Under Dodd-Frank, the GAO is required to assess annually the effectiveness of the SEC’s conflict minerals rules in promoting peace and security and to report on the rate of sexual violence in the DRC and adjoining countries. Recently, the GAO released its annual report submitted to Congress on conflict mineral disclosures filed with the SEC in 2018. The report is based on a random sample of 100 Forms SD, interviews with company representatives, DRC officials and other stakeholders, as well as reviews of government reports and fieldwork conducted at an industry conference. Any big changes? Not really. But, interestingly, in the GAO sample, only two companies indicated that they relied on Corp Fin’s 2017 guidance (discussed below) to avoid filing a conflict minerals report or providing an independent private-sector audit. With the 2017 guidance apparently not having much impact, is a revision of the conflict minerals rules to address the impact of the litigation (which held that the requirements violated the First Amendment) even a twinkle in the staff’s eye at this point?
As you may recall, in 2017, after an appellate court had concluded that the conflict minerals rule amounted to “compelled speech” in violation of companies’ First Amendment rights to the extent that the statute and the rule required companies to report publicly that any of their products “have not been found to be ‘DRC conflict free,’” Corp Fin issued an Updated Statement on the Effect of the Court of Appeals Decision on the Conflict Minerals Rule. (See this PubCo post. For more background on the case, see this PubCo post.) The Statement advised that the staff would not recommend enforcement against companies if they filed only a Form SD with disclosure under only paragraphs (a) and (b) and did not prepare and file a conflict minerals report (Item 1.01(c) of Form SD)—even if they would otherwise be required to do so under the rule. (See this PubCo post.)
The GAO found that, generally, the disclosures filed in 2018 were similar in number and content to those filed in the prior two years. The GAO estimated that, out of 1,117 companies that filed conflict minerals disclosures in 2018, all reported that they performed country-of-origin inquiries. As a result of those inquiries, an estimated 56% reported whether the conflict minerals in their products came from the DRC or one of the adjoining countries, up from estimated 53% in 2017 and 49% in 2016. (Note, however, that the estimates have a margin of error of plus or minus 10 percentage points at the 95-percent confidence level.) The percentage is 2018 was statistically significantly higher than the estimate of 30% in 2014.
In their 2018 disclosure reports, many companies described taking the same actions they took in past years to improve data collection processes,
“including using standardized tools and conducting surveys. Those companies that conducted surveys reported doing further investigation into the source of minerals, for example, by following up with suppliers to improve the specificity and completeness of their survey responses. Other actions companies reported taking to improve supply chain data collection included educating suppliers about conflict-free sourcing and creating and publicizing conflict minerals policies. In interviews, representatives of selected companies and other industry participants also noted, as they had in prior years, that awareness among suppliers about the use of conflict minerals continued to increase. However, many companies reported difficulties in determining the country of origin of conflict minerals, in part as a result of lack of access to suppliers and complex supply chains involving many suppliers and processing facilities. Specifically, some companies reported that some suppliers did not respond to requests for information, or that supplier and smelter information was incomplete or contained errors. Some companies also reported, among other factors, confusion among suppliers about the requirements of the SEC disclosure rule, and gaps in supplier education and knowledge.”
Of the companies that reported the types of minerals used, an estimated 76% reported using tin, 62% tantalum, 63% tungsten, and 66% reported using gold, similar to the percentages reported in 2017. An estimated 24% did not specify the minerals used.
Gold has turned out to be the most problematic mineral in terms of supply chain transparency and responsible sourcing. According to a 2017 GAO report, gold is a significant driver of the DRC’s economy. There are reportedly more than 1,000 mining sites for artisanal and small-scale mined (ASM) gold in the DRC, typically employing groups of 30 to 300 miners. The way the gold mining process is supposed to work is that the supply chain participants are required to obtain DRC government authorization, such as official mining cards, or register with the provincial or national government to trade or export ASM gold in or from the DRC. They are also required to pay provincial or national taxes to mine, trade or export ASM gold. In reality, however, “almost all DRC-sourced ASM gold is produced and traded unofficially and smuggled from the country…. Further, elements of the Congolese army as well as illegal armed groups, frequently exploit ASM gold, often through illegal taxes on its production and transport, according to reports and stakeholders.” Some of the factors cited in the report that facilitate smuggling include “limited government control over the remote areas where ASM gold is primarily produced, inadequate infrastructure, and corruption,” as well as weak border enforcement. The report observes that, while progress has been made recently “in reducing the presence of armed groups at tantalum, tin, and tungsten mine sites,…the widespread availability of gold in remote, difficult-to-access areas of the eastern DRC and the lack of a functioning traceability system allow armed groups to operate at gold mine sites with minimal government and international oversight.” The report observes that, while progress has been made recently “in reducing the presence of armed groups at tantalum, tin, and tungsten mine sites,…the widespread availability of gold in remote, difficult-to-access areas of the eastern DRC and the lack of a functioning traceability system allow armed groups to operate at gold mine sites with minimal government and international oversight.” (See this PubCo post.)
Similar to the prior two years, the GAO found that 94% of companies that were required to conduct due diligence as a result of their country-of-origin inquiries reported doing so, notwithstanding the revised Corp Fin guidance, discussed below. Approximately 89% of companies reported using the OECD due diligence framework (with the remaining 11% using non-OECD framework or not specifying the framework used), compared with an estimated 87% in 2017 and 92% in 2016.
After conducting due diligence to determine the source and chain of custody of conflict minerals used, an estimated 35% reported in 2018 that they were able to determine that their conflict minerals came from one of the covered countries or from scrap or recycled sources, compared with 37% in 2017 and 39% in 2016; by comparison, 61% reported that they could not confirm the source, compared with 47% in 2017 and 55% in 2016.
But, as in prior years, almost all companies reported that, after conducting due diligence, they could not determine whether their conflict minerals financed or benefited armed groups. Three companies in the GAO sample determined that the minerals in at least some of their products had not financed or benefited armed groups in covered countries, but none characterized its products specifically as “DRC conflict-free” (the phrase that clearly triggers the IPSA requirement). One of those companies did include an IPSA. In 2018, the GAO reports, 14 companies filed IPSAs compared with 16 in 2017 and 19 in 2016.
What about the impact of the 2017 Corp Fin guidance? Some companies and industry participants told the GAO that the Corp Fin guidance “had caused confusion among some suppliers and stakeholders about reporting requirements, sometimes leading suppliers to be reluctant or slow to share information required by companies for their due diligence reporting.” One reason for the confusion could be that, as the GAO was told by the SEC staff, “the guidance is not binding on the commission and…the commission could still initiate enforcement action if companies did not report on their due diligence in accordance with the rule. According to SEC staff, the 2017 guidance, while temporary, is still in effect, pending review of the rule by the commission.” (Note, however, that, as indicated in footnote 16 to the GAO report, the staff subsequently advised that companies that do file conflict minerals reports remain subject to the 2014 staff guidance. See this PubCo post.)
Perhaps adding to the confusion, the State Department told the GAO that “they had begun to take actions related to the revised guidance. Specifically, State officials told [the GAO] that they had conducted public outreach, such as attending industry events to remind stakeholders that the conflict minerals disclosure rule was still in effect, provide an overview of the rules and requirements, and answer questions.”
Some companies, however, did change their approach to filing as a result of the guidance. As noted above, one company in the sample cited the guidance as the rationale for its decision not to file a conflict minerals report, “despite noting it had determined there was reason to believe that minerals in its products may have come from covered countries.” Another company cited the guidance as its reason for not filing an IPSA (although the company did not identify any product as “DRC conflict free”).
Representatives of other companies indicated that “their companies planned to continue to report conflict minerals disclosure information, including information from their due diligence efforts, and some may “even expand their due diligence, in response to the conflict minerals disclosure rule and other incentives for filing—such as consumer pressure and European Union reporting requirements scheduled to take effect in 2021.”
And the SEC? As of June 2019, consideration of recommendations to address the effect of litigation over the conflict minerals rule was on the SEC’s long-term regulatory agenda. In its report, the GAO indicates that, according to the SEC staff, these recommendations may affect the 2017 guidance; however, any action “would likely not take place until after March 2020.”