United States: SEC Adopts Final Conflict Mineral Rules

Last Updated: September 19 2012
Article by Troy M. Calkins and Peter B. Wolf

The Securities and Exchange Commission (the Commission), on August 22, 2012, adopted a final rule implementing disclosure requirements for reporting issuers that use "conflict minerals" originating in the Democratic Republic of the Congo or its adjoining countries (Covered Countries).

Under newly adopted Rule 13p-1, an issuer that determines conflict minerals are "necessary to the functionality or production of a product manufactured" by the issuer will be required to file a specialized disclosure report on new Form SD. The Commission's adopting release can be found at http://www.sec.gov/rules/final/2012/34-67716.pdf.

All issuers required to file Form SD under the final rule must do so on a calendar-year basis by May 31 of the following year. The first report, covering calendar year 2013, must be filed by May 31, 2014. In a change from the proposed rule, the specialized disclosure report and, if required, the Conflict Minerals Report must be "filed" -- not "furnished" -- under the Securities Exchange Act of 1934 (the Exchange Act) and are thereby subject to potential Section 18 liability.

Issuers should not underestimate the scope of this undertaking. In its adopting release, the Commission estimates that the initial aggregate cost that will be incurred by all affected issuers in complying with Rule 13p-1 and Form SD will be approximately $3 to $4 billion, with annual compliance costs thereafter aggregating between $207 and $609 million.

Conflict minerals are defined in newly adopted Form SD as:

  • cassiterite, the ore from which tin is extracted;
  • columbite-tantalite, the ore from which tantalum is extracted;
  • gold;
  • wolframite, the ore from which tungsten is extracted;
  • their derivatives, which are limited to tantalum, tin and tungsten under Form SD (known as the 3Ts);
  • and any additional derivatives or other minerals and their derivatives determined by the Secretary of State to be financing conflict in the Covered Countries.

These minerals are commonly used in the production of countless products, including jewelry, cell phones, computers, video game consoles, digital cameras, solder and metal wires. The Commission estimates that close to 6,000 issuers will be affected by the disclosure requirements in the final rule.

The final rule was adopted pursuant to Section 1502 (the Conflict Minerals Statutory Provision) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). For more information on Section 1502 of the Dodd-Frank Act, please refer to our January 2011 Securities Alert regarding the proposed conflict mineral rules, which can be found at http://www.drinkerbiddle.com/resources/publications/2011/sec-proposes-conflict-minerals-disclosure-rules.

Overview of the Final Rule

In the final rule, the Commission chose to preserve the three-step disclosure analysis that it originally proposed:

  • First, the issuer is required to determine whether it is subject to the Conflict Minerals Statutory Provision as a person for whom "conflict minerals are necessary to the functionality or production of a product manufactured by the person;"
  • Second, an issuer subject to the provision would be required to conduct a reasonable country of origin inquiry in order to determine whether its conflict minerals originated in the Covered Countries, and to disclose the results of the inquiry on Form SD;
  • Third, an issuer whose conflict minerals did originate in the Covered Countries and did not come from recycled or scrap sources, or who 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, must file a separate Conflict Minerals Report as an exhibit to Form SD. In addition to complying with certain auditing requirements that may apply, the issuer must provide a description of its products containing conflict minerals that the issuer was unable to determine did not "directly or indirectly finance or benefit armed groups" in the Covered Countries.

The Commission's adopting release included the following flowchart summarizing the steps:

Step 1—Determine If the Issuer is Covered by the Conflict Minerals Provision

Consistent with the proposed rule, the final rule only applies to issuers:

  • That file reports with the SEC under Sections 13(a) or 15(d) of the Exchange Act, including domestic companies, foreign private issuers and small reporting companies; and
  • For whom conflict minerals are "necessary to the functionality or production of a product manufactured or contracted by that [issuer] to be manufactured."

As in the proposed rule, the final rule does not define "manufacture" or "contract to manufacture," but the Commission did provide some additional guidance. The Commission believes the term "manufacture" is generally understood, but noted that it does not consider an issuer that only services, maintains, or repairs a product containing conflict minerals to be "manufacturing" a product. While the final rule does not define "contract to manufacture," the Commission did clarify that in order to be deemed to have "contracted to manufacture" an issuer must have "some actual influence over the manufacturing of their products." The Commission also clarified that the final rule extends to issuers that contract the manufacturing of components of their products. Further, the Commission stated that an issuer that takes the following actions, without more, is not "contracting to manufacture" products:

  • Specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product (such as training, price, insurance, indemnification, etc.), unless the issuer, by doing so, exercises a degree of influence over the manufacturing of the product;
  • Affixing its 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.

This is slightly more forgiving to retailers than the Commission's original rule proposal, which would have considered an issuer that sells "generic products under its own brand name or a separate brand name, regardless of whether it has any influence over the manufacturing specifications of the product," to be "contracting to manufacture."

Like the proposed rule, the final rule does not define "necessary to the functionality or production" of a product. The Commission did, however, slightly modify its guidance as to when a mineral would be considered "necessary." Whether a conflict mineral is "necessary to the functionality" of a product depends on an issuer's particular facts and circumstances, including whether the conflict mineral is:

  • Contained in and intentionally added to the product or any component of the product, as opposed to being a naturally occurring by-product;
  • Necessary to the product's function, use or purpose; and
  • Incorporated for decorative purposes, in a product whose primary purpose is decorative.

Whether a conflict mineral is "necessary to the production" of a product also depends on an issuer's particular facts and circumstances, including whether the conflict mineral is:

  • Necessary to produce the product; and
  • 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.

However, in order to be "necessary to the production" of a product, the conflict mineral must also be contained in the product. Thus, a conflict mineral used as a catalyst in the production process of a product is not "necessary to the production" of the product unless the conflict mineral is also contained in the product.

In the final rule, the Commission chose not to include a de minimis threshold -- if a conflict mineral is "necessary" in any amount, no matter how small, the rule applies.

The Commission did, however, create an exemption from Rule 13p-1 for any stockpiled conflict minerals that are "outside the supply chain" prior to January 31, 2013. Rule 13p-1 considers conflict minerals to be "outside the supply chain" only: after any columbite-tantalite, cassiterite and wolframite minerals have been smelted; after gold has been fully refined; or after any conflict mineral, or derivatives thereof, that have not been smelted or fully refined are located outside of the Covered Countries.

An issuer that is not covered -- either because it is not a reporting issuer or because it does not use conflict minerals in its manufacturing process -- would not need to take any further action, make any disclosure, or submit any reports under Rule 13p-1. On the other hand, an issuer that meets both conditions would move to the second step of the disclosure analysis.

Step 2—Conduct a Reasonable Country of Origin Inquiry and Disclose the Results

Under the final rule, and consistent with the proposed rule, if conflict minerals are necessary to the functionality or production of a reporting issuer's products, the issuer is required to conduct a reasonable country of origin inquiry to determine whether the conflict minerals originated in the Covered Countries or are from recycled or scrap sources. The final rule clarifies that in order to satisfy the reasonable country of origin inquiry requirement, an issuer must make a good faith country of origin inquiry that is "reasonably designed" to determine whether its conflict minerals originated in the Covered Countries or are from recycled or scrap sources, including taking into account any applicable warning signs or other circumstances indicating its conflict minerals may have originated in the Covered Countries or did not come from recycled or scrap sources. The Commission did reiterate its stance from the proposed rule that receiving reasonably reliable country of origin representations from the facility at which the conflict minerals were processed would satisfy the reasonable inquiry standard. These representations can come either directly from the facility or indirectly from an issuer's immediate suppliers, so long as those suppliers have a reason to believe these representations are true given the particular facts and circumstances.

Under the final rule, an issuer that concludes that, based on its reasonable country of origin inquiry, (i) its conflict minerals did not originate in the Covered Countries or are from recycled or scrap sources, or (ii) it has no reason to believe that its conflict minerals may have originated in the Covered Countries or it reasonably believes that its conflict minerals are from recycled or scrap sources, must:

  • Disclose this determination, and briefly describe the reasonable country of origin inquiry process it used in reaching this determination and the results of that inquiry on Form SD under a separate heading titled "Conflict Minerals Disclosure;"
  • Disclose this information on its publicly available website; and
  • Provide the Internet address of that website under the "Conflict Minerals Disclosure" heading on Form SD.

The issuer would not be required to exercise due diligence on the source or chain of custody of its conflict minerals or file a Conflict Minerals Report as an exhibit to Form SD. This is a more lenient standard than the proposed rule, which would have required an issuer to prove that its conflict minerals did not originate in the Covered Countries in order to avoid conducting due diligence on the chain of supply.

On the other hand, an issuer that concludes, based on its reasonable country of origin inquiry, (i) its conflict minerals did originate in the Covered Countries and did not come from recycled or scrap sources, or (ii) it 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, must:

  • Move on to "Step 3" and conduct due diligence on the source and chain of custody of its conflict minerals;
  • Disclose this conclusion on Form SD under a separate heading entitled "Conflict Minerals Disclosure" and note that the Conflict Minerals Report is furnished as an exhibit thereto;
  • File the Conflict Minerals Report as an exhibit to Form SD and make the report publicly available on its website; and
  • Provide the Internet address of that website under the "Conflict Minerals Disclosure" heading on Form SD.

Step 3—Supply Chain Due Diligence and Conflict Minerals Report's Content

As mentioned above, an issuer that determined (i) its conflict minerals did originate in the Covered Countries and did not come from recycled or scrap sources, or (ii) it 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, must conduct due diligence that conforms to a nationally or internationally recognized due diligence framework on the source and chain of custody of its conflict minerals to determine whether these minerals directly or indirectly finance or benefit armed groups in Covered Countries. Appropriate due diligence measures include those set forth in the due diligence guidance approved by the Organization for Economic Cooperation and Development (OECD).

The information that must be disclosed in the Conflict Minerals Report depends on the results of the issuer's due diligence.

"DRC Conflict Free"

Those products containing conflict minerals that do not directly or indirectly finance or benefit armed groups in Covered Countries are considered "DRC conflict free." An issuer that is able to determine, after exercising due diligence, that its products are "DRC conflict free" must do the following:

  • Provide a description of the due diligence exercised in the Conflict Minerals Report;
  • Obtain an independent private sector audit of the Conflict Minerals Report;
  • Include a certification by the issuer that it obtained such an audit;
  • Include the audit report prepared by the independent private sector auditor in the Conflict Minerals Report; and
  • Identify the auditor.

Not Found to Be "DRC Conflict Free"

In addition to the requirements listed above for "DRC conflict free" products, the Conflict Minerals Report for an issuer whose products have not been found to be "DRC conflict free" must describe:

  • Each product that is not "DRC conflict free;"
  • The facilities used to process those conflict minerals;
  • The country of origin of those conflict minerals; and
  • The efforts taken to determine the mine or location of the mineral's origin with the greatest possible specificity.

"DRC Conflict Undeterminable"

In the final rule, the Commission created a temporary status called "DRC conflict undeterminable" for issuers who are unable to determine whether any of their products are or are not "DRC conflict free." This status is available for a two-year period for most issuers (four years for smaller reporting companies). Under these circumstances, an issuer's Conflict Minerals Report must include the same information, to the extent known, as it would if the issuer concluded its products are not "DRC conflict free;" however, such an issuer is not required to obtain an independent private sector audit. Additionally, the issuer's Conflict Minerals Report must describe the steps the issuer has taken or will take, if any, since the end of the period covered in its last Conflict Minerals Report to mitigate the risk that its conflict minerals benefit armed groups, including steps to improve its due diligence.

Note on Recycled or Scrap Conflict Minerals

Consistent with the proposed rule, products using conflict minerals that an issuer obtains from "recycled or scrap" sources are considered "DRC conflict free." Unlike the proposed rule, which did not define "recycled or scrap," the final rule considers conflict minerals to be recycled or scrap if they are from "recycled metals, which are reclaimed end-user or post-consumer products, or scrap processed metals created during product manufacturing."

As described in "Step 3" above, an issuer that cannot reasonably conclude, based on its reasonable country of origin inquiry, that its conflict minerals come from recycled or scrap sources, must conduct due diligence on the source and chain of custody of its conflict minerals. For gold, the due diligence measures must be in accordance with the OECD's approved guidance for determining whether gold is recycled or scrap. Since there are no nationally or internationally recognized due diligence frameworks for determining whether the other conflict minerals are recycled or scrap, an issuer must describe the due diligence exercised in reaching the determination that the minerals were obtained from recycled or scrap sources on Form SD.

Acquired Companies

The instructions to Form SD provide relief for issuers acquiring companies that had not been required to file Form SD prior to acquisition. The acquired company's products will not need to be included in the acquiror's Form SD until the end of the first reporting year that begins not less than eight months following the completion of the acquisition.

Next Steps

Issuers must make their initial conflict minerals analysis and, if necessary, file their initial Form SD and Conflict Minerals Report for the 2013 calendar year by May 31, 2014. An issuer that fails to comply with final rules would not satisfy the Conflict Minerals Provision and would, therefore, be subject to liability for violations of Sections 13(a) or 15(d) of the Exchange Act. Therefore, a reporting issuer that manufactures or contracts to manufacture any products, including components, containing tin, tantalum, tungsten, or gold should begin preparing for their initial disclosure by:

  • Identifying the conflict minerals that are necessary to the functionality or production of the products made;
  • Evaluating the supply chains of those minerals to determine their origins;
  • Reviewing the available due diligence frameworks that have been published by national or international agencies for guidance on the elements of a "reasonable country of origin inquiry";
  • Formulating appropriate inquiries to be made to suppliers;
  • Assessing the terms of any supply contract to determine whether the contracts can be revised to (i) eliminate the purchase of conflict minerals from the Covered Countries, and (ii) require vendors to make representations with respect to the origins of all conflict minerals supplied; and
  • Considering whether a consultant should be retained to assist in the identification and due diligence process.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Troy M. Calkins
 
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