Keywords: Asia, conflict minerals, disclosure requirements
On 22 August 2012, the U.S. Securities Exchange Commission (the "SEC") adopted a final rule (the "Rule") pursuant to the directives of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") compelling certain companies with U.S. securities reporting obligations ("Reporting Companies")1 to assess and disclose their use of "conflict minerals," consisting of certain metals (including tin, titanium, tungsten and gold) originating from certain targeted sources supporting conflict in the Democratic Republic of Congo (DRC) or adjoining countries (together with the DRC, the "Covered Countries").2
While directly applicable to Reporting Companies, the Rule indirectly imposes obligations on manufacturers throughout the supply chain with customers that are Reporting Companies. We anticipate that such customers may make widely divergent requests of their Asian suppliers, especially given the lack of guidance regarding how compliance with the Rule will be determined. To prepare for such requests from its customers, a supplier should:
- evaluate its upstream materials contracts to ensure that it understands and can substantiate whether any conflict minerals issues need to be raised with its upstream suppliers, which may necessitate documenting existing materials or other supply arrangements;
- implement a consistent approach to responding to requests from customers seeking information regarding conflicts minerals, including ensuring that requests (and responses) are reasonable, accurate and not overly broad;
- develop a uniform method of responding to requests, while ensuring contractual protections with upstream suppliers as well as customers when giving such responses, to minimize the possibility of and liability for inaccuracies; and
- consider the potential impact on confidential information related to the manufacturing or supply chain process, including price-sensitive information and supplier identity that may be revealed in the Reporting Company's SEC filings.
The Rule's new conflict minerals disclosure requirements are a key component of a broader, multi-agency initiative to further the goal of ending human rights abuses by limiting the ability of armed groups in the Covered Countries to fund their activities through the exploitation of and trade in conflict minerals. The Rule seeks to encourage Reporting Companies to conduct thorough due diligence on their supply chains, and to promote transparency and public awareness of the human rights impact of the trade in these minerals.
The cost of compliance will be substantial for many Reporting Companies. The SEC estimates that the initial compliance costs for Reporting Companies will approach US$4 billion with ongoing annual compliance costs of US$609 million. However, in defining compliance requirements, the SEC has made some attempt to balance the economic impact of conflict minerals disclosure, taking into account the limitations of the currently available tools for identifying conflict minerals, allowing flexibility in compliance and limiting certain potential competitive disadvantages. Nonetheless, Reporting Companies with limited existing supply chain compliance controls in place will likely face substantially increased initial cost burdens. Further, these SEC figures do not appear to include the impact on and additional costs for the suppliers of Reporting Companies (not themselves Reporting Companies).
We expect the impact on suppliers of Reporting Companies to be significant. At a minimum, Reporting Companies will almost certainly look to their suppliers to provide a preliminary "country of origin" analysis for product materials inputs, thereby requiring the suppliers to evaluate upstream sources of potential conflict minerals. Further due diligence and substantiation, such as audited conflict minerals reports, may be necessary, involving substantial resources to be expended across the supply chain, not to mention potential costs and dislocations resulting from demands of Reporting Company customers to eliminate conflict minerals from their supply chain where they are found to exist.
Applicability of Rule-Affected Industries and Suppliers
Reporting Companies in a variety of industries are affected by the Rule's disclosure requirements, including electronics and communications, aerospace, automotive, industrial machinery, healthcare devices, jewelry, diversified industrial and consumer goods that produce products that contain potential conflict minerals or involve potential conflict minerals in their manufacture. Although mining companies are a notable exception to this list of affected industries, the SEC acknowledges that mining Reporting Companies will likely incur substantial costs in providing information on the source and custody of the minerals they provide to their customers and other participants in the supply chain.
The Rule applies where a potential conflict mineral is "necessary to the functionality or production" of a product that the Reporting Company either manufactures itself or "contracts to manufacture" through third parties. Whether a potential conflict mineral is "necessary to the functionality or production" of a product depends on facts and circumstances, but basically the analysis focuses upon whether the mineral is actually part of the final product itself or is necessary for the production of the product. If so, the Rule applies if the Reporting Company manufactures or "contracts to manufacture" the product.
To be considered to be "contracting to manufacture" a product, SEC guidance suggests that virtually any involvement in manufacturing will meet the test, perhaps even as little as affixing a brand name to the product. Specifically, SEC guidance suggests that "substantial influence" over the manufacture of a product is not required. Rather, the focus of consideration is whether the Reporting Company, by specific contract specifications or otherwise, may be in a position to influence whether its supplier uses or refrains from using conflict minerals.
Rule Requirement—Investigation and Reporting
Once applicable, the Rule requires the Reporting Company to conduct a good-faith, "reasonable country of origin inquiry" to determine whether the minerals in fact originated in a Covered Country and to disclose its findings or whether they are or are not conflict minerals on new Form SD.3 Reporting Companies must take reasonable steps, based on their specific facts and circumstances, to satisfy this first level of inquiry.
Where the Reporting Company determines that (a) after reasonable inquiry, there is no reason to believe that the suspect minerals originated in Covered Countries or (b) the suspect minerals originated from recycled or scrap sources, the Reporting Company must disclose these findings on Form SD and state that no further due diligence or conflict minerals report ("CMR") will be issued. If, however, the Reporting Company determines that it has reason to believe that suspect minerals originated in a Covered Country and may not come from recycled or scrap sources, or it cannot determine the source of potential conflict minerals it uses, the Reporting Company must undertake further due diligence.
While the Rule does not establish a formal framework for this due diligence process, it requires the due diligence to conform with nationally or internationally established due diligence guidelines.4 Further, the Reporting Company is required to engage an independent private sector auditor and complete a CMR if the potential conflict minerals are determined to originate in a Covered Country. Results of the CMR must be published on the Reporting Company's website with a link to the website provided on Form SD.
The required inquiry will therefore vary among Reporting Companies based on their size, products and relationships with their suppliers. SEC guidance suggests that there should be some flexibility in the standard, and that a Reporting Company is not required to make the determination with absolute certainty. So long as the Reporting Company reasonably designs and carries out its "country of origin" inquiry process and, based on application of that process, can come to a reasonable belief as to the origin of its minerals, the requirement will be satisfied.
Compliance Impact on Suppliers
Manufacturing suppliers should be prepared to cooperate with Reporting Companies in all levels of conflict minerals due diligence. From the initial "country of origin" analysis to the follow-on preparation of CMRs, suppliers will need to be able to provide increasingly detailed responses to facilitate accurate inquiry and reporting by their Reporting Company customers. Contractual arrangements with both covered issuers and upstream suppliers will need to be re-evaluated in light of additional disclosure, data sharing and, potentially, audit requirements, as well as to address requirements arising from compliance requests.
The extent to which suppliers will need to implement additional compliance measures will turn on their commercial relationship with their Reporting Company customers and the potential exposure to conflict minerals within their supply chain. Under existing contractual arrangements, many suppliers may have limited obligations to assist their customers in complying with regulatory inquiries (although sophisticated supply contracts may have provisions addressing compliance with law support); nonetheless, the practical realities of their commercial relationships with their Reporting Company customers will likely necessitate enhanced cooperation to meet conflict minerals reporting requirements. The contours of this cooperation should be carefully mapped between the parties in order to equitably share additional compliance costs and mitigate potential risks. Because many supply contracts are driven by the buyer's issuance of a purchase order, the arrival of these "enhanced cooperation" realities may be abrupt.
A primary concern for many suppliers will be the depth and extent (and resulting expense) of the reviews necessary to satisfy a customer's reporting requirements. The "reasonable" level of inquiry standard applied to Reporting Companies should assist a supplier in determining the depth of inquiry necessary at the supplier level, but ultimately the scope will be largely driven by facts and circumstances and the requirements of its customer. If, for instance, a supplier is likely exposed to higher-risk supply chain sources, the supplier should be prepared for more frequent secondary due diligence inquiries and, possibly, to participate in the preparation of audited CMRs for its customers. Where a supplier expects to be involved in regular, in-depth reviews of its minerals sourcing for conflict minerals, it should consider implementing on-going, standardized conflict minerals compliance policies across its relevant business units. SEC guidance indicates that the OECD due diligence guidelines may provide an effective best-practices framework for due diligence at the Reporting Company level, thus suppliers would likely be well served by similarly implementing and maintaining OECD-compliant supply chain due diligence systems.
Suppliers also need to consider the conflict minerals disclosure regime's potential impact on confidentiality issues. Existing commercial arrangements with customers and upstream suppliers often involve sensitive data-sharing arrangements that may be compromised through conflict minerals disclosures. Suppliers should consider reviewing their agreements with customers and upstream suppliers to assess whether additional steps should be taken to protect commercial or price-sensitive information, which may include supplier identity.
All Reporting Companies must comply with the Rule for the year beginning 1 January 2013 and initial Form SD filings are due by 31 May 2014. In preparation for compliance with the Rule, suppliers may soon begin to receive requests for information to assist their customers prepare for handling what they will likely perceive to be a heavy additional regulatory obligation.
1 The Rule applies where the Reporting Company files reports with the SEC under Section 13(a) or 15(d) of the U.S. Securities Exchange Act of 1934, as amended (the "Exchange Act").
2 For a detailed summary of the rule with a discussion of how the Rule will impact Reporting Companies and issuers of registered securities, see Mayer Brown LLP's legal update entitled "US Securities and Exchange Commission Adopts Final Conflict Minerals Disclosure Rule" dated 5 September 2012. The targeted sources are sources determined by the U.S. Secretary of State as financing conflict in the Covered Countries.
3 As Form SD will be required to be filed and not furnished, a Reporting Company will be subject to liability for false or misleading statements under Section 18 of the Exchange Act unless it can establish that it acted in good faith and had no knowledge that the statement was false or misleading.
4 See, e.g., OECD (2011), OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas, OECD Publishing.
Originally published 27 November 2012
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