On May 30, 2013, the Division of Corporation Finance of the Securities and Exchange Commission (SEC) issued new guidance regarding the rule published last year under Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to the use of conflict minerals in products.1 The new guidance takes the form of a list of “Frequently Asked Questions.”2
As described in Arnold & Porter’s August 2012 Advisory,3 the final rule is intended to reduce the flow of funds from the extraction and sale of four minerals that have been used to finance armed conflict in the Democratic Republic of Congo (DRC) and surrounding countries by increasing accountability for parties involved in the supply chains for those minerals. This “conflict minerals” rule creates significant burdens on companies that manufacture or “contract to manufacture” products that contain the relevant minerals – tantalum, tin, tungsten, and gold – if those minerals are “necessary to the functionality or production” of such products. The SEC has created a new Form SD for companies to file annually in order to report, under certain circumstances, use of these minerals.
Our August 2012 Advisory provides an overview of the burdens that the conflict minerals rule may impose on affected companies, as well as the many uncertainties remaining about compliance with the rule. Although the SEC’s recent guidance adds some clarity to compliance with the conflict minerals rule, it leaves unaddressed many of the important issues about the burdens imposed. The issues covered by the SEC’s guidance fall into five categories:
- What Qualifies as a “Product” Covered By the Rule?
Packaging sold with a product is not considered part of the “product.”
The SEC confirmed that packaging and containers are not part of a “product” that a company sells for the purpose of the rule. Thus, if a company sells a product in packaging or a container that the company manufactures or contracts to manufacture, the company need not report that product or its packaging in any Form SD the company files, even if that packaging contains conflict minerals. Importantly, this is true even if such packaging or container is necessary to preserve the usability of the product (such as the packaging of food). If, on the other hand, a company manufactures or contracts to manufacture packaging or a container containing conflict materials and sells this packaging independently, the packaging is considered a “product” and must be reported in Form SD.
Equipment used to provide a service is not a “product.”
A company that uses equipment containing conflict minerals to provide a service rather than to sell as a product need not describe that equipment in any Form SD the company files. If the equipment is retained by the service provider, required to be returned to the service provider, or is intended to be abandoned by the customer following the terms of service, it is not a “product.” The SEC cited a cruise ship as an example of a piece of equipment used to provide a service that would not be considered a “product.”
Equipment previously used in manufacturing and later resold is not a “product.”
The SEC clarified that equipment containing conflict minerals that a company has previously used for manufacturing and later resells is not considered a “product.” A company selling such used equipment need not describe this equipment in any Form SD it files.
When Does A Company “Manufacture or Contract to Manufacture” A Product Containing Conflict Minerals?
Branding alone is not “contracting to manufacture.” The SEC reaffirmed that when a company buys a generic product manufactured by a third party and requires that its logo, serial number, or other marks or identifiers be affixed onto the product, the branding or marking alone does not make that product “manufactured or contracted to manufacture” by the company, and need not be included in any Form SD the company files.
A company that manufactures a generic component containing conflict materials is subject to the rule. A company is considered to have “manufactured or contracted to manufacture” a product containing conflict minerals even if the only conflict mineral in that product is contained in a “generic” component bought from a third party. For such products, the issuer must conduct a reasonable country of origin inquiry to determine if it needs to be reported in Form SD.
- Who Needs to File Form SD?
The rule applies to voluntary filers.
The SEC confirmed that voluntary filers are subject to the conflict minerals rule. Thus, all companies that file reports with the SEC under Exchange Act Sections 13(a) or 15(d) are required to comply. The lone exception provided is for registered investment companies that are required to file reports pursuant to Rule 30d-1 under the Investment Company Act.
Mining companies may not need to file.
The SEC confirmed that companies that only engage in activities associated with mining, including the steps involved in processing lower grade gold ore, are not considered manufacturers and thus need not file a Form SD.
Companies must file if their consolidated subsidiaries would be covered by the rule.
An issuer must file a Form SD report if one of its consolidated subsidiaries would, if it were itself an issuer, be required to file a Form SD due to the products it manufactures or contracts to manufacture. Companies may be able to delay reporting after their initial public offering. After an issuer’s IPO, it may delay reporting until the first calendar year that begins no sooner than eight months after the IPO – that is, it need not file a report for the calendar year in which it goes public unless the effective date of its IPO registration statement is before May 1.
Companies with only “DRC conflict free” products are still subject to reporting requirements.
Some companies may determine that they manufacture or contract to manufacture products that contain conflict minerals from the DRC or an adjoining country, but still may be categorized as “DRC conflict free.” Such companies are still required to file Form SD and obtain an independent private sector audit of the Conflict Minerals Report, but need not disclose which products have been found to be “DRC conflict free.”
- What Level of Detail Is Necessary in Form SD?
Products must be described pursuant to industry terms.
If a product is not found to be “DRC conflict free” or is found to be “DRC conflict undeterminable,” it should be described using terms commonly used in the relevant industry, and need not be described with model numbers.
Products must be described as either not “DRC conflict free” or “DRC conflict undeterminable.”
Products described in Form SD are those that either have been found not to be “DRC conflict free” or are “DRC conflict undeterminable.” Filing companies must state under which of these categories the described products fall.
- Does Failure to Timely File Form SD Make a Company Ineligible for Shelf Offerings?
Companies who fail to timely file Form SD do not become ineligible for shelf offerings?
The SEC confirmed that only failure to timely file reports under certain other sections of the Exchange Act make a company ineligible to conduct shelf offerings using Form S-3. Form SD is not among these reports, so failure to timely file it will not make that company ineligible for shelf offerings. But, as described in Arnold & Porter’s August 2012 Advisory, companies that fail to file Form SD pursuant to the rule may face other forms of liability.
The SEC’s latest guidance has, for the most part, confirmed prevailing views on compliance with the conflict minerals rule, while leaving many other questions unanswered. While the SEC’s clarifications regarding packaging and equipment may be helpful to companies in particular industries, the new guidance does not otherwise lessen the compliance burden on issuers.
The timing of this guidance may relate to a delay in the litigation brought by the National Association of Manufacturers and U.S. Chamber of Commerce challenging the SEC rule. Those groups filed a petition with the U.S. Court of Appeals for the District of Columbia Circuit last October, and have contended that, among other things, the SEC failed to perform the necessary cost-benefit analysis in promulgating the rule and that certain provisions were arbitrary and unreasonably stringent. Arnold & Porter submitted an amicus brief on behalf of several distinguished experts in African affairs and the situation in the DRC region contending that the rule does not achieve Congress’ objectives in enacting Section 1502. The plaintiffs recently re-filed the case with the U.S. District Court for the District of Columbia, which is set to hear argument on July 1. Any resolution to the case is likely still several months away, because of the time required for a trial court decision and strong likelihood of appeal.
Against this backdrop, it is imperative that companies begin working on their efforts to comply with the conflict minerals rule if they have not already done so. The first Form SD will cover the 2013 calendar year, and will be due by May 31, 2014. Thus, companies should be determining if they are covered by the rule, what the framework for their due diligence needs to be, the possible outcomes of due diligence inquiries, when independent auditing will be required, what scope those audits will cover, and how they will meet the deadlines and requirements for compliance.