The Securities and Exchange Commission (“SEC”) recently adopted final disclosure and reporting rules requiring certain public companies to disclose information about their use of “conflict minerals” originating in the Democratic Republic of the Congo (the “DRC”) or an adjoining country. The new rules are mandated by the Dodd-Frank Act and address concerns that trading in conflict minerals by armed groups is helping to finance conflicts in the DRC region and contributing to a humanitarian crisis. Companies are required to comply with the new disclosure rules for the calendar year beginning January 1, 2013, with the first disclosures due on May 31, 2014 and annually on May 31 thereafter.
As defined in the Dodd-Frank Act, conflict minerals include gold, tin, tantalum, tungsten and their derivatives, and any other minerals or their derivatives determined by the Secretary of State to be financing conflicts in covered countries. At present, the countries covered by these rules are the DRC, Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia (each, a “Covered Country”).
The new rules require disclosure by a public company if it manufactures, or contracts to have manufactured, a product that includes a conflict mineral that is needed to produce or operate the product, and mandate that issuers pursue a three-step analysis to determine the character of any required disclosure.
The conflict mineral disclosure rules are particularly relevant to suppliers of electronics products since electronic devices commonly require one or more conflict minerals to function properly. Electronics companies will often want to focus on approaches to the inquiry required by step 2 of the review process contemplated by the rules–that is, a reasonable inquiry into the derivation of conflict minerals used in the companies’ products.
First, an issuer must determine whether a product that it manufactures or contracts to be manufactured includes any volume of a conflict mineral that is “necessary to the functionality or production” of a product. SEC guidance on this step advises issuers to determine: (1) whether their product contains a conflict mineral; (2) whether the conflict mineral was intentionally added during the product’s production process; and (3) whether the conflict mineral is necessary to produce the product or cause the product to function properly.
Whether a company “contracts to manufacture” a product depends largely on the degree of influence exercised by the issuer on manufacturing of the product. The SEC has indicated that issuers will not be viewed as “contracting to manufacture” a product if their actions involve no more than: (1) specifying or negotiating contractual terms with a manufacturer that do not relate directly to manufacturing of the product; (2) affixing its brand, marks, logo, or label to a generic product manufactured by a third party; or (3) servicing, maintaining, or repairing a product manufactured by a third party. But it is understood, for example, that a semiconductor supplier that relies on third party foundries for production of its products would ordinarily be covered by the rules.
As to any given product of an issuer, if it does not include a conflict mineral or the conflict mineral is not necessary for the product’s functionality or production, the issuer is not required to make any disclosure under the rules and need not proceed to step 2. To “off ramp” at step one, though, the issuer should have a reasonable basis to conclude that its product satisfies one of these tests.
If application of step one reveals that the new rules require disclosure action by an issuer, it must conduct a reasonable, good faith inquiry to determine whether conflict minerals used for its product(s) derive from mining in a Covered Country–a reasonable “country-of-origin inquiry.” The rules do not mandate a specific approach to a reasonable country-of-origin inquiry on the grounds that the character of an issuer’s inquiry will depend on the facts and circumstances of it and its products. The SEC has advised simply that the inquiry must be reasonably designed to determine whether the issuer’s conflict minerals fall into one of two categories such that it need not proceed to step three: (1) the conflict minerals did not originate in a Covered Country; or (2) the conflict minerals derive from scrap or recycled sources.
If a company determines that its conflict minerals did not originate in a Covered Country or are from recycled or scrap sources, or, if the company has no reason to believe that the minerals may have originated in a Covered Country or are from scrap or recycled sources, then the inquiry ends. The issuer is to disclose this information to the SEC on new SEC Form SD and describe the steps it completed in making this determination. The issuer must also place the description of its finding and reasonable country-of-origin inquiry on its public Internet site and provide the URL of its Form SD disclosure.
Expert assessments are ongoing regarding approaches to a country-of-origin inquiry that the SEC would consider to be adequate. Written certifications of suppliers would typically play a central role in such inquiries, but SEC guidance suggests that, as to a supplier that incorporates a conflict mineral into a supplied item, a certification alone would be inadequate. Rather, the issuer would also need to obtain from the supplier either: (1) the report of a reputable third-party auditor in support of a representation that conflict minerals did not derive from a Covered Country or are from recycled or scrap sources; or (2) proof of a “conflict-free” designation by a recognized industry group that requires an independent private sector audit of the supplier’s smelter.
If an issuer determines that its product uses a conflict mineral that originated in a Covered Country and that did not come from recycled or scrap sources, the issuer must proceed to step 3. The issuer will also be required to file a Conflict Minerals Report as an exhibit to its Form SD, and make that report publicly available on its Web site, together with its Form SD.
An issuer that is required to file a Conflict Minerals Report must perform due diligence on the conflict minerals source and chain of custody, which is to be summarized and included in the final Conflict Minerals Report submitted to the SEC with the Form SD. The subject of the step three inquiry is whether operations in a Covered Country from which conflict minerals derived help to finance armed conflict. Companies performing due diligence are required to do so in conformance with a nationally or internationally recognized due diligence framework, such as the OECD Due Diligence Guidance. Following this due diligence, the issuer’s remaining obligations depend on whether its products are “DRC conflict free,” “Not DRC conflict free,” or “DRC conflict undeterminable.”
- If an issuer determines that conflict minerals originated in a Covered Country but did not finance or benefit armed groups, the issuer must obtain an independent private sector audit of its Conflict Minerals Report, certify that it obtained such audit, include it in the Conflict Minerals Report and identify the auditor.
- If an issuer determines that its minerals are not DRC conflict free, the Conflict Minerals Report must describe the applicable products, facilities used to process those minerals, the country of origin of the conflict minerals, and the efforts to determine the location of origin.
- If an issuer is unable to determine whether the conflict minerals came from a Covered Country, came from recycled or scrap sources, or directly or indirectly financed or benefitted armed groups in a Covered Country, the company is–during a two to four-year grace period–permitted to not perform the independent private sector audit. The issuer is still required to disclose in its Conflict Minerals Report the steps it has taken or will take to mitigate the risk that its conflict minerals benefit armed groups, the country of origin of the conflict minerals (if known), the facilities used to process the conflict minerals (if known), and the efforts to determine the mine or location of origin with the greatest possible specificity.
The policy permitting an “undeterminable” finding is scheduled to last through the first two calendar years following the effective date of the rules (November 13, 2012) for all registrants and the first four calendar years for smaller reporting companies.