Regulations giving effect to section 1502 of the Dodd-Frank Act, an act passed by Congress predominantly to increase transparency of financial institutions, are currently being finalized by the U.S. Securities and Exchange Commission (SEC). Despite the general focus of the Act on financial transparency, section 1502 and the proposed regulations create reporting requirements for companies that either produce or consume certain minerals, defined as conflict minerals, mined in the Democratic Republic of the Congo (DRC), and adjacent countries.
When final rules are adopted by the SEC, Section 1502 will be one of an increasing number of regulatory frameworks which focus on tracking and reporting the source of natural resources, and the processes used to extract and refine them. The approach, which takes cues from the Kimberly Process developed for diamonds, aims to encourage the resource extraction sector to develop processes which allow for an accurate record of the source of natural resources and the modes of extraction.
The goal of such legislation is to facilitate public support for, or public pressure against, practices that have potential human rights, ecological or social impacts. In the case of the Dodd-Frank Act, the preamble to Section 1502 states the issue targeted by that section as follows:
It is the sense of the Congress that the exploitation and trade of conflict minerals originating in the Democratic Republic of the Congo is helping to finance conflict characterized by extreme levels of violence in the eastern Democratic Republic of the Congo, particularly sexual- and gender-based violence, and contributing to an emergency humanitarian situation therein…
Dodd-Frank Section 1502
The Dodd-Frank Act passed the U.S. legislative houses in 2010 and was signed into law on July 21, 2010. At section 1502, the law set standards, and mandated the creation of rules, which allow for the tracing of conflict minerals, and required substantial reporting on the supply chains of natural resource extraction industries from companies that utilize the refined derivatives of those conflict minerals.
The section targeted a series of minerals defined as “conflict minerals”. These included raw minerals from which tin, coltan, tungsten, gold are extracted, and any additional derivatives of those raw minerals. It also allowed for the designation of further minerals as conflict minerals if it is determined by the Secretary of State that such minerals are financing conflict in the DRC.
While final regulations have not yet been adopted, as proposed that reporting will be mandatory for reporting issuers, including publicly traded companies in the U.S., for whom use of the conflict minerals is necessary to the product or products the company creates. The SEC has taken the position in its proposed regulations that this includes mining companies, as they produce refined minerals as a product .
If a publicly traded company requires the use of conflict minerals, that company will be obligated to determine, or attempt to determine the source of the minerals that it uses. If any of the conflict minerals a company uses originate in the DRC itself, or in any adjoining countries (the “DRC Countries”), or it is unable to determine the source of the minerals, it will be required to report this publicly. The proposed approach would be for this information to be included as part of the company’s annual report and made available on its website. Additionally, if minerals originated in one of the DRC Countries, the company will be required to provide a supply chain due diligence report, including a private sector audit.
The mandatory nature of the reporting requirements under section 1502 is one of the major departures from the largely voluntary Kimberly Process developed in relation to diamond extraction.
The Increasing Prevalence of Resource Reporting Requirements
In addition to section 1502, and the forthcoming regulations, a separate guidance document relating to conflict minerals has been approved by the OECD. The recommendations relate to the same conflict minerals, and seek to “provide management recommendations for global responsible supply chains of minerals to help companies to respect human rights and avoid contributing to conflict through their mineral or metal purchasing decisions and practices.” The OECD has suggested that adherence to its approach may also meet the informational requirements that may be set by the Dodd-Frank regulations. However, before the regulations are drafted, this is difficult to assess.
Additionally, in 2010 the European Parliament invited the European Commission to draft a similar legislative scheme to be implemented by the European Union.
Beyond the DRC conflict mineral regulations, and the pre-existing Kimberly Process, reporting requirements are an increasingly popular way for national governments to address international concerns, such as the humanitarian concerns in the DRC. The implementation of multiple reporting requirements, with potentially different goals or applications has the potential to create a complex regulatory system in any resource extraction or manufacturing sector.
This trend towards transparency in reporting is evident in the voluntary initiative focused on national reporting of payments made by oil, gas and mining companies called the Extractive Industries Transparency Initiative (EITI), which has been implemented by a number of countries in Africa and internationally.
Criticism of Dodd-Frank and Resource Transparency
While the goal of resource reporting is laudable, section 1502 does not come without controversy.
Since the time that the Act was passed, a number of companies, as well as industry organizations, have begun to develop processes to adhere to the anticipated guidelines. While these initiatives have had a positive influence in reducing the funds passing to militant groups in the DRC, they have also reduced investment in other sectors, including most or all of the mining initiatives in the eastern Congo, an area where conflict is more prevalent. However, it could also be that the delay by the SEC in instituting these regulations has lengthened the period of decreased investment as industry waits to see if they can safely invest and still be compliant. It is hoped that what is happening now is not indicative of any long term dry up of investment. As a result, some argue that the overall impact of the measure has been more negative than positive.
Despite the controversy, the SEC is required to adopt regulations and it looks as if these draft regulations are set to go ahead, and look likely to be followed by similar measures elsewhere.
Navigating the Resource Supply Chain Reporting Requirements
Section 1502 of Dodd-Frank leaves many questions unanswered. For example, how much due diligence will be required of a reporting company that concludes that it requires the use of a conflict mineral? How critical must a conflict mineral be for it to be considered “necessary” in a company’s production?
Once these questions have been answered, presumably by the forthcoming regulations, it will be necessary for affected companies to develop processes to fulfill the requirements set by section 1502. This will include the need to identify and address the obvious practical difficulties that arise with tracing and reporting.
As new standards arise, those standards will have to be tested against existing reporting requirements to assess whether they have already been met, or whether they require additional due diligence and reporting. Will the OECD guidance actually satisfy the Dodd-Frank requirements? If so, will the proposed European initiative impose more or less restrictive standards?
Each of these questions require attention, and will involve a careful approach to developing reporting processes that meet the standards set without sacrificing competitiveness in the market.