The Securities and Exchange Commission (SEC) recently proposed significant new reporting and supply-chain due diligence requirements relating to the use of so-called "conflict minerals." The new requirements are sweeping and, according to SEC estimates, would impact nearly 6,000 international trading companies, including manufacturers (and, in some cases, retailers) of technology, telecommunications, aerospace, automotive, electronics, industrial, jewelry and children's toy products, to name a few. The SEC's Notice of Proposed Rulemaking (NPRM) was published in the Federal Register on December 23, 2010, and the SEC has requested comments by January 31, 2011.
The proposed regulations would implement the "conflict minerals" reporting requirements directed by the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frankjg1 Act"), which the president signed into law on July 21, 2010. Section 1502 of the Dodd-Frank Act amends Section 13 of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78. New subsection (p) of Section 13, titled "Disclosures Relating to Conflict Minerals Originating in the Democratic Republic of Congo," is intended to limit trade in minerals originating from sources controlled by armed groups operating in the Democratic Republic of Congo (DRC) and adjoining countries and to decrease the violence funded by such trade.
SUMMARY OF THE NEW REQUIREMENTS
A few key aspects of the NPRM, discussed in greater detail below, are as follows:
Who and what is covered?
- The proposed reporting requirements would apply to any issuer of U.S. securities who is otherwise required to file a report with the SEC if "conflict minerals" are necessary to the functionality or production of a product that they manufacture or contract to be manufactured. Companies that are otherwise exempt from filing reports with the SEC or whose products do not contain conflict minerals would be exempt from the new reporting requirements.
- Conflict minerals are: columbite-tantalite (coltan), commonly used to produce tantalum; cassiterite, commonly used to produce tin; wolframite, commonly used to produce tungsten; and gold.
What is required?
- Covered issuers would be required to determine and disclose in their annual reports to the SEC and on their public Web sites whether their manufactured goods contain conflict minerals (or their derivatives) that originated in the DRC or adjoining countries.
- Issuers whose products include DRC or adjoining country conflict minerals would also be required to conduct "supply chain due diligence" in an effort to certify that their conflict minerals do not "directly or indirectly finance or benefit armed groups" in the DRC or adjoining countries.
- Any required supply chain due diligence efforts and conflict minerals certifications must be documented in a "Conflict Minerals Report" that must be accompanied by a certified private-sector audit.
- The reporting issuer would be required to submit the Conflict Minerals Report and the certified private-sector audit with its annual SEC filing and to post the report and audit on its public Web site.
- The Dodd-Frank Act requires the SEC to promulgate final regulations by April 2011. Initial disclosures and reports are due at the end of the first full fiscal year following the promulgation of final regulations, e.g., May 31, 2012 or December 31, 2012. This means that, for issuers with a May 31 fiscal year-end, activities beginning as soon as June 1, 2011 would be subject to the requirements of the NPRM.
- Issuers who fail to make the required disclosures or submit a required report would be subject to the full array of SEC reporting penalties, including injunctive, civil and criminal penalties, and may also extend to individual executives of the issuer.
CONFLICT MINERALS WILL COVER MANY INDUSTRIES
The Dodd-Frank Act defines "conflict minerals" as columbite-tantalite (coltan), cassiterite, wolframite and gold, and their derivatives, and empowers the U.S. secretary of state to designate other minerals or their derivatives as "conflict minerals." The NPRM describes each mineral, its common derivative and its uses as follows—
- Cassiterite is the metal ore that is most commonly used to produce tin, which is used in alloys, tin plating and solders for joining pipes and electronic circuits.
- Columbite-tantalite is the metal ore from which tantalum is extracted. Tantalum is used in electronic components, including mobile telephones, computers, videogame consoles, and digital cameras, and as an alloy for making carbide tools and jet engine components.
- Gold is used for making jewelry and, due to its superior electric conductivity and corrosion resistance, is also used in electronic, communications and aerospace equipment.
- Wolframite is the metal ore that is used to produce tungsten, which is used for metal wires, electrodes and contacts in lighting, electronic, electrical, heating and welding applications.1
THE NPRM BROADLY INTERPRETS THE DISCLOSURE REQUIREMENT AND ITS OPERATIVE TERMS
The SEC explains that it understands the Dodd-Frank Act's disclosure requirement to involve three steps.
- First, an entity must determine whether it is a "person described" within the meaning of the Act.
- Second, a "person described" must make "a reasonable country of origin inquiry" to determine whether it sources conflict minerals that are "necessary to the functionality or production" of one of its products from any of the covered countries.
- Third, a covered person that determines that its products include necessary conflict minerals from the DRC or adjoining countries or that is "unable to conclude that its conflict minerals did not originate" in the DRC or adjoining countries must include with its annual report a Conflict Minerals Report documenting the supply chain due diligence efforts of the reporting entity, as well as a certified, third-party audit of such efforts. The Conflict Minerals Report must be published on the company's public Web site.
The Dodd-Frank Act amends Section 13(p)(2)(A) and (B) of the Exchange Act to define a "person described" as one (a) that "is required to file reports under Section 13(p)(1)(A)," and (b) for which conflict minerals are "necessary to the functionality or production of a product manufactured by such person."
The definition of a "person described" appears to contain a drafting error, in that Section 13(p)(1)(A) does not contain a definition, but rather makes circular reference back to Section 13(p)(2). Part of the definition is, therefore, ambiguous. Several commentators urged the SEC to interpret the Dodd-Frank Act as applying to any person for whom conflict minerals are "necessary to the functionality or production of a product." The NPRM rejects such an expansive interpretation and proposes to limit the definition of "person described" to issuers of securities that are otherwise required to file annual or quarterly reports with the SEC pursuant to Sections 13(a) or 15(d) of the Exchange Act. This means that the majority of publicly traded U.S. companies as well as some foreign private issuers of securities would qualify as "persons described." However, companies that are exempt from the Section 13(a) and 15(d) reporting requirements are also exempt from the conflict minerals reporting requirements. The NPRM considers, but rejects, additional exclusions for smaller reporting companies (i.e., those worth less than $75 million) and non-exempt foreign private issuers.
The second part of the definition of "person described" is whether conflict minerals are "necessary to the functionality or production of a product manufactured by such person." The NPRM does not define "manufacture" or "necessary." It does, however, offer fairly expansive interpretations of each term.
The NPRM interprets "manufacture" to include any issuers that directly manufacture or that contract for the manufacture of products incorporating conflict minerals. The SEC notes that it intends to apply the Dodd-Frank Act to any issuer that has "any influence over the manufacturing specifications" of products that they contract to have manufactured. This interpretation would likely include pure retailers that contract for the manufacture of products containing conflict minerals. The proposed rules would also specifically include mining operations within the scope of the term "manufacture."
The SEC states that it will interpret "necessary" to mean "intentionally included in." The NPRM rejects an exclusion from the Act's requirements for de minimis amounts of the covered minerals and includes minerals used during the production of a product, but not actually present in the final product. The SEC does not consider "necessary" to include tools or machinery used during the production of a product. Also excluded are recycled or scrap materials.
Reasonable Country of Origin Inquiry
The SEC's proposed rules would require reporting issuers to make "a reasonable country of origin inquiry" regarding the origins of the covered minerals incorporated in their products. The NPRM does not further describe what actions the SEC will consider a reasonable inquiry. It does, however, state that reporting entities would be required to include in their annual reports, and to post on their Web sites, the steps taken, as well as to retain reviewable business records documenting the inquiry. Issuers who conclude that their products incorporate necessary conflict minerals that originate in the DRC or an adjoining country, or for which the country of origin is unknown, would be required to so disclose and to submit a Conflict Minerals Report.
The Conflict Minerals Report
The Conflict Minerals Report is the most burdensome requirement of the Act and the proposed regulations. The required elements of the Conflict Minerals Report under the proposed regulations are as follows—
- a description of all products that contain conflict minerals and either originate in the DRC or an adjoining country, or for which the origin is unclear
- a description of the measures taken to exercise due diligence with respect to the source and chain of custody of such minerals and a certification as to whether or not such minerals "directly or indirectly finance or benefit armed groups" in the DRC or adjoining countries, including a list of the facilities used to process those conflict minerals, the country of origin of those conflict minerals and the efforts to determine the mine or location of origin with the greatest possible specificity of those conflict minerals
- a certified private-sector audit concerning the above-referenced report.
Products incorporating covered minerals that a) originate in the DRC or an adjoining country, and b) "directly or indirectly finance or benefit armed groups" must be described as "not DRC conflict free" in the annual report. The Dodd-Frank Act defines the term "armed group" as "an armed group that is identified as perpetrators of serious human rights abuses in the annual Country Reports on Human Rights Practices under sections 116(d) and 502B(b) of the Foreign Assistance Act of 1961." The issuers that would be required to submit a report must also post the entire contents of the report, as well as the certified private-sector audit, on their companies' public Web sites.
SUPPLY CHAIN DUE DILIGENCE
As with other aspects of the Dodd-Frank Act's requirements, the SEC declines to define "due diligence" or to "prescribe any particular guidance for conducting due diligence." That notwithstanding, the regulations would require reporting issuers to describe their due diligence efforts. The SEC does indicate that due diligence conducted in conformity with a nationally or internationally recognized set of supply chain due diligence standards would likely "provide evidence that the issuer used due diligence in making its supply chain determinations." The NPRM makes specific note of draft due diligence guidance published by the Organization for Economic Co-operation and Development (OECD). Since the publication of the NPRM, OECD has issued a final version of its due diligence guidance.
The OECD guidance is structured around five tenets: (1) establishing strong company management systems, (2) identifying and assessing risk in the supply chain, (3) designing and implementing a strategy to respond to identified risks, (4) ensuring an independent third-party audit of due diligence practices and (5) publishing an annual report on supply chain due diligence. The guidance provides specific steps for ensuring compliance with each tenet.
Also of note is the fact that the guidance distinguishes between the roles and due diligence requirements of upstream and downstream companies, recognizing that precise verification of the supply chain of components containing conflict minerals may be difficult, if not impossible, for downstream companies. Accordingly, the guidance allows downstream companies, following a thorough review, to rely on the due diligence process of upstream smelters in their supply chain.
The Dodd-Frank Act does not set forth proposed penalties for failure to comply with the new reporting requirements. The NPRM, however, indicates that failure to comply with the new reporting requirements, including the submission of an "unreliable" report, would be subject to liability for violations of Sections 13(a) or 15(d) of the Exchange Act. Penalties for such violations may be injunctive, civil or criminal and may also extend to individual executives of the issuer.
Section 1502 of the Act mandates that, within 180 days of enactment, the secretary of state must submit to Congress a "strategy" that, inter alia, describes "punitive measures that could be taken against individuals or entities whose commercial activities are supporting armed groups and human rights violations in the Democratic Republic of the Congo." The NPRM does not propose penalties for the direct or indirect support of armed DRC or adjoining country groups.
1 79 Fed. Reg. 80,948, 80,950 (Dec. 23, 2010) (internal citations omitted).
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