April has been a busy month for developments relating to the SEC’s rule requiring reporting companies under the Securities Exchange Act of 1934 to provide annual disclosures about conflict minerals.
Court of appeals decision
On April 14, the U.S. Court of Appeals for the District of Columbia Circuit, in a decision available here, rejected an array of challenges to the rule brought under the Administrative Procedure Act and the Exchange Act. The Court of Appeals, however, also found that the rule, and the Dodd-Frank Act provision mandating it, violate the First Amendment’s prohibition against compelled speech to the extent that they require issuers to disclose in their Conflict Minerals Report filed with the SEC and to state on their website that any of their products have “not been found to be ‘DRC conflict free.”’ The Court held that by “compelling an issuer to confess blood on its hands, the statute interferes with that exercise of the freedom of speech under the First Amendment.” The Court said that it was returning the case to the U.S. District Court for further action consistent with its opinion. There may be further proceedings on the challenge at the Court of Appeals before it issues an order and the District Court takes up the case again. Therefore, for now, issuers remain subject to the rule’s current requirements.
On April 7, the staff of the SEC’s Division of Corporation Finance answered nine additional frequently asked questions relating to the conflict minerals rule. The new guidance supplements the 12 FAQs issued by the staff in May 2013. The annual disclosures under the rule are required if an issuer determines that conflict minerals are necessary to the functionality or production of products the issuer manufactures or contracts to manufacture. Exchange Act Rule 13p-1 and Form SD set forth the disclosure requirements implementing Section 13(p) of the Exchange Act, which was added by Section 1502 of the Dodd-Frank Act.
Issuers subject to the disclosure requirements must report on Form SD and in the associated Conflict Minerals Report whether the conflict minerals utilized by them originated in the Democratic Republic of the Congo (DRC) or an adjoining country (Covered Countries) and the due diligence they undertook on the source and chain of custody of the conflict minerals. The disclosure requirements became effective on November 13, 2012 and first apply for the 2013 calendar year, with the report on Form SD for 2013 due by May 31, 2014.
We discussed the conflict minerals rule in the SEC Update we issued on September 5, 2012, which is availablehere. For our discussion of the first set of frequently asked questions on the rule issued by the staff, please refer to the SEC Update we issued on June 26, 2013, which is available here. The full set of FAQs can be viewedhere. Some of the new FAQs address the disclosure requirement that was held to violate the First Amendment by the Court of Appeals in the decision summarized above.
Independent private sector audit
Rule 13p-1 requires an issuer to obtain an independent private sector audit (IPSA) of its Conflict Minerals Report after the temporary transition period, which is four years for smaller reporting companies and two years for all other issuers. Set forth below is a summary of the staff’s guidance in the new FAQs with respect to the IPSA.
- The auditor performing the IPSA does not have to be a certified public accountant. The IPSA of an issuer’s Conflict Minerals Report must be conducted in accordance with the standards established by the U.S. Government Accountability Office, whose staff has advised the SEC that the “Yellow Book” is applicable to the IPSA. The Yellow Book provides that auditors who are not certified public accountants may conduct performance audits, which is a permitted type of IPSA, so long as the auditor meets the applicable requirements under the Yellow Book. (FAQ 13)
- An IPSA is not required if any of an issuer’s products is “DRC conflict undeterminable” during the temporary transition period. If an issuer determines that any of its products is “DRC conflict undeterminable” during the temporary transition period, the issuer will not be required to obtain an IPSA of its Conflict Minerals Report. (FAQ 14)
- An issuer must obtain an IPSA to describe any of its products as “DRC conflict free” in its Conflict Minerals Report. An issuer is not required to describe its qualifying products as “DRC conflict free” in its Conflict Minerals Report, but may do so if it conducts proper due diligence, which includes an IPSA, and determines that the conflict minerals in those products did not finance or benefit armed groups in the applicable region. (FAQ 15)
- The IPSA scope is limited to the IPSA objective provided in the rule. The IPSA objective is to express an opinion as to whether the design of the issuer’s due diligence measures in the Conflict Minerals Report is in conformity with a nationally or internationally recognized due diligence framework used by the issuer, and whether the issuer’s description of its due diligence measures is consistent with the process the issuer undertook. The IPSA is not required to discuss the completeness or reasonableness of the due diligence measures actually performed. (FAQ 17)
- The IPSA does not have to include the issuer’s reasonable country of origin inquiry. The country of origin inquiry is a distinct step separate from the due diligence process. As a result, the auditor need opine only on the issuer’s due diligence framework beginning after the country of origin determination. (FAQ 18)
- An issuer does not have to carry out due diligence measures throughout the calendar year. The IPSA must express an opinion as to whether the issuer’s description of the due diligence measures it undertook is consistent with the processes it undertook during the period covered by the report, which is the calendar year. This requirement, however, does not direct the issuer to carry out due diligence measures “constantly throughout the year.” Further, the issuer’s due diligence measures may begin before or extend beyond the calendar year. (FAQ 20)
Conflict Minerals Report
Rule 13p-1 requires an issuer to publish a Conflict Minerals Report if it determines that it has products with conflict minerals that originated in the Covered Countries or if the issuer has products with conflict minerals, but was unable to conclude that those conflict minerals did not originate in the Covered Countries. The rule allows for different treatment of conflict minerals from recycled or scrap sources. The staff confirms in the new FAQs the following applications of the rule.
- If an issuer determines that the conflict minerals in its product came from recycled or scrap sources, the issuer must include the appropriate disclosures on Form SD, but does not have to file a Conflict Minerals Report. If an issuer determines that its product also includes conflict minerals not from recycled or scrap sources, however, it must file a Conflict Minerals Report that includes the required disclosures about the conflict minerals not from recycled or scrap sources. The report would not have to include disclosures for the conflict minerals from recycled or scrap sources. The issuer will have to obtain an IPSA only on its Conflict Minerals Report and not on the disclosures contained in the body of its Form SD. (FAQ 19)
- The rule does not require an issuer to provide a full description in its Conflict Minerals Report of the design of its due diligence. To satisfy one of the objectives of the IPSA, however, the issuer must describe the due diligence measures undertaken in sufficient detail for the auditor to form an opinion about whether the description in the Conflict Minerals Report is consistent with the process the issuer actually performed. (FAQ 21)
- During the temporary transition period, an issuer may not describe a product as “DRC conflict free” if it is unable to determine that the conflict minerals in the product originated outside the DRC or an adjoining country, or is unable to determine that the conflict minerals in the product did not finance or benefit armed groups in those countries. If an issuer determines that a product contains conflict minerals that did finance or benefit armed groups in the region, the issuer must describe that product, both during and after the temporary transition period, as “having not been found to be ‘DRC conflict free.’” (FAQ 16)