Summary

Recently, the Securities and Exchange Commission (the “SEC”) adopted final rules implementing the “conflict minerals” disclosure requirements in Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).1 Section 1502 of the Dodd-Frank Act was enacted by Congress in order to impair the financing of the conflict in the Democratic Republic of Congo (“DRC”) and adjoining countries (the “Conflict Countries”) 2, which has been effectuated significantly by the trade of conflict minerals.

Section 1502 of the Dodd-Frank Act required the SEC to adopt regulations requiring persons to annually disclose their use of conflict minerals that originated in the Conflict Countries. The SEC has adopted a new Form SD to be filed3 by covered issuers on May 31 of each year (beginning on May 31, 2014 for the 2013 calendar year) covering the period of the prior calendar year, regardless of when the issuer’s fiscal year ends.4 The final rules do not apply to any conflict minerals that are “outside the supply chain” prior to January 31, 2013.5

Under the final rules, if conflict minerals are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by a company that files reports with the SEC under Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), such company will be required to file a report on Form SD disclosing whether its conflict minerals originated in a Conflict Country, based on its reasonable country of origin inquiry.

Regardless of the conclusion, the company is required to disclose the determination and the reasonable “country of origin” inquiry process it used in reaching this determination on Form SD, make the report publicly available on its website and provide the Internet address of that site in the Form SD. A company that determines both that (i) it knows or has reason to believe that the minerals may have originated in the Conflict Countries and (ii) it knows or has reason to believe that the minerals may not be from scrap or recycled sources6 is required to undertake “due diligence” on the source and chain of custody of its conflict minerals, file, as an exhibit to its Form SD, a separate report that describes, among other matters, the measures taken to exercise due diligence on the source and chain of custody of its conflict minerals (the “Conflict Minerals Report”), make the Conflict Minerals Report publicly available on its website and provide the Internet address of that site on its Form SD.

Attached as Exhibit A is a flowchart included in the adopting release for the final rules that indicates which companies will need to file a Form SD related to conflict minerals usage and the contents of such Form SD. As a general matter, companies will need to, depending on each successive determination:

  • determine whether the company is subject to the final rules;
  • conduct a country of origin inquiry;
  • conduct supply chain due diligence; and
  • prepare and file a Conflict Minerals Report.

In a modification of the proposed rules, the Form SD will be filed with the SEC, rather than furnished, subjecting companies to potential liability under Section 18 of the Securities Exchange Act for false or misleading statements.

Applicability

Covered Issuers: The final rules cover any issuer that files reports with the SEC under Section 13(a) or Section 15(d) of the Exchange Act, including domestic issuers, foreign private issuers, Canadian issuers that file reports pursuant to the U.S.-Canada Multi-Jurisdictional Disclosure System and smaller reporting issuers, for which conflict minerals are necessary to the functionality or production of a product manufactured, or contracted to be manufactured7, by that issuer. Foreign private issuers that are exempt from Exchange Act registration under Rule 12g3-2(b) are not subject to the final rules. The rules do not apply to investment companies required to file report pursuant to Rule 20d-1 under the Investment Company Act of 1940.

“Conflict Minerals”: The final rules define “conflict mineral” to include cassiterite, columbite-tantalite (coltan), gold, wolframite and their derivatives, which are limited to the so-called 3Ts (tantalum, tin and tungsten), unless the Secretary of State determines that additional derivatives are financing conflict in the Conflict Countries, in which case they will also be considered “conflict minerals”.

Manufacturing or Contracting to Manufacture: If conflict minerals are necessary to the functionality or production of a product manufactured by a company or contracted by a company to be manufactured, such company is subject to the conflict mineral rules. The final rules do not define when a company contracts to manufacture a product. In general, the question of whether a company contracts to manufacture a product will depend on the degree of influence exercised by the company on the manufacturing of the product based on the individual facts and circumstances surrounding the company’s business and industry. In the adopting release, the SEC indicated that it believes the phrase “contract to manufacture” captures manufacturers that contract the manufacturing of components of their products and that such companies, for purposes of the rules, such companies should be viewed as responsible for the conflict minerals in those products to the same extent as if they manufactured the components themselves. The SEC believes that “contract to manufacture” is intended to include companies that have some actual influence over the manufacturing of their products. However, the SEC has provided that a company should not be viewed as contracting to manufacture a product for purposes of the rules if its actions involve no more than:

  • 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; or
  • affixing its brand, marks, logo or label to a generic product manufactured by a third party; or
  • servicing, maintaining or repairing a product manufactured by a third party.

Mining is not Manufacturing: While under the initially proposed rules companies that mine, extract or contract for the mining or extraction of conflict minerals would have been considered to be manufacturing those minerals, the final rules provide that such companies will not be considered to be manufacturing those minerals unless such company engages in manufacturing, either directly or through contract, in addition to mining.

When Conflict Minerals are “Necessary” to a Product: The final rules do not define when a conflict mineral is “necessary to the functionality” or “necessary to the production” of a product. Such a determination depends on the company’s particular facts and circumstances, but there are certain factors the SEC provided to assist companies in making their determinations. There is no de minimis exception, as the SEC determined that the Dodd-Frank Act provisions were intended to include even minimal amounts of conflict mineral usage in instances where such usage is indeed “necessary to the functionality or production” of the product. In determining whether its conflict minerals are “necessary to the functionality” of a product, a company should consider:

  • 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;
  • whether a conflict mineral is necessary to the product’s generally expected function, use or purpose; or
  • if a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration.

The adopting release provides that only a conflict mineral that is contained in the product and is necessary for the product’s production should be considered “necessary to the functionality or production” of that product. The adopting release provides that being intentionally added, rather than being a naturally occurring by-product, is a significant factor in determining whether a conflict mineral is “necessary to the functionality or production” of a product, regardless of who intentionally added the conflict mineral to the product.

The SEC provides that it does not consider a conflict mineral that is merely used as a catalyst or in another manner in the production process of a product to be “necessary to the production” of the product if that conflict mineral is not contained in the product. However, the SEC does consider such a conflict mineral to be “necessary to the production” of the product if that conflict mineral otherwise is necessary to the production of the product and is contained in any amount, including trace amounts, in the product. The SEC does not believe that a conflict mineral in a physical tool or machine used to produce a product or in indirect equipment, such as computers and power lines, used in the production of a product to be “necessary to the production” of the product. Similarly, companies are not required to report on the conflict minerals in materials, prototypes and other demonstration devices containing or produced using conflict minerals that are necessary to the functionality or production of those items until a company enters those items in the stream of commerce by offering them to third parties for consideration.

The Reasonable Country of Origin Inquiry

Under the final rules, if a company is one for whom “conflict minerals are necessary to the functionality or production of a product manufactured by such person,” such company is required to conduct in good faith a reasonable country of origin inquiry regarding those conflict minerals that is reasonably designed to determine whether any of the conflict minerals originated in a Conflict Country or are from recycled or scrap sources. Although the SEC does not prescribe the steps constituting a reasonable country of origin inquiry, the SEC release provided that a company would satisfy the reasonable country of origin inquiry standard if it seeks and obtains reasonably reliable representation indicating the facility at which its conflict minerals were processed and demonstrating that those conflict minerals were processed and demonstrating that those conflict minerals did not originate in the Conflict Countries or came from recycled or scrap sources. These representations could come either directly from that facility or indirectly through the company’s immediate suppliers, but the company must have a reason to believe these representations are true given the facts and circumstances surrounding those representations. The company must also take into account any applicable warning signs or other circumstances indicating that its conflict minerals may have originated in the Conflict Countries or did not come from recycled or scrap sources.

A company would have reason to believe representations were true if a processing facility received a “conflict-free” designation by a recognized industry group that requires an independent private sector audit of the smelter, or an individual processing facility, while it may not be part of the industry group’s “conflict-free” designation process, obtained an independent private sector audit that is made publicly available. A company’s policies with respect to the sourcing of conflict minerals will generally form a part of the company’s reasonable country of origin inquiry, and therefore would generally be required to be disclosed in the company’s Form SD. Moreover, if a company reasonably designs an inquiry and performs the inquiry in good faith, and in doing so receives representations indicating that its conflict minerals did not originate in the Conflict Countries, even though it does not hear from all of its suppliers, as long as it does not ignore warning signs or other circumstances indicating, the company would have good reason to believe the representations were true that the remaining amount of its conflict minerals originated or may have originated in the Conflict Countries.

Content of the Form SD

A company that determines, following its reasonable country of origin inquiry, its conflict minerals did not originate in the Conflict Countries or come from recycled or scrap sources or has no reason to believe that its necessary conflict minerals may have originated in the Conflict Countries or may not be from recycled or scrap sources must disclose its determination and results and provide, under the “Conflict Minerals Disclosure” heading of Form SD, a brief description of the inquiry it undertook and the results and provide a link to its Internet website where the disclosure is publicly available.

Content of the Conflict Minerals Report

As discussed above, the final rules require a company to undertake “due diligence” on the source and chain of custody of its conflict minerals and file a Conflict Minerals Report as an exhibit to its Form SD, make the Conflict Minerals Report publicly available on its website and provide the Internet address of that site on its Form SD if the company determines both that (i) it knows or has reason to believe that the minerals may have originated in the Conflict Countries and (ii) it knows or has reason to believe that the minerals may not be from scrap or recycled sources based on its country of origin inquiry. However, if a company, as a result of its due diligence, determines that its conflict minerals did not originate in the Conflict Countries or that its conflict minerals did come from recycled or scrap sources, no Conflict Minerals Report is required. However, the company is required, in the body of its Form SD, to disclose its determination (including a brief description of its due diligence efforts) and demonstrate why the company believes that the conflict minerals did not originate in the Conflict Countries or that the conflict minerals came from recycled or scrap sources.

The due diligence undertaken in connection with a Conflict Minerals Report must conform to a nationally or internationally recognized due diligence framework, such as the due diligence guidance approved by the Organisation for Economic Co-Operation and Development (“OECD Guidance”), which is available at

http://www.oecd.org/daf/internationalinvestment/guidelinesformultinationalenterprises/46740847.pdf.8

Any issuer filing such a report is required to:

  • obtain an independent private sector audit of its report;
  • certify that it obtained such an audit9;
  • include the audit report as part of its Conflict Minerals Report; and
  • identify the auditor.

If a company’s products have not been determined to be “DRC conflict free,” that is, the minerals may originate from the Conflict Countries but did not finance or benefit armed groups, then the company must still file a Form SD including a Conflict Minerals Report and must describe in the Conflict Minerals Report:

  • the products manufactured or contracted to be manufactured that have not been found to be “DRC conflict free”;
  • the facilities used to process the conflict minerals in those products10;
  • the country of origin of the conflict minerals in those products; and
  • the efforts to determine the mine or location of origin with the greatest possible specificity.

For a temporary two-year period (or four-year period for smaller reporting companies), if the company is unable to determine whether the minerals in its products originated in the Conflict Countries or financed or benefited armed groups in those countries, then those products are considered “DRC conflict undeterminable.” In that case, the company is not required to obtain an independent private sector audit but must describe the following in its Conflict Minerals Report:

  • its products manufactured or contracted to be manufactured that are “DRC conflict undeterminable”;
  • the facilities used to process the conflict minerals in those products, if known;
  • the country of origin of the conflict minerals in those products, if known;
  • the efforts to determine the mine or location of origin with the greatest possible specificity; and
  • the steps it has taken or will take, if any, since the end of the period covered in its most recent Conflict Minerals Report to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve due diligence.

Exception for Acquisitions: The final rules allow a company that acquires control over a company that manufactures or contracts for the manufacturing of products with necessary conflict minerals, and that had not previously been obligated to provide disclosure under the conflict minerals rules, to delay their first conflict minerals disclosure until the due date for the first report due after the end of the first calendar year that begins no sooner than eight months after the effective date of the acquisition. However, companies should inquire during due diligence for an acquisition regarding any exposure a target company may have to conflict minerals.

Practical Compliance Suggestions

To prepare for these imminent disclosure requirements, affected issuers should consider implementing some or all of the following steps set forth below. Each issuer will need to determine its own compliance program based on its particular facts and circumstances.

  • Conduct a compliance risk assessment to determine exposure related to the final rules on conflict minerals
    • Identify products potentially covered by the final rules
    • Audit suppliers to assess the issuer’s risk exposure associated with relevant product supply chains
  • Compose a compliance working group dedicated to conflict minerals compliance
    • Adequately staff the team with a combination of legal and business personnel
    • Establish enterprise-wide reporting mechanisms to identify relevant risks
    • Integrate the conflict minerals compliance working group into the issuer’s established internal controls
  • Establish a compliance program with policies and procedures dedicated to conflict minerals compliance
    • Establish due diligence requirements and procedures to adequately satisfy the investigatory burden imposed on issuers by the final rules (due diligence should comply with industry-wide guidance, e.g., OECD Guidance)
    • Refine issuer policies related to product manufacturing, or contracts to manufacture, to include a “red flag” checklist assessment based on supplier responses to issuer questionnaires or other due diligence inquiries
    • Establish reporting procedures for counterparties in product supply chains to identify relevant information for potential disclosure
    • Establish internal monitoring protocols and system checks to avoid potential compliance failures
    • Establish an adequate personnel reporting system for potential compliance issues with an express “no-reprisal” policy for individuals who report suspected issues in good faith
    • Integrate, as appropriate, provisions into contracts and other commercial documents certifying counterparty compliance with applicable conflict minerals disclosure requirements
  • Develop due diligence procedures specifically related to mergers and acquisitions (“M&A”) and joint ventures (“JVs”)
    • Coordinate with the legal and conflict minerals compliance working group to create and maintain M&A and JV due diligence procedures (including questionnaires and checklists)
  • Train management and personnel on the new disclosure requirements and applicable internal compliance procedures
    • Personnel at all levels should be aware of the final rules and of new procedures dedicated to conflict minerals compliance