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Outdated SEC mining disclosure rules need reform.

Summary: More than 30 years ago, the U.S. Securities and Exchange Commission (SEC) enacted Industry Guide 7 under Regulation S-K to govern SEC disclosure by mining ...

More than 30 years ago, the U.S. Securities and Exchange Commission (SEC) enacted Industry Guide 7 under Regulation S-K to govern SEC disclosure by mining companies. Even though it does not appear on a company's balance sheet, the resources estimated to be contained within the properties owned by a mining company are among the most significant assets of any mining company. Given that they often lie in deeply buried geological formations, such resources are difficult to measure and, until a company extracts them, can only be estimated. Under Industry Guide 7, estimates other than reserves (as defined by the SEC) are not allowed to be disclosed in Securities Act or Exchange Act filings, subject to certain exceptions. For the reasons described below, this prohibition needs to be reformed or repealed by the SEC.

Reserves, categorized as "proven" or "probable," are defined by the SEC to be "that part of a mineral deposit which could be economically and legally extracted or produced at the time of the reserve determination." Although not specified by Industry Guide 7, the SEC has taken the position that reserves cannot be designated as such unless a detailed engineering and economic feasibility study has been conducted, and the study demonstrates that a mineral deposit can be mined at a commercial rate and a profit made. Further, the SEC has specified that such feasibility studies should be "final" or "bankable" and employ a historical three-year average price for the economic analysis.

The purported rationale behind Industry Guide 7 is consistent with the SEC's mission but in reality misses the mark. The mission of the SEC is to protect investors; maintain fair, orderly and efficient markets; and facilitate capital formation. Industry Guide 7 purportedly exists to protect investors by ensuring that unknowing investors are not fooled into investing in mining enterprises with significant mineralization that is unlikely to ever be extracted for a profit. However, Industry Guide 7 does not enhance investor protection or accomplish the SEC's other stated objectives for a number of reasons.

A company's estimate of its mineral resource is material information

First, irrespective of the economic feasibility of extracting certain mineralization, there is no question that a mining company's estimate of its own mineral resource (however calculated) is material information for the management of such companies and, therefore investors. Ironically, Industry Guide 7 expressly acknowledges this fact, while inexplicably still prohibiting mining companies from disclosing such critical information to investors. For example, Section (b)(7) provides that "[d]etailed geographic maps and reports, feasibility studies and other highly technical data should not be included in the report [filed by the mining company with the SEC] but should be, to the degree appropriate and necessary for the Commission's understanding of the registrant's presentation of business and property matters, furnished as supplemental information." (Emphasis added.)

Further, Section (g)(2) requires mining companies to furnish a complete copy of every material engineering, geological or metallurgical report concerning the company's property, including governmental reports. In both instances, the SEC has effectively prohibited investors from having access to information that it requires mining companies to provide the SEC for the purpose of the SEC better understanding such companies.

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Exceptions to the rule result in different treatment of similar companies

Second, the exceptions to the general rule of prohibiting non-reserve data result in arbitrarily different treatment of similarly situated companies. The two main exceptions to the general rule are that mining companies can disclose non-reserve data if: such information is required to be disclosed by foreign or state law; or such estimates previously have been provided to a person (or any of its affiliates) that is offering to acquire, merge or consolidate with the relevant mining company or otherwise to acquire the company's securities.

As a result of the first exception, numerous U.S.-based mining companies have incurred the additional expense and administrative burden to be organized and/or listed on stock exchanges in non-U.S. jurisdictions that require the disclosure of non-reserve data; for example, Canadian requirements to disclose "measured and indicated resources." Many of these companies are dual-listed in the U.S. but are otherwise indistinguishable from U.S.-based mining companies.

By virtue of the prohibitions of Industry Guide 7, the SEC has created information asymmetry for investors evaluating similarly situated companies. Similarly, the second exception allows for a mining company that is being acquired to present non-reserve data if it has been provided to the acquirer. This exception means that a mining company that proposes to do a public offering would be prohibited from disclosing data that the same company would be allowed to disclose in connection with being acquired. In both cases, the fact that similarly situated companies (or perhaps even the same company) have different parameters for prohibited disclosure clearly does not promote fair, orderly and efficient markets or facilitate capital formation.

The SEC's interpretive requirement imposes additional expense

Third, the SEC's interpretative requirement for a feasibility study imposes additional unwarranted expense. Feasibility studies are very expensive. The cost for a feasibility study can exceed 5 percent of the estimated cost of a mining project. For many mining companies, the additional cost of a feasibility study when compared to a technical report prepared by an independent, competent geologist is hard to justify. The mining industry is not dissimilar to many other industries that are highly speculative. For example, many biotechnology companies research, evaluate and develop drugs over many years, and undoubtedly many of the drugs in the pipeline will prove not to be commercially viable.

If the biotechnology industry had rules in place similar to Industry Guide 7, such companies would be prohibited from describing promising research and drug trials until millions of dollars were spent to "prove" that such drugs could be sold for a profit (in addition to all of the inherent costs of actually developing the drugs). Moreover, the fact that the feasibility studies rely on historical three-year average prices, as opposed to projections, means that investors are indirectly betting on the future market prices of such resources strictly based on old data. The implication that proven and probable reserves are more likely to result in future profits than measured and indicated resources is very misleading.

Industry Guide 7 should be replaced with a principles-based rule

The SEC should seriously consider reforming or replacing Industry Guide 7 with a principles-based rule. The primary disclosure principle of any such rule should be that mining companies have a duty to provide fulsome disclosure about all material facts that a reasonable investor wants to know, including how they estimate resources, the qualifications and experience of the parties estimating such resources, and the costs estimated to extract and sell such resources and forward-looking price estimates for the sale of such resources (and the basis for such estimates). Public mining companies should utilize their political lobbying power and outside counsel to petition for rulemaking changes. In addition, until Industry Guide 7 is reformed, mining companies should also communicate with the SEC through its outside counsel to request authority to disclose non-reserve information, if necessary to protect investors. The staff of the SEC has advised the author in at least one instance that furnishing such information to investors is appropriate to comply with other securities law requirements, such as Regulation FD.

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Publication:Inside Counsel
Date:Oct 28, 2014
Words:1284
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