On August 22, 2012, the Securities and Exchange Commission (the "SEC") adopted final rules to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to the public disclosure by companies of their use of "conflict minerals" that originated in the Democratic Republic of the Congo (the "DRC") or adjoining countries (collectively with the DRC, the "Covered Countries"). The rules are intended to address concerns that the sourcing of these minerals -- tantalum, tungsten, tin and gold -- supports the ongoing conflict in the DRC. These minerals are used in the manufacturing of a wide variety of products, from gold jewelry to jet engines to electronic components in high-tech devices. The SEC anticipates that the new disclosures could affect as many as 6,000 reporting companies, as well as companies in their supply chains.
The new rules, which were the subject of considerable debate resulting in a lengthy delay in their approval, apply to reporting companies for which conflict minerals are "necessary to the functionality or production" of products that they manufacture or contract to have manufactured.
The disclosure requirement under the rule is divided into three steps. The first step is to determine whether a company is subject to the rule. The rule applies to a company if:
- The company files reports with the SEC under the Securities Exchange Act of 1934 (the "Exchange Act"); and
- Conflict minerals are "necessary to the functionality or production" of a product manufactured or contracted to be manufactured by the company.
The SEC did not define "necessary to the functionality or production" or "manufactured or contracted to be manufactured," but did provide some interpretive guidance in the release.
To determine whether conflict minerals are necessary to the functionality or production of a product, a company must consider relevant facts and circumstances, including whether the minerals are (i) contained in the product, (ii) intentionally added in the production process (rather than being a naturally occurring by-product), (iii) necessary to the functionality of the product, and (iv) necessary to production of the product. Note that, in a change from the proposed rule, the adopting release clarifies that the mineral must be contained in the final product in order for a company to be subject to the requirements of the rule, not just used in its manufacturing (e.g., as a catalyst).
In determining whether conflict minerals are necessary to the functionality of a product, a company should look at whether the minerals are necessary to the product's generally expected function, use or purpose (e.g., not just incorporated for decoration or ornamentation, unless that is the product's primary purpose, as in the case of jewelry).
With respect to whether a company is "contracting to manufacture" a product, a company must look at whether it has some actual influence over manufacturing of that product. This determination is again based on relevant facts and circumstances, taking into account the degree of influence a company exercises over the product's manufacturing. A company is not considered to have influence over manufacturing if it merely:
- Affixes its brand, marks, logo or label to a generic product manufactured by a third party;
- Services, maintains or repairs a product manufactured by a third party; or
- Specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of a product.
If the rule does not apply to a company, that company is not required to take any action, make any disclosure or submit any report under the rule.
If the rule does apply to a company, the second step requires that the company conduct a reasonable country of origin inquiry regarding the origin of its conflict minerals. A reasonable country of origin inquiry must be reasonably designed to determine whether any of the company's conflict minerals originated in any of the Covered Countries, or are from recycled or scrap sources, and must be performed in good faith. The company's circumstances will determine the exact nature of the inquiry as the rule does not specify particular actions to be taken by a company to perform the inquiry.
- If, based on a company's reasonable country of origin inquiry, a company (i) knows that the minerals did not originate in any of the Covered Countries or are from scrap or recycled sources, or (ii) has no reason to believe that the minerals may have originated from the Covered Countries or reasonably believes that the minerals came from scrap or recycled sources, then the company must disclose its determination and provide a brief description of the inquiry it undertook on a new specialized disclosure report, Form SD, that is discussed below.
- If a company (i) knows or has reason to believe that the minerals may have originated in one of the Covered Countries, or (ii) knows or has reason to believe that the minerals may not be from scrap or recycled sources, then the company must take step three.
The third step requires that a company undertake "due diligence" on the source and chain of custody of the minerals and, unless the company determines as a result of that due diligence that the conflict minerals did not originate in any of the Covered Countries or did come from recycled or scrap materials, file a Conflict Minerals Report as an exhibit to its Form SD.
The company must describe its due diligence process with respect to the source and chain of custody of the conflict minerals in the Conflict Minerals Report. The due diligence must be done using measures that conform to a nationally or internationally recognized due diligence framework, if available. Currently, only the due diligence guidance approved by the Organization for Economic Cooperation and Development fits that criteria. Subject to a temporary exception for "DRC Conflict Undeterminable" products (discussed below) and other limited exceptions, the due diligence measures also must include an independent audit of the Conflict Minerals Report. The objective of the audit will be to determine whether the company's due diligence measures were designed in conformity with the recognized framework that was applied and whether the company's description of its due diligence process is consistent with the process that the company performed.
In its Conflict Minerals Report, the company must:
- Certify that it obtained the required audit;
- Include the audit report as part of the Conflict Minerals Report; and
- Identify the auditor.
If a company determines that its products are not DRC Conflict Free, then the company must include the following in its Conflict Minerals Report, in addition to the audit-related requirements described above:
- A description of the products manufactured or contracted to be manufactured that have not been found to be DRC Conflict Free;
- A description of the facilities used to process the conflict minerals in those products;
- Identification of the country of origin of the conflict minerals in those products; and
- A description of the efforts made to determine the mine or location of origin with the greatest possible specificity.
For a two-year temporary transition period (or four-year period for smaller reporting companies), beginning on the effective date of the final rule, if a company is unable to determine whether the conflict minerals in its products originated in any of the Covered Countries or financed or benefited armed groups in any of those countries, those products are considered "DRC Conflict Undeterminable." In that case, a company must include the following in its Conflict Minerals Report:
- A description of the products manufactured or contracted to be manufactured that are DRC Conflict Undeterminable;
- A description of the facilities used to process the conflict minerals in those products, if known;
- Identification of the country of origin of the conflict minerals in those products, if known;
- A description of the efforts made to determine the mine or location of origin with the greatest possible specificity; and
- A description of the steps it has taken or will take, if any, since the end of the period covered by 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.
A company is not required to obtain an independent private sector audit of the Conflict Minerals Report regarding the conflict minerals in products that are DRC Conflict Undeterminable. At the end of the temporary two-year (or four-year) temporary transition period referred to above, if a company is still unable to determine whether the conflict minerals in its products originated in any of the Covered Countries or financed or benefited armed groups in those countries, it must classify these products as not DRC Conflict Free.
As noted above, the final rule creates a new form, Form SD, which is to be publicly filed on EDGAR by companies subject to the rule by May 31 of each calendar year. The required disclosures and report, if applicable, will cover the prior calendar year. All companies subject to the requirements will be subject to this calendar-year timeline, regardless of the timing of their fiscal years. Form SD will be considered "filed" for purposes of the liability provisions of Section 18 of the Exchange Act. However, as a result of the disclosures and report being provided pursuant to the new Form SD, rather than in the company's annual report, the disclosures and report will not be incorporated by reference into filings under the Securities Act of 1933 and will not be subject to the CEO and CFO certifications that accompany annual reports.
The final rule also requires website posting of the information included in the Form SD.
Companies that are subject to the rule must comply beginning January 1, 2013. The first Form SD reports will be due May 31, 2014.
Note that the rule excludes any minerals that are "outside the supply chain" (i.e., already smelted, refined, or otherwise located outside of the Covered Countries) before January 1, 2013.
No De Minimus Exception
The final rule does not contain an exemption for companies that use only small amounts of conflict minerals.