As part of the reforms enacted under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), Congress directed the Securities and Exchange Commission (“SEC”) to implement regulations regarding the use of “conflict minerals” originating from certain countries, including the Democratic Republic of Congo (“DRC”). The goal of such regulations is to curb the trade in these minerals, thereby preventing human rights abuses occurring in the DRC and, ultimately, bringing an end to the conflict there—a conflict that has been at least partially funded by the trade of certain minerals originating in the DRC and neighboring countries.
After an extensive rule-making period that included the submission of hundreds of comment letters and a roundtable discussion with interested parties, the SEC recently published its final rule for disclosing the use of conflict minerals (the “Conflict Minerals Rule”). The final rule, released with over 300 pages of commentary and guidance, creates new reporting requirements for a broad swath of companies, many of which may not even be aware of their reporting obligations.1 And, despite the hundreds of pages of discussion, the final rule seems to create more questions than it answers, leaving many companies to wonder: Are we required to file a disclosure on conflict minerals? If so, when? And what does such a disclosure entail?
For companies navigating a wholly-new regulatory regime, the Conflict Minerals Rule has led to uncertainty as to the scope of the rule and its exact requirements, as well as the level of analysis necessary to satisfy the rule’s “inquiry” and due diligence provisions.2 The SEC suggests that compliance with the rule follows a simple three-step process, whereby a reporting company first determines if it is subject to the rule. If it is, the company then moves to the second step and conducts an inquiry to determine the country of origin for any specified conflict minerals in its products (or contracted-for products). Depending on the outcome of that inquiry, a reporting company may move to the third step, which requires some or all of the following: due diligence on the source and chain of custody of conflict minerals, the filing of a Conflict Minerals Report, and an independent private-sector audit of such a report. While these three steps seem simple in concept, they are less-than-clear in practice.
To begin complying with the Conflict Minerals Rule, companies will need help understanding the sometimes complex language of the rule and the nuances of its reporting requirements. This article outlines key definitions and timing requirements, provides an overview of the “three-step process” for compliance, and highlights possible areas of uncertainty within the rule.3
As a preliminary matter, the “conflict minerals” covered by this rule are defined as “columbite-tantalite (coltan), cassiterite, gold, wolframite, or their derivatives, which are limited to tantalum, tin, and tungsten,” subject to revisions by the State Department. For all practical purposes, the relevant conflict minerals are gold, tantalum, tin, and tungsten. The disclosures on use required by the Conflict Minerals Rule relate specifically to conflict minerals that originated in the DRC or an “adjoining country.” The Conflict Minerals Rule defines “adjoining country” as “a country that shares an internationally recognized border with the Democratic Republic of Congo,”4 which currently includes Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia (collectively, the “Covered Countries”).
The Conflict Minerals Rule goes into effect on November 13, 2012. Reporting companies must comply with the final rule for the calendar year beginning January 1, 2013 by filing a new Exchange Act form—Form SD—with the SEC.5 These initial reports and any related exhibits are due May 31, 2014. Subsequent reports on the preceding calendar—not fiscal year—are due on May 31st of each year.
The Three-Step Process
Step One: Determine Whether You Are Subject to the Conflict Minerals Rule
The Conflict Minerals Rule applies to “every registrant that files reports with the Commission under [Sections 13(a) or 15(d)] of the Exchange Act, having conflict minerals that are necessary to the functionality or production of a product manufactured or contracted by that registrant to be manufactured.”
While a company will know if it is a covered registrant, whether it uses conflict minerals that are “necessary to the functionality or production” of a product or contracted to “manufacture” a product may be less clear. The final rule does not define these terms, though it does offer some guidance on interpreting these provisions.
Noting that whether a conflict mineral is “necessary to” the production or functionality of a product is a facts-specific inquiry, the SEC offers the following factors to be considered in determining whether a conflict mineral is “necessary to the functionality” of a product:
- “whether a conflict mineral is contained in and intentionally added to the product or any component of the product and is not a naturally-occurring by-product;
- whether a conflict mineral is necessary to the product’s generally expected function, use, or purpose; or
- if a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration.”6
Likewise, in determining whether a conflict mineral is “necessary to the production” of a product, reporting companies should consider the facts and circumstances relevant to the specific product at issue as well as the following factors:
- “whether a conflict mineral is contained in the product and intentionally added in the product’s production process, including the production of any component of the product; and
- whether the conflict mineral is necessary to produce the product.”7
Importantly, for both of these inquiries, “only a conflict mineral that is contained in the product should be considered ‘necessary to the functionality or production’ of that product.”8 Although the “contained in” requirement limits the scope of the rule only to products that actually contain a conflict mineral, it is important to note that conflict minerals may be “contained in” a product in various ways, including as part of a component of the overall product. This is true even where a component part “was manufactured originally by a third party.”9 Thus, a reporting company must consider the product both as a whole and as the sum of its parts.
"Manufacture" and "Contract to Manufacture"
Noting that the term “manufacture” is generally understood, the SEC declined to define the term. With respect to the phrase “contract to manufacture,” however, the SEC offered guidance as to factors to consider along with the facts and circumstances specific to a given product. In general, a reporting company will be deemed to “contract to manufacture” a product if it has “actual influence” over the manufacturing, which depends on “the degree of influence it exercises over the materials, parts, ingredients, or components” included in any product that contains conflict minerals.10 What is meant by “actual influence” is not spelled out, though the guidance makes clear that a company “should not be viewed” as “contracting to manufacture” where its involvement is limited to:
- specifying or negotiating contract terms that do not directly relate to a product’s manufacturing;
- affixing its brand, marks, logo, or label to a generic product manufactured by a third party; or
- servicing, maintaining, or repairing a product manufactured by a third party.11
To recap, the first step in complying with the Conflict Minerals Rule is determining whether—in light of the guidance outlined above—conflict minerals are “necessary to the functionality or production” of a product either manufactured by a company or contracted by the company to be manufactured, keeping in mind that the presence of conflict minerals contained in component parts (even if manufactured by a third party) may subject a company to the rule’s reporting requirements. If a company finds that it satisfies these requirements, it moves to “Step Two” of the reporting requirements.
Step Two: If Subject to the Rule, Conduct a Reasonable Country of Origin Inquiry
Under the final rule, once a company satisfies the “necessary to” requirements discussed above, it “must conduct in good faith a reasonable country of origin inquiry . . . that is reasonably designed to determine whether any of the conflict minerals originated in [the Covered Countries], . . . . or are from recycled or scrap sources[.]”12
As with many aspects of the rule, what constitutes a “reasonable country of origin inquiry” is a fact-specific inquiry and depends on the facts and circumstances of a particular company and a particular product. Indeed, such an inquiry “can differ among issuers based on the issuer’s size, products, relationships with suppliers, or other factors.”13
While there is no guidance as to what constitutes a “reasonable” inquiry, the rule speaks for itself with respect to general standards: the inquiry must be undertaken in good faith and must be “reasonably designed” to determine the country of origin for the conflict minerals at issue. Significantly, the guidance does note that the reasonable country of origin inquiry standard is satisfied where a reporting company:
seeks and obtains reasonably reliable representations indicating the facility at which its conflict minerals were processed and demonstrating that those conflict minerals did not originate in the Covered Countries or came from recycled or scrap sources. These representations could come either directly from that facility or indirectly through the issuer’s immediate suppliers, but the issuer must have a reason to believe those representations are true given the facts and circumstances surrounding those representations.14
Further, a reporting company is “not required to receive representations from all of its suppliers. The standard focuses on reasonable design and good faith inquiry.”15 In other words, if a company undertakes a reasonable inquiry in good faith and learns that its conflict minerals are not from the Covered Countries, it may reasonably conclude that its conflict minerals did not originate from the Covered Countries “even though it does not hear from all of its suppliers,” so long as it does not ignore red flags or other warning signs.16 Under this reasonableness approach, “certainty is not required to satisfy the country of origin inquiry standard,” and “[d]isclosure indicating that the determination is uncertain is unnecessary.”17
What happens next is controlled by the outcome of the country of origin inquiry. If the company determines that:
- its conflict minerals did not originate in the Covered Countries or did come from recycled or scrap sources, or
- it has no reason to believe that its conflict minerals may have originated in the Covered Countries, or
- it reasonably believes that its conflict minerals did come from recycled or scrap sources,
then “the registrant must, in the body of its specialized disclosure report under a separate heading entitled ‘Conflict Minerals Disclosure,’ disclose its determination and briefly describe the reasonable country of origin inquiry it undertook in making its determination and the results of the inquiry it performed.”18 Thus, even where a company undertakes a reasonable country of origin inquiry and determines that its conflict minerals are properly sourced or recycled, or reasonably believes they are recycled, it must still disclose the fact of the inquiry, the steps taken, and the results.
If the results of the country of origin inquiry do not fall within any of the above-listed categories, the reporting company moves to “Step Three” and must perform due diligence on the source of the conflict minerals and the chain of custody.
Step Three: Conduct Due Diligence & Prepare a Conflict Minerals Report
A reporting company is required to perform due diligence where it knows that its conflict minerals are from a Covered Country and are not from recycled or scrap sources or where there is some ambiguity as to the source of the conflict minerals.
More specifically, the rule provides that, “if the registrant knows” that its conflict minerals originated in a Covered Country and are not from recycled or scrap sources, or “has reason to believe” that the conflict minerals “may have” originated from a Covered Country and has “reason to believe” that they “may not be” from recycled or scrap sources, the “registrant must exercise due diligence on the source and chain of custody[.]”19 Depending on the outcome of this due diligence, the reporting company may have to submit a detailed Conflict Minerals Report. At a minimum, however, the company must disclose its findings and describe the inquiry and due diligence undertaken to reach those conclusions.
If a company undertakes due diligence and determines that the conflict minerals did not originate in a Covered Country or did come from recycled or scrap sources, the company is not required to submit a Conflict Minerals Report. It must, however, “disclose its determination and briefly describe . . . the reasonable country of origin inquiry and the due diligence efforts it undertook in making its determination and the results of the inquiry and due diligence efforts it performed.”20 In all other circumstances, a company must file a Conflict Minerals Report as an exhibit to Form SD.
The Conflict Minerals Report
Pursuant to the final rule, Conflict Minerals Reports must include, among other things, a description of the due diligence undertaken to identify the source and chain of custody of the conflict minerals, which “shall include but not be limited to an independent private sector audit of the Conflict Minerals Report[.]”21 For a temporary period, companies may report that a product is “DRC conflict undeterminable;” such companies are not required to obtain an independent private sector audit of their Conflict Minerals Reports.22
If a reporting company manufactures products or contracts for products to be manufactured “that have not been found to be ‘DRC conflict free,’”23 the Conflict Minerals Report must describe those products as well as “the facilities used to process the necessary conflict minerals in those products, and the efforts to determine the mine or location of origin with the greatest possible specificity.”24 Companies with products that are “DRC conflict undeterminable” must provide “a description of those products, the facilities used to process the necessary conflict minerals in those products, if known, the country of origin of the necessary conflict minerals in those products, if known, and the efforts to determine the mine or location of origin with the greatest possible specificity[.]”25
This overview is just that—an overview. While it attempts to give some color to the “Three-Step Process” for complying with the Conflict Minerals Rule, it by no means answers all of the questions faced by potential reporting companies. Indeed, each company is certain to have issues unique to its products and its supply chain. Given this overview, however, companies should be in a better position to identify potential problem areas as they begin to create internal controls and design policies to oversee supply chain and sourcing for conflict minerals.