On August 22, 2012, the U.S. Securities and Exchange Commission (SEC) adopted final rules under Section 13(p)1 of the Securities Exchange Act of 1934 (Exchange Act) relating to the use of “conflict minerals” originating in the Democratic Republic of the Congo or an adjoining country2 (collectively, the DRC). Newlyadopted Rule 13p-1 (Rule)3 is expected to significantly impact issuers (registrants) that file reports with the SEC, as well as a number of other public and private companies along the supply chain. Initially proposed almost two years ago,4 the Rule was adopted by a 3-2 vote5 of the SEC and represents the culmination of a difficult debate among industry participants, professional associations, the legal and academic community, as well as public policy and human rights groups, on the appropriateness of extending the SEC’s mission to moral and humanitarian causes beyond America’s borders.
The Rule imposes diligence, audit, disclosure and reporting obligations on registrants whose products use any of four specified minerals and their derivatives — columbite-tantalite (tantalum), cassiterite (tin), wolframite (tungsten) (referred to as the 3Ts) or gold6 — whether or not they actually finance or benefit armed groups in the DRC. Central to the application of the Rule is whether a conflict mineral contained or used in a registrant’s product and “necessary to the functionality or production of a product manufactured or contracted by that registrant to be manufactured” originated in the DRC.
Registrants subject to the Rule are required initially to conduct a “reasonable country of origin inquiry” to determine whether the conflict minerals originated in the DRC. If the registrant’s conclusion is positive, then specific supply-chain diligence, auditing and certification obligations may be necessary. Disclosure is required with respect to the diligence measures undertaken with specificity on supply chain source and chain of custody consistent with a “nationally or internationally recognized diligence framework,” including a certified independent private sector audit conducted according to the standards established by the U.S. General Accounting Office (GAO), as well as a description of products that are not conflict mineral free, the facilities used to process the minerals, and country of origin.
Registrants must file an annual report on newly-adopted Form SD on a calendar year basis commencing January 1, 2013, with the first report due May 31, 2014, and make the disclosure publicly available on the company’s website. The Rule applies equally to all registrants, except certain registered investment companies; however, the Rule is expected to impact other companies along the supply chain who may be required to participate in a registrant’s diligence inquiries. No exemptions have been granted to emerging growth companies, smaller reporting companies or foreign private issuers.
The Rule establishes a three-step process, which the SEC acknowledges will not be without significant financial implications to registrants who use or supply conflict minerals. See page 7 for the flowchart the SEC included in the adopting release to facilitate the registrant’s understanding of the procedures under the Rule.
Step One: Assessing Applicability of the Rule to Your Company
In undertaking the initial assessment of whether a registrant is subject to the Rule, the registrant must consider: (1) whether conflict minerals are contained or used in any of its products; (2) if so, whether such minerals are “necessary to the functionality or production” of such product; and (3) whether it manufactures the product and/or contracts to manufacture the product. Conflict minerals that are “outside the supply chain” prior to January 31, 2013 — that is, minerals that have been smelted or fully refined or that are outside the DRC — are exempt from the analysis on the basis that they are unlikely to further finance or benefit armed groups.
Significantly, unless the conflict minerals are necessary to the functionality or production of a product which is manufactured by the registrant or with respect to which the registrant has contracted to manufacture, then the registrant is not required to undertake a country of origin analysis (described under Step Two below), make any disclosures or submit any reports on Form SD. The SEC declines, however, to provide definitions of the key terms, including “contract to manufacture,” “necessary to the functionality,” and “necessary to the production,” leaving registrants with only limited guidance in the adopting release. Inevitably, industry associations and other groups will be required to fill the large gap by developing norms in order to achieve a measure of standardized practice and consistent application over time. Since the enactment of Dodd-Frank, there has been an ongoing effort among industry groups to collaborate in the development of processes and procedures for use by affected companies. The Electronic Industry Citizenship Coalition, in conjunction with the Global e-Sustainability Initiative (EICC/GeSI), have been active in developing implementation tools and programs to improve supply chain transparency for DRC conflict minerals and to aid compliance with the impending disclosure and reporting requirements. EICC/GeSI have worked closely with the Organization for Economic Cooperation and Development (OECD) to foster consistency in the approach to conflict mineral due diligence, and have partnered with the Automotive Industry Action Group, the Japan Electronics and Information Technology Industries Association, and the Retail Industry Leaders Association.7
“Contract to Manufacture.” While the SEC defers to commonly accepted definitions on the term “manufacture,” the adopting release suggests that a registrant may be considered to “contract to manufacture” depending upon the “degree of influence” it exercises over the “materials, parts, ingredients, or components to be included in any product that contains conflict minerals or their derivatives.” The SEC stresses that the analysis is based upon the particular registrant’s facts and circumstances as well as its business and industry. More specifically, the SEC states that the following activities do not fall within the meaning of the phrase: (i) specifying or negotiating contractual terms that do not relate directly to the manufacturing, unless there is such a degree of influence exerted as to be practically equivalent to contracting on terms that directly relate to the manufacturing; (ii) affixing one’s brand, logo, or label to a generic product manufactured by a third party (provided there is no involvement in the manufacturing beyond affixing a brand, logo or label); or (iii) servicing, maintaining, or repairing a product manufactured by a third party. The SEC distinguishes between a registrant as a “sales channel,” such as a pure retail outlet, and one which “outsources” its manufacturing. In particular, the adopting release notes that the rules are not intended to apply to retailers that sell only the products of others if the retailers (i) had no contract or other involvement in the manufacturing of the products or (ii) did not sell the products under their brand name or a separately established owned brand, and did not have the products manufactured specifically for them. In addition, the adopting release clarifies that mining or contracting to mine alone is not sufficient to bring the registrant within the scope of the Rule unless the registrant also engages in manufacturing.
“Necessary to the Functionality or Production.” Here the SEC instructs that the following factors should be considered by the registrant: (i) whether the conflict mineral is intentionally added to the product or any component of the product and is not a naturally-occurring by-product (even if the component was manufactured originally by a third party); (ii) whether the conflict mineral is necessary to the product’s generally expected function, use, or purpose; and (iii) if the conflict mineral is incorporated for the purposes of ornamentation, decoration or embellishment, whether the product’s primary purpose is ornamentation or decoration. The SEC emphasizes that the analysis must be based on the particular facts and circumstances applicable to the product.
To be considered necessary to the production of a product, the SEC concludes that the conflict mineral must, in fact, be contained in the product as well as intentionally added to the product’s production process. In other words, it is not sufficient if the mineral is used merely as a catalyst or in a similar manner in the production process; provided, however, that if the catalyst is not completely washed away and is contained in the product in any amount, even trace amounts, it is subject to the Rule. The SEC also recommends that registrants assess whether the conflict mineral is intentionally included in the actual production process, rather than used in a tool, machine or indirect equipment (such as a computer or a power line) used to produce the product. The adopting release notes that it may be the tool or machine that is necessary to the production and not the conflict mineral. A further distinction is drawn with respect to conflict minerals in materials, prototypes and other demonstration devices, which the SEC does not consider to be products until they enter the stream of commerce.
Step Two: Conducting a Reasonable Country of Origin Inquiry
If a registrant determines that a conflict mineral is necessary to the functionality or production of any of its products, it must then undertake an inquiry into the country of origin of the mineral. The SEC concluded that the registrant is best suited to determine the nature of such an inquiry in consideration of its own facts and circumstances. Nonetheless, in response to comments, the SEC provides general standards for registrants: (i) the inquiry must be “reasonably designed” to determine whether any conflict minerals originated in the DRC or are from recycled or scrap sources; and (ii) the inquiry must be conducted in good faith. The inquiry under the Rule is consistent with the supplier engagement approach set forth in the OECD Guidance described below.
A registrant is expected to seek and obtain “reasonably reliable representations indicating that the facility at which its conflict minerals were processed and demonstrating that those conflict minerals did not originate in the DRC or come from recycled or scrap sources.” The required representations may come directly from the facility or through intermediate suppliers; however, the registrant must have a reasonable belief as to the veracity of the representations based upon the facts and circumstances known to it. The adopting release suggests that it would be reasonable to rely upon representations from a processor that has received a “conflictfree” designation from a recognized industry group that requires an independent private sector audit. The registrant is not required to obtain representation from all suppliers if it receives a sufficient response indicating the minerals did not originate in the DRC and has not otherwise obtained any warning signs or other indicia of concern with respect to the remaining suppliers or facilities. It is also required to disclose on Form SD its policies for sourcing of conflict minerals as part of its description of its country of origin inquiry.
If the registrant concludes, following such inquiry, that the minerals did not originate in the DRC or are from recycled or scrap sources, or the registrant has no reason to believe the minerals may have originated in the DRC based upon its inquiry, such determination, together with a brief description of the process and results, must be disclosed on Form SD under the heading “Conflict Minerals Disclosure.” At this point, the registrant need not proceed to the due diligence process in Step Three. The registrant is not required to retain reviewable business records to support its conclusion; however, the SEC suggests that retention may be used to demonstrate compliance and may be required as part of the recognized due diligence framework relied upon.
Step Three: Source and Chain of Custody Due Diligence; Preparation of Conflict Minerals Report
In order to prepare the required Conflict Minerals Report, which must be filed as an exhibit to the Form SD, the registrant must conduct due diligence on the source and chain of custody of the minerals utilizing a nationally or internationally recognized framework, provided one is available for the specific conflict mineral. In 2011, the OECD adopted its “Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas,” which covers the 3Ts, and in July 2012 adopted a “Supplement on Gold” (collectively, the Guidance). Notably, the Guidance sets forth a “Five-Step Framework for Risk-Based Due Diligence in the Mineral Supply Chain.” The Guidance has been accepted by the OECD members, as well as the countries in the DRC and other affected areas, and is recognized in the adopting release as the “only” available nationally or internationally recognized framework for conducting the required supply chain due diligence that satisfies the SEC’s criteria. In addition, the U.S. State Department has published a conflict minerals map and has developed guidance for companies seeking to exercise supply chain diligence.
Conformity with a nationally or internationally recognized due diligence framework is also required in connection with assessing whether the minerals are from recycled or scrap sources. The SEC notes that the gold supplement to the Guidance is the only known such framework currently available in this regard. Consequently, with respect to whether the 3Ts in products are from recycled or scrap sources, registrants are required to exercise due diligence without the benefit of a recognized framework until one is established. Relying upon the OECD definition, the SEC considers minerals as recycled or from scrap “if they are from recycled metals which are reclaimed end-user or post-consumer products, or scrap processed metals created during product manufacturing,” including “excess, obsolete, defective and scrap metal materials that contain refined or processed metals that are appropriate to recycle in the production” of the 3Ts and/or gold. Minerals that are partially processed, unprocessed or a byproduct from another ore will not be included in the definition of recycled metal.
Audit and Certification Requirements. The Conflict Minerals Report must be subjected to an “independent private sector audit,” which must opine as to whether (i) the design of the registrant’s due diligence measures conform, in all material respects, to the Guidance and (ii) the description of the registrant’s due diligence measures are consistent with the process undertaken. An audit is not required if (a) the registrant has products that are “DRC conflict undeterminable” within the temporary transition period discussed below, (b) a nationally or internationally recognized due diligence framework does not exist for the conflict mineral, or (iii) the due diligence exercise is undertaken based upon the reasonable belief of the registrant that the conflict minerals in its products originated in the DRC and the results of the diligence cause the registrant to conclude that such minerals did not originate in the DRC or did come from recycled or scrap sources.
The audit must be conducted in accordance with the GAO’s existing Government Auditing Standards, commonly referred to as the “Yellow Book,” and satisfy the independence standards established by the GAO. Notably, the SEC states that it would not be inconsistent with the independence requirements in Rule 2-01 of Regulation S-X if the registrant’s independent public accountant also performs the independent private sector audit of the Conflict Minerals Report. Such engagement would be subject to the pre-approval requirements under Rule 2- 01(c)(7) of Regulation S-X as a “non-audit service” and the related fees would be required to be disclosed in the “All Other Fees” category of the principal accountant fee disclosures. As a further requirement, the registrant must “certify” in the Conflict Minerals Report that it has obtained an independent private sector audit; however such certification is not required to be signed by an officer of the registrant.
Section 13(p)(1)(C) of the Exchange Act enables the SEC to determine whether a registrant’s independent audit and other diligence procedures may be unreliable and, as a consequence, whether the Conflict Minerals Report does not satisfy the statutory reporting requirement.
“DRC Conflict Free” and “DRC Conflict Undeterminable” Products. The Conflict Minerals Report must include a description of products that “have not been found to be ‘DRC conflict free’” (meaning they “contain minerals that directly or indirectly finance or benefit armed groups” in the DRC), a description of the processing facilities, the country of origin of those conflict minerals, and the efforts to determine the mine or location of origin with the “greatest possible specificity.” Products containing conflict minerals from recycled or scrap sources may be designated as “DRC conflict free.”
A temporary transition period has been incorporated for registrants who are unable to determine if their minerals are “DRC conflict free” for one of two reasons: (i) following a conclusion in Step Two that the minerals originated in the DRC and after the due diligence exercise in Step Three, the registrant is unable to determine if the minerals financed or benefited armed groups in the DRC; or (ii) despite a reasonable belief after Step Two that the minerals may have originated in the DRC or did not come from recycled or scrap sources, the due diligence exercise did not clarify (a) country of origin, (b) whether the minerals financed or benefited armed groups in the DRC, or (c) whether the minerals came from recycled or scrap sources. The associated products may be described in the Conflict Minerals Report as “DRC conflict undeterminable” and need not be audited. The Report must describe the registrant’s due diligence, as well as the steps that have or will be taken to mitigate the risk that the necessary conflict minerals benefit armed groups, including steps to improve the due diligence process. The transition period applies for the first two reporting calendar years after effectiveness for all registrants and for the first four reporting calendar years for smaller reporting companies. If a registrant is still unable to make a clear determination as to the source of the minerals following the transition period, the products containing such minerals must be described as “not having been found to be ‘DRC conflict free.’”
Registrants subject to the disclosure requirement must file a specialized disclosure report on Form SD by May 31 of each year, reporting on the prior calendar year ended December 31. The initial report must be filed on or before May 31, 2014 for the calendar year 2013. The May 31 filing date was established so as not to interfere or distract from the registrant’s preparation of its Annual Report on Form 10-K or Form 20-F. The disclosure must be provided for any year in which the manufacture of a product that contains any conflict minerals is completed, regardless of whether the registrant manufactured the product itself or contracted to have the product manufactured. The Conflict Minerals Report (which must include the registrant’s audit certification) is filed as an exhibit to the Form SD, rather than included in the body of the form, to facilitate access through EDGAR. In addition, the registrant must post the Conflict Minerals Report or, if no Report is required, conflict minerals disclosure on its website for a period of one year after filing with the SEC.
A grace period is provided for registrants who acquire or obtain control over a company that manufactures or contracts to manufacture products with conflict minerals necessary to the functionality or production of the product. In order to allow sufficient time to establish appropriate systems and gather the necessary information, the initial reporting period is delayed until the first calendar year beginning no earlier than eight months after the effective date of the acquisition.
For purposes of Exchange Act Section 18 liability, Form SD, together with the Conflict Minerals Report and independent audit report, is “filed” rather than “furnished.” Section 18 states that a person will not be held liable for misleading statements in a document filed under the Exchange Act if such person shows that he acted in good faith and without knowledge that the statement was false or misleading. Further, since Form SD is filed separate from the registrant’s Exchange Act annual report, the disclosures will not be included in the officers’ certificates under Exchange Act Rules 13a-14 and 15d-14. Form SD will not be incorporated into a registrant’s registration statements under the Securities Act of 1933, as amended, unless the registrant so specifies.
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New reporting requirements for any registrant must be analyzed based on the facts of the registrant’s business to ensure compliance with any new Rule. However, practice has shown that in the real world there are very few straightforward facts and, as undoubtedly will be the case with this new Rule, questions of interpretation will emerge as companies are left to implement the Rule’s requirements.
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