What you need to know:

New SEC rules require public companies who utilize gold, tin, tantalum or tungsten, so-called “conflict minerals,” in their products to provide annual disclosures regarding their use of these minerals and their sources.

What you need to do:

Public companies should create a basic inventory of conflict minerals used in their products, the sources of those conflict minerals, and in which products the conflict minerals are used.  Companies should also evaluate existing supply agreements for adequacy of representations regarding sourcing of conflict minerals.

The SEC recently adopted final rules requiring all public companies – including smaller reporting companies, emerging growth companies and foreign private issuers – that use conflict minerals to make specified annual disclosures if the conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the company.  The disclosures are required to be made on a newly created Form SD not later than May 31st with respect to the preceding calendar year, commencing for the year ending December 31, 2013.

The SEC adopted these rules as mandated by the Dodd-Frank Act, which included conflict mineral disclosure rules based upon the concern that minerals originating from the Republic of Congo and adjoining countries were being exploited to benefit and finance armed groups.  While not prohibiting the use of these minerals, the rules require companies to implement a supply chain audit trail aimed at avoiding sourcing conflict minerals from these areas.  We expect that the practical result of these rules will be enhanced supply chain management, both by companies and their suppliers.  Because the so-called conflict minerals—gold, tin, tantalum and tungsten—are commonly found in all forms of electronic devices, these rules will impact a large number of public companies.

Overview of Rules

The final rules adopt a three-step analytic process, with each step contingent on answering the preceding step in the affirmative:

  • First, the company is to determine if it uses conflict minerals that are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the company.
  • Second, the company is to determine whether such conflict minerals originated in the Republic of Congo or adjoining countries and are not from scrap or recycled sources.
  • Third, the company is to complete due diligence on these minerals to determine if the conflict minerals financed or benefited armed groups in a covered country and issue a Conflict Minerals Report, which may be required to be audited by an independent auditor.

Step One:  Evaluate Rule Applicability

Conflict Minerals Are Common.  Conflict minerals are routinely found in a wide range of electronic devices, meaning that this rule will be applicable to many public companies.  As a first step towards compliance, companies will want to create a basic inventory of conflict minerals used, the sources of those conflict minerals, and in which products the conflict minerals are used.  Conflict minerals that, prior to January 31, 2013, have been either smelted or fully refined or are located outside of the covered countries are excluded from the new rules.  Technically, conflict minerals also include the source minerals of tin, tantalum and tungsten: cassiterite, columbite-tantalite and wolframite.

Whether Conflict Minerals are Necessary to the Functionality or Production is a Low Hurdle.  While the final rules do not define when a conflict mineral is necessary to the function or manufacture of a product, the adopting release does indicate that being intentionally added to a product would be a significant affirmative factor in making this determination, and that the conflict mineral need only be necessary for one function, use or purpose of a product—even if it isn’t necessary for all functions or even the primary function.  No de minimus exception exists, but the conflict mineral must be present in the final product (and not used only as a catalyst or in the tools used to manufacture the product) for this analysis to be required.

Products Manufactured or Contracted to be Manufactured.  The adopting release gives guidance, but not a bright line test, on when a company would be deemed to contract to manufacture a given product or component of a product, indicating that the company would need to exert some actual influence over the manufacturing.  The adopting release indicates that simply specifying terms that do not directly relate to the manufacturing of the product, affixing a brand or logo to a generic product, or servicing, maintaining or repairing a product manufactured by a third party would not generally be treated as contracting to manufacture.  Companies are not required to provide a specialized disclosure report with respect to conflict minerals included in products manufactured or contracted to be manufactured by an acquired company until the end of the first calendar year that begins no sooner than eight months after the acquisition.

Step Two:  Reasonable Country of Origin Inquiry

Standard of Evaluation.  The final rules do not mandate a standard of evaluation into country of origin, but the adopting release indicates that the nature of the inquiry will depend on a company’s particular facts and circumstances.  The adopting release also indicates that the SEC would view a company as satisfying the reasonable country of origin inquiry if it seeks and obtains reasonably reliable representations from the company’s supplier or processing facility indicating that the facility at which its conflict minerals were processed did not originate in the covered countries or the conflict minerals came from recycled or scrap sources.  The company must demonstrate that it had reason to believe the accuracy of the representations and took into account any warning signs indicating that the conflict minerals may have originated in a covered country or did not come from recycled or scrap sources.  The adopting release indicates that a company would have reason to believe the accuracy of the representations if the processing facility received a “conflict-free” designation by a recognized industry group that requires an independent private sector audit of the smelter, or an individual processing facility obtained an independent private sector audit that is made publicly available.

Companies should review their existing supply agreements to ensure reasonably reliable representations relating to conflict minerals are included prospectively.  While the adopting release indicates that companies are not required to obtain representations from each supplier, companies are required to design an evaluation method that enables the inquiry to be performed in good faith and not ignore warning signs or other circumstances with respect to any supplier.

Reporting of Evaluation Results on Form SD.  Companies are required to describe this evaluation process and the conclusions reached in the newly-created Form SD, include this information on their company website for a one-year period and provide a link to that website in the Form SD.  If the company concludes either that the conflict minerals “did” or “may have” originated from a covered country and “did not” or “may not have” come from recycled or scrap sources, the company is required to complete the additional review, described below, to determine whether the conflict minerals came from a covered country and financed or benefited armed groups in a covered country.  While the Form SD is treated as filed (and not furnished) for SEC purposes, it is not automatically incorporated by reference into SEC registration statements and is not covered by CEO and CFO certifications.

Step Three:  Supply Chain Due Diligence and Conflict Minerals Report

Substance of Due Diligence.  The required additional due diligence assesses whether the conflict minerals came from a covered country and financed or benefited armed groups in a covered country.  Where the country of origin inquiry determined only that the conflict minerals “may have” originated from a covered country or “may not have” come from recycled or scrap sources, the additional due diligence is intended to address these matters in greater depth.

Level of Required Due Diligence.  Companies required to complete additional review are required to complete due diligence conforming to a nationally or internationally recognized due diligence framework, such as the OECD Due Diligence Guidance, with the objective of determining whether the conflict mineral originated in a covered country and financed or benefitted an armed group in the covered country.  Where additional review is required because the company has reason to believe the conflict mineral may not be from recycled or scrap sources, the diligence review is also required to focus on whether the conflict mineral is, in fact, from a recycled or scrap source, with the company being required to use a nationally or internationally recognized framework for such determination, if such a framework exists.

Reporting of Diligence Results.  If the company concludes that the conflict minerals did not originate in a covered country or did come from recycled or scrap sources, the company is required to describe its evaluation process and the conclusions reached in the Form SD, include this information on its website for a one-year period, and provide a link to that website in the Form SD.  However, if the company concludes that the conflict minerals did originate in a covered country and either did not or may not have come from recycled or scrap sources, the company must file a Conflict Minerals Report as an exhibit to the Form SD.  The Conflict Minerals Report must describe the evaluation process and the conclusions reached, certifying and including a copy of the independent private sector audit required to be undertaken in that circumstance as to the conformity of the evaluation process with the nationally or internationally recognized framework used, and as to whether the company undertook the diligence measures described in the Conflict Minerals Report.  This private sector audit need not be undertaken by a company’s regular financial auditors, though that would be permitted if pre-approved as a non-audit service.

With respect to products not found to be DRC conflict free (meaning not directly or indirectly financing or benefiting armed groups in the covered countries), the Conflict Minerals Report must also describe the applicable products, the facilities used to process the conflict minerals, the country of origin of those conflict minerals, and the efforts to determine the location of origin.  The final rules created a limited transition period of calendar years 2013 and 2014 (and 2015 and 2016 for smaller reporting companies).  If the company is unable to conclude with respect to those periods whether or not the conflict minerals either came from a covered country, came from recycled or scrap sources, or directly or indirectly financed or benefited armed groups in a covered country, the company is permitted to not perform the independent private sector audit.  However, the company is required to additionally disclose the steps the company has taken or will take both to mitigate the risk that its conflict minerals benefit armed groups and to improve its due diligence.

Current Action Items for Companies

The new conflict minerals rules will impact a substantial number of public companies, given that gold, tin, tantalum and tungsten are commonly found in many electronic devices.  Impacted public companies will have a substantial amount of work to do to bring themselves into compliance with the new rules, even if it is determined that the conflict minerals used are not sourced from any covered country of origin.  To begin compliance with these new rules, companies will want to create a basic inventory of conflict minerals used, the sources of those conflict minerals, and in which products the conflict minerals are used.  Companies will also want to evaluate existing supply agreements for adequacy of representations regarding sourcing of conflict minerals.