On August 22, 2012, the SEC, by a vote of 3 to 2, adopted final rules under the Securities Exchange Act that require disclosure of “conflict minerals” in an issuer’s supply chain, as required by Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
“Conflict minerals” include columbite-tantalite (also known as coltan), tantalum, cassiterite, tin, gold, wolframite and tungsten, and are found in a wide array of products and other applications.
Each SEC reporting issuer that uses conflict minerals necessary to the functionality or production of a product that it manufactures, or contracts to manufacture, must file a new Form SD with the SEC not later than May 31 with respect to the prior calendar year. The proposed rules, by contrast, would have required the relevant disclosures to be furnished in or as an exhibit to an issuer’s annual report. Since the new Form SD will be filed and not furnished, an issuer will be subject to liability under Section 18 of the Exchange Act for false or misleading statements in the report unless it can establish that it acted in good faith and had no knowledge that the statement in question was false or misleading. The Form SD, however, would not be incorporated into an issuer’s registration statement, unless the issuer so specifies, and is not required to be accompanied by officer certifications that are required under Forms 10-K, 10-Q, 20-F and 40-F.
The details of the reporting required by Form SD, and the accompanying reasonable country of origin inquiry and due diligence requirements, are described in detail in the body of this memorandum.
The SEC has indicated that, in light of the many uses of these minerals and their derivatives, it expects the rules to apply to approximately 6,000 issuers and, after analyzing the comments and taking into account additional data and information, the SEC believes the initial cost of compliance is likely to be between $3 billion and $4 billion, while the annual cost of ongoing compliance will be between $207 million and $609 million.
Issuers must comply with the new rules for the calendar year beginning January 1, 2013, and the first Form SD filings will be due by May 31, 2014.
Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) added a new Section 13(p) to the Securities Exchange Act and instructed the SEC to implement regulations requiring disclosure of information about certain minerals whose exploitation and trade Congress believed are helping to finance conflicts characterized by “extreme levels of violence . . . , particularly sexual- and gender-based violence, and contributing to an emergency humanitarian situation” in the eastern Democratic Republic of the Congo (the “DRC”).1
After soliciting and receiving pre-rulemaking comments, the SEC issued proposed rules on December 15, 20102 to implement this statutory directive.3 After a long and extended comment period,4 including an SEC-hosted public roundtable on October 18, 2011, and significant additional public attention,5 the SEC adopted the final rules on August 22, 2012. The rules incorporate a number of changes to address comments, but the basic three-step disclosure requirement that the SEC originally proposed remains the core of the requirements under the new rules.
CONFLICT MINERALS DISCLOSURES AND RELATED PROCEDURES
STEP ONE—NECESSARY TO THE FUNCTIONALITY OR PRODUCTION OF A PRODUCT
As a first step, a covered issuer must determine whether conflict minerals are necessary to the functionality or production of a product that it manufactured or contracted to be manufactured in the applicable calendar year. If not, the issuer would not be required to take any action, make any disclosures or submit any reports pursuant to the final rules.
Consistent with the proposed rules, the final rules apply to all issuers that file reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act, including foreign private issuers, emerging growth issuers and smaller reporting companies.
Under the final rules, “conflict minerals” are defined to include columbite-tantalite (also known as coltan), cassiterite, gold, wolframite, and the following derivatives thereof: tantalum, tin and tungsten (according to the SEC, the “only economically significant derivatives of the conflict minerals”).6 According to the SEC’s adopting release, there is a wide array of uses to which conflict minerals are put into the global economy. For example, tantalum is used in electronic components, such as those found in mobile telephones, computers, videogame consoles and digital cameras, and in carbide tools and jet engine components. Tin is used in alloys, tin plating and solders for joining pipes and electronic circuits. Gold is used in jewelry and electronics, communications, and aerospace equipment. Tungsten is found in metal wires, electrodes and contacts in lighting, and in other electronic, electrical, heating and welding applications. Accordingly, the SEC expects the final rules to impact approximately 40% of all reporting companies.7
“Manufactured or Contracted to be Manufactured”
The final rules apply to products manufactured or contracted to be manufactured by a reporting issuer. As with the proposed rules, the SEC has chosen not to define “manufacturing” for purposes of the final rules, noting that it is a generally understood term. However, unlike the instruction to the proposed rules, the instructions to the final rules do not consider “manufacturing” to include the extraction of conflict minerals. Thus, issuers that mine or contract to mine conflict minerals are excluded from the coverage of the rules.
As in the proposed rules, the final rules do not attempt to define “contract to manufacture” because the SEC found any such definition to be “unworkable.”8 In guidance set forth in the SEC’s adopting release, however, the SEC states that it believes that “‘contract to manufacture’ is intended to include issuers that have some actual influence over the manufacturing of their products.” Specifically, a core concept is whether an issuer has influence on the selection of materials, parts, ingredients or components to be included in the ultimate product. An issuer would not be deemed to have a “contract to manufacture” if its actions involve no more than: (i) specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product, such as training or technical support, price, insurance, indemnity, intellectual property rights, dispute resolution, or other like terms or conditions concerning the product, “unless the issuer specifies or negotiates taking these actions so as to exercise a degree of influence over the manufacturing of the product that is practically equivalent to contracting on terms that directly relate to the manufacturing of the product”; (ii) affixing a brand, mark, logo or label to a generic product manufactured by a third party; or (iii) servicing, maintaining or repairing a product manufactured by a third party. Although the SEC clarifies that the final rules do not apply to retailers that only sell the products of third parties and have no contract or other involvement regarding the manufacturing of those products, uncertainty remains over what is sufficient to demonstrate “any influence over manufacturing.”9
“Necessary to the Functionality or Production of a Product”
The final rules apply to reporting issuers for whom conflict minerals are necessary to the functionality or production of products manufactured or contracted to be manufactured by the issuer. An issuer is required to file disclosure whenever it determines that conflict minerals are necessary to the functionality or production of a product it manufactures or contracts to manufacture, regardless of whether the issuer has determined the source of the conflict minerals.
The SEC has not defined when a conflict mineral is necessary to the functionality or production of a product, explaining that it chose to leave the term undefined as the determination needs to be made “[b]ased on the applicable facts and circumstances.” However, the SEC provides guidance in its adopting release, stating that issuers should consider: (i) whether a conflict mineral is contained in, and intentionally added to, the product or any component of the product and is not a naturally-occurring by-product; (ii) whether a conflict mineral is necessary to the product’s generally expected function, use or purpose; or (iii) if a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration. Retreating from guidance contained in the release accompanying the proposed rules, the SEC states that the final rules do not cover products for which a conflict mineral is not found in the final product, even if the conflict mineral is intentionally included in the production process. Only final products are captured by the rules, rather than prototypes and other demonstration devices.
However, despite seeking comment on the question, the SEC declined to adopt a de minimis threshold based on the amount of conflict minerals used by an issuer in a particular product or in its overall enterprise. The SEC reasoned that the omission of such a threshold to the statutory provision reflected Congressional intent in this regard.10
Filing of Form SD (Specialized Disclosure Report)
If it is determined that conflict minerals are necessary to the functionality or production of a product manufactured or contracted by the issuer, the issuer will be required to file conflict minerals information with the SEC on a new Form SD.11 Conflict minerals disclosure on Form SD will be with regard to a calendar year period and must be filed with the SEC no later than May 31 of the following calendar year. For example, with respect to 2013, the first calendar year that will require Form SD reporting, an issuer’s report for 2013 will be due no later than May 31, 2014. In addition, an issuer is required to make its conflict minerals disclosure and Conflict Minerals Report available on its internet website for one year. The final rules exempt any conflict minerals that are “outside the supply chain”—if it was smelted, refined or has already been removed from a Covered Country—prior to January 31, 2013.
The contents of an issuer’s Form SD are dependent on the issuer’s determinations with regard to the remaining two steps outlined below.
STEP TWO—COUNTRY OF ORIGIN OF CONFLICT MINERALS
Under the second step, an issuer must conduct a good faith “reasonable country of origin inquiry” that is reasonably designed to determine whether the conflict minerals necessary to the functionality or production of a product that the issuer manufactures or contracts to be manufactured originated in the DRC or a country that shares an internationally recognized border with the DRC (each, a “Covered Country” and, together, the “Covered Countries”),12 or are from recycled or scrap sources.
In a significant change from the proposed rules, conflict minerals from recycled or scrap sources are treated as if they did not originate from a Covered Country and issuers are no longer required to proceed to Step Three and furnish a Conflict Minerals Report with respect to such minerals.
“Reasonable Country of Origin Inquiry”
Similar to the proposed rules, the final rules do not prescribe any required elements of the reasonable country of origin inquiry and the final release indicates that this inquiry is dependent on the “issuer’s particular facts and circumstances,” such as the issuer’s size, products, relationships with suppliers or other factors. In addition, the SEC believes “that the steps necessary to constitute a reasonable country of origin inquiry depend on the available infrastructure at a given time.” According to the SEC’s adopting release, the issuer’s reasonable country of origin inquiry must be reasonably designed to determine whether the issuer’s conflict minerals originated in a Covered Country or from recycled or scrap sources. Such inquiry must be made in good faith. The SEC further indicated that it will “view an issuer as satisfying the reasonable country of origin inquiry standard if it seeks and obtains reasonably reliable representations indicating the facility at which its conflict minerals were processed and demonstrating that those conflict minerals did not originate in the Covered Countries or came from recycled or scrap sources.” The SEC noted, however, that “[a]n issuer must also take into account any applicable warning signs or other circumstances indicating that its conflict minerals may have originated in the Covered Countries or did not come from recycled or scrap sources.”
If, as a result of such inquiry, the issuer: (i) determines that its necessary conflict minerals did not originate in a Covered Country, or (ii) determines that its necessary conflict minerals came from recycled or scrap sources, or (iii) has no reason to believe that its necessary conflict minerals may have originated from a Covered Country, or (iv) reasonably believes that its necessary conflict minerals came from recycled or scrap sources, then the issuer would indicate this determination in its Form SD report and describe the inquiry conducted. The issuer would not be required to move to Step Three as described below, which is a significant change from the proposed rules. As proposed, an issuer always would have been required to move to Step Three unless it could actually prove that its conflict minerals did not originate in a Covered Country. Also, unlike the proposed rules, conflict minerals from recycled or scrap sources are treated as if they did not originate from a Covered Country.
Unlike the proposed rules, the final rules do not require an issuer to maintain reviewable business records supporting the conclusion of its reasonable country of origin inquiry.
STEP THREE—SUPPLY CHAIN DUE DILIGENCE AND CONFLICT MINERALS REPORT
If an issuer determines, or has reason to believe, based on its reasonable country of origin inquiry, that any of its conflict minerals originated in a Covered Country, or did not come from recycled or scrap sources, the issuer is required to conduct due diligence on the source and chain of custody of its conflict minerals, following “a nationally or internationally recognized framework” to determine the source of the conflict minerals and whether the minerals financed or benefited armed groups. If the issuer determines, based on this due diligence, that its conflict minerals did not originate from a Covered Country, or originated from recycled or scrap sources, then the issuer would only be required to note the results of its reasonable country of origin inquiry and its due diligence measures in its specialized disclosure report on Form SD. However, if the issuer determines that, or is unable to determine whether, its conflict minerals came from a Covered Country, the issuer would be required to file a Conflict Minerals Report, as described below.
Source and Chain of Custody Due Diligence
Unlike the proposed rules, which did not prescribe standards applicable to the source and chain of custody due diligence, the final rules require that the issuer establish diligence standards based on “a nationally or internationally recognized due diligence framework” designed to uncover the source of the conflict minerals, and, if the minerals came from a Covered Country, whether the conflict minerals financed or benefited armed groups in a Covered Country. The SEC explains in its adopting release that requiring issuers to follow such a framework will “enhance the quality of an issuer’s due diligence and will promote the comparability of the Conflict Minerals Reports of different issuers.” Under the final rules, a “nationally or internationally recognized due diligence framework” is a framework that is “established following due-process procedures, including the broad distribution of the framework for public comment, and is consistent with the criteria standards in the Government Auditing Standards established by the Comptroller General of the United States.” While the final rule does not mandate a particular framework, the SEC indicated that the “Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas” of the Organisation for Economic Cooperation and Development (“OECD”) currently satisfies its criteria and may be used as a framework for purposes of satisfying the final rules’ due diligence requirement.13 While other frameworks are currently in development, the SEC acknowledged that the OECD framework may be the only “nationally or internationally recognized due diligence framework” currently available.
Recycled or Scrap Sources
There are special rules governing the due diligence and Conflict Minerals Report for minerals from recycled or scrap sources. As noted above, if after the reasonable country of origin inquiry, an issuer determines that its necessary conflict minerals are derived from recycled or scrap sources, or the issuer has no reason to believe that the necessary conflict minerals did not originate from recycled or scrap sources, the issuer is not required to proceed to Step Three. However, if an issuer cannot reasonably conclude after its reasonable country of origin inquiry that its necessary conflict minerals came from recycled or scrap sources, the final rules require issuers to move to Step Three and exercise due diligence regarding whether their conflict minerals are from recycled or scrap sources and to conform their due diligence to a nationally or internationally recognized due diligence framework, if one is available for the particular recycled or scrap conflict mineral.14 If a nationally or internationally recognized due diligence framework is not available for a particular recycled conflict mineral, an issuer would be required to describe the due diligence measures it exercised in its Conflict Minerals Report.
Content of the Conflict Minerals Report
If, as a result of its source and chain of custody due diligence, the issuer determines that its conflict minerals are from a Covered Country, or if the issuer cannot determine the source of its conflict minerals, then the issuer is required to file a Conflict Minerals Report as an exhibit to its Form SD. The Conflict Minerals Report would be required to include the following information:
- A description of the issuer’s due diligence procedures.
- A copy of a report prepared by an independent private sector auditor that expresses an opinion or conclusion on the design of the issuer’s due diligence procedures and the accuracy of the issuer’s description of its due diligence process in its Conflict Minerals Report.
A description of any of the issuer’s products manufactured or contracted to be manufactured containing conflict minerals that are not “DRC conflict free” (as defined below), together with descriptions of the facilities used to process such conflict minerals, the country of origin of such conflict minerals and the efforts to determine the mine or location of origin with the greatest possible specificity.
- The description of products should identify specific products, models or categories of products that are not DRC conflict free.
- Facilities used to process the conflict minerals refers to the smelter or refinery through which the issuer’s minerals pass.
- For a temporary period of two to four years after the effectiveness of the rules (depending on the size of the issuer) the final rules allow issuers that are unable to determine that their conflict minerals did not originate in a Covered Country, or who are unable to determine whether the conflict minerals financed or benefited armed groups in a Covered Country, to classify the products as DRC conflict undeterminable (as defined below) in their Conflict Minerals Reports. Such issuers must describe the steps it has taken or will take, if any, to mitigate the risks that its conflict minerals benefit armed groups (as defined below) in its Conflict Minerals Report.
“DRC Conflict Free” and “DRC Conflict Undeterminable”
The final rules define “DRC conflict free” to mean that a product “does not contain minerals necessary to the functionality or production of that product that directly or indirectly finance or benefit armed groups” in a Covered Country. The final rules define an armed group as “an armed group that is identified as a perpetrator of serious human rights abuses in [the U.S. State Department’s] annual Country Reports on Human Rights Practices under Sections 116(d) and 502B(b) of the Foreign Assistance Act of 1961 . . . relating to [a Covered Country].”
The final rules define “DRC conflict undeterminable” to mean, with respect to any product manufactured or contracted to be manufactured by an issuer, a product where the issuer “is unable to determine, after exercising due diligence . . . whether or not such product qualifies as DRC conflict free.”
Independent Private Sector Audit
Under the final rules, the independent private sector audit must be conducted “in accordance with the standards established by the Comptroller General of the United States and certified” by the issuer. According to the final release, the Comptroller General does not anticipate adopting any specific standards with respect to the conflict minerals audits and will likely rely on existing Government Auditing Standards (“GAGAS”) and independence criteria. The final rules specify that the object of the audit is to express an opinion or conclusion as to whether the design of the issuer’s due diligence framework, as set forth in the Conflict Minerals Report, is in conformity, in all material respects, with 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 as set forth in the Conflict Minerals Report is consistent with the due diligence process that the issuer undertook with respect to the period covered by the report. The final rules do not require an audit of the entire Conflict Minerals Report, including the issuer’s determinations as to whether certain products are DRC conflict free. The SEC commented in the adopting release that it did not “believe that it would be inconsistent with the independence requirements in Rule 2-01 of Regulation S-X if the independent public accountant also performs the independent private sector audit of the Conflict Minerals Report.”
The SEC has provided for a two year period for issuers (or four years for smaller issuers), that, in exercising their due diligence, were not able to determine whether the products they manufacture, or contract to manufacture, are DRC conflict free. During this period, issuers do not have to obtain an independent audit of the due diligence process. After the period expires, an issuer with products manufactured or contracted to be manufactured that would have been “DRC conflict undeterminable” will be required to describe those products as having not been found to be “DRC conflict free” and must provide the audit report.
LIABILITY FOR CONFLICT MINERALS-RELATED DISCLOSURES
As proposed, disclosure was required to be made in the issuer’s annual report and would be deemed to be furnished rather than filed with the SEC. The SEC decided to take a different approach in the final rules. Instead, disclosures under Form SD, the Conflict Minerals Report and the independent auditors report will be deemed to be filed with SEC and, therefore, will be subject to liability under Section 18 of the Securities Exchange Act.15 Under Section 18 of the Exchange Act, “[a]ny person who shall make or cause to be made any statement in any application, report, or document filed pursuant to this chapter or any rule or regulation thereunder . . . which statement was at the time and in the light of the circumstances under which it was made false or misleading with respect to any material fact, shall be liable . . . .” Section 18 further provides a private cause of action to investors who can prove that they relied on the misstatement and were harmed as a result. However, an issuer will not be liable for any misstatements in a filed document if it can establish that it acted in good faith and had no knowledge that the statement was false or misleading. Additionally, by using a separate form, the disclosures would not be subject to the officer certification requirements applicable to annual reports.
Consistent with the proposed rule, any disclosures under the final rule, including the Form SD, the Conflict Minerals Report and the audit report would not be deemed to be incorporated by reference into any filing under the Securities Act or the Securities Exchange Act, including registration statements, except to the extent that the issuer specifically decides to incorporate such disclosures by reference. The independent private sector auditor does not assume the liability of an expert and the issuer is not required to file a consent from that auditor with the SEC.