On August 22, 2012, the U.S. Securities and Exchange Commission (the “Commission”) adopted final rules (the “Conflict Minerals Rules” or the “Rules”) mandated by Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) to require companies to publicly disclose their use of “conflict minerals” originating from the Democratic Republic of the Congo (the “DRC”) and adjoining countries, including Angola, Burundi, Central African Republic, Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia (the “Adjoining Countries” and together with the DRC, the “Covered Countries”).  The conflict minerals that are regulated under the Conflict Minerals Rules are:

  • cassiterite (tin), columbite-tantalite (tantalum), gold, wolframite (tungsten), and their derivatives, which are limited to tantalum, tin and tungsten, unless the Secretary of State determines that additional derivatives are financing conflict in the Covered Countries, in which case they are also considered “conflict minerals”; or
  • any additional minerals or their derivatives determined by the Secretary of State to be financing conflict in the Covered Countries.

The Conflict Mineral Rules apply to any issuer that files reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) and there are no exceptions for foreign private issuers, emerging growth issuers or smaller reporting companies.

Specifically, under the new Rules, companies are required to disclose annually whether they use “conflict minerals” that are ”necessary to the functionality or production” of a product that they either “manufacture” or “contract to manufacture” and that originate from the Covered Countries.  Companies must comply with the Rules for the calendar year beginning on January 1, 2013, with the first reports due on May 31, 2014 and subsequent reports due on May 31 of each year.  The reports under the Conflict Minerals Rules will not be included in or as an exhibit to an issuer’s annual report on Form 10-K as originally proposed, but rather, disclosures must be made on a new form, Form SD, which will be filed separately with the SEC.  Any materially false or misleading statement in the form will be subject to liability under Section 18 of the Exchange Act subject to a defense if the issuer acted in good faith and did not have knowledge that the report was false or misleading.  The Form SD is not required to be accompanied by the officer certifications that apply to Forms 10-K and 10-Q, and is not incorporated into an issuer’s registration statements under the Securities Act of 1933, unless the issuer so specifies. 

The report on Form SD should include, among other matters, a description of the measures taken by the issuer to exercise due diligence with respect to the conflict minerals’ source and chain of custody.  These due diligence measures must include an independent private sector audit of the issuer’s report conducted in accordance with standards established by the Comptroller General of the United States.  An issuer furnishing the report is also required to identify the auditor and to certify the audit by including a statement in the report that the issuer obtained the required audit.  The report also must include a description of the products manufactured or contracted to be manufactured that are not “DRC conflict free,” the facilities used to process such conflict minerals, the country of origin of the conflict minerals, and the efforts made to determine the mine or location of origin.  The information disclosed by the issuer must be made available to the public on its Internet website.

Requirements of the Final Conflict Minerals Rules

The Conflict Minerals Rules adopt a three-step framework for determining whether an issuer must file a conflict minerals report on Form SD.  First, an issuer must determine whether it is subject to the Rules by determining whether conflict minerals are necessary to the functionality or production of products manufactured or contracted to be manufactured by an issuer. Second, if an issuer uses conflict minerals in its products, it must undertake a reasonable country of origin inquiry to determine whether the conflict mineral it uses originated in the Covered Countries or from recycled or scrap sources. Finally, if an issuer determines or has reason to believe that its conflict minerals may have originated in the Covered Countries, or may not be from scrap or recycled sources, it is required to conduct due diligence on the source and chain of custody of the conflict minerals and file a conflict minerals report containing certain additional disclosures and an independent private sector audit.  A copy of the Commission’s flowchart summary of the final rule is included at the end of this alert.

Step 1: Determination of Applicability of Conflict Minerals Rules

Public companies are subject to the conflict minerals rules if the regulated conflict minerals are “necessary to the functionality or production” of a product they “manufacture” or a product they “contract to manufacture” by third parties.  The final rules do not define any of the quoted terms, but provide interpretive guidance on them.

The determination of whether a conflict mineral is deemed “necessary to the functionality or production” of a product depends on the issuer’s particular facts and circumstances, taking into account the following: 

  • whether the conflict mineral is intentionally added to the product or any component of the product and is not a naturally-occurring-by-product;
  • whether the conflict mineral is necessary to the product’s generally expected function, use, or purpose;
  • if the conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration;
  • whether the conflict mineral is intentionally included in the product’s production process, other than if it is used in a tool, machine or equipment used to product the product (such as computers or power lines);
  • whether the conflict mineral is included in the product; and
  • whether the conflict mineral is necessary to produce the product. 

For a conflict mineral to be considered “necessary to the production” of a product, the mineral must be both contained in the product and necessary to the product’s production.  The Commission will not consider a conflict mineral to be “necessary to the production” of a product if the conflict mineral is used as a catalyst, or in a similar manner in another process that is necessary to produce the product but is not contained in the product. 

The Commission believes the term “manufacture” is generally understood and declined to define the term.   The Commission noted that a company that manufactures a product by assembling that product out of materials, substances, or components that are not in raw material form (such as auto and electronics manufacturers) may be considered to be to be manufacturing a product. The Commission also noted it does not consider a company that only services, maintains, or repairs a product containing conflict minerals to be “manufacturing” a product.

In addition, a company will be considered to be “contracting to manufacture” a product under the Rules if it has some actual influence over the manufacturing of that product.  This determination is based on the facts and circumstances, taking into account the degree of influence the company exercises over the product’s manufacturing.  A company will not be deemed to have influence over the manufacturing if it merely attaches its brand or logo to a generic product manufactured by a third party, a potential loophole of the new Rules for companies that do not specify manufacturing standards but retain broad discretion to respect delivery of manufactured products.  In addition, a company does not have influence over the manufacturing if it services, maintains or repairs a product manufactured by a third party, or specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product.

Issuers whose products do not use conflict minerals are not required to make any conflict minerals disclosures.  Additionally, issuers whose operations are limited to mining conflict minerals will not be treated as manufacturing those minerals unless such issuer also engages in manufacturing, and conflict minerals that are “outside the supply chain” prior to January 31, 2013, including minerals that have been smelted or fully refined or if they have not been smelted and fully refined, are outside the Covered Countries, will also be exempt from the Conflict Minerals Rules. 

The requirements apply equally to all domestic and foreign issuers, including those issuers that are smaller reporting companies.

Step 2: Reasonable Country of Origin Inquiry

Under the Rules, a company that uses any of the designated minerals is required to conduct a reasonable “country of origin” inquiry that must be performed in good faith and be reasonably designed to determine whether any of those minerals originated in the Covered Countries or are from scrap or recycled sources.  The inquiry must cover all conflict minerals that are necessary to the functionality or production of the reporting company’s products.  The required inquiry depends on each issuer’s facts and circumstances. 

If, after conducting its reasonable country of origin inquiry, an issuer determines that the conflict minerals used in its products did not originate from the DRC or an Adjoining Country, or the issuer has no reason to believe that they may have originated in the DRC or an Adjoining Country, then the issuer’s Form SD only has to disclose its determination and provide a brief description of the inquiry it undertook. These same disclosures are required if the issuer determines that the conflict minerals used in its products are from scrap or recycled sources, or if the issuer has no reason to believe that they are not from scrap or recycled sources. 

On the other hand, if, after conducting its reasonable country of origin inquiry, an issuer cannot reach one of the foregoing conclusions, then it must conduct due diligence on the source and chain of custody of its conflict minerals and its Form SD must include a Conflicts Mineral Report.  However, if during the exercise of its due diligence, an issuer determines that its conflict minerals did not, in fact, originate in the Covered Countries, or if it determines that its conflict minerals did, in fact, come from recycled or scrap sources, it is not required to submit a Conflict Minerals Report. Such an issuer is still required to submit a specialized disclosure with its determination regarding its conflict minerals and a brief description of its inquiry and its due diligence efforts, and the results of that inquiry and due diligence efforts, which should demonstrate why the issuer believes that the conflict minerals did not originate in the Covered Countries or that they did come from recycled or scrap sources. The Rules do not require an issuer to retain reviewable business records to support its reasonable country of origin conclusion, although maintenance of appropriate records may be useful in demonstrating compliance with the Rules.

If the issuer knows that it has necessary conflict minerals that originated in the Covered Countries, or if the issuer has reason to believe that its necessary conflict minerals may have originated in such areas and may not have come from recycled or scrap sources, the issuer must move on to the third step described below.

Step 3: Conduct Supply Chain Due Diligence and Issuer a Conflict Minerals Report

The final step requires an issuer to exercise due diligence to determine the source and chain of custody of its conflict minerals and to provide a Conflict Minerals Report describing its due diligence measures, a description of the products manufactured or contracted to be manufactured that are not “DRC conflict free,” the facilities used to process such conflict minerals, the country of origin of the conflict minerals, and the efforts made to determine the mine or location of origin.   Products manufactured or contracted to be manufactured are “DRC conflict free” if they do not contain conflict minerals that directly or indirectly finance or benefit armed groups in the Covered Countries*. The due diligence must conform to a nationally or internationally recognized due diligence framework*. The Rules require an independent private sector audit of an issuer’s Conflict Minerals Report. The audit’s objective is to express an opinion or conclusion as to whether the design of the issuer’s due diligence measures as set forth in the Conflict Minerals Report, with respect to the period covered by the report, is in conformity with the criteria set forth in the nationally or internationally recognized due diligence framework used by the issuer in all material respects. Further, the audit should determine whether the issuer’s description of the due diligence measures it performed as set forth in the Conflict Minerals Report, with respect to the period covered by the report, is consistent with the due diligence process that the issuer undertook. 

The Conflict Minerals Rules also require descriptions in the Conflict Minerals Report of an issuer’s products “that have not been found to be DRC conflict free.”  Further, there is a temporary transition period for two (2) years for all issuers and four (4) years for smaller reporting companies during which time issuers may describe their products as “DRC conflict undeterminable” if they are unable to determine that their minerals meet the statutory definition of “DRC conflict free” for two reasons: (1) they proceeded to step three based upon the conclusion, after their reasonable country of origin inquiry, that they had conflict minerals that originated in the Covered Countries and, after the exercise of due diligence, they are unable to determine if their conflict minerals financed or benefited armed groups in such countries; or (2)  they proceeded to step three based upon the conclusion, after their reasonable country of origin inquiry, that they had a reason to believe that their necessary conflict minerals may have originated in the Covered Countries and may not have come from recycled or scrap sources, and the information they gathered as a result of their due diligence failed to clarify the country of origin, whether the conflict minerals financed or benefited financed or armed groups in those countries, or whether the conflict minerals came from recycled or scrap sources. If the issuer knows that its products contain conflict minerals that directly or indirectly financed or benefited armed groups in the Covered Countries, the issuer may not describe those products as “DRC conflict undeterminable.”

Issuers who describe their products as “DRC conflict undeterminable” during the transition period are not required to have their Conflict Minerals Report audited, however they must still file a Conflict Minerals Report describing their due diligence and must additional describe the steps they have taken or will take to mitigate the risk that their necessary conflict minerals benefit armed groups, including any steps to improve their due diligence.

Timing

The new rules will be effective on November 13, 2012.  Issuers must comply with the final rule for the calendar year beginning January 1, 2013 with the first reports due by May 31, 2014 for calendar year 2013.

The final rules are available here.