The SEC's New Conflict Mineral Rule
Oct 01, 2012 QuickCounsel Download PDF
By Tricia Dunlap and Dan Slone,
The legacy of a fifteen-year-old civil war in Africa has become the latest sustainability issue impacting corporations. Unlike many other sustainability issues, where companies can voluntarily address their practices, this one is mandatory. On August 22, the SEC approved the Dodd-Frank Act’s conflict mineral rule. After extensive stakeholder engagement, the final rule affirms the first disclosure mandate designed to further corporate social responsibility and adds the phrase “Conflict Mineral Report” (“CMR”) to our lexicon.
The rule is intended to end cash flow supporting warlords in the Democratic Republic of Congo (the “DRC”) and neighboring countries (“Covered Countries”). Though war in the DRC technically ended in 2003, illegal armed gangs still dominate its eastern region. Enriched by “conflict minerals” which are processed into gold, tungsten, tantalum, and tin for widespread use in modern electronics and other products, the gangs are infamous for mass killings, rape, mutilation, sexual slavery, and the use of child slaves as miners. Dodd-Frank requires companies to disclose use of minerals from Covered Countries.
The federal government is not alone in its increased willingness to use corporate reporting to achieve social goals. In 2011 both California and Pittsburgh prohibited public procurement from companies that do not disclose their conflict mineral sources. This year, Maryland followed their lead and Massachusetts has pending legislation. Similar legislation in Rhode Island (H7695) stalled in committee. Leaders in Australia, Canada and the European Union have voiced support for the U.S. rule, and are considering similar measures. Beyond governments, NGO’s, such as the Enough Project, bolster legal mandates by engaging in private tracking and public reporting of corporate sourcing. Recently, the Enough Project released a report that lauded Intel, HP and SanDisk for their work to “develop solutions” and criticized Nintendo, Sharp, HTC, Canon, and Nikon for lack of progress. There is increasing pressure on corporations to take proactive steps toward a conflict-free supply chain. This QuickCounsel provides an overview of the conflict mineral rule and its implications for in-house counsel.
The final rule applies to approximately 6,000 foreign or domestic corporations. It impacts all corporations that file annual 10-K reports with the SEC (“Issuers”) if conflict minerals are “necessary to the production or functionality” of a product the company manufactures or contracts to have manufactured. Whether a mineral is “necessary” requires a nuanced, fact-specific inquiry. Similarly, whether an Issuer “contracts to have a product manufactured” depends on the degree of influence it holds over the products manufactured. In response to retailers’ concerns, the SEC exempted companies without direct control over the manufacture of their products. All companies potentially impacted by the rule need to carefully assess whether it applies to their operations because CMRs are subject to the same legal liability as other SEC filings.
Though technically limited to Issuers, the rule also impacts non-reporting companies such as original equipment manufacturers and electronic manufacturing service providers that supply parts to Issuers. These vendors have already experienced customer demand to investigate their supply chains for conflict minerals; the mandate has rolled downhill and includes them too.
Step One: Reasonable Country of Origin Inquiry
All Issuers covered by the rule must complete the first step – conducting a “reasonable country of origin inquiry” to determine the origin of their necessary minerals (even if used in de minimus amounts). If after the reasonable inquiry, minerals qualify as “DRC conflict free” then a reduced reporting burden exists. Minerals are DRC conflict-free if the reasonable inquiry allows Issuers to know its minerals are not from Covered Countries, or to know or have reason to believe the minerals are sourced from recycled or scrap, or if there is no reason to believe the minerals originated from Covered Countries. For DRC conflict-free minerals, Issuers need not continue to step two, due diligence, or step three, issuing a CMR. Instead, Issuers must simply describe the process and results of the reasonable country of origin inquiry, disclose the determination reached as a result of reasonable inquiry, and provide a link to the company website where this same information is housed. No further disclosure is required.
Step Two: Due Diligence
By contrast, however, if the reasonable inquiry causes Issuers to know or have reason to believe their minerals are from Covered Countries or are not from recycled or scrap sources, then Issuers must conduct step two – supply chain and chain of custody due diligence. Due diligence must follow a nationally or internationally recognized framework.
As a result of due diligence, an Issuer may ascertain that its minerals are not from Covered Countries or are, in fact, from scrap or recycled sources. When this is the case, the minerals may carry the DRC conflict-free tag and are subject to the reduced reporting burden explained above. However, if due diligence does not allow an Issuer to reasonably believe its minerals are DRC conflict-free, then it must move on to step three.
Step Three: Conflict Mineral Reports
CMRs are required when the due diligence causes the Issuer to know that its minerals are from Covered Countries, or the minerals’ origins are undetermined, or they are not from scrap or recycled sources. CMRs must describe the due diligence measures undertaken by the company to determine the source and chain of custody of its conflict minerals, include a certified, independent private-sector audit of the CMR, and supply a link to the company’s website where the CMR is housed. In addition, corporations must:
Conflict Undeterminable: A Temporary Port in the Storm
Among concessions to stakeholder concerns, the SEC pushed the original 2013 CMR reporting deadline to May 31, 2014 and also will allow reporting companies to use the label “conflict undeterminable” for two years while systems for tracking conflict minerals sources are built and refined. Smaller companies impacted by the rule may use the “conflict undeterminable” tag for four years. Conflict undeterminable status applies after step two, due diligence, when Issuers cannot know or reasonably believe that:
Issuers with conflict undeterminable minerals must still file a CMR describing their due diligence and the steps they are taking to minimize chances that warlords benefit from their mineral procurements, including enumerating steps they are taking to improve due diligence practices. A conflict undeterminable CMR must also include information on the minerals’ country of origin, the facilities used in processing, and the Issuers effort to determine the mine or location of origin with the greatest possible specificity.
Though the rule has raised anxiety in C-suites, it is a navigable process that corporate leaders might use to their advantage with creative long-term thinking. In the short term, it is critical for business leaders to parse the rule’s application to their operations and implement effective inquiries and due diligence in order to meet the new mandate. However, because the rule is designed around a “reasonableness” standard it will evolve – and tighten – over time as supply chain tracking improves. Therefore, focusing solely on today’s need to comply may not build an effective platform for long-term advantage.
The SEC expects reasonable country of origin inquiry standards to “change over time based both on improved supply chain visibility and the results of an issuer’s prior year inquiry.” Such an approach allows “stakeholders to track that progress and advocate for different procedures if they think it is necessary.” Given the time and energy some NGO, government, and institutional leaders have invested in the new rule, these stakeholders will certainly continue to track progress. Engaging with this broader constituency confers long-term advantages. In response to Dodd-Frank, some corporations took the lead with exactly this goal in mind.
Recognizing that the rule not only burdens business but also risks abandonment of the DRC people, many of whom depend on mining for their livelihood, passage of Dodd-Frank was swiftly followed by private and public work to create robust standards and systems for tracking conflict minerals. The OECD convened a working group that produced due diligence standards Issuers may use to meet the mandate. Industry leader Motorola created the Solutions for Hope initiative – a closed-pipe supply line with defined suppliers – to source conflict-free tantalum from the DRC. Meanwhile, industry groups, multilateral organizations, and NGOs are working to build global or in-region sourcing initiatives that meet certified conflict-free standards.
While the Conflict Mineral Rule is a daunting challenge, systems and methods for meeting it are emerging. In addition to crafting compliance-focused systems, navigating untraditional relationships and finding the right partners are keys to gaining advantage. Such an approach also offers a unique opportunity for high reward from the triple benefit of compliance, a clean and more reliable supply chain, and positive relationships with government, civil society, and customers.
Published on October 1, 2012
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