On August 22, 2012, the Securities and Exchange Commission, by a 3-2 party line vote, adopted final rules regarding the disclosure and reporting requirements with respect to the use of “conflict minerals.” These new SEC rules, first proposed in December 2010, implement Section 1502 of the Dodd-Frank Act.

“Conflict minerals” include tin, gold, tungsten, and tantalum that originate in the Democratic Republic of the Congo (“DRC”) or the adjoining central African countries of Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia, collectively referenced as the “DRC countries” or the “covered countries.” These rare earth minerals are used primarily in electronic devices, but also turn up in other products.

These rules apply to products that an issuer either “manufactures” or “contracts to manufacture,” if a conflict mineral is “necessary to the functionality or production” of the products. While these quoted terms are undefined in the final rule, the lengthy adopting release (356 pages) does provide some guidance. (Release No. 34-67716 is linked here). A company will not be deemed to have “influence” over the manufacturing of a product, and thus be exempt from this rule, if it merely: (1) affixes its brand, marks, logo, or label to a generic product manufactured by a third party, (2) services, maintains or repairs a product manufactured by a third party, or (3) specifies or negotiates terms with a manufacturer that do not directly relate to the manufacturing of the product. Interestingly, the final rules, unlike the proposed rules, also do not apply to issuers that mine conflict minerals or contract for such mining.

The analytic process set up by these final rules involves three steps: (1) a determination of whether conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the issuer; (2) if the answer to the first question is affirmative, a “reasonable” country of origin inquiry must be conducted to determine if the issuer knows or has reason to believe that such minerals may have originated from the DRC or other “covered country” and not from another region or from scrap or recycled sources; and (3) if the answer to the second question is affirmative, the issuer must conduct supply chain due diligence and issue a “Conflict Minerals Report” reporting whether the product is “DRC conflict free.”

A company must trace the origin of the rare earth minerals it utilizes. There is no “de minimus” exception, if these minerals are necessary for the functionality or production of the product. Even trace amount may count. The compliance burden is to establish, and report, whether the conflict minerals used in the product originated in the DRC or covered countries, another region, or from scrap or recycled sources. The company must disclose the nature of its inquiry and its results in a report to be filed with the SEC. The SEC in its final rule provides an early “off ramp” for a company that can establish using scrap or recycled conflict minerals. However, many companies will still have to go through the first two steps outlined above, which will contribute to a substantial compliance burden. The standard for due diligence is unclear. The standard for gold contained in guidance from the OECD, but no guidance is available for the other conflict minerals.

In order to determine a product is “DRC conflict free” if the conflict minerals originate in the DRC or a covered country, the company must obtain an independent private sector audit of its Conflict Minerals Report, certify that it has obtained such an audit, include and disclose the audit in its Report, and identify the auditor.

The final rules contained a change in that the required disclosure and “Conflict Minerals Report” are set forth in a new, specialized Form SD and are not in or made an exhibit to the issuer’s annual report on Form 10-K (or 20-F). However, this Form must be “filed” with, not merely “furnished” to, the SEC, which means the issuer will have liability for any false or misleading statement contained in the Form pursuant to Section 18 of the Securities Exchange Act of 1934 (“Exchange Act”). In addition to its filing, the company is required to make publicly available its required disclosure and “Conflict Minerals Report” on its internet website.

If for a two year transition period (four years for small businesses), a company cannot determine the source of the conflict minerals, the company can report the source as “DRC conflict undeterminable”. The ultimate question which may not be immediately determinable is whether the sale of these minerals financed or benefited armed groups in the DRC countries, which is a difficult determination. However, if the source is determined to be the DRC or other covered countries, the issuer must commission an independent private sector audit of its due diligence findings. These findings and the audit report must then be filed with the SEC.

Despite many objections from the issuer community, the final rules apply to any issuer that files reports with the SEC under Section 13(a) or 15(d) of the Exchange Act, without exceptions for “foreign private issuers” or small reporting issuers. These new rules apply to all issuers on a calendar year basis, regardless of the issuer’s reporting year. They commence on January 1, 2013, with the first reports due on May 31, 2014.

The due diligence burden of these rules is very significant. The SEC’s own, revised estimate is an initial cost of compliance of between $3-4 billion and the ongoing cost between $200-600 million. The compliance cost burden for small and mid-sized companies that have not already started to build the necessary internal due diligence infrastructure will be particularly burdensome.

This final rule is complex and will require companies subject to the rule to conduct a comprehensive review of their product lines to determine whether products they manufacture or contract to manufacture contain conflict minerals. If a product contains conflict minerals, the company must carry out a reasonable “country of origin” assessment. Most companies will be able to stop their inquiry at this point but will still be required to make a filing with the SEC. Businesses need to start now to activate a conflict minerals compliance program to meet these new reporting obligations.