Overview

Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act was aimed at drying up the main funding source of the war in the Democratic Republic of the Congo (the “DRC”). The related SEC final rule (Rule 13p-1 under the Securities Exchange Act of 1934 (the “Exchange Act”)), adopted on August 22, 2012 (the “Final Rule”), will require certain issuers (“Issuers”) of securities that file reports pursuant to Section 13(a) or 15(d) of the Exchange Act to report on their use of Conflict Minerals in products that they manufacture or contract to be manufactured for each calendar year starting with year calendar 2013, with the initial report due no later than May 31, 2014. “Conflict Minerals” are defined as columbite-tantalite (tantalum ore), cassiterite (tin ore), gold, wolframite (tungsten ore) or their derivatives (which are limited to tantalum, tin, and tungsten), or any other mineral or its derivatives determined by the U.S. Secretary of State to be financing conflict in the Covered Countries (defined below).

Changes to the Final Rule

The Final Rule contains several notable changes from the proposed rules, including:

  • the change of disclosure location (now on new Form SD) and timing (now calendar year for all Issuers, commencing with 2013);
  • addition of the temporary “DRC conflict undeterminable” designation for years 2013 and 2014 for all Issuers (and 2015 and 2016 for smaller reporting companies);
  • the exemption of any Conflict Minerals smelted, fully refined or located outside of the Covered Countries prior to January 31, 2013; and
  • a revised process for addressing Conflict Minerals derived from recycled or scrap sources.

This Market Alert focuses on the major actions and some of the practical steps that Issuers will need to take. We will address the changes to the Final Rule in more detail in a follow-up Market Alert.

The Major Requirements

The Final Rule will require Issuers to do the following:  

STEP 1. DETERMINE IF CONFLICT MINERALS ARE “NECESSARY TO THE FUNCTIONALITY OR PRODUCTION” OF ANY PRODUCT THAT THEY MANUFACTURE OF CONTRACT TO BE MANUFACTURED.

  • For each product manufactured or contracted to be manufactured by an Issuer, the Issuer will need to conduct an assessment, which will likely include requesting information from its suppliers, to determine if there are any Conflict Minerals in the product and whether such Conflict Minerals are “necessary” to the functionality or production of the product.
  • The Final Rule does not define when a Conflict Mineral is “necessary to the functionality or production” of a product. However, the adopting release (the “Adopting Release”) provides some interpretive guidance:
    • “Necessary to the functionality” -- an Issuer should consider whether: (a) a Conflict Mineral is contained in and intentionally added to the product or any component of the product; (b) a Conflict Mineral is necessary for the product’s generally expected function, use, or purpose; or (c) the primary purpose of the product is ornamentation or decoration and if a Conflict Mineral is incorporated for purposes of ornamentation, decoration or embellishment.
    • “Necessary to the production” -- an Issuer should consider whether a Conflict Mineral is contained in the product and intentionally added in the product’s production process, including the production process of any component of the product; and whether the Conflict Mineral is necessary to produce the product. However, note that only a Conflict Mineral that is contained in the product should be considered “necessary to the functionality or production” of that product; thus, for example, any Conflict Mineral that is used in the production of the product but is not contained in the product is exempt from the Final Rule.
  • For products where “necessary” Conflict Minerals are found, each Issuer will be required to perform Step 2.

STEP 2. CONDUCT “REASONABLE COUNTRY OF ORIGIN INQUIRY,” IN GOOD FAITH, TO DETERMINE IF THE “NECESSARY” CONFLICT MINERALS IN EACH PRODUCT ORIGINATED IN ANY OF THE COVERED COUNTRIES OR WERE DERIVED FROM RECYCLED OR SCRAP SOURCES.

  • For each of its products that contains “necessary” Conflict Minerals, the Issuer will likely need to obtain “reasonably reliable” representations about the country of origination of the newly-mined minerals from the smelters or refineries where such Conflict Minerals were processed, or whether such Conflict Minerals are derived from recycled or scrap sources. These representations may be obtained directly from the smelters or refineries or indirectly from the Issuer’s immediate suppliers, who also may require indirect representations from their suppliers. It is possible that such indirect representations may traverse through several layers of the supply chain in the case of certain Issuers.
  • Based on the results of the reasonable country of origin inquiry, if the Issuer:
    • determines that the “necessary” Conflict Minerals in a product did not originate in any Covered Country or did come from recycled or scrap sources;
    • has no reason to believe that such Conflict Minerals may have originated in any Covered Country; or 
    • reasonably believes that such Conflict Minerals did come from recycled or scrap sources, then, in any of such cases, the assessment process ends as the product is deemed to be “DRC conflict free. 1“ The Issuer is required to report this determination and the inquiry process and results on Form SD, and disclose this information on its publicly available Internet website.
  • However, if based on the results of the reasonable country of origin inquiry the Issuer:
    • knows that any of the “necessary” Conflict Minerals in a product originated in any Covered Country and are not from recycled or scrap sources; or
    • has reason to believe that such Conflict Minerals may have originated in any Covered Country and may not be from recycled or scrap sources, then, in either of such cases, the Issuer will be required to perform Step 3A below.
  • “Covered Countries” are defined in the Final Rule to mean the DRC and adjoining countries, which are Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia.

STEP 3A. CONDUCT DUE DILIGENCE TO DETERMINE THE SOURCE AND CHAIN OF CUSTODY OF THE “NECESSARY” CONFLICT MINERALS NOT FOUND TO BE “DRC CONFLICT FREE” IN STEP 2.

  • The Issuer will need to follow the OECD due diligence guidance2 (or another nationally or internationally recognized due diligence framework) to conduct a more in-depth assessment of the source of the “necessary” Conflict Minerals in each product, including more detailed surveys of its suppliers and additional investigations further upstream in the supply chain, as required, to ascertain, to the extent possible, whether such Conflict Minerals are from mines or trading that contributes to the financing of “armed groups” in the Covered Countries, or if the Conflict Minerals are from recycled or scrap sources.
  • Based on the results of the due diligence, if the Issuer determines that the “necessary” Conflict Minerals in a product did not originate in any Covered Country or that they did come from recycled or scrap sources, the assessment process ends as the product is deemed to be “DRC conflict free” and the Issuer is required to report this determination, its reasonable country of origin inquiry, and the due diligence process and results on Form SD. The Issuer is also required to disclose this information on its publicly available Internet website.
  • However, if based on the results of the due diligence, the Issuer knows that any of the “necessary” Conflict Minerals originated in any Covered Country and are not from recycled or scrap sources, or has reason to believe that such Conflict Minerals may have originated in any Covered Country and may not be from recycled or scrap sources, the Issuer will be required to perform Step 3B below.

STEP 3B. PREPARE CONFLICT MINERALS REPORT AND OBTAIN INDEPENDENT THIRD-PARTY AUDIT (AS REQUIRED) FOR CONFLICT MINERALS THAT ORIGINATED IN OR MAY HAVE ORIGINATED IN COVERED COUNTRIES AND ARE NOT OR MAY NOT BE FROM RECYCLED OR SCRAP SOURCES.

  • The Issuer will be required to prepare and file a Conflict Minerals Report, as an exhibit to Form SD, on its due diligence process and results (determination as to whether the “necessary” Conflict Minerals in each product are from mines or trading that contributes to the financing of “armed groups” in any of the Covered Countries). For those products that have not been found to be “DRC conflict free” and those found to be “DRC conflict undeterminable” (defined below), the Issuer must provide a description of the products, the facilities used to process the necessary conflict minerals in the products (if known), the country of origin of the necessary conflict minerals in the products (if known), and the efforts to determine the mine or location of origin with the greatest possible specificity. The Issuer must also provide the Conflict Minerals Report on its publicly available Internet website. The report must be audited by an independent third-party auditor (except for the section pertaining to the due diligence on recycled or scrap Conflict Minerals for which no nationally or internationally recognized due diligence framework is available, as noted below), and the audit report must be disclosed with the Conflict Minerals Report. 
  • For the calendar years 2013 and 2014 for all Issuers (and 2015 and 2016 for smaller reporting companies), Issuers may describe their products with “necessary” Conflict Minerals as “DRC conflict undeterminable” if after due diligence they are unable to determine whether the Conflict Minerals in such products are “DRC conflict free.” Issuers are required to report on their “DRC conflict undeterminable” products in a Conflict Minerals Report, as described above. However, no independent third-party audit of the due diligence conducted for such Conflict Minerals described in the report is required. After this temporary period, Issuers will not be allowed to use the “DRC conflict undeterminable” designation and will be required to designate such products as “not having been found to be DRC conflict free.”

The below is a simplified flow-chart of the process.

Click here to view the chart.

Timing

All Issuers are required to report on a calendar year basis starting with calendar year 2013, with the initial report due no later than May 31, 2014. Reporting will be on the new Form SD, and the Conflict Minerals information in Form SD (and any Conflict Minerals Report submitted as an exhibit) will be “filed” under the Exchange Act and thereby subject to potential Exchange Act Section 18 liability. Issuers will not be required to report on Conflict Minerals that are smelted, fully refined or located outside the Covered Countries prior to January 31, 2013.

Costs

The Adopting Release, as required by statute, includes the SEC’s economic analysis of the expected compliance costs of the Final Rule. The SEC estimates that initial compliance costs for Issuers and the suppliers in their supply chains will be approximately $3 billion to $4 billion, with ongoing annual compliance costs between $207 million and $609 million. The SEC identifies three categories of costs as the most significant: IT systems modification (estimates of $205,000 per small Issuer and $410,000 per large Issuer); Conflict Minerals Report audits (estimate of $100,000 annually for large Issuers); and due diligence related activities (varying estimates). It should be noted that overall compliance cost estimates from commentators on the proposed rules vary widely from $388 million to $16 billion, though in all cases significantly greater than the SEC’s initial estimate of $71 million.