The Securities and Exchange Commission (“SEC”) adopted a final rule for disclosing the use of “Conflict Minerals” on August 22, 2012 (See SEC Release 34-67716). This rule, which finalizes a rule first publicly proposed in December 2010, implements Section 13(p) to the Securities Exchange Act of 1934 (the “Exchange Act”), which was adopted in response to Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and provides a new form, Form SD, for providing the disclosure required under the new rule.
The stated intent behind Section 13(p) was to further the humanitarian goal of ending the extremely violent conflict and human rights abuses suffered in the Democratic Republic of the Congo and adjoining countries, which have been partially financed through the exploitation and trade of conflict minerals in those regions, and that this disclosure, along with the exercise of due diligence on conflict mineral supply chains, would presumably have the effect of reducing such trade, which would correspondingly help to eliminate such conflict and abuse. The estimated initial cost of compliance with the rule is estimated by the SEC to be between $3 and $4 billion dollars, with annual compliance costs thereafter estimated between $207 and $609 million. Given the large costs associated with implementing and effectuating this rule and the potential increased shareholder activism that disclosure under the rule may promulgate, we anticipate continued discussion and challenge on this subject.
The new SEC rule requires:
- any issuer that files reports with the SEC under Section 13(a) or Section 15(d) of the Exchange Act, including domestic companies, foreign private issuers and smaller reporting companies,
- with conflict minerals that are “necessary to the functionality or production of a product” manufactured or contracted to be manufactured by such issuer
- to disclose annually on the new Form SD whether any of those minerals originated in the Democratic Republic of the Congo or an adjoining country, which currently includes Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia (the “Covered Countries”).
If an issuer’s conflict minerals originated in those countries, the issuer must submit a report to the Commission as an exhibit to the new Form SD that includes a description of the measures it took to exercise due diligence on the conflict minerals’ source and chain of custody, as well as a description of the products manufactured or contracted to be manufactured that are not “DRC conflict free,” the facilities used to process the conflict minerals, the country of origin of the conflict minerals and the efforts to determine the mine or location of origin.
The SEC has established a three-step process for issuers to use to determine the applicability of the new rule to their business. The SEC has also provided a flowchart that presents a general overview of the conflict minerals rule to be used as a guide, which can be found in the links on the right.
Step 1: Determine Whether Company is Subject to the Conflict Minerals Rule
The initial step requires an issuer to determine whether it is subject to the requirements of the conflict minerals rule. An issuer for whom conflict minerals are “necessary to the functionality or production of a product manufactured or contracted by that issuer to be manufactured” would be subject to the rule and must proceed to Step 2. If an issuer does not meet this definition, the issuer is not required to take any action, make any disclosures or submit any reports under the conflict minerals rule.
Conflict minerals are defined to include cassiterite, columbite-tantalite, gold and wolframite, as well as their “3T” derivatives, which include tantalum, tin and tungsten. The SEC provides additional guidance as to whether an issuer will be considered to “contract to manufacture” or whether a conflict mineral is deemed “necessary to the functionality” or “necessary to the production” of a product, but caveats in all circumstances that such a determination will depend on the particular facts and circumstances involved. To provide additional guidance, the SEC has indicated that:
- Whether an issuer is considered to “contract to manufacture” generally depends on the degree of influence the issuer exercises over the materials, parts, ingredients, or components to be included in any product that contains conflict minerals or their derivatives. Generally, an issuer must have some actual influence over the manufacturing of their product, and will not be considered by the SEC to “contract to manufacture” a product if it does no more than specify or negotiate contractual terms with a manufacturer that do not directly relate to the manufacturing of the product, affixes its brand, marks, logo, or label to a generic product manufactured by a third party, or services, maintains, or repairs a product manufactured by a third party.
- To determine whether a conflict mineral is “necessary to the functionality” of a product, the SEC advises issuers to consider whether the conflict mineral is intentionally added to the product or any component of the product (and is not a naturally-occurring by-product), is necessary to the product’s generally expected function, use, or purpose, and if a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration.
- For a conflict mineral to be considered “necessary to the production” of a product, the mineral must be intentionally included in the product’s production process (rather than be a naturally-occurring by-product), be contained in the product and be necessary to the product’s production; conflict minerals are not considered “necessary to the production” of a product if the conflict mineral is used as a tool, machine or equipment or used as a catalyst, or in a similar manner in another process, that is necessary to produce the product but is not contained in that product.
An Issuer that mines conflict minerals is not subject to the rule unless it also engages in manufacturing. Additionally, the final rule exempts any conflict minerals that are “outside the supply chain,” that is, if they have been smelted or fully refined or, if they have not been smelted or fully refined, they are deemed to be outside the Covered Countries, prior to January 31, 2013.
Step 2: Reasonable Country of Origin Inquiry
If an issuer determines that they utilize conflict minerals that are necessary to the functionality or production of a product manufactured by them or contracted by them to be manufactured, the second step requires the issuer to conduct a reasonable country of origin inquiry regarding the origin of the conflict minerals used. Although the final rule does not prescribe the actions for a reasonable country of origin inquiry that are required, the SEC did provide general standards applicable to the inquiry.
Specifically, to satisfy the reasonable country of origin inquiry requirement, an issuer 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” and must perform the inquiry in good faith. An issuer that determines that its conflict minerals did not originate in the Covered Countries, or did come from recycled or scrap sources, must disclose the determination in its specialized disclosure report and briefly describe the reasonable country of origin inquiry it used in reaching such determination; however, such an issuer will not be required to adhere to Step 3 of the process. The SEC does not require an issuer to retain reviewable business records to support its reasonable country of origin conclusion, although maintenance of appropriate records may be useful in demonstrating compliance with the final rule.
Step 3: Exercise Due Diligence on Source and Chain of Custody and Provide Conflict Minerals Report
If an issuer either knows that it has necessary conflict minerals that originated in the Covered Countries and did not come from recycled or scrap sources, or has reason to believe that its necessary conflict minerals may have originated in the Covered Countries and may not have come from recycled or scrap sources, the issuer must move to Step 3. Step 3 requires such an issuer to exercise due diligence on the source and chain of custody of its conflict minerals and provide a Conflict Minerals Report describing its due diligence measures, among other matters, as an exhibit to its specialized disclosure report on Form SD using a nationally or internationally recognized due diligence framework, if such a framework is available for the specific conflict mineral or for exercising due diligence regarding whether their conflict minerals are from recycled or scrap sources.
The SEC notes that the only nationally or internationally recognized due diligence framework currently available for conflict minerals is the due diligence guidance approved by the Organisation for Economic Co-operation and Development (“OECD”). The SEC also notes that a gold supplement to the OECD’s due diligence guidance is the only nationally or internationally recognized due diligence framework for any conflict mineral from recycled or scrap sources of gold of which the SEC is aware. In the event that an additional nationally or internationally recognized due diligence framework becomes available for other recycled or scraps derived from conflict minerals, issuers will be required to utilize that framework in exercising due diligence to determine that conflict minerals are from recycled or scrap sources.
If an issuer conducting the due diligence required by Step 3 determines as a result that its conflict minerals did not, in fact, originate in the Covered Countries, or that its conflict minerals did come from recycled or scrap sources, it will not be required to provide a Conflict Mineral Report (although a specialized disclosure report disclosing its determination and briefly describing its inquiry and its due diligence efforts and the results thereof must still be provided). Otherwise, an issuer must create a Conflict Minerals Report as an exhibit to its specialized disclosure report.
An issuer’s Conflict Minerals Report must be subjected to an independent audit objective, to express an opinion or conclusion as to whether the design of the issuer’s due diligence measures as set forth in the Conflict Minerals Report is in conformity with, in all material respects, the criteria set forth in the nationally or internationally recognized due diligence framework used by the issuer and whether the issuer’s description of the due diligence measures it performed as disclosed is consistent with the due diligence process undertaken. The final rule refers to the audit standards established by the GAO, which plans to look to its existing Government Auditing Standards, commonly referred to as “the Yellow Book.”
Location of Disclosure – Form SD
The final rule requires an issuer that utilizes conflict minerals that are necessary to the functionality or production of a product manufactured or contracted by that issuer to be manufactured to provide the conflict minerals disclosures on a new form, Form SD. An issuer required to provide a Conflict Minerals Report pursuant to Step 3 will provide that report as an exhibit to the specialized disclosure report. The specialized disclosure report on Form SD and/or in the Conflict Minerals Report must cover the calendar year (January 1 to December 31) regardless of the issuer’s fiscal year end, and the specialized disclosure report must be provided each year by May 31 for the prior calendar year and be available on the issuer’s Internet website for one year. Further, Form SD, including any Conflict Minerals Report submitted as an exhibit to the form, must be “filed” under the Exchange Act and thereby subject to potential Exchange Act Section 18 liability, rather than be “furnished.” However, Form SD does not require any officer certifications, and is not incorporated by reference into Securities Act or Exchange Act filings unless so specified by an issuer.
Timing of Compliance
Issuers must comply with the final rule for the calendar year beginning January 1, 2013 with the first reports due May 31, 2014. The SEC has included a temporary transition period for two years for all issuers and four years for smaller reporting companies, during which issuers may describe their products as “DRC conflict undeterminable” if they are unable to determine that their minerals meet the statutory definition of “DRC conflict free” for one of two reasons:(1) if they determine that they had conflict minerals that originated in the Covered Countries but are unable after due diligence to determine if their conflict minerals financed or benefited armed groups in the Covered Countries, or (2) if they had a reason to believe that their necessary conflict minerals may have originated in the Covered Countries and may not have come from recycled or scrap sources but following due diligence could not clarify the conflict minerals’ country of origin, whether the conflict minerals financed or benefited armed groups in those countries or whether the conflict minerals came from recycled or scrap sources. During the transition period, issuers with products that may be described as “DRC conflict undeterminable” are not required to have their Conflict Minerals Report audited, although such a Report must be filed describing their due diligence, and must additionally describe the steps they have taken or will take, if any, since the end of the period covered in their most recent prior Conflict Minerals Report to mitigate the risk that their necessary conflict minerals benefit armed groups, including any steps to improve their due diligence.
This temporary provision will apply for the first two reporting calendar years after effectiveness of the final rule for all issuers that are not smaller reporting companies, and for the first four reporting calendar years after effectiveness of the final rule for smaller reporting companies. After the applicable transition periods, issuers that have proceeded to Step 3 but are unable to determine that their conflict minerals did not originate in the Covered Countries or are unable to determine that their conflict minerals that originated in the Covered Countries did not directly or indirectly finance or benefit armed groups must describe their products containing those conflict minerals as not having been found to be “DRC conflict free.”
As it relates to acquired companies, the final rule allows issuers that obtain control over a company that manufactures or contracts for the manufacturing of products with necessary conflict minerals that previously had not been obligated to provide a specialized disclosure report for those minerals to delay reporting on the acquired company’s products until the end of the first reporting calendar year that begins no sooner than eight months after the effective date of the acquisition.