On August 22, 2012, the U.S. Securities and Exchange Commission ("SEC") adopted a final rule requiring SEC reporting companies to disclose annually whether any "conflict minerals" necessary to the functionality or production of their manufactured products originated in the Democratic Republic of Congo ("DRC") or an adjoining country (together with the DRC, the "Covered Countries").

The term "conflict mineral" is defined to mean columbite-tantalite (colton), cassiterite, gold, wolframite, and their derivatives (which currently are limited to tantalum, tin and tungsten, often referred to as the "3Ts").1 Because these minerals are widely used in many industries, including jewelry, health care devices, automotive and aerospace components, electronics, lighting and heating products, communications equipment and industrial manufacturing, the rule will have a very broad application.

As stated in Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), the origin of this rule lies in Congress' concerns regarding the exploitation and trade of conflict minerals originating in the DRC and adjoining countries. To further the humanitarian goal of ending the violent conflict in the region, which has been partially financed by the exploitation and trade of conflict minerals, Congress "chose to use the securities laws disclosure requirements to bring greater public awareness of the source of the issuers' conflict minerals and to promote the exercise of due diligence on conflict minerals supply chains."2

The rule was adopted by a 3-2 vote following extensive public comment and deliberations on a proposed rule published in December 2010. The rule imposes potentially burdensome diligence and disclosure obligations on all domestic and foreign issuers required to file reports under the Securities Exchange Act of 1934, as amended (the "1934 Act"), including Canadian reporting companies that file reports under the U.S. Multijurisdictional Disclosure System (MJDS). The first reporting period under the rule for all issuers will be from January 1, 2013 through December 31, 2013, and the first specialized disclosure report must be filed with the SEC on or before May 31, 2014. Issuers subject to the rule must also make their disclosures publicly available on their Internet websites.

Overview of the Process: How the Rule Works

As a first step, an issuer must determine whether it is subject to Section 1502 of Dodd- Frank (new Section 13(p) of 1934 Act) and the conflict minerals rule. The rule applies only to issuers that file reports under the 1934 Act3 whose conflict minerals are necessary to the functionality or production of a product manufactured by that issuer or contracted by that issuer to be manufactured.4 Issuers not meeting these criteria are not required to take any action, make any disclosures, or submit any reports under the final rule.

The rule does not define "manufacture," relying instead on the generally understood meaning of that word.5 Whether an issuer "contracts to manufacture" a product will depend on the degree of influence exercised by the issuer on the manufacture of the product based on the individual facts and circumstances in each instance. Some actual influence over the materials, parts, ingredients or components of the product is required, but the rule does not specify a particular degree of influence. Mining activity, in and of itself, does not constitute "manufacturing" for the purposes of the rule.

The final rule does not define when a conflict mineral is "necessary to the functionality or production" of a product, and that determination will depend on the issuer's particular facts and circumstances. The adopting release provides guidance with respect to making the determination. First, the product must contain a conflict mineral, i.e., conflict minerals that are catalysts or otherwise used in the production of a product but are completely washed away are not subject to the rule (but will be if any amount of the mineral remains). Second, the conflict mineral must be intentionally added to the product or a component of the product (rather than being a naturally occurring by-product) or intentionally added in the product's production process. Third, the conflict mineral must be necessary to either the product's generally expected function, use or purpose (or at least one of these if there are multiple functions, uses or purposes) or necessary to produce the product. If the primary purpose of the product is mainly ornamentation or decoration (e.g., jewellery), it is more likely that conflict minerals added for ornamentation or decorative purposes is "necessary to the functionality" of the product whereas conflict minerals having an ancillary purpose strictly for decoration that is unrelated to the functionality of the product would not.

As a second step, issuers covered by the rule are required to perform a "reasonable country of origin" inquiry regarding the origin of their conflict minerals. The inquiry must be performed in good faith and must be reasonably designed to determine whether any conflict minerals originated in the Covered Countries or are from recycled or scrap sources. Based on this inquiry, if an issuer (a) determines that its necessary conflict minerals did not originate in the Covered Countries or did come from scrap or recycled sources, or (b) has no reason to believe that its necessary conflict minerals may have originated in the Covered Countries or reasonably believes that its necessary conflict minerals did come from scrap or recycled sources, then the issuer must file with the SEC a specialized disclosure report on Form SD that discloses that determination with a brief description of the inquiry it undertook in making its determination and the results of that inquiry. This information must also be disclosed on the issuer's public website.6

An issuer that either (a) knows that its conflict minerals originated in the Covered Countries and did not come from recycled or scrap sources, or (b) has reason to believe that its conflict minerals may have originated in the Covered Countries and may not have come from scrap or recycled sources, must proceed to the third step. Under the third step, the issuer must perform due diligence on the source and chain of custody of its conflict minerals following a nationally or internationally recognized framework (if such framework is available for the specific conflict mineral).7 If, however, in exercising its due diligence the issuer determines that the conflict materials are not from the Covered Countries or did come from scrap or recycled materials, then the issuer must file with the SEC a specialized disclosure report on Form SD that discloses that determination with a brief description of inquiry and due diligence it undertook in making its determination and the results of that inquiry and due diligence. This information must also be disclosed on the issuer's public website.

If as a result of its country of origin inquiry and/or in exercising its due diligence the issuer knows or has reason to believe that the conflict materials are from the Covered Countries and did not or may not have come from scrap or recycled materials (or if it cannot determine the source of its conflict minerals), then the issuer must file with the SEC a specialized disclosure report on Form SD together with a report ("Conflict Minerals Report") as an exhibit to its specialized disclosure report on Form SD and make the Conflict Minerals Report publicly available on its website.8

The Conflicts Minerals Report must include a description of the due diligence measures undertaken by the issuer on the minerals' source and chain of custody. Except if undeterminable during the temporary transition period (discussed below), the Conflict Minerals Report must state whether, having conducted due diligence, the issuer determines that the products are either (i) "DRC Conflict Free," meaning that the products do not contain conflict minerals that directly or indirectly finance or benefit armed groups in the Covered Countries, or (ii) have not been found to be DRC Conflict Free. In either case, the issuer must obtain an independent private sector audit of its Conflict Minerals Report, as discussed below. If the issuer's products have not been found to be DRC Conflict Free, the Conflict Minerals Report must also describe the products that have not been found to be DRC Conflict Free, the facilities (i.e., the smelter or refinery) used to process the conflict minerals in those products, the country of origin of such minerals, and the issuer's efforts to determine the mine or originating location with the greatest possible specificity.

Independent Private Sector Audit of the Conflict Minerals Report

Where an issuer is required to file a Conflict Minerals Report, the issuer must (i) obtain an independent private sector audit of its Conflict Minerals Report, (ii) include a statement in its Conflict Minerals Report that it has obtained such an audit, (iii) include the audit report as part of its Conflict Minerals Report and (iv) identify the independent auditor if not identified in the audit report. The audit must be conducted according to standards established by the Comptroller General of the United States.9 The audit's objective is to express an opinion or conclusion as to whether the design of the issuer's due diligence measures, as set forth in the Conflict Minerals Report, is in conformity with, in all material respects, the criteria set forth in the due diligence framework used by the issuer, and whether the issuer's description of the due diligence measures it performed as set forth in the Conflict Minerals Report is consistent with the process actually undertaken by the issuer.

The Reporting Period and Timing of the Required Disclosure

Issuers must report their conflict minerals information on a new 1934 Act form, called a specialized disclosure report on Form SD, by May 31st of each year, reporting on the preceding calendar year.10 The final rule requires issuers to provide their Conflict Minerals Report, if any, as an exhibit to Form SD.11 Each issuer must provide its conflict minerals information on a calendar year basis covering January 1st through December 31st regardless of any particular issuer's fiscal year end. The first reporting period for all issuers will be January 1, 2013 through December 31, 2013, and the first specialized disclosure report must be filed on or before May 31, 2014.

An issuer must provide its required conflict minerals information for the calendar year in which the manufacture of a product that contains any necessary conflict minerals is completed, irrespective of whether the issuer manufactured the product itself or contracted to have the product manufactured.12 For example, if an issuer completes the manufacture of a product with necessary conflict minerals on December 30, 2018, the issuer must provide a specialized disclosure report regarding the conflict minerals in that product for the 2018 calendar year. However, if that issuer completes the manufacture of that same product on January 2, 2019, the issuer must provide a specialized disclosure report regarding the conflict minerals in that product for the 2019 calendar year.

An instruction to the final rule permits an issuer that acquires or otherwise obtains control over a company that manufactures or contracts to manufacture products with necessary conflict minerals that previously had not been obligated to file with the SEC a specialized disclosure report to delay the reporting period on the products manufactured by the acquired company until the end of the first reporting calendar year that begins no sooner than eight months after the effective date of the acquisition.

The final rule provides that Form SD, including the conflict minerals information provided therein and any Conflict Minerals Report attached as an as exhibit, will be "filed" (as opposed to "furnished") under the 1934 Act. Information filed under the 1934 Act is subject to potential liability under Section 18 of the 1934 Act for material misrepresentations or omissions. Section 18 does not, however, create strict liability for filed information, but rather provides a defense to persons acting in good faith with no knowledge that the statement was false or misleading. Finally, an issuer must make its conflict minerals disclosure or its Conflict Minerals Report available on the issuer's Internet website for one year. The issuer's Form SD and any Conflict Minerals Report included as an exhibit will be available on EDGAR indefinitely, so the information will continue to be widely available.

Temporary Transition Period

The SEC acknowledged in the final rule that there are legitimate concerns about the feasibility of preparing the required disclosure in the near term because of the stage of development of the supply chain tracing mechanisms. To address these concerns, rather than providing a general delay of effectiveness, the final rule includes a temporary transition period intended to help issuers address some of the burdens and costs of compliance. This transition period is two years for all issuers and four years for smaller reporting companies.13 During this transition period, an issuer may describe its products as "DRC Conflict Undeterminable" if the issuer is unable to determine that its minerals meet the statutory definition of DRC Conflict Free for either of the following two reasons:

  • the issuer proceeded to the third step based upon the conclusion, after its reasonable country of origin inquiry, that it had conflict minerals that originated in the Covered Countries and, after the exercise of due diligence, it is unable to determine if its conflict minerals financed or benefited armed groups in the Covered Countries; or
  • the issuer proceeded to the third step based upon the conclusion, after its reasonable country of origin inquiry, that it had a reason to believe that its necessary conflict minerals may have originated in the Covered Countries and may not have come from recycled or scrap sources and the information it gathered as a result of its subsequent exercise of due diligence failed to clarify the conflict minerals' originating country, whether the conflict minerals financed or benefited armed groups in the Covered Countries, or whether the conflict minerals came from recycled or scrap sources.

During the transition period an issuer with products that may be described as DRC Conflict Undeterminable is not required to have its Conflict Minerals Report audited, but its Conflict Minerals Report must include the following disclosure:

  • a description of the products manufactured or contracted to be manufactured that are DRC Conflict Undeterminable;
  • the facilities used to process the necessary conflict minerals in those products, if known;
  • the country of origin of such minerals, if known;
  • the efforts to determine the mine or location of origin with the greatest possible specificity; and
  • the steps it has taken or will take, if any, since the end of the period covered in the last Conflict Minerals Report to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve due diligence.

After the transition period, issuers that have proceeded to the third step but are unable to determine that their conflict minerals did not originate in the Covered Countries or are unable to determine that their conflict minerals that originated in the Covered Countries did not directly or indirectly finance or benefit armed groups must describe their products containing those conflict minerals as not having been found to be DRC Conflict Free and provide the additional disclosure required under the rule with respect to the conflict materials in those products.

Recycled or Scrap Conflict Minerals

In light of the difficulty in determining the origin of conflict minerals in scrap or recycled material, and to avoid discouraging the use of conflict minerals from such sources, the final rule provides alternative treatment for conflict minerals from recycled and scrap sources. Because the use of conflict minerals from recycled or scrap sources will not directly or indirectly finance or benefit armed groups in the Covered Countries, the final rule treats products with conflict minerals from recycled or scrap sources as DRC Conflict Free. Therefore, with respect to conflict minerals from recycled or scrap sources the rule does not require any disclosure regarding the processing facilities, countries of origin, or efforts to determine the mine or location of origin. Under the final rule, conflict minerals are considered to be from recycled or scrap sources if they are from recycled metals, which are reclaimed end-user or post-consumer products, or scrap processed metals created during product manufacturing. Also, consistent with the OECD definition, the final rule provides that recycled metal includes excess, obsolete, defective, and scrap metal materials that contain refined or processed metals that are appropriate to recycle in the production of tin, tantalum, tungsten and/or gold. However, minerals partially processed, unprocessed, or a by-product from another ore are not included in the definition of recycled metal.

If, after conducting its reasonable country of origin inquiry, an issuer has reason to believe that its conflict minerals may not have been from recycled or scrap sources, then it must conduct due diligence that conforms to a nationally or internationally recognized due diligence framework (if such a framework is available). The issuer would then be required to provide a Conflict Minerals Report if it is unable to determine that the conflict minerals came from recycled or scrap sources.

Presently, it appears that the OECD's supplement for gold is the only nationally or internationally recognized due diligence framework for any conflict mineral from recycled or scrap sources. Until one or more such frameworks are developed for the other conflict minerals, issuers will have to exercise due diligence for recycled and scrap sources without the benefit of a due diligence framework, and until such time (in contrast to a Conflict Minerals Report pertaining to gold from scrap or recycled sources for which an independent private sector audit is required) an independent private sector audit will not be required for the section of the Conflict Minerals Report pertaining to the issuers' due diligence on those other conflict minerals from recycled or scrap sources.

Footnotes

1 The Secretary of State may determine that additional derivatives from these minerals are financing conflict in the Covered Countries, in which case they, as well as any other minerals or their derivatives determined by the Secretary of State to be financing conflict in the Covered Countries, will also be considered "conflict minerals."

2 SEC Release No 34-67716, page 8.

3 An issuer with a class of securities exempt from the 1934 Act registration pursuant to Rule 12g3-2(b) is not subject to the rule.

4 The final rule does not include a de minimis exception. As explained by the SEC in its adopting release, Section 1502 of Dodd Frank provides that a conflict mineral must be "necessary to the functionality or production" of an issuer's product to trigger any disclosure regarding that conflict mineral. This standard focuses on whether the conflict mineral is "necessary" to a product's functionality or production; it does not focus on the amount of a conflict mineral contained in the product. The SEC believes that Congress understood, in selecting the standard it did, that a conflict mineral used in even a very small amount could be "necessary" to the product's functionality or production. Had Congress intended that the provision be limited further so as not to apply to a de minimis use of conflict minerals, Congress would have done so explicitly.

5 The SEC does not consider an issuer that only services, maintains or repairs a product containing conflict minerals to be "manufacturing" a product.

6 The issuer must provide a link to that website under a separate heading in its specialized disclosure report entitled "Conflict Minerals Disclosure."

7 Presently, it appears that the only nationally or internationally recognized due diligence framework available is the due diligence guidance approved by the Organization for Economic Co-operation and Development ("OECD").

8 Under a separate heading in its specialized disclosure report entitled "Conflicts Minerals Disclosure," the issuer must disclose that it has filed a Conflicts Minerals Report and provide a link to its website where the Conflict Minerals Report is publicly available.

9 Under Section 1502 of Dodd-Frank, the U.S. General Accounting Office ("GAO"), which is headed by the Comptroller General, is to establish the standards for the audit. The staff of the GAO has advised the SEC that existing U.S. Government Auditing Standards (GAGAS) will apply to the conflict minerals audit.

10 In response to commentators' concerns, the report is due later than the 1934 Act annual reports for calendar yearend issuers so as not to interfere with such issuers' preparation of their annual reports.

11 Providing the Conflict Minerals Report as an exhibit to the specialized disclosure report will enable anyone accessing the EDGAR system to determine quickly whether an issuer provided a Conflict Minerals Report with its specialized disclosure report.

12 No information is required to be provided for any conflict minerals that are "outside the supply chain" prior to January 31, 2013. The final rule considers conflict minerals to be "outside the supply chain" only in the following instances: after any columbite-tantalite, cassiterite, and wolframite minerals, or their derivatives, have been smelted; after gold has been fully refined; or after any conflict mineral, or its derivatives, that have not been smelted or fully refined are located outside of the Covered Countries. Therefore, the final rule exempts any conflict minerals that prior to January 31, 2013 have been smelted or fully refined or were outside of the Covered Countries.

13 "Smaller reporting company" (in general terms) means an issuer having a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter, as determined in accordance with Rule 12b-2 under the 1934 Act.

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.