 Report on Oil and Gas Companies, that is indicative of the pressure being placed on extractive sector companies to report on their payments to host governments and the value-sharing stipulations in their contracts.

The report ranks 44 oil and gas companies – both publicly listed and national oil companies – in three different areas:

1. Reporting on anti-corruption programs - This section of the report looks at corporate policies and management systems, including whether information on such programs is available to the public;
2. Organizational disclosure - This section examines whether companies disclose their upstream project partners, subsidiaries, fields of operations, and accounting practices; and
3. Country-level disclosure - This section reviews whether companies report on: payments to governments; operating data, such as reserves and production; and data from profit-and-loss accounts – all on a country-by-country basis.

According to the report, companies have improved their performance in the first category, but score much lower in the third category. Companies such as BP, BG Group, and BHP Billiton scored high in the first two categories, but joined their peers’ lower rankings in the third category. Generally, publicly listed companies scored significantly better than national oil companies, with the exception of Statoil, a Norwegian state-owned company.

The report's focus on country-level data suggests that civil society will continue to push companies to reveal more disaggregated data on payments made at the country and project levels. Led by umbrella organization Publish What You Pay, civil society organizations have already successfully advocated for legally-mandated extractive sector reporting regarding payments to governments through the passage of Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Securities and Exchange Commission has yet to issue its final rules guiding the disclosures required by Section 1504, but it is likely that the reporting will be on a project basis, and by type of payment – such as taxes and royalties. These requirement are more specific than what is currently required by the Extractive Industries Transparency Initiative, a voluntary initiative in which many extractive sector companies participate.

Section 1504 has come under fire from a number of companies, including Royal Dutch Shell, whose CEO stated recently, “Dodd-Frank treats foreign governments not only as irrelevant, but as a problem and not a solution.” Meanwhile, civil society organizations are seeking to expand the requirements of Section 1504 to other jurisdictions - an initiative that received support from some European leaders. 

In January, French President Nicolas Sarkozy wrote to U2 rock star-activist Bono, stating “I have decided to ask the European Union to adopt as quickly as possible legislation forcing companies in the extractive sector to publish what they pay to host countries.” He has since reiterated this position. In February, the U.K. Finance Minister publicly supported a plan put forward by President Sarkozy for new E.U.-wide rules. Whether such rules are passed remains to be seen, but Section 1504 of the Dodd-Frank Act has already made it clear that the rules are changing, and that companies will be expected to be more transparent than ever before.

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Last week, Sarah Altschuller was interviewed on Capital Thinking, an internet radio program on VoiceAmerica Business Network. During the interview, she addressed several recent legal developments in the field of corporate social responsibility, including the Dodd-Frank provisions on conflict minerals and disclosure of payments to governments, as well as the California Transparency in Supply Chains Act. She also discussed the Draft Guiding Principles recently released by the U.N. Special Representative on Business and Human Rights. A podcast of the interview is available here (.mp3).

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The Securities and Exchange Commission ("SEC") has extended the time period for comments on proposed rules issued pursuant to Section 1502 (conflict minerals) and Section 1504 (disclosure of payments to governments) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The proposed rules are now open for comment until March 2, 2011.

The extension applies to rules proposed pursuant to:

• Section 1502 of the Dodd-Frank Act, which requires companies that utilize certain conflict minerals to conduct and disclose due diligence on their supply chains in order to identify whether the sourcing of these minerals is supporting the ongoing conflict in the Democratic Republic of Congo; and
• Section 1504, which lays out transparency provisions requiring oil, gas, mining, and other extractive industry companies to report their payments to governments to the SEC.

As stated by the SEC in the notices of extension (.pdf),

The nature of the proposed disclosure requirements differs from the disclosure traditionally required by the Exchange Act…The Commission believes that providing the public additional time to consider thoroughly the matters addressed by the release and to submit comprehensive responses to the release would benefit the Commission in its consideration of final rules. 

Many companies and industry groups had requested an extension of the comment period because of the new and complex issues raised by the proposed disclosure provisions.

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In previous posts, we have discussed the requirements and implications of Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (.pdf), which requires companies that utilize certain conflict minerals to conduct and disclose due diligence on their supply chains in order to identify whether the sourcing of these minerals is supporting the conflict in the Democratic Republic of Congo.  The Security and Exchange Commission released its proposed rule on conflict minerals in on December 15, 2010.  The rule is open for comment until January 31, 2011.

Recently, Sarah Altschuller, one of the attorneys in our CSR practice, recorded a podcast on the SEC's proposed conflict minerals rule for Compliance Week.  The podcast is available here.  Conflict minerals consist of columbite-tantalite (tantalum precursor), wolframite (tungsten precursor), cassiterite (tin precursor), and gold.  As noted in the podcast, these minerals are used in the production of automobiles, jet engines, computers, cell phones, jewelry, medical equipment and many other products, and the rule will thus affect a broad range of industries. 

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Looking back at 2010, there have been a number of significant legal developments in the field of corporate social responsibility.  New federal and state statutes have imposed due diligence requirements on companies with the specific intent of addressing human rights concerns, ranging from forced labor to the ongoing conflict in the Democratic Republic of Congo.  Courts continue to grapple with the potential scope of corporate liability under the Alien Tort Statute (“ATS”).  At the international level, the concept of the corporate “responsibility to respect” human rights continues to gain credence, at the same time as access to water was recognized as a human right by the United Nations.

As lawyers, we advise clients on developments in both “hard law” requirements and “soft law” expectations for companies in the area of human rights and social responsibility.  The intersection of what is required and what is expected of companies can present both challenges and opportunities.  In no specific order, here are five “big developments” that we think will impact corporations, and the expectations of corporate stakeholders, in 2011 and beyond.

• The SEC, Conflict Minerals, and Disclosure of Payments.  Buried in the Dodd-Frank financial reform legislation are two provisions that impose significant new disclosure requirements on companies.  Section 1502 requires companies that utilize certain conflict minerals to conduct and disclose due diligence on their supply chains in order to identify whether the sourcing of these minerals is supporting the conflict in the Democratic Republic of Congo.  Section 1504 requires companies in the extractive sector to report on taxes, royalties, fees, and other material benefits paid to foreign governments and the United States.  Compliance with these provisions will be a significant challenge for many companies.  In mid-December, the SEC released proposed rules pursuant to these two provisions, and final rules are expected to be in place by April 2011, although under the new Congress implementation of these rules may be delayed.

• Ruggie's Draft Guiding Principles.  The U.N. Special Representative on Business and Human Rights, John Ruggie, released his Draft Guiding Principles for the implementation of the three-part “Protect, Respect, and Remedy” framework first set forth in his 2008 report to the U.N. Human Rights Council.  Institutions ranging from the European Parliament to the OECD have already cited certain provisions of the framework, especially with regard to the corporate responsibility to respect human rights -- that is, not to infringe on rights -- and its central component of human rights due diligence.

• Water is a Human Right.  In July, the U.N. General Assembly declared access to safe water to be a human right.  In September, the U.N. Human Rights Council adopted a resolution recognizing access to clean water and sanitation as a fundamental human right, “equal to all other human rights” and capable of legal enforcement.  These developments came at the same time as increasing water scarcity is impacting communities, and companies, around the world.  Companies will likely find that stakeholders increasingly expect due diligence efforts, especially with regard to human rights impacts, to include assessments of corporate impacts on community water resources.

• The Second Circuit Declares that Companies are Not Proper Defendants Under the ATS.  In a controversial opinion, the Second Circuit Court of Appeals held in Kiobel v. Royal Dutch Petroleum that corporations cannot be properly sued under the ATS for violations of customary international law.  Already cited by other courts, and by many defendant briefs, this opinion, whether or not it is upheld, stands as one of the most significant ATS decisions to date.

• California Transparency in Supply Chains Act.  Retailers and manufacturers operating in California with global receipts in excess of $100 million will now be required to disclose what efforts they are taking, if any, to “evaluate and address” the risks of slavery and human trafficking in their supply chains.  This requirement applies to a wide range of companies, ranging from apparel companies that have grappled with concerns about their supply chains for many years, to companies in other sectors for which these due diligence requirements represent a new challenge.

As the New Year begins, we will continue to monitor these developments, and others, in the dynamic field of corporate social responsibility and the law.

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Yesterday, the Securities and Exchange Commission (“SEC”) posted proposed rules pursuant to Section 1502 (conflict minerals) and Section 1504 (disclosure of payments to governments) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

The proposed rules are open for comment until January 31, 2011.  Final rules will be issued no later than April 15, 2011.

We will be providing further analysis of both of these proposed rules.  Based on an initial review, key points include:

Section 1502 (Conflict Minerals)

• The proposed reporting requirements apply to all SEC issuers who file reports with the Commission, including foreign private issuers and smaller reporting companies, for which conflict minerals are "necessary to the functionality or production of a product manufactured" or contracted to be manufactured by such an issuer.  Conflict minerals consist of columbite-tantalite (tantalum), wolframite (tungsten), cassiterite (tin), and gold.  The rules apply even if only small amounts of such minerals are utilized. 
• If an issuer determines through a "reasonable country of origin inquiry" process that the conflict minerals it uses did not originate in the Democratic Republic of the Congo or adjoining countries ("DRC countries"), it will be required to disclose this determination in its annual 10-K report.  The annual report must also state what "reasonable country of origin inquiry" process the issuer undertook.  The issuer would be required to maintain records demonstrating that its conflict minerals did not originate in the DRC countries.
• If an issuer either determines that its conflict minerals originated in the DRC countries, or cannot conclude that they did not originate in the DRC countries, the issuer will be required to disclose this information in its annual report. The issuer must then furnish a Conflict Minerals Report as an exhibit to the annual report, and must disclose the Internet address at which this exhibit is available.
• The Conflict Minerals Report must describe the due diligence that the issuer conducted on the source and chain of custody of its conflict minerals.  Issuers will be required to describe: products that are not "DRC conflict free"; the country of origin of those conflict minerals; the facilities used to process those minerals; and efforts taken to locate the mine or source of the minerals with the greatest possible specificity.
• The Conflict Minerals Report must be audited by an independent private sector auditor. Issuers must identify the auditor and certify the audit. 
• Issuers will be required to provide their first disclosures after their first full fiscal year following the promulgation of the final rules.

Section 1504 (Disclosure of Payments by Resource Extraction Issuers)

• All U.S. and foreign companies engaged in the commercial development of oil, natural gas, or minerals that are required to file annual reports with the SEC are subject to the rule, regardless of size. Commercial development encompasses exploration, processing, export, and other “significant actions,” but does not include ancillary activities such as producing equipment utilized in commercial development or providing transport.
• Covered companies must report on taxes, royalties, fees, production entitlements, bonuses, and other material benefits paid to foreign government and the Federal Government that are not de miminis. The SEC does not plan to define "de minimis." These benefits can be in cash or in kind.
• Covered companies must report the type and total amount of payments made to a government for each project. The SEC does not propose to define the term "project."
• Covered companies must report on such payments made by subsidiaries or entities under their control, where the definition of control is taken from existing securities law.
• Covered companies must disclose a brief statement of this information in their annual 10-K reports, which refers investors to detailed information provided in two exhibits that would be furnished to the SEC as part of the 10-K. One of the two exhibits would include information in XBRL format, an interactive data format.
• Disclosure will be required in annual reports relating to fiscal years ending on or after April 15, 2012.

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CDP Water Disclosure, a program of the Carbon Disclosure Project, released its first water disclosure report (.pdf) last week.  The report summarizes the results of a survey of 302 companies from 34 countries regarding their water use and their management of water-related risks.  The findings highlight the degree to which water-related challenges are capturing the attention of a wide range of corporate stakeholders.

Of the 150 companies that responded to CDP’s questionnaire: 67% reported that responsibility for water-related issues lies at the Board or Executive Committee level; 89% have developed specific water policies, strategies, and plans; and 60% stated they have established water-related performance targets.

As companies evaluate approaches to water management, they must confront a wide range of operational, reputational, regulatory, and legal risks, including:

• scaled-back production or production interruptions due to water shortages in water-stressed areas;
• community opposition as a result of a company’s real or perceived impacts on local watersheds, and the potential loss of a social license to operate;
• regulatory changes leading to changes in available supply and/or higher costs; and
• litigation stemming from disputes regarding corporate usage of, and impacts on, local watersheds.

Notably, 96% of the respondents to CDP's questionnaire were able to identify water-related risks in their own operations, while only 53% were able to identify such risks in their supply chains.  This is surprising given the potential impact of supply chain concerns.  A 2008 report by JPMorgan Global Environmental, Social, and Governance Research found that the risks associated with water scarcity “may actually be greater in companies’ supply chains than in their own operations.”

As companies identify the water-related risks specific to their operations, the information they gather will increasingly inform dialogues with two distinct groups of stakeholders: investors and the communities living in the vicinity of company facilities. 

Continue Reading...

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On October 4, the Securities and Exchange Commission ("SEC") granted a stay of the new proxy access rules that are intended to allow certain shareholders to: (1) nominate directors and have those nominations included in corporate proxy materials; and (2) propose amendments to corporate procedural requirements for shareholder director nominations.  The proxy access rules, adopted in August, had been scheduled to go into effect on November 15, 2010.  A request for a stay was filed by the U.S. Chamber of Commerce and the Business Roundtable after these organizations sought judicial review of the rules before the D.C. Circuit Court of Appeals.

At the time the SEC announced that it was exercising its discretion to issue the stay, SEC spokesman John Nester stated that, because the business groups had sought expedited judicial review, "it is our expectation that the legal issues will be resolved by late spring."  Even assuming that the rules are upheld, given the time that will likely be required for judicial review, it is unlikely that the new rules will be a significant factor in the upcoming proxy season. 

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The Securities and Exchange Commission ("SEC") published Rule 14a-11 today in the Federal Register (.pdf).  As discussed in our September 7 post below, this Rule provides for proxy access to certain long-term shareholders, including socially responsible investment funds and pension funds.  The rule is effective 60 days after being published in the Federal Register, or November 15, 2010.

Taking into account the uniform 120 day advanced notice deadline, any issuer whose one year anniversary for mailing date is prior to March 15, 2011 will not be subject to a proxy access campaign in 2011.  Application of the new access rules to the smallest public companies ("smaller reporting companies" under SEC rules) will be deferred for three years from the effective date.

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On August 25, the Securities and Exchange Commission (“SEC”) passed a new proxy access rule that will provide certain shareholders with the right to nominate corporate directors and have those nominations appear in corporate proxy statements.  Shareholder advocates have advocated for a federal proxy access rule for nearly thirty years.  A draft rule was published in June 2009, and the recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act (.pdf) confirmed the SEC's authority to issue the new rule.

Specific provisions of new Exchange Act Rule 14a-11 include:

• A shareholder or shareholder group must have held at least 3 percent of a company’s shares continuously for at least three years in order to nominate a director, or directors. 
• Shareholders may nominate up to 25 percent of a company’s directors.  If the board includes less than eight directors, only one director may be nominated.
• Companies with less than $75 million in market capitalization are exempted from the rule for at least three years.
• Shareholders may not utilize the new proxy access rule if they are doing so with the purpose or effect of changing control of the company.
•  The rule impacts all Exchange Act reporting companies, including investment companies.  Companies whose only public securities are debt securities and foreign private issuers are not subject to the new rule. 

For certain companies, depending upon the mailing date of their last proxy statement, the new proxy access rule will impact the 2011 proxy season.  The new rule will go into effect 60 days after publication in the Federal Register (expected soon).  Shareholders must submit nominees no later than 120 days before the anniversary date of the mailing of a company’s proxy statement from the previous year.

Significantly, in addition to the new Rule 14a-11, the SEC also amended Rule 14a-8(i)(8) to limit corporate capacity to exclude shareholder proposals seeking revisions to a company’s procedural requirements for shareholder director nominations. 

Without a doubt, the 3 percent ownership threshold represents a significant hurdle to shareholders and is a strong counter-argument to the assertion that the new rules will allow director nominations to be “hijacked” by special interests.  That said, the new rules provide shareholders with significant new tools for use in engaging companies and pushing for changes in corporate management and operations.  Groups seeking to take advantage of the new proxy access rule will likely represent broad coalitions of shareholders concerned with issues ranging from corporate governance to the management of social and environmental concerns.  Even if these shareholders are unsuccessful in achieving the necessary ownership threshold, they will likely be able to use the new proxy access rule as an additional basis for the initiation of dialogue with corporate management regarding issues of concern. 

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The Dodd-Frank Wall Street Reform and Consumer Protection Act (.pdf), signed into law by President Obama on July 21, contains provisions requiring publicly traded companies that utilize certain "conflict minerals" to report regarding whether their products are “conflict free” – meaning that they should report on any due diligence steps taken to demonstrate that their products are not fueling conflict in the Democratic Republic of Congo ("DRC"). The legislation does not prohibit companies from using minerals from conflict areas. Rather, it relies on the reputational effects of public reporting to push companies to rely on conflict free sources. Human rights organizations believe that the sale of conflict minerals -- tantalum (coltan), cassiterite (tin), wolframite (tungsten), and gold – helps armed groups fund the purchase of weapons and the continuation of hostilities in the DRC.

For over a year, civil society has pushed the U.S. Congress to implement these provisions (.pdf) as an attempt to address the ongoing conflict in the eastern DRC, and have used a variety of means, including viral videos, to focus the public's attention on this issue. 

The minerals in question are commonly utilized in a variety of commercial products, such as automobiles, cellular phones, and airplane engines. The legislation therefore affects a large spectrum of industries, including mining, automotive, aerospace, and jewelry. The aim of the legislation is not to ban the use of these minerals if they originate from the DRC, but rather to ensure that the minerals do not come from conflict areas of the DRC or otherwise help fund the conflict. Given the due diligence that may be necessary to decisively demonstrate that products are conflict free, some have argued that the legislation will unintentionally create a de facto ban on minerals from the DRC and neighboring countries. On the other hand, if the SEC provides appropriate guidance, the legislation is likely to offer a clearer path for companies to demonstrate that they are not supporting conflict in the DRC.

Requirements imposed by the legislation include:

• A company that uses conflict minerals must produce an annual disclosure to the Securities and Exchange Commission ("SEC") if the minerals are "necessary to the functionality or production of a product" manufactured by the company. The company must also report on its public website.
• The annual disclosure must state whether the conflict minerals originated in the DRC or an adjoining country (including Angola, Burundi, Central African Republic, Republic of Congo, Rwanda, Sudan, Tanzania, Uganda, and Zambia).
• If the minerals used by a company originate in the DRC or an adjoining country, the company must report on the due diligence measures that it took regarding the source and chain of custody of those minerals. These measures are expected to include an audit by an independent professional audit company.
• Companies must also submit a description of any products manufactured by the company that are not "DRC conflict free." Products are conflict free if they do not contain minerals that directly or indirectly finance or benefit armed groups in the DRC or an adjoining country. Products are considered to benefit such groups if they come from areas where armed groups physically control mines or force civilians to mine, transport, or sell conflict minerals; tax, extort, or control any part of trade routes for the minerals up to the point of export; or tax, extort, or control trading facilities, in whole or in part.

Unfortunately, many key aspects of the legislation remain uncertain at this time. It is not clear exactly which companies will be required to produce reports.   In addition, it is not clear whether the information must be in companies’ 10-Ks or can be contained in other reports, although it is likely that penalties associated with fraud or deceit in SEC reporting will apply. Finally, it is not certain what it means for a mineral to be "necessary to the functionality or production of a product.” The SEC's 270-day rulemaking process should provide greater clarity for many companies.

The legislation is likely to affect all levels of the supply chain for these minerals. At this time, companies that utilize the named minerals should consider how they will demonstrate that they conducted due diligence to ensure that the mines from which their minerals come, as well as the routes and trading depots through which the minerals came, are conflict free. For end-user companies, this will mean ensuring, at a minimum, that smelters have robust due diligence processes on the ground and providing for an independent audit of those due diligence processes.

The legislation allows the U.S. State Department to expand the list of minerals that fuel conflict in the DRC, which would potentially affect a larger number of companies. The legislation currently covers the minerals that human rights organizations believe are primarily funding the conflict, so the expansion of the list seems unlikely unless a new mineral begins to be sourced from the eastern DRC in significant quantities.  

Under the legislation, the Department of Commerce can designate specific independent private sector auditors and due diligence processes as “unreliable.” If, in its reporting, a company relies on a determination of an independent audit or other due diligence process that is deemed unreliable, the report does not satisfy the SEC reporting requirement. Therefore, it is particularly important that due diligence processes are robust.

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The Dodd-Frank Wall Street Reform and Consumer Protection Act (.pdf), signed into law by President Obama on July 21, contains broad-reaching transparency provisions requiring oil, gas, mining, and other extractive industry companies to report their payments to governments to the Securities Exchange Commission (“SEC”).

The premise of the bill is that transparency, in the long run, supports human rights, and helps limit corruption in countries where few benefits from mineral wealth typically reach the general population.

Key elements of the legislation include:

• Companies that are securities issuers under U.S. law must report annually to the SEC on their payments, as well as those of their subsidiaries and entities under their control, to the U.S. and foreign governments. The law does not exempt foreign issuers, and it is likely that the legislation will cover many issuers of ADRs, as well. The legislation does not specify whether the annual report must be the company’s 10K or another form of reporting, leaving this decision to the SEC rule-making process. It is likely that the penalties related to fraudulent or deceptive reporting to the SEC will apply. 
• Companies must report on the type and total amount of payments made on a project basis to both the U.S. and foreign governments. It is unclear whether companies must report on projects for which they do not serve as the operator, nor hold a majority interest in the project. 
• The payments that companies must report include taxes, royalties, fees, production entitlements, bonuses, and other material benefits, to the extent that the SEC determines that these are part of the commonly recognized revenue stream for extractive projects. Payments do not include de minimis payments. The SEC rulemaking process should help clarify the extent to which this information must be disaggregated. 

The legislation covers most, but not all, major multinational companies, but likely does not encompass a number of state-owned companies that are primarily active in their own jurisdictions and have no presence in the United States. The SEC rule-making process will help determine whether contractors and service providers must comply with the legislation.

The legislation is intended to reinforce the Extractive Industries Transparency Initiative, which is a multi-stakeholder initiative consisting of oil, gas, and mining companies; civil society; and governments. Under the Extractive Industries Transparency Initiative, many U.S. companies already report their payments to some, although not all, governments around the world. The bill may require the reporting of more detailed payment information than the Extractive Industries Transparency Initiative demands, depending on the SEC’s interpretation of the legislation. 

The SEC’s rulemaking process will help define more clearly how companies will need to change their accounting practices. For instance, the SEC will presumably define a de minimis payment. Companies are advised to monitor the SEC’s rulemaking process closely.

 

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