On August 22, 2012, the U.S. Securities and Exchange Commission (SEC) adopted a new rule to give effect to the conflict mineral disclosure requirements of section 1502 of the Dodd-Frank Act, an act passed by the U.S. Congress predominantly to increase transparency of financial institutions. Despite the general focus of the Act on financial transparency, section 1502 and the newly adopted regulations create reporting requirements for companies that use in the manufacture of their products certain minerals, defined as conflict minerals, mined in the Democratic Republic of the Congo (DRC), and adjacent countries.
Section 1502 is one of an increasing number of regulatory frameworks which focus on tracking and reporting the source of natural resources, and the processes used to extract and refine them. The approach, which takes cues from the Kimberly Process developed for diamonds, aims to encourage the resource extraction sector to develop processes which allow for an accurate record of the source of natural resources and the modes of extraction.
The goal of such legislation is to facilitate public support for, or public pressure against, practices that have potential human rights, ecological or social impacts. In the case of the Dodd-Frank Act, the preamble to Section 1502 states the issue targeted by that section as follows:
It is the sense of the Congress that the exploitation and trade of conflict minerals originating in the Democratic Republic of the Congo is helping to finance conflict characterized by extreme levels of violence in the eastern Democratic Republic of the Congo, particularly sexual- and gender-based violence, and contributing to an emergency humanitarian situation therein...1
Dodd-Frank Section 1502 and the New Conflict Minerals Disclosure Rule
The Dodd-Frank Act passed the U.S. Congress in 2010 and was signed into law on July 21, 2010. At section 1502, the law set standards, and mandated that the SEC create new rules, which allow for the tracing of conflict minerals, and require substantial reporting on the supply chains of companies that utilize conflict minerals and their derivatives in products they manufacture. As defined, "conflict minerals" include:
- columbite-tantalite, also known as coltan, and its derivative tantalum,
- cassiterite and its derivative tin,
- gold, and
- wolframite and its derivative tungsten.
The US Secretary of State is also authorized to designate additional minerals or their derivatives determined to be financing conflict in the DRC or its adjoining countries.
Step 1 - Determine Whether A Company is Subject to the New Rule:
The final rule adopted by the SEC to implement section 1502 applies to a company that uses conflict minerals if:
- the company files reports with the SEC under the U.S. Securities Exchange Act of 1934, and
- the conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the company.
The new conflict mineral disclosure rule applies to U.S. and foreign companies that satisfy both of these criteria. A company that does not satisfy both criteria is not required to take any action, make any disclosures or file or submit any reports under the new conflict minerals rule. Critically, however, even a company that is not directly subject to the rule's requirements may nevertheless be affected by the rule if it is part of the supply chain for a company that is subject to the rule.
Significantly, in response to comments the SEC received on the rule as originally proposed, the final rule does not treat a company that mines conflict minerals as manufacturing those minerals unless the company also engages in manufacturing. In addition, the final rule does not apply to any conflict minerals that are "outside the supply chain" prior to January 31, 2013. A conflict mineral is outside of the supply chain if it has been smelted or fully refined or, if the mineral has not been smelted or fully refined, is outside of the Covered Countries. The "Covered Countries" are defined as the DRC and the countries sharing an internationally recognized border with the DRC, including Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia.
As adopted, the new rule does not define the phrases "contract to manufacture" or "necessary to the functionality" or "necessary to the production" of a product. The SEC, however, has provided some guidance in its adopting release 2 to assist companies in determining whether the new rule applies to them.
Contracting to Manufacture:
In the adopting release, the SEC states that whether a company will be deemed to "contract to manufacture" a product depends on the degree of influence the company exercises over the materials, parts, ingredients, or components to be included in any product that contains conflict minerals or their derivatives. The company must make this determination based on the actual facts and circumstances. The SEC has also clarified that a company will not be deemed to "contract to manufacture" a product merely because it:
- specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product, unless it takes such 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,
- sells under its own brand, mark, logo, or label a generic product manufactured for the company by a third party, or
- services, maintains, or repairs a product manufactured by a third party.
Necessary to the Functionality of a Product:
The SEC's guidance in the adopting release advises companies that in determining whether a conflict mineral is "necessary to the functionality" of a product the company should consider:
- whether the conflict mineral is intentionally added to the product or any component of the product and is not a naturally-occurring by-product,
- whether the conflict mineral is necessary to the product's generally expected function, use or purpose, and
- if the conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration.
Necessary to the Production of a Product:
In order for a conflict mineral to be necessary to the production of a product, the mineral must be contained in the product and necessary to the product's production. The SEC has stated that in making this determination, companies should consider:
- whether the conflict mineral is intentionally included in the product's production process, other than if it is included in a tool, machine, or equipment used to produce the product (such as computers or power lines),
- whether the conflict mineral is included in the product, and
- whether the conflict mineral is necessary to produce the product.
A conflict mineral will not be considered "necessary to the production" of a product if the mineral is used solely as a catalyst, or in a similar manner in another process, that is necessary to produce the product but is not contained in that product.
Step 2 - Determining Whether Conflict Minerals Originated in the DRC or Other Covered Countries:
Under the final rule, if a company determines that one or more conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the company, then the company is required to conduct in good faith a reasonable 'country of origin' inquiry that is reasonably designed to determine whether any of those minerals originated in the Covered Countries or whether they are from scrap or recycled sources.
If as a result of the inquiry a company determines that either:
- the minerals did not originate in the any of the Covered Countries, or that the minerals are from scrap or recycled sources, or
- the company has no reason to believe that the minerals may have originated in the Covered Countries or may not be from scrap or recycled sources,
then the company must disclose its determination, provide a brief description of the inquiry it undertook and the results of the inquiry. This disclosure is required to be made on the newly adopted Form SD as well as on the company's website.
If the company determines through its inquiry that:
- the company knows that the conflict minerals originated in the Covered Countries and did not come from recycled or scrap sources, or
- the company reason to believe that the conflict minerals may have originated in the Covered Countries and may not be from recycled or scrap sources,
then the company must conduct "due diligence" on the source and chain of custody of its conflict minerals. The due diligence conducted by the company must conform to a nationally or internationally recognized due diligence framework, such as the due diligence guidance approved by the Organisation for Economic Co-operation and Development, if such a framework is available for the relevant conflict mineral.
Step 3 - Preparing and Filing a Conflict Minerals Report:
Contents of the Conflict Minerals Report
If, as a result of the due diligence on the source and chain of custody, the company is able to determine that its conflict minerals did not originate in the Covered Countries or that they came from recycled or scrap sources, the company does not need to complete and file a Conflict Minerals Report, but instead is required only to file the Form SD as described above, and disclose in that form how it has reached this determination.
If a company is able to determine that although the minerals it uses may originate from the Covered Countries they did not finance or benefit armed groups (meaning the minerals are "DRC Conflict Free" for purposes of the new rule), then the company must:
- obtain an independent private sector audit of its Conflict Minerals Report conducted in accordance with standards established by the Comptroller General of the United States (at present, this appears to be the generally accepted government auditing standards (GAGAS) such as those applicable to attestation engagements or performance audits 3),
- certify that it obtained such an audit, and
- identify the auditor and include the audit report as part of the Conflict Minerals Report.
If a company determines that any of its products are not "DRC Conflict Free," then the company must also disclose 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.
In response to comments the SEC received on the rule proposal, the new rule does provide a temporary two-year period (or four-year period for smaller reporting companies), during which the company is permitted to state in its Conflict Minerals Report that it is not able to determine whether the minerals in its products originated in the covered countries or whether those minerals financed or benefited armed groups in those countries. In this case the company will be required to disclose in its Conflict Minerals Report:
- which of its products manufactured or contracted to be manufactured 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 the company made to determine the mine or location of origin with the greatest possible specificity, and
- the steps the company has taken or will take, if any, since the end of the period covered in its most recent Conflict Minerals Report to mitigate the risk that its conflict minerals benefit armed groups, including any steps to improve the company's due diligence.
The company is not required to obtain an independent private sector audit for those products that are "DRC conflict undeterminable".
Recycled and Scrap Source Conflict Minerals
If a company's conflict minerals are derived from recycled or scrap sources, and not from mined sources, the company's products containing such minerals are deemed to be "DRC conflict free." Under the new rule, conflict minerals are deemed to be from recycled or scrap sources if:
- they are from recycled metals, which are end-user or post-consumer products,
- they are scrap processed metals created during product manufacturing, or
- they are excess, obsolete, defective or scrap metal materials that contain refined or processed metals that are appropriate to recycle in the production of tin, tantalum, tungsten and/or gold.
Minerals that are partially processed, unprocessed, or a by-product from another ore are not recycled metals for purposes of the new rule.
If a company is not able to reasonably conclude that the conflict minerals used in its products are from recycled or scrap sources, then the rule contains different requirements depending on whether the mineral is gold or one of the other three conflict minerals.
In the case of gold, if the company is not able to determine whether it is from recycled or scrap sources then the company is required to conduct due diligence in accordance with the OECD Due Diligence Guidance and obtain an audit of its Conflict Minerals Report. This is because gold is the only conflict mineral, at this time, with a nationally or internationally recognized due diligence framework for determining whether it is recycled or scrap.
For the other three conflict minerals, if a company cannot reasonably conclude that those minerals are from recycled or scrap sources then until a recognized due diligence framework is developed the company is required to describe in its Conflict Minerals Report the due diligence it conducted in attempting to determine whether its conflict minerals are from recycled or scrap sources. However, the company is not required to obtain an independent private sector audit in respect of those minerals.
When Must Companies Comply with the New Rule and File the Required Disclosure?
The new rule requires companies that are subject to the rule to provide the requisite conflict minerals information on a calendar year basis, with the first reporting period for all companies being the year beginning January 1, 2013 and ending December 31, 2013. The Form SD, and if required the Conflict Minerals Report, must be filed with the SEC on EDGAR and posted on the company's website on or before May 31 of the year following the year being reported on. As a result, companies subject to the rule must file their first report on or before May 31, 2014 in respect of the 2013 calendar year.
While the goal of resource reporting is laudable, section 1502 does not come without controversy.
Since the time that the Dodd-Frank Act was passed, a number of companies, as well as industry organizations, have begun to develop processes to adhere to the anticipated guidelines. While these initiatives have had a positive influence in reducing the funds passing to militant groups in the DRC, they have also reduced investment in other sectors, including most or all of the mining initiatives in the eastern DRC, an area where conflict is more prevalent. However, it could also be that the delay by the SEC in adopting these regulations has lengthened the period of decreased investment as industry has waited to see whether they can safely invest and still be compliant. It is hoped that now that the regulations have been adopted, that some certainty will return, and with it legitimate investment.
1. Dodd Frank s. 1502(a).
2. When the SEC adopts a rule it publishes an adopting release setting out the new rule, the statutory authority for the new rule and certain other matters. While the adopting release is not part of the rule it frequently contains an explanation of the originally proposed rule, comments the SEC may have received on that proposed rule, and the SEC's reasoning in adopting the rule in its final form. The SEC may expressly set out guidance for issuers to assist them in interpreting provisions of a new rule that may be subject to more than one interpretation or that may require a facts and circumstances analysis. As such, an adopting release provides guidance as to the SEC's interpretation of a rule.
3. Securities and Exchange Commission Release No. 34-67716 Section II.E.3.c.i (available at http://www.sec.gov/rules/final/2012/34-67716.pdf ) (Release No. 34-67716); and U.S. Gov't Accountability Office, GAO-12-331G, Government Auditing Standards 2011 Revision (Dec. 2011) (available at http://www.gao.gov/assets/590/587281.pdf). The GAGAS Attestation Engagement standards require that auditors be "licensed certified public accountants, persons working for a licensed certified public accounting firm or for a government auditing organization, or licensed accountants in states that have multi-class licensing systems that recognize licensed accountants other than certified public accountants." The GAGAS Performance Audit standards allow auditors other than certified public accountants to perform a Performance Audit. See Release No. 34-67716 at footnote 650.
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