On August 22, 2012, the Securities and Exchange Commission (SEC) adopted its final rule (the Rule) implementing Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). The SEC's final Rule makes a number of important changes to its original proposals for implementing Section 1502, which imposes new audit and disclosure requirements on SEC reporting companies regarding their use of "conflict minerals". The Rule will have wide-ranging impact, with nearly 6,000 companies estimated to be subject to the new disclosure requirements, at an initial compliance cost of anywhere from $3 billion to $16 billion.
The Dodd-Frank Act was signed into law in July 2010. Though the vast majority of the Dodd-Frank Act is dedicated to improving accountability and transparency in the financial system, Section 1502 imposes new audit and disclosure requirements on SEC reporting companies regarding their use of "conflict minerals" in products they manufacture.
In response to the violence in the Democratic Republic of the Congo (DRC) perpetrated by armed groups and thought to be financed, in part, by the exploitation and trade of certain "conflict minerals" produced there and in adjoining countries, Section 1502 was enacted to force SEC reporting companies to disclose the use of these minerals in their products.
- "Covered Countries": DRC, Angola, Burundi, the Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia.
- Covered "Conflict Minerals": Under the Dodd- Frank Act, "conflict minerals" include columbitetantalite (coltan, the metal ore from which tantalum is extracted), cassiterite (the metal ore from which tin is extracted), gold, wolframite (the metal ore from which tungsten is extracted) and any of their respective derivatives. Under the Rule, such derivates are currently limited to the "3 Ts" (tantalum, tin and tungsten). "Conflict minerals" also include any other mineral or its derivatives determined by the Secretary of State to be financing conflict in any of the Covered Countries.
Conflict minerals are utilized in numerous industries, but they are especially prevalent in the electronics, aerospace, automotive, industrial machinery, construction, jewelry, and medical device industries. Columbite-tantalite is used in the manufacture of condensers as well as in microchips, cell phones, computers, digital cameras, nuclear reactors, carbide tools and jet engine components. Casserite is an important source of tin ore, which is widely used as a solder ingredient, in alloys such as bronze, brass and pewter, and for tin plating of steel. Gold is utilized in jewelry and the electroplating of many electronics components to prevent corrosion. Wolframite is the main source of tungsten, which is used to make tools, filaments, engines and electronics, and in heating and welding applications.
Section 1502 and the Rule apply to all SEC reporting companies (both domestic and foreign private issuers) for whom conflict minerals "are necessary to the functionality or production" of a product manufactured or contracted to be manufactured by such entities. There are no exceptions for small enterprises or foreign issuers.
Of note is that the Dodd-Frank Act and the Rule do not define "manufacture", "contract to manufacture" or "product". The Rule specifically provides, however, that registrants that are only engaged in mining conflict minerals would not be considered to be manufacturing those minerals for these purposes. Furthermore, the adopting release accompanying the Rule states that registrants that only service, maintain or repair products should not be considered to be manufacturing those products. In its adopting release the SEC also offers guidance on circumstances under which an issuer is considered to be contracting to manufacture a product, based on the degree of influence it exercises over the materials, parts, ingredients or components included in the product.
Also not expressly defined is when a conflict mineral is "necessary to the functionality or production of a product", though again the SEC's adopting release offers some guidance on this point. Only a conflict mineral that is actually contained in the product (including in trace amounts) should be considered "necessary" in this context, and other factors that issuers should consider include whether a conflict mineral is intentionally added to the product, whether the conflict mineral is necessary to the product's generally expected function, use or purpose, and whether the conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment. The SEC declined to adopt a de minimis exclusion for products containing only minute or trace amounts of conflict minerals.
The SEC's adopting release also clarifies that a reporting company is responsible for the totality of its products, including all parts and components, and must work with suppliers to comply with the Rule's requirements. Therefore, any company that has conflict minerals in its products, whether such materials were introduced or became incorporated anywhere along the supply chain, could become subject to these requirements. Even non-public companies may be burdened by this legislation by having to keep thorough chain-of-custody records to assist in the compliance of customers that are SEC reporting companies.
Determining whether and how much disclosure is required under Section 1502 is a three-step analysis.
First, covered companies must determine whether any conflict minerals are necessary for the functionality or production of a product that they manufacture or contract to manufacture (as described above).
Second, if conflict minerals are used, then the company must make a "reasonable country of origin inquiry" as to whether the necessary conflict mineral(s) originated in Covered Countries, and file a new Form SD disclosing its determination and briefly describing the inquiry it undertook and the results of the inquiry. Though the steps required for such an inquiry are not explicitly stated, the Rule provides that it must be conducted in good faith and must be reasonably designed. The SEC also suggests that a company should be able to meet this standard by receiving reasonably reliable representations indicating the facilit(ies) at which its conflict minerals were processed and demonstrating that those conflict minerals did not originate in the Covered Countries. Furthermore, the SEC states that an issuer is not necessarily required to receive representations from all of its suppliers, but also must not ignore warning signs or other circumstances indicating that the remaining amount of its conflict minerals may have originated in Covered Countries.
Third, a company that knows or, based on its reasonable country of origin inquiry, has reason to believe that its conflict minerals may have originated in a Covered Country, then the company must also exercise due diligence on the source and chain of custody of its conflict minerals, in accordance with a nationally or internationally recognized framework, and possibly disclose additional information to the SEC in a Conflict Minerals Report, including:
- measures taken to exercise due diligence about the source and chain of custody of the minerals;
- a description of the products that are not "DRC conflict free"; and
- a description of the facilities used to process the conflict minerals, the country of origin of the conflict minerals, and efforts taken to determine the mine or location of origin with greatest possible specificity.
Products made with recycled or scrap conflict minerals are still covered by the disclosure process. A company that knows or reasonably believes that its conflict minerals came from recycled or scrap sources (as defined in the Rule) must file a Form SD but does not need to conduct additional due diligence.
All disclosures in the Conflict Minerals Report must be verified by an independent private sector auditor in accordance with a standard that will be established by the U.S. Comptroller General. The audit must then be certified by the reporting company. The information required pursuant to Form SD as well as the Conflict Minerals Report must be published on the reporting company's publicly available website..
Timeframe and transitional measures
Registrants with necessary conflict minerals in their products must file their first disclosure reports on Form SD by May 31, 2014, covering the initial reporting period of the 2013 calendar year. Each subsequent report shall be due annually on May 31 for the prior calendar year. The SEC elected not to base the reporting period on each registrant's fiscal year, and not to require reporting in registrants' 10-K or other annual reports, as had originally been proposed.
The Rule provides a temporary "DRC conflict undeterminable" category for a two-year period for all issuers and a four-year period for smaller reporting companies. Issuers taking advantage of this temporary category are still required to conduct due diligence and file a Conflict Minerals Report. The Rule also provides for transitional requirements applicable to, for example, recently acquired companies and conflict minerals "outside the supply chain" prior to 2013.
The SEC's final Rule makes a number of important changes to its original proposals for implementing Section 1502. Covered companies had been anxiously awaiting the SEC's adoption of the Rule to see just how far the requirements would reach. The best course for companies that might be affected continues to be to take action by evaluating their supply chains for the presence of conflict minerals, creating systems for a reasonable and good-faith inquiry as to such minerals' country of origin, establishing chain-of-custody records and considering relevant corrective action measures and business impacts.