01.16.2013 Preparing for the 2013 SEC Periodic Reporting and Proxy Season



As management and the boards of public companies prepare for the challenges of 2013, there are several proxy advisory, corporate governance and securities law developments that should be considered and addressed by those companies and their counsel. The key changes for 2013 are summarized below.


1.  ISS Voting Policy Revisions for 2013


On November 16, 2012, the influential proxy advisory firm Institutional Shareholder Services (“ISS”) published its voting policy updates applicable to shareholder meetings occurring on or after February 1, 2013.  The most significant changes to the voting policies relate to executive compensation matters, board responsiveness to majority-supported shareholder proposals, director “overboarding” and the treatment of hedging and pledging of company stock. In addition, ISS made changes to voting policies relating to shareholder proposals on social and environmental issues and corporate political spending. 


Executive Compensation.  For 2013, ISS has made the following changes to its voting policies relating to executive compensation:

  • Peer Group Selection.  The methodology that ISS uses to select a peer group has been changed so that there will be a closer alignment between a company’s self-selected peer group, as disclosed in the proxy statement, and the ISS peer group constructed to analyze executive compensation.  Under the 2013 methodology, ISS expects that the average company will have more than 80% of peer group selections drawn from the company’s eight-digit GICS code (to identify peers that are closely related to the company’s specific industry) and the eight-digit GICS code of the company’s self-selected peers, rather than the previous method which drew only 40% of peers from the company’s eight-digit GICS code and resulted in 12% of ISS peer groups containing companies selected from a more general two-digit GICS code. Industry profile, comparable size and market capitalization remain important factors in peer selection. In addition, the ISS methodology will prefer peers that maintain the company near the median of the peer group, are in the company’s peer group and have chosen the company as a peer. ISS expects that the average ISS peer group in 2013 will be generally comprised of 14 to 24 companies and contain 44% of a company’s self-selected peers.
  • Realizable Pay.  In 2012, ISS was subject to criticism by some companies for issuing “against” recommendations on executive compensation based on an analysis of CEO pay that allocated the full grant date value of long-term incentive awards to the year of grant. The concern was that the ISS methodology overstated CEO compensation because the grant date value of the awards may be significantly different than the value actually realized by the executive. Some companies receiving adverse ISS recommendations in 2012 made supplementary filings disclosing “realizable pay” using various assumptions.  For the 2013 proxy season, ISS will consider realizable pay in its proxy recommendations, but only for “large-cap” companies.  Realizable pay will consist of the sum of relevant cash and equity-based grants and awards made during the performance period being measured.  Equity award values for actual earned awards and target values for ongoing awards will be calculated using the stock price at the end of the performance measurement period.  Stock options and SARs will be revalued using the remaining term of the award and updated assumptions using a Black-Scholes option pricing model.
  • Severance/Golden Parachutes.   In connection with the separate non-binding vote to approve executive golden parachute compensation in the context of a proxy statement for a merger or acquisition transaction, ISS has changed its voting policy for 2013 to include a review of problematic pay practices in all existing change-in-control compensation arrangements rather than basing its analysis on new agreements or new provisions of existing arrangements.  Under the ISS policy in 2012, problematic severance practices in existing arrangements, such as single trigger cash severance or excise tax gross-ups, were grandfathered and therefore not considered in the ISS analysis and voting recommendation related to the parachute compensation disclosed in the transaction proxy statement.  For 2013, all of the company’s existing arrangements will be considered in making a voting recommendation on parachute compensation, and the presence of multiple problematic arrangements could result in a negative recommendation from ISS.  In cases where the golden parachute vote is incorporated into a company’s periodic advisory vote on executive compensation (management “say-on-pay” proposals), ISS will evaluate existing severance or parachute arrangements in accordance with the new policy guidelines as part of its analysis of the say-on-pay proposal.  Although not expressly set out in the 2013 guidelines, the new policy should not apply to management say-on-pay proposals where the company is not seeking approval of parachute payments as part of the proposal.
  • Linking Executive Compensation to Environmental and Social Criteria. ISS policy has been to recommend a vote “against” shareholder proposals that seek to link executive compensation to environmental and social criteria such as corporate downsizing, customer or employee satisfaction, community involvement, human rights or environmental performance. For 2013, ISS has replaced its automatic “against” recommendation with a case-by-case analysis.  The new policy now refers to “sustainability” (a broader and less precise term) in place of “environmental and social” criteria, but apparently without an intended change in meaning or scope of the policy.  ISS noted that the incorporation of sustainability-related (i.e., environmental and social) non-financial performance metrics into executive compensation is becoming commonplace in certain industry sectors, specifically the extractive industry sector.

Board Responsiveness to Majority-Supported Shareholder Proposals.  For 2013, ISS has changed its voting policy relating to a board’s response to shareholder proposals that received majority support in prior years.  Previously, ISS would recommend an “against” or “withhold” vote from an entire board of directors if the board failed to act on a shareholder proposal that received (i) the support of a majority of the shares outstanding the previous year or (ii) a majority of the votes cast in the last year and one of the two previous years.  The 2013 voting policy eliminates the “shares outstanding” threshold for triggering an ISS recommendation and changes the “votes cast” threshold to a majority of the votes cast at a single meeting.  Thus, if a shareholder proposal receives a majority of the votes cast at the 2013 meeting, ISS will be evaluating the company’s response to that shareholder proposal for purposes of deciding whether to recommend “against” or “withhold” votes with respect to the board in connection with the 2014 meeting.  However, for purposes of issuing voting recommendations for the 2013 meeting, ISS will apply the prior policy to determine whether a shareholder proposal received majority support. 


In addition, the 2013 voting policies permit ISS to recommend “against” or “withhold” votes against individual members of the board rather than the full board of directors and provides guidance on ISS’s evaluation of the board’s responsiveness to a majority-supported shareholder proposal.  Specifically, ISS has indicated that a proper company response to a majority-supported shareholder proposal will mean fully implementing the proposal or, if the matter requires a shareholder vote, including a management proposal at the next annual meeting that will lead to full implementation of the proposal.  If a company does not fully implement a majority-supported shareholder proposal, ISS will evaluate the company’s response on a case-by-case basis taking into account various factors, including the subject matter of the proposal, the level of shareholder support for the proposal, shareholder engagement by the company with respect to the proposal and other factors ISS deems appropriate. 


Hedging and Pledging of Company Stock.  For 2013, ISS will consider the hedging and pledging of company stock by directors or officers as part of its evaluation of the board’s risk oversight and fiduciary responsibilities.  The 2013 policy update now includes hedging or significant pledging of company stock by directors or officers to be examples of risk oversight failures that could lead to an “against” or “withhold” recommendation with respect to individual directors, committee members or the entire board of directors.  In its 2013 policy update, ISS indicated that any amount of current or future hedging will be considered a problematic practice warranting a negative voting recommendation.  With respect to the current or future pledging of a “significant” amount of company stock, ISS will consider whether the company’s proxy statement discloses:

  • the presence of an anti-pledging policy that prohibits future pledging activity;
  • the aggregate amount of pledged shares in relation to total common shares outstanding, market value or  trading volume;
  • the company’s efforts to reduce the amount of aggregate pledged shares over time;
  • that shares subject to director and officer stock ownership and holding requirements do not include pledged shares; and
  • other factors that ISS considers relevant.

Overboarded Directors.  ISS will continue to recommend “against” or “withhold” votes for “overboarded” directors, i.e., directors that sit on more than six public company boards or who are CEOs of a public company and sit on the boards of more than two public companies besides their own. However, for 2013, ISS has changed how it counts subsidiary boards of a public company.  Under the previous policy, any publicly traded subsidiary owned 20% or more by the parent company was counted as one board with the parent company rather than as a separate board for purposes of the overboarding policy.  Under the voting policy for 2013, ISS will count all subsidiaries as a separate board. However, ISS will not recommend a withhold vote from the CEO of a parent company board or any of the controlled (greater than 50% ownership) subsidiaries of that parent, but will do so at subsidiaries that are less than 50% controlled by the parent company and boards outside the parent-subsidiary relationship.    Subsidiaries with only publicly traded debt will not count as a separate board for purposes of the ISS policy.  ISS stated that it intends to continue its existing policy of not counting service by directors on the boards of nonprofit organizations, universities, advisory boards or private companies.


Social and Environmental Shareholder Proposals.  For 2013, ISS revised its voting policy to provide that the overarching principle for evaluating social and environmental shareholder proposals is whether the proposal is likely to enhance or protect shareholder value in either the short-term or long-term.  ISS will continue to take a case-by-case approach.  ISS noted in its 2013 policy updates that issues covered under the policy include a wide range of topics, including consumer and product safety, environment and energy, labor standards and human rights, work place and board diversity, and corporate political issues.


Political Spending/Lobbying Activities.  ISS expects a large number of shareholder proposals to be submitted in 2013 relating to political contributions.  For those shareholder proposals seeking public disclosure of information about a company’s political spending or lobbying activities, ISS has retained its case-by-case approach for 2013 but has clarified that lobbying includes “indirect” lobbying as well as direct and grassroots lobbying. According to the 2012 CPA-Zicklin Index of Corporate Political Accountability and Disclosure study, there has been an increased level of voluntary public disclosure of political spending by the largest 196 public companies in the S&P 500 through September 2012.  Political spending in the CPA-Zicklin Index included direct political spending, payments to trade associations, ballot initiative contributions, direct independent expenditures and contributions to Section 501(c)(4) organizations. The SEC has indicated publicly that it is considering mandatory disclosure rules relating to political spending, and it is expected that the SEC will issue a notice of proposed rulemaking on this topic by April 2013.


2.  Other Institutional Investor Concerns for 2013


“Say-On-Pay” Vote.   Executive compensation will continue to be an issue for institutional investors in 2013.  The number of failed (less than 50%) say-on-pay votes increased in 2012 as compared to 2011 and was largely due to negative recommendations by proxy advisors based on a perceived disconnect between executive pay and corporate performance. To avoid negative recommendations, companies increasingly are becoming more proactive in meaningful shareholder engagement and more descriptive in CD&A disclosures to explain the connection between pay and performance.  Companies also are seeking to enhance relationships with proxy advisory firms to avoid adverse voting recommendations or to challenge an adverse voting recommendation prior to the vote.  In addition, smaller reporting companies, as defined in Exchange Act Rule 12b-2, will be required to have their first say-on-pay and say-on-frequency votes for annual or other shareholder meetings held on or after January 21, 2013.


Majority Voting for Directors.  Institutional investors will continue to focus on majority voting for directors in 2013 after the success of majority voting shareholder proposals in 2012, which received an average favorable vote of over 60% from S&P 1500 companies.  Institutional investors seek majority voting with a specific resignation requirement in a company’s bylaws, and not just a plurality plus resignation policy adopted by the board of directors. The Council for Institutional Investors reported in October 2012 that more than 70% of S&P 500 companies have adopted majority voting in uncontested elections of directors, but the majority of all U.S. public companies still employ plurality voting. The CII has sent letters to the American Bar Association and Delaware Bar Association proposing changes to state corporation law that would require public companies to adopt majority voting for directors.


Declassification of the Board.  Shareholder rights advocates have continued to submit proposals to selected S&P 500 companies seeking to repeal classified board structures and move to annual elections of directors.  Shareholder proposals to declassify the board received strong support in 2012. Companies that have received declassification proposals for voting at their 2013 annual meetings include, among others, Best Buy Co., BorgWarner Inc., Marathon Petroleum Corporation and Moody’s Corporation.


Proxy Access.   As a result of amendments to SEC Rule 14a-8, shareholders could for the first time in 2012 submit proposals relating to director election and nomination procedures that would permit inclusion of shareholder-nominated directors in a company’s proxy materials for shareholder meetings at which directors are to be elected. There were approximately two dozen proxy access proposals submitted to S&P 500 companies in the 2012 proxy season with share ownership thresholds ranging from one percent (1%) to three percent (3%) of the outstanding shares entitled to vote at the meeting. Of the submitted proposals, only 13 proposals came to a vote, including seven binding proposals, and ISS supported only six proposals. The proposals that received significant support (two of which received more than 50% of the vote) contained a threshold eligibility requirement that shareholders own at least three percent (3%) of the outstanding shares entitled to vote at the meeting and have held those shares for a period of at least three years. For the 2013 proxy season, ISS has stated that it expects fewer proxy access proposals to be submitted by shareholders.  However, in response to a shareholder proposal in 2012, Hewlett-Packard is expected to propose a bylaw amendment in 2013 to permit proxy access that would likely contain a three percent-three year eligibility threshold. At this early stage in the development of proxy access, it is unclear what effect Hewlett-Packard’s 2013 management proposal and the shareholder proposal outcomes of 2012 will have on the “private ordering” of proxy access.


Independent Chairman of the Board.  Shareholder proposals relating to the separation of the positions of CEO and Chairman of the Board remain popular in terms of the number of proposals, although average shareholder support in 2012 is reported to have been only 36% for S&P 1500 companies.  Shareholder support for an independent chair proposal may be lessened where the company has strong corporate governance practices and an independent lead director with a defined set of responsibilities that meets ISS guidelines or in cases where the company agrees to separate the CEO and Chairman positions upon election of a new CEO. ISS expects more than 50 proposals relating to an independent chair to be submitted in 2013.


3.  Compensation Committee Independence; Consultant Conflicts of Interest


On January 11, 2013, the SEC approved new listing standards for public companies listed on the NYSE and NASDAQ (other than smaller reporting companies) that will require:

  • compensation committee consideration of new independence and conflicts of interest factors prior to engaging a compensation consultant or adviser; and
  • heightened independence standards for compensation committee members.

In addition, the listing standards for NASDAQ companies contain new requirements relating to the composition and governance of compensation committees.


Consultant/Adviser IndependenceThe new listing standards require compensation committees to consider the six independence factors set out in SEC Rule 10C-1 before hiring a consultant or adviser (other than in-house legal counsel), unless the role of the consultant or adviser is limited to (i) consulting on broad-based employee benefit plans that are generally available to salaried employees and that do not discriminate in favor of executive officers or directors of the listed company or (ii) providing information that is not customized for the listed company or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.  The six independence factors that must be considered by compensation committees are:

  • the provision of other services to the listed company by the person that employs the adviser;
  • the amount of fees received from the listed company by the adviser’s employer, as a percentage of the total revenue of the employer;
  • the policies and procedures of the adviser’s employer that are designed to prevent conflicts of interest;
  • any business or personal relationship of the adviser with a member of the compensation committee;
  • any stock of the listed company owned by the adviser; and
  • any business or personal relationship of the adviser or the adviser’s employer with an executive officer of the listed company.

A compensation committee may select or receive advice from a consultant or adviser that is not independent after considering the foregoing six factors. The new NYSE and NASDAQ listing standards relating to consultant and adviser independence are scheduled to become effective on July 1, 2013.


Director Independence.  The new listing standards also add two new director independence factors that must be considered by the listed company’s board of directors in connection with appointments to the board’s compensation committee. These factors are in addition to the independence factors currently required by the applicable exchange.  The two new factors are: (i) the source of compensation paid to a director, including any consulting, advisory or other compensatory fee paid by the listed company to the director, and (ii) any affiliation of the director with the listed company, a subsidiary of the listed company or an affiliate of a subsidiary of a listed company.  These listing standards are scheduled to become effective for NYSE and NASDAQ listed companies on the earlier of (i) the listed company’s first annual meeting after January 15, 2014 or (ii) October 31, 2014.


New NASDAQ Compensation Committee Requirements. For the first time, NASDAQ will require listed companies to have an entirely independent compensation committee composed of at least two directors.  In addition, the compensation committee will be required to have a written charter.  Except for smaller reporting companies, the charter must contain, among other things, the authority to retain and fund consultants and advisers and the responsibility to consider the independence of consultants and advisers.  Companies listed on NASDAQ are expected to be in compliance with the new requirements on the earlier of (i) the listed company’s first annual meeting after January 15, 2014 or (ii) October 31, 2014.


Proxy Disclosure of Consultant Conflicts. Beginning with the 2013 proxy season, public companies will be required by SEC rules to assess whether any conflicts of interest are raised by the work of compensation consultants that are involved in determining or recommending executive or director compensation and, if so, to make disclosure in the proxy statement of any such conflicts of interest and the steps that the company took to address those conflicts.  The new disclosure requirement applies to compensation consultants retained by either the compensation committee or management, and includes consultants advising on director compensation.  In each case the company will need to conduct a conflict of interest assessment that includes information obtained from the company’s compensation consultants and considers the six factors set forth in new SEC Rule 10C-1 relating to the independence of compensation advisers.  In addition to collecting information from compensation consultants, companies will need to update their D&O questionnaires for 2013 to obtain information from directors and executive officers regarding any business or personal relationships with compensation consultants.


4.  SEC Staff Review and Comments on Periodic Reports


Based on public comments by the SEC Staff in November 2012, the following items appear to be of interest to the Staff in their review of periodic reports for 2013: 

  • the use of non-GAAP financial measures, including the recent trend of companies providing non-GAAP financial measures relating to pension expense;
  • the sufficiency of loss contingency disclosure under FAS 5 (FASB ASC 450), even though the FASB has discontinued its FAS 5 rulemaking project;
  • published materials outside of the four corners of the filing, including company websites, articles, analyst conferences, officer comments, Facebook and Twitter;
  • disclosure of performance targets and performance measures in connection with executive compensation arrangements;
  • a company’s disclosure and risk factors relating to holdings of sovereign debt (CF Disclosure Guidance Topic No. 4);
  • disclosure regarding significant foreign sales and the impact, if any, that macroeconomic factors (such as recessions in parts of the global economy) may have on the company; and
  • any inconsistencies between one section of a report that discloses significant amounts of cash held offshore that are available for operations and dividends, and one or more sections of the same report disclosing that such cash is located permanently offshore to avoid taxation in the U.S.

The SEC Staff also is reviewing the sufficiency of disclosure regarding debt covenants in circumstances where there is a breach, or risk of breach, of those covenants.  The SEC’s 2003 MD&A interpretive release (SEC Release No. 33-8350) sets out the Staff’s guidance on disclosure of debt covenants.  In recent public comments the SEC Staff has pointed to the 2003 MD&A guidance and reminded companies that if a debt covenant has been breached, or is reasonably likely to be breached, then the SEC Staff expects the company to describe:

  • the debt covenants in detail, including quantification of the covenants (such as ratios);
  • the consequences of any breach;
  • what the company is doing about seeking a waiver or avoiding the breach;
  • the collateral impact of the breach, such as cross-defaults and cross acceleration with respect to other debt;
  • the effects of a breach on the company’s liquidity and cash resources;
  • any negative consequences of the breach with respect to obtaining alternative debt; and
  • any material adverse impact on the company’s ability to pay dividends.

Finally, the SEC Staff has noted that it is reviewing cybersecurity disclosure in response to the views of the SEC’s Division of Corporation Finance set out in its October 2011 guidance (CF Disclosure Guidance Topic No. 2).  The SEC Staff reminded companies of the various disclosure obligations that may arise in this context, including risk factor and MD&A disclosure. However, the Staff reiterated that public companies are not required to provide a “road map” for potential hackers in their public filings. The Staff  also indicated that the U.S. government (other than the SEC) may be interested in and may review the cybersecurity disclosures of public companies.


5.  New PCAOB Auditing Standard Approved


On December 17, 2012, the SEC approved Auditing Standard No. 16, “Communications with Audit Committees,” proposed by the Public Company Accounting Oversight Board (“PCAOB”).  In the adopting Release, the SEC noted that the new standard retains or enhances existing audit committee communication requirements and adds new communication requirements that are generally linked to performance requirements set forth in other PCAOB auditing standards.


Specifically, Auditing Standard No. 16 requires auditors to communicate, among other things, the following to audit committees:

  • certain matters regarding the company’s accounting policies, practices and estimates consistent with Rule 2-07 of Regulation S-X;
  • the auditor’s evaluation of the quality of the company’s financial reporting;
  • information related to significant unusual transactions, including the business rationale for such transactions;
  • an overview of the overall audit strategy, including timing of the audit, significant risks the auditor identified, and significant changes to the planned audit strategy or identified risks;
  • information about the nature and extent of specialized skill or knowledge needed in the audit, the extent of the planned use of internal auditors, company personnel or other third parties, and other independent public accounting firms, or other persons not employed by the auditor that are involved in the audit;
  • difficult or contentious matters for which the auditor consulted outside the engagement team;
  • the auditor’s evaluation of going concern;
  • expected departures from the auditor’s standard report; and
  • other matters arising from the audit that are significant to the oversight of the company’s financial reporting process, including complaints or concerns regarding accounting or auditing matters that have come to the auditor’s attention during the audit.

In addition, the new standard requires the auditor to establish an understanding of the terms of the audit engagement with the audit committee and record the terms of the engagement in an engagement letter that is executed by the company and acknowledged and agreed to by the audit committee.  Although auditors retain the option to communicate with audit committees either orally or in writing, the auditor is required to document the communications in the audit work papers, regardless of whether communications take place orally or in writing.  It is anticipated that the PCAOB will be better able to conduct auditor inspections by using the new standard as a reference.  Auditing Standard No. 16 supersedes previous interim auditing standards (AU section 380 and AU section 310) and applies to the audits of all issuers, including audits of emerging growth companies.  The new standard is effective for audits of financial statements with fiscal years beginning on or after December 15, 2012.


6.  “End-User Exception" from Clearing Certain Swap Transactions


The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) established a comprehensive framework for regulating the OTC derivatives market to reduce systemic risk, increase the transparency of derivative transactions and promote market integrity within the financial system.  As part of this regulatory scheme, the Dodd-Frank Act imposed requirements for the clearing and trading of certain swaps (regulated by the CFTC) and security-based swaps (regulated by the SEC). The Commodity Exchange Act, as amended by the Dodd-Frank Act, contains an optional exception to the clearing and trading requirements for commercial businesses (“End-Users”) that are not financial entities, that are using swaps to hedge or mitigate commercial risk and that satisfy certain reporting obligations to the CFTC (the “End-User Exception”). Each End-User also must determine that it is an “eligible contract participant,” as defined in the Commodity Exchange Act, to enter into swaps that are not subject to the rules of a designated swap trading market.


For purposes of the End-User Exception, financial entities generally include swap dealers, major swap participants, private funds, commodity pools, employee benefit plans as defined in ERISA and financial institutions, except depository institutions with $10 billion or less in total assets. Captive finance subsidiaries are not considered financial entities if they meet certain requirements.


The CFTC adopted final rules implementing the End-User Exception effective September 17, 2012.  Non-financial entities that wish to qualify for the End-User Exception must determine that their swap arrangements are being used “to hedge or mitigate commercial risk.”  Under the CFTC’s final rules, a swap is used to hedge or mitigate commercial risk if:

  • the swap is economically appropriate to the reduction of risks of a commercial enterprise where the risks arise from potential changes in the value of assets, liabilities, services, products or commodities, or from potential changes in the value of any of the foregoing based on fluctuations in interest, currency or foreign exchange rates; or
  • the swap qualifies for hedging treatment under applicable FASB or governmental accounting standards.

In addition, the CFTC rules provide that a swap will qualify for the End-User Exception only if it is not entered into for speculative, investment or trading purposes and is not being used to hedge or mitigate the risk of another swap, unless the other swap itself is used to hedge or mitigate commercial risk within the meaning of the CFTC’s rules.


Importantly, End-Users that are publicly traded companies must have the End-User’s board of directors, or a committee of the board with appropriate authority, review and approve the company’s decision to enter into swaps that rely on the End-User Exception.  The CFTC rules permit the approval of non-cleared swaps generally rather than on a swap-by-swap basis.  However, the CFTC expects boards or authorized committees to adopt policies governing the End-User’s use of exempt swaps and to review those policies at least annually.  Board or authorized committee reviews may be necessary more often than annually if, for example, there is an adoption of a new hedging strategy that was not contemplated in the original approval.   


The CFTC also requires that End-Users file a report with the CFTC or a swap data repository on an annual basis to provide information regarding the basis for relying on the End-User Exception. The report must specify how the End-User generally meets its financial obligations associated with entering into non-cleared swaps.  An End-User must update the annual filing with any material changes that occur prior to the next filing.


The CFTC has made a determination that the clearing requirement for End-Users that engage in certain interest rate swaps and credit default swaps will begin on September 9, 2013 for all swaps entered into on or after that date, and therefore companies that intend to take advantage of the End-User Exception will need to take appropriate steps prior to that date.


7.  New SEC Specialized Disclosure Requirements


In 2013, public companies will need to determine whether new specialized disclosure requirements will apply to their businesses.  The disclosure topics that follow highlight the efforts of Congress to use the federal securities laws to further foreign policy, human rights and other social benefit objectives.  Although these provisions may not apply to many reporting companies, each company will need to adopt disclosure controls and procedures to make those determinations.


Conflict Minerals.  Pursuant to the Dodd-Frank Act, the SEC issued final rules in August 2012 implementing new Section 13(p) of the Exchange Act relating to conflict minerals.  Section 13(p) and the SEC’s final rules require public companies to determine whether they manufacture, or contract to manufacture, a product where “conflict minerals” are necessary to the functionality or production of that product.  Conflict minerals are defined by the SEC to include cassiterite, columbite-tantalite, gold and wolframite, as well as their derivatives tantalum, tin and tungsten, sourced from the Democratic Republic of the Congo or any adjoining country.  These minerals may be found in a very broad group of products, including electronic components and circuits, packaging, pigments, metal wiring, lighting contacts, heating elements, jewelry and electrodes. 


Under the SEC rules, each company must first determine if conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the company.  If not, then no action or disclosure is required.  If the answer is affirmative, then the company must conduct an inquiry regarding the origin of its conflict minerals that is reasonably designed to determine whether any of its conflict minerals originated in the covered countries or are from recycled or scrap sources.  If the company’s conflict minerals did not come from covered countries or did come from recycled or scrap sources, the company must describe the process and results of its inquiry in new Form SD, due each May 31st beginning in 2014.  If the company cannot conclude that its conflict minerals did not come from covered countries or did come from recycled or scrap sources, the company must undertake due diligence on the source and chain of custody of its conflict minerals and produce an audited Conflict Minerals Report to be filed as an exhibit to its Form SD.


The new SEC rules apply to products in the chain of production starting on January 31, 2013.  Although the SEC rules have been challenged in the courts, the outcome is uncertain and companies should not delay in completing their analysis of conflict minerals under the SEC rules.


Resource Extraction Issuers. In August 2012, the SEC adopted final rules pursuant to the Dodd-Frank Act to implement Section 13(q) of the Exchange Act, which provides that companies that are required to file an annual report with the SEC and are engaged in the commercial development of oil, natural gas or minerals (a “resource extraction issuer”) must disclose certain payments made by such issuer or its subsidiaries or other controlled entities to the U.S. government or foreign governments (including subnational governments).


Payments that must be disclosed are those that are made to further the commercial development of oil, natural gas or minerals, are “not de minimis” and are within the types of payments contemplated by Section 13(q) of the Exchange Act and the SEC rules.  A payment is “not de minimis” if it equals or exceeds $100,000 (whether as a single payment or a series of related payments) during the most recent fiscal year.  The types of payments that must be disclosed include taxes, royalties, fees (including license fees), production entitlements, bonuses, dividends and infrastructure improvements.


If the threshold for disclosure has been met, the SEC rules require a resource extraction issuer to disclose:

  • the type and total amount of payments made for each project;
  • the type and total amount of payments made to each government;
  • the total amounts of the payments, by category;
  • the currency used to make the payments;
  • the financial period in which the payments were made;
  • the business segment of the resource extraction issuer that made the payments;
  • the government that received the payments and the country in which the government is located; and
  • the project of the resource extraction issuer to which the payments relate.

The required information must be disclosed annually on Form SD filed with the SEC no later than 150 days after the end of the issuer’s fiscal year.  The SEC rules apply to fiscal years ending after September 30, 2013, but issuers may provide a partial report in the initial filing that discloses only those payments made after September 30, 2013.


Iran Sanctions Law.  With the adoption of the Iran Threat Reduction and Syria Human Rights Act of 2012, effective August 10, 2012, new Section 13(r) was added to the Exchange Act to require a company that files Exchange Act periodic reports to provide disclosure in its periodic report if, during the reporting period, it or its affiliates knowingly engaged in certain specified activities relating to contact with or support for Iran or other identified persons involved in terrorism or the creation of weapons of mass destruction.  If a company or any of its affiliates has knowingly engaged in any such activities, it must disclose a detailed description of each activity, including the nature and extent of the activity, the gross revenues and net profits, if any, attributable to the activity and whether the company or its affiliate intends to continue the activity.


In addition, a notice of the required disclosure must be filed by the company with the SEC concurrently with the annual or quarterly report that contains the disclosure.  Upon receiving the notice, the SEC must promptly transmit the report to the President of the United States and to designated committees of the U.S. House of Representatives and U.S. Senate and make the information provided in the disclosure and the notice available to the public by posting on the SEC’s website.  The President must, upon receiving the SEC’s report, initiate an investigation into the possible imposition of sanctions against the company and make a determination as to whether sanctions should be imposed on the company or the affiliate within 180 days after initiating the investigation.


On December 4, 2012, the SEC staff issued compliance and disclosure interpretations relating to Section 13(r) of the Exchange Act.  The SEC clarified that the disclosures required under Section 13(r) are required in annual and quarterly reports that are due after February 6, 2013, even if the report is filed before that date.  In addition, the required disclosures include activities during the entire period covered by the report.  As a result, a Form 10-K filed with the SEC for the fiscal year ending December 31, 2012 should include disclosure of any activities that took place during the entire fiscal year even though Section 13(r) did not become effective until August 10, 2012.  Disclosures are required only if the company or its affiliates engaged in prohibited activities during the period covered by the report.  A company does not need to state in its periodic reports that it did not engage in such activities.  The SEC staff also indicated that the definition of “affiliate” for purposes of Section 13(r) will be the same as the definition in Rule 12b-2 of the Exchange Act.


On December 19, 2012, the SEC announced that the notice required under Section 13(r) of the Exchange Act should be filed on a new EDGAR form type, IRANNOTICE, which became available on January 14, 2013.  Any filed notices will appear in the company’s filing history on EDGAR.