In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The act directed the Securities and Exchange Commission (SEC) to issue rules to implement the “conflict mineral” provisions contained in Section 1502 of the act, which address the concerns that proceeds from certain minerals mined from the Democratic Republic of Congo and/or other neighboring Central African countries (South Sudan, Uganda, Rwanda, Burundi, Tanzania, Malawi, Zambia, Angola, Congo, and the Central African Republic) are being used to finance conflicts in the region with extreme levels of violence. The explicit purpose of Section 1502 is to promote transparency and consumer awareness regarding the use of these minerals, which include gold, wolframite, casserite, columbite-tantalite, and their derivative metals, including tin, tungsten, and tantalum, and ultimately to discourage their use. Section 1502 directs the SEC to issue rules requiring companies to disclose in 10-K, 20-F, 40-F filings, and even in some cases in audited “Conflict Minerals Reports,” whether they manufacture products containing these conflict minerals.
In December 2010, the SEC issued proposed rules requiring a covered issuer to disclose in the body of its annual report whether its conflict minerals originated in the Democratic Republic of Congo or an adjoining country. If so, that issuer would be required to furnish a separate report as an exhibit to its annual report that includes, among other things , a description of the measures the issuer has taken to exercise due diligence on the source and chain of custody of its conflict minerals. These due diligence measures would include, but would not be limited to, an independent private sector audit of the issuer’s report. Further, any issuer furnishing such a report would be required, in that report, to certify that it obtained an independent private sector audit of its report, to provide the audit report, and make its reports available to the public on its website.
In late August, the SEC adopted a final rule implementing Section 1502 of the Dodd Frank Act. The SEC considered thousands of comments from potentially affected businesses in drafting the final rule. Consequently, while the final rule implements much of the text in the proposed rule, there are in fact a number of changes, some of them substantial. Additionally, the final rule does not explicitly define many portions of the rule, but instead offers guidance on interpreting those provisions.
In terms of the scope of applicability of the final rule, the definition of “conflict minerals” mirrors the definition in the Dodd-Frank Act. For purposes of the rule, conflict minerals are defined to include cassiterite, columbite-tantalite, gold, wolframite, and their derivatives. The final rule limits the derivatives to tantulum, tin, and tungsten. “Covered issuers” are defined in the final rule as any issuer that files reports with the SEC under Section 13(a) or Section 15(d) of the Exchange Act, including domestic companies, foreign private issuers and smaller reporting companies, so long as the issuer’s use of conflict minerals is “necessary to the functionality or production of a product,” “manufactured” by the issuer or “contracted to be manufactured” by the issuer.
The final rule does not define “manufacture,” instead relying on the “generally understood” definition of that term. However, the SEC does note that issuers only servicing, maintaining, or repairing products containing conflict minerals are not considered to be “manufacturing” a product under the rule. Similarly, the SEC did not define “contract to manufacture” in the final rule, instead choosing to offer guidance to issuers regarding when an issuer is considered to be “contracting to manufacture.”
Where the final rule is clear is that manufacturers that contract the manufacturing of components of their products are subject to the rule. However, whether an issuer “contracts to manufacture” a product will require a case-by-case review of the unique circumstances of the issuer, and will depend on the specific degree of influence exercised by the issuer on the manufacturing of the product, and over the materials, parts, ingredients, or components to be included in any product that contains conflict minerals or their derivatives.
In terms of specific guidance, the SEC will not consider the following activities to be “contracting to manufacture.”
- “Specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product, such as training or technical support, price, insurance, indemnity, intellectual property rights, dispute resolution, or other like terms or conditions concerning the product, unless the issuer specifies or negotiates taking these actions so as to exercise a degree of influence over the manufacturing of the product that is practically equivalent to contracting on terms that directly relate to the manufacturing of the product;” or
- “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.”
Outside of the activities defined above, whether an issuer is considered to be “contracting to manufacture” will rest on the issuer’s degree of influence. Although this portion of the final rule is less stringent than the proposed rule, under which the threshold for influence was “any” influence, the SEC did not adopt the recommendations of several commentators who argued for a raised threshold of “substantial” influence. Again, this means that a determination of whether an issuer’s influence is sufficient for the issuer to be considered “contracting to manufacture” will rest on a case-by-case assessment of that issuer’s unique circumstances.
In another deviation from the proposed rule, the final rule does not consider an issuer that mines or contracts to mine conflict minerals to be manufacturing or contracting to manufacture those minerals, unless the issuer is also engaged in the direct or indirect manufacturing of those minerals.
The final rule also does not define when a conflict mineral is “necessary to the functionality” of a product or “necessary to the production” of a product. Again, rather than an explicit definition, the SEC offered guidance to issuers on interpreting how the rules apply. In the final rule, the SEC advised that in determining whether conflict minerals are “necessary to the functionality” of a product, the issuer should consider the following:
- “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.”
Moreover, any of the above factors, whether individually or in the aggregate, may determine whether conflict minerals are “necessary to the functionality” of a product. This is limited to conflict minerals actually contained in the product, and does not include, for example, conflict minerals used in the manufacturing or production of the product that are not contained in the product itself. If the conflict mineral is not contained in the product, it is not “necessary to the functionality” of the product.
Furthermore, only conflict minerals “intentionally added” will be considered “necessary to the functionality” of a product. Note that for purposes of subjecting an issuer to the rule, whether the conflict mineral is “necessary” to the product does not depend on whether the issuer adds it to a product or component, or whether it is added by a third party. The issuer must consider any conflict minerals in the product, even if the only conflict minerals in the product are from a component manufactured by a third party.
The final rule also does not define a concrete threshold for determining whether a conflict mineral is itself “necessary to the functionality” of a product. Instead, the SEC indicates that this interpretation rests upon whether the conflict mineral is necessary to a product’s expected “function, use, or purpose.” The SEC also notes that, while a product may have more than one function, use, or purpose, the conflict mineral need only be necessary for one of those functions, uses, or purposes to subject the issuer to the rule.
In a similar vein, the SEC did not define when a conflict mineral is “necessary to the production” of a product, stating instead that conflict minerals used as a catalyst in the production process will not be considered “necessary to the production” of a product if the conflict mineral is not contained in the product. However, if the conflict mineral is otherwise necessary to the production of the product, or is contained in even trace amounts, the conflict mineral will be considered “necessary to the production” of the product. In keeping therewith, the final rule indicates that there is no de minimis exception to the final rule.
Assuming your company is a covered issuer that makes use of conflict minerals, the final rule requires that the company conduct a reasonable “country of origin” inquiry that must be performed in good faith and be reasonably designed to determine whether any of its minerals originated in the covered conflict countries or are from scrap or recycled sources. If the inquiry leads the company to the conclusion that: 1) its conflict minerals did not originate in the conflict countries or that they come from recycled or scrap sources; or 2) that the company has no reason to believe that its conflict minerals may have originated in conflict countries or may not be from recycled or scrap sources; then the company must disclose this conclusion and a brief description of the inquiry taken under the “Conflict Minerals Disclosure” heading of Form SD. Furthermore, the company is also required to make this process publicly available on its website and provide a link to the website on Form SD.
Alternatively, if the inquiry leads to the conclusion that: 1) the company knows or has reason to believe that its conflict minerals may have originated in conflict countries; or 2) the company knows or has reason to believe that the minerals may not be from scrap or recycled sources, then the company must conduct a due diligence review on the source and chain of custody of its conflict minerals and file a Conflict Minerals Report as an exhibit to Form SD. Furthermore, the company is also required to make this report publicly available on its website and provide a link to the website on Form SD. The due diligence undertaken at this stage must conform to a nationally or internationally recognized due diligence framework, such as the due diligence guidance approved by the Organization for Economic Co-operation and Development (OECD).
At the conclusion of the due diligence process, the company will determine whether or not its products are “DRC conflict free.” If the company’s products are “DRC conflict free,” then the company will be required to obtain an independent private sector audit of its report; certify that the audit was obtained; include the audit as part of the report; and identify the auditor. On the other hand, if the determination is negative, then in addition to the audit and certification steps, the company must describe the following in the report: the products manufactured or contracted to be manufactured that have not been found to be DRC conflict free; the facilities used to process the conflict minerals in those products; the country of origin of the conflict minerals in those products; and the efforts to determine the mine or location of origin with the greatest possible specificity.
Finally, if the result of the due diligence is a determination of “DRC conflict undeterminable,” then for a temporary period (two years for larger reporting and four years for smaller reporting issuers), the company must describe in its report: the company’s products manufactured or contracted to be manufactured that are “DRC conflict undeterminable;” the facilities used to process the conflict minerals in those products, if known; the country of origin of the conflict minerals in those products, if known; the efforts to determine the mine or location of origin with the greatest possible specificity; and the steps it has taken or will take, if any, since the end of the period covered in its most recent report to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve due diligence.
One final important point is that conflict minerals “outside the supply chain” prior to January 31, 2013, are exempt from the final rule. “Outside the supply chain” includes conflict minerals that have been smelted or fully refined, or, if they have not been smelted or fully refined, are outside the conflict countries. The final rule becomes effective on November 13. Issuers must comply with the final rule for the calendar year beginning January 1. The first reports will be due May 31, 2014.