On August 22, over two years after enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), and over one year beyond its statutory rulemaking deadline, the SEC adopted its final rule implementing the “conflict minerals” provision set forth in Section 1502 of the Dodd-Frank Act. Section 1502 added Section 13(p) to the Securities Exchange Act of 1934, which requires annual disclosures by SEC-reporting companies if conflict minerals are necessary to the functionality or production of products they manufacture or contract to manufacture. Such companies are required to disclose in a special report whether any of those conflict minerals originated in the Democratic Republic of the Congo or an adjoining country. If the conflict minerals originated in any of those countries, the companies will have to include in their report a description of the measures they took to exercise due diligence on the source and chain of custody of the conflict minerals. To implement these requirements, the SEC adopted new Exchange Act Rule 13p-1 and a new Form SD for the “specialized disclosure report” required by the new rule.

Rule 13p-1 will become effective 60 days after publication in the Federal Register. Companies must first comply with the new rule for the calendar year beginning on January 1, 2013. The first specialized disclosure reports due under the rule must be filed with the SEC by May 31, 2014.

This SEC Update summarizes, in a question and answer format, the principal provisions of the conflict minerals rule. The SEC’s release (No. 34-67716) adopting the new rule can be viewed here.

What is the purpose of the conflict minerals law?

The congressional purpose in enacting the conflict minerals provision of the Dodd-Frank Act was to address the humanitarian crisis in the Democratic Republic of the Congo (DRC). The proponents of the provision have sought to reduce the trade in conflict minerals, which has been a major funding source for armed groups in eastern Congo.

Which minerals are conflict minerals?

Conflict minerals currently are gold and the minerals associated with tin (cassiterite), tungsten (wolframite) and tantalum (columbite-tantalite or “coltan”), or their derivatives. The list of conflict minerals may be expanded to include other minerals or their derivatives determined by the Secretary of State to be financing conflict in the Democratic Republic of the Congo or any adjoining country. As noted below, the rule excludes minerals that are outside an issuer’s supply chain prior to January 31, 2013.

To what types of companies does the new rule apply?

The new rule applies to any issuer that files reports with the SEC under Section 13(a) or 15(d) of the Exchange Act. The rule thus encompasses both domestic companies and foreign private issuers and applies to smaller reporting companies as well as to companies subject to the full Exchange Act reporting requirements. Investment companies registered under the Investment Company Act of 1940 are not subject to the rule.

Where can companies find the new requirements?

The requirements for conflict minerals disclosure are contained in the instructions to the new “Form SD, Specialized Disclosure Report,” which is set forth beginning on page 344 of the SEC’s adopting release. New Rule 13p-1 under the Exchange Act does not prescribe any requirements other than the filing of Form SD. The SEC’s release is an indispensable source of guidance on the application of the new rule.

Where will the conflict minerals disclosure appear?

Form SD is the sole Exchange Act report designated by the new rule for conflict minerals disclosure. An issuer filing Form SD also will be required to disclose on its publicly available Internet website the information contained in the report. In addition, in certain circumstances described below, the issuer will have to file a Conflict Minerals Report as an exhibit to its Form SD report.

Will a specialized disclosure report on Form SD be deemed “filed” under the Exchange Act?

Yes. Form SD will be a “filed” report for purposes of Section 18 of the Exchange Act and subject to the liabilities of that section.

The SEC’s rule release refers to the “Covered Countries.” What are those countries?

The new rule requires issuers to determine whether their conflict minerals originated in what the SEC’s rule release refers to as the “Covered Countries.” These countries are the Democratic Republic of the Congo and any “adjoining country.” The adjoining countries currently are Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia. 

What process should an issuer follow to determine if it is subject to the new rule’s disclosure obligations?

In its rule release (on page 33), the SEC includes a helpful flowchart to illustrate actions for the following “three-step process” which the SEC recommends companies employ in their compliance analysis and which is described in more detail later in this SEC Update: 

  1. Step One: Determine Whether Conflict Minerals are Necessary to Functionality or Production of Products. In the first step of the process, the issuer should consider if conflict minerals are “necessary to the functionality” or “necessary to the production” of products which it “manufactures” or which it has “contracted to be manufactured.” If the issuer determines that conflict minerals are not necessary to the functionality or production of any such product, it will not have to file a Form SD with the SEC. In addition, no filing will be required if the conflict minerals were outside the supply chain prior to January 31, 2013.
  2. Step Two: Determine Whether Conflict Minerals Originated in the Covered Countries and File Specialized Disclosure Report. The issuer would proceed to the second step if it has determined that conflict minerals are necessary to the functionality or production of its covered products and are not outside the supply chain prior to January 31, 2013. In this step, the issuer would be required to conduct “in good faith a reasonable country of origin inquiry” to determine whether any of its conflict minerals originated in Covered Countries or came from “recycled or scrap sources.” If, based on this inquiry, the issuer (1) determines that its conflict minerals did not originate in the Covered Countries or came from recycled or scrap sources, or (2) has no reason to believe that its conflict minerals may have originated in the Covered Countries or may not have come from recycled or scrap sources, it would be required to file a Form SD briefly describing its inquiry and the results of the inquiry and to make the disclosure publicly available on its Internet website.
  3. Step Three: Exercise Due Diligence on Source and Chain of Custody of Conflict Minerals and File Conflict Minerals Report. The issuer would proceed to the third step only if, based on its reasonable country of origin inquiry, it determined (or has reason to believe) that its conflict minerals may have originated in the Covered Countries and may not have come from recycled or scrap sources. In this step, the issuer would be required to “exercise due diligence on the source and chain of custody” of its conflict minerals and, following its review, to provide a Conflict Minerals Report as an exhibit to its Form SD, describing its due diligence and matters relating to the products containing its conflict minerals, and to make the report publicly available on its Internet website.

How does the rule define such key terms as “manufacture,” “contracted to be manufactured,” “necessary to the functionality” or “necessary to the production”?

Rule 13p-1 applies to any issuer for which conflict minerals “are necessary to the functionality or production of a product manufactured or contracted by the [ issuer ] to be manufactured.” The key terms above are not defined in the rule. Companies should consult the SEC’s guidance in the adopting release on the application of the terms.

What actions by an issuer would constitute “manufacture” of a product?

Although the SEC believes the term “manufacture” is generally understood, it clarifies in its release that it would not consider an issuer that only services, maintains or repairs a product containing conflict minerals to be manufacturing the product. In addition, the SEC would not consider an issuer that mines or contracts to mine conflict minerals to be manufacturing or contracting to manufacture those minerals as “products” unless the issuer also engages in manufacturing in addition to mining, whether directly or indirectly.

In what circumstances would an issuer’s products be deemed “contracted to be manufactured?”

The SEC stated in its release, as the governing principle for this determination, that “the question of whether an issuer contracts to manufacture a product will depend on the degree of influence exercised by the issuer on the manufacturing of the product based on the individual facts and circumstances surrounding an issuer’s business and industry.” Manufacturing issuers that contract for the manufacture of certain components of their products will be responsible for the conflict minerals in those products and for providing disclosure under the rule with respect to those conflict minerals.

The SEC indicates that, if an issuer’s actions were limited to the following, it would not be deemed to exercise sufficient influence over the materials, parts, ingredients, or components included in any product containing conflict minerals or their derivatives to be considered to be contracting to manufacture the product: 

  • Specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product, such as terms relating to such matters as training or technical support, price, insurance, indemnity, intellectual property rights, and dispute resolution;
  • Affixing the issuer’s 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.

When is a conflict mineral “necessary to the functionality” of a product?

In its release, the SEC sets forth the following three principal considerations for a “functionality” determination, which it says each issuer should undertake in light of its particular facts and circumstances:

  1. 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;
  2. Whether a conflict mineral is “necessary” to the product’s generally expected function, use or purpose; and
  3. If a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration.  

The SEC indicates that any of these factors, either individually or in the aggregate, may be determinative as to whether conflict minerals are necessary to the functionality of a product.

When is a conflict mineral “necessary to the production” of a product?

According to the SEC’s release, an issuer evaluating whether a conflict mineral is necessary to the production of a product should be guided by two principal considerations in light of its particular facts and circumstances:

  1. Whether a conflict mineral is “contained in” the product (including in any trace amounts) and “intentionally added” to the product’s production process (including the production process of any component of the product); and
  2. Whether the conflict mineral is “necessary” to produce the product.  

Under these standards, the SEC would not consider a conflict mineral used as a catalyst, or in a similar manner in the production process of a product, to be necessary to the production of a product if the conflict mineral is not contained in the product. This might be the case, for example, where gold is used as a catalyst to produce products which themselves do not contain gold.

In addition, products are not within the ambit of the rule’s “necessary to the production” language where a conflict mineral is (1) contained in a physical tool or machine used to produce a product, because the tool or machine (and not the conflict mineral) is necessary for the production, (2) necessary to the production of indirect equipment (such as computers and power lines) used in connection with the production of a product, because the equipment is only tangentially necessary for production, or (3) contained in materials, prototypes, and other demonstration devices, because those items are not “products” until they are offered for consideration to third parties in commerce.

Is there a de minimis exception to the rule’s application?

No. The rule applies to the use of a conflict mineral necessary to a product’s functionality or production regardless of the amount of the conflict mineral. Even the use of minute or trace amounts of the conflict mineral could trigger the rule’s disclosure requirements.

In what circumstances will an issuer be required to file a Form SD?

An issuer will be required to file a Form SD report if it concludes that conflict minerals are necessary to the functionality or production of a product manufactured by it or contracted by it to be manufactured during the calendar year to which the Form SD relates. No filing will be required if the conflict minerals were outside the issuer’s supply chain prior to January 31, 2013.

When must the issuer file its Form SD?

A Form SD report is required to be filed annually and to cover a calendar year, regardless of the issuer’s fiscal year. The issuer will have to file the report by May 31 of the year following the calendar year to which the disclosure relates. The first Form SD reports due under the rule must be filed on or before May 31, 2014 setting forth conflict minerals disclosure for the calendar year period from January 1 through December 31, 2013.

What actions will the issuer have to take in preparing its filing on Form SD?

Once an issuer has determined that it has a Form SD filing obligation, it must “conduct in good faith a reasonable country of origin inquiry” to determine whether the conflict minerals in its products originated in any of the Covered Countries or were obtained from “recycled or scrap sources,” as defined in Form SD. Issuers should not wait until the end of the calendar year to begin their reasonable country of origin inquiry or other inquiries, but should commence their inquiries as early as possible.

What actions are necessary to conduct a “reasonable country of origin inquiry”?

Form SD provides that the inquiry must be “reasonably designed” to determine whether the issuer’s conflict minerals originated in any of the Covered Countries or came from recycled or scrap sources. The rule does not identify specific steps the issuer must take in connection with its inquiry. The SEC indicates that the inquiry can differ among issuers based on such factors as the issuer’s size, products and relationships with suppliers, as well as on “the available infrastructure at a given time.” The SEC notes that an issuer could satisfy this statement if it obtains “reasonably reliable representations” from the operator of the facility at which the conflict minerals were processed or from the issuer’s immediate suppliers indicating that the conflict minerals did not originate in any of the Covered Countries or came from recycled or scrap sources. The issuer must have a reason to believe the representations are true in light of the facts and circumstances surrounding the representations.

What must the issuer report after it completes its “reasonable country of origin inquiry”?

The issuer will be required to disclose in the body of the Form SD report, under a separate heading entitled “Conflict Minerals Disclosure,” its determination regarding whether its conflict minerals came from any of the Covered Countries or from recycled or scrap sources, and to provide a brief description of the inquiry it undertook and the results of the inquiry. The issuer also must disclose this information on its publicly available Internet website and provide a link to that website in its report. The issuer will not be required to take further action if, following its reasonable country of origin inquiry, it determines that its conflict minerals either did not come from a Covered Country or came from recycled or scrap sources, or has no reason believe that its conflict minerals may have originated in a Covered Country or may not have come from recycled or scrap sources.

On the other hand, if based on its reasonable country of origin inquiry, the issuer knows that it has conflict minerals that originated in any of the Covered Countries and did not come from recycled or scrap sources, or has reason to believe that its conflict minerals may have originated in the Covered Countries and may not have come from recycled or scrap sources, the issuer must “exercise due diligence on the source and chain of custody” of its conflict minerals.

What standards will apply to the issuer’s exercise of due diligence on the source and chain of custody of its conflict minerals?

The issuer must conduct its due diligence in a manner that conforms to any existing “nationally or internationally recognized due diligence framework” for any conflict minerals, such as the due diligence guidance approved by the Organisation for Economic Co-operation and Development (OECD). If such a framework is not available for a particular conflict mineral, Form SD instructs the issuer to exercise “appropriate due diligence” without the benefit of a framework.

Is an issuer expected to exercise due diligence on the source and chain of custody of conflict minerals that are outside the supply chain before January 13, 2013?

No. The SEC acknowledges that it would be difficult, if not impossible, for issuers to perform such due diligence. The rule therefore excludes from the reporting obligation any conflict minerals that were outside the supply chain prior to January 31, 2013. A conflict mineral is considered “outside the supply chain” after any columbite-tantalite, cassiterite and wolframite minerals, or their derivatives, have been smelted; after any gold has been fully refined; or if any conflict mineral or its derivatives that have not been smelted or fully refined are located outside of the Covered Countries.

What information must the issuer provide in its Form SD report after it completes the due diligence review?

If the issuer has determined that its conflict minerals originated in a Covered Country and did not come from recycled or scrap sources, or was unable to determine the sources of its conflict minerals,  it will be required to file a Conflict Minerals Report as an exhibit to its Form SD report and to make the report publicly available on its Internet website. In addition, the issuer will have to disclose in the body of the report, under a separate heading entitled “Conflict Minerals Disclosure,” that it has filed a Conflict Minerals Report and provide the link to its Internet website where the Conflict Minerals Report is publicly available.

What information must appear in a Conflict Minerals Report?

The Conflict Minerals Report must include information regarding the issuer’s due diligence review, including:

  • A description of the measures undertaken by the issuer to exercise due diligence on the source and chain of custody of its conflict minerals;
  • An identification of a nationally or internationally recognized due diligence framework used for the issuer’s review with respect to any particular conflict mineral, if such a framework is available; and
  • Except as provided in connection with the accommodations described below, an independent private sector audit of the Conflict Minerals Report conducted in accordance with standards established by the U.S. Comptroller General.  

The Conflict Minerals Report prescribes different informational requirements based on whether or not the products containing conflict minerals have been found to be “DRC conflict free.” “DRC conflict free” products are those that do not contain conflict minerals that directly or indirectly finance or benefit armed groups in a Covered Country. If the issuer finds that its products are DRC conflict free, it must undertake the following audit and certification requirements:

  • Obtain an independent private sector audit of its Conflict Minerals Report;
  • Certify that it obtained such an audit;
  • Include the audit report as part of the Conflict Minerals Report; and
  • Identify the auditor.  

If the issuer does not find that its products are DRC conflict free, it must, in addition to the audit and certification requirements, describe the following in its Conflict Minerals 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.  

Will the SEC provide companies any accommodations with respect to required disclosures in the Conflict Minerals Report?

The SEC has acknowledged that, in order to reduce the rule’s burdens and costs, a phase-in period for the required disclosures is appropriate. Accordingly, for the 2013 and 2014 calendar year reporting periods for companies that are not smaller reporting companies, and for the 2013 through 2016 calendar year reporting periods for smaller reporting companies, the SEC will permit companies to describe products containing the following conflict minerals as “DRC conflict undeterminable” rather than as “DRC conflict free”:

  • Conflict minerals that, following its due diligence, the issuer was unable to determine did not originate in the Covered Countries;
  • Conflict minerals that originated in the Covered Countries the issuer was unable to determine did not directly or indirectly finance or benefit armed groups; and
  • Conflict minerals the issuer was unable to determine came from recycled or scrap sources.  

During the phase-in period, the issuer will not be required to obtain an independent private sector audit of its Conflict Minerals Report. The issuer, however, will be required to describe the following in the Conflict Minerals Report:

  • The 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 issuer’s efforts to determine the mine or location of origin with the greatest possible specificity; and
  • The steps the issuer has taken or will take, if any, since the end of the period covered in its most recent Conflict Minerals Report, including any steps to improve due diligence, to mitigate the risk that its conflict minerals benefit armed groups.  

What are an issuer’s obligations with respect to conflict minerals from recycled or scrap sources?

There are special provisions governing the due diligence and Conflict Minerals Report for conflict minerals from recycled or scrap sources. If an issuer’s conflict minerals are derived solely from recycled or scrap sources rather than from mined sources, the issuer’s products containing such minerals are considered “DRC conflict free.” If an issuer cannot reasonably conclude after its country of origin inquiry that its gold is from recycled or scrap sources, it will be required to undertake due diligence in accordance with the OECD Due Diligence Guidance, and to obtain an independent private sector audit of its Conflict Minerals Report. For the other three minerals in those circumstances, until a due diligence framework is developed, the issuer will be required to describe in its Conflict Minerals Report the due diligence measures it exercised in determining that its conflict minerals are from recycled or scrap sources, but will not be required to obtain an audit regarding such disclosures.

If an issuer acquires an entity during the calendar year to which the report pertains, must the report include information about conflict minerals in the acquired entity’s products?

The SEC acknowledges that it would be burdensome to require conflict minerals reporting with respect to the products manufactured by a recently acquired entity. Accordingly, Form SD provides that if the issuer acquires an entity that uses conflict minerals in its products, the issuer may delay reporting on the products manufactured by the acquired entity until the end of the first reporting calendar year that begins no sooner than eight months after the effective date of the acquisition. For example, an issuer that acquires an entity on any date during the period from January 1 through April 30, 2014 would be required to provide conflict minerals information regarding the acquired entity for the 2015 calendar year. If the acquisition became effective on any date during the period from May 1, 2014 through December 31, 2014, the issuer would have to provide conflict minerals information regarding the acquired entity for the 2016 calendar year.

What industry initiatives are being undertaken in connection with the conflict minerals rule?

Since the passage of the Dodd-Frank Act, a number of groups have undertaken various initiatives relating to conflict minerals. One organization (the Electronics Industry Citizenship Coalition-Global eSustainability Initiative (EICC-GeSI)) has initiated a smelter certification program, pursuant to which smelters will be certified as selling metals that are “DRC conflict free,” thereby permitting manufacturers whose products contain only conflict minerals sourced from those smelters to report that the products are “DRC conflict free.” Similar initiatives are underway in the gold industry. In addition, many companies have created conflict minerals teams, composed of compliance and procurement employees. The teams have begun to review the presence of conflict minerals in their products, as well as to undertake due diligence reviews of the sources of those minerals, and in some cases to change the sources. These actions are being supplemented by initiatives undertaken by various industry groups to coordinate efforts of their members to implement the provisions of this very challenging rule.