On August 22, 2012, the U.S. Securities and Exchange Commission (“SEC”) issued a final rule (the “Final Rule”) implementing Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). Section 1502 requires the SEC to establish new disclosure requirements for companies that manufacture products containing “conflict minerals” from the Democratic Republic of the Congo and adjoining countries: Angola, Burundi, Central African Republic, Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia (collectively, the “Covered Countries”). The Final Rule was implemented by a 3-to-2 vote after a long and comprehensive comment period and public debate. The goal of the new disclosure rules, as articulated by Congress, is to increase public pressure on companies to cease using minerals that are helping to finance conflict and accompanying human rights abuses in this region of the world.
A company will be directly impacted by the Final Rule if (i) the company files reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and (ii) conflict minerals are “necessary to the functionality or production” of a product that the company manufactures or contracts to manufacture. If a company determines that it is subject to the new disclosure rules, it is required to submit a certified Conflict Minerals Report to the SEC on a new Form SD that includes, among other things, a description of the due diligence measures the company has taken to determine the source and chain of custody of the conflict minerals. If a company determines that its products do not contain conflict minerals, then there are no new disclosure obligations as a result of the Final Rule.
Overview of the SEC’s Final Rule[i]
What is a Conflict Mineral?
The Final Rule defines the term “conflict mineral,” without regard to its country of origin, as the following minerals, any derivatives thereof and any other minerals or derivatives determined by the U.S. Secretary of State to be financing conflict in the Covered Countries[ii]:
- Gold – Gold is used in electronic, communications and aerospace equipment.
- Cassiterite – Tin is derived from cassiterite and used in tin plating and as a solder for joining pipes and producing many electronic circuits.
- Columbite-tantalite (commonly referred to as coltan) – Tantalum is derived from coltan and used in many electronic components, including cell phones, computers and cameras.
- Wolframite – Tungsten is derived from wolframite and used in metal wires, electrodes and electronic, electrical, heating and welding applications.
Industries that use tin, tantalum, tungsten or gold include the electronics, communication, medical devices, lighting, aerospace, manufacturing and automotive industries. In the Preamble to the Final Rule, the SEC acknowledges that, based on the many uses of these minerals, many companies and industries will be subject to these new disclosure requirements.
What Operations Trigger the Rule?
A company will be directly impacted by the Final Rule if (i) the company files reports with the SEC under Section 13(a) or 15(d) of the Exchange Act, including domestic issuers, foreign private issuers (such as Canadian issuers that file reports with the SEC under the U.S.-Canada Multijurisdictional Disclosure System (“MJDS”)) and smaller reporting companies, and (ii) conflict minerals are “necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company. Whether an issuer is considered to be “contracting to manufacture” a product will depend on the degree of influence it exercises over the materials, parts, ingredients, or components to be included in any product that contains conflict minerals or their derivatives. This must be decided on a case-by-case basis, based on each issuer’s individual facts and circumstances.
Based on comments received on the proposed conflict minerals rule, the SEC concluded that an issuer should not be viewed as contracting to manufacture a product if its actions involve no more than:
- in general, specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product, such as training or technical support, price, insurance, indemnity, intellectual property rights, dispute resolution, or other like terms or conditions concerning 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.
The SEC does not consider an issuer that mines or contracts to mine conflict minerals to be manufacturing or contracting to manufacture those minerals unless the issuer also engages in manufacturing in addition to mining. The Final Rule is unclear on whether downstream mineral processing activities such as smelting or refining would constitute “manufacturing” under the rule. Moreover, even though a company that merely mines conflict minerals is not directly subject to the rule, it is very likely that the mining company’s customers, and the customers of its customers, will need to obtain information from the mining company in order to satisfy their reporting obligations under the rule. As such, mining companies that extract or utilize conflict minerals will incur new costs in connection with the Final Rule.
What Steps Does an Issuer Have to Take to Determine if Disclosure is Required?
The Final Rule creates a three-step process for determining an issuer’s disclosure obligations. This process will not only create costs for issuers, but also for all of the companies in its supply chain that will need to do their own diligence work in order to report back to the issuers.
Step #1: Determine whether the company is required to make any conflict minerals disclosure.
A company that files reports with the SEC under Section 13(a) or Section 15(d) of the Exchange Act must first determine if “conflict minerals are necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company. If this is not the case, a company is not required to take any action, make any disclosures or submit any reports.
In determining whether a conflict mineral is “necessary to the functionality of a product,” an issuer should consider (1) whether the conflict mineral is intentionally added to the product or any component of the product and is not a naturally occurring by-product; (2) whether the conflict mineral is necessary to the product’s generally expected function, use, or purpose; and (3) if the conflict mineral is incorporated for purposes of ornamentation, decoration, or embellishment, whether the primary purpose of the product is ornamentation or decoration.
In determining whether a conflict mineral is “necessary to the production” of a product, an issuer should consider whether (1) 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, hand tools or power lines that are used in connection with the production of a product); (2) the conflict mineral is included in the product; and (3) the conflict mineral was necessary to produce the product. The SEC does not consider a conflict mineral to be “necessary to the production” of a product if the conflict mineral is used as a catalyst or in a similar manner, or is necessary to produce the product but is not contained in the product.
Step #2: Determine whether the conflict minerals used by the company originated in the Covered Countries.
If conflict minerals are determined to be necessary to the functionality or production of a product manufactured by a reporting company, the Final Rule requires the issuer to disclose on Form SD whether those conflict minerals originated in the Covered Countries. To make this disclosure, the issuer must conduct a “reasonable country of origin inquiry” in good faith to determine whether any of its conflict minerals originated in the Covered Countries or if the minerals are from scrap or recycled sources. The results of this inquiry will determine the substance and scope of the Form SD disclosure.
a) Form SD Disclosure: No Due Diligence Exercise and No Conflict Minerals Report
If a company concludes:
- the conflict minerals it uses did not originate in the Covered Countries;
- the conflict minerals it uses came from recycled or scrap sources; or
- the company has no reason to believe that the minerals may have originated in the Covered Countries,
then it is not required to exercise due diligence on its conflict minerals’ source or chain of custody or to file a Conflict Minerals Report with its Form SD. However, the company must still file a Form SD disclosing its determination and summarizing its inquiry and the results of that inquiry. The company must also disclose this information on its public website and provide a link to this website on the Form SD.
b) Form SD Disclosure: Due Diligence Exercise and No Conflict Minerals Report
If a company concludes:
- that the conflict minerals it uses originated in the Covered Countries and did not come from recycled or scrap sources;
- that it has reason to believe that the conflict minerals it uses originated in the Covered Countries and may not come from recycled or scrap sources; or
- can not determine the source of the conflict minerals it uses,
then the company must undertake further due diligence on the source and chain of custody of the conflict minerals.
In these circumstances, the Final Rule requires the company to follow the due diligence efforts established by a nationally or internationally recognized due diligence framework. The SEC Release notes that the OECD’s “Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High Risk Areas” satisfies this criteria.
If, as a result of that due diligence effort, the company determines that its conflict minerals did not originate from the Covered Countries or that its conflict minerals did come from recycled or scrap sources, no Conflict Minerals Report is required, but the company is required to disclose in its Form SD its determination and describe the due diligence efforts it undertook.
c) Form SD Disclosure: Due Diligence Exercise and Conflict Minerals Report
If, as a result of the due diligence effort described above, the company determines that its conflict minerals did originate in Covered Countries and did not come from recycled or scrap sources, the company is required to include a Conflict Minerals Report with its Form SD. The contents of that report are detailed below under “Step #3.”
Step #3: Prepare a Conflict Minerals Report.
A company that determines that it uses, or has reason to believe that it uses, conflict minerals that originated in the Covered Countries must prepare a Conflict Minerals Report and commission an independent private sector audit to be performed on its supply chain and sources. The Conflict Minerals Report must include: (i) a description of the due diligence efforts undertaken in connection with its country of origin inquiry; (ii) the results of the independent private sector audit performed on the supply chain and sources; and (iii) a description of the products and facilities where conflict minerals may have been used.
Is there a Transition Period for the Final Rule?
For most of the provisions of the Final Rule there are no transition periods. However, the Final Rule does state that for a temporary two-year period (or four-year period for smaller reporting companies), if the company is unable to determine whether the minerals in its products originated in the Covered Countries, then those products are considered “DRC conflict undeterminable.” In such a case, the company still must prepare a Conflict Minerals Report, but the requirements for such report differ slightly.
Specifically, where the products are deemed “DRC conflict undeterminable,” the Conflict Minerals Report must disclose: (i) its products manufactured or contracted to be manufactured that are “DRC conflict undeterminable”; (ii) the facilities used to process the conflict minerals in those products, if known; (iii) the country of origin of the conflict minerals in those products, if known; (iv) the efforts to determine the mine or location of origin with the greatest possible specificity; and (v) the steps it 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 necessary conflict minerals benefit armed groups, including any steps to improve due diligence. For those products that are “DRC conflict undeterminable,” the company is not required to obtain an independent private sector audit of the Conflict Minerals Report.
How are Recycled or Scrap Minerals Treated Under the Final Rule?
The Final Rule includes special provisions governing due diligence and conflict minerals reporting for minerals derived from recycled or scrap sources. If a company’s conflict minerals are derived from recycled or scrap sources rather than from mined sources, the company’s products containing such minerals are considered “DRC conflict free” and, as such, no Conflict Minerals Report need be prepared. Instead, disclosure need be made only in accordance with the provisions, discussed above, dealing with conflict minerals that have been determined, based upon the country of origin good faith inquiry, to not have originated in the Covered Countries.
What Period is Covered by the Rule and When Does the Final Rule Take Effect?
The Final Rule requires all issuers to report conflict minerals information on a calendar year basis regardless of its fiscal year end. Conflict mineral disclosure is required every year on Form SD for the period beginning on January 1st and ending on December 31st. This eases the burdens of companies in the supply chain and provides additional time after the deadline for filing the issuer’s Annual Report on Form 10-K for such issuer to gather, report on, and have audited their conflict minerals information. Issuers must comply with the Final Rule for the calendar year beginning January 1, 2013, with the first reports due May 31, 2014. Disclosure is required for any calendar year in which the manufacture of a product that contains any conflict minerals is completed. Therefore, any issuer that completes the manufacture of a product containing conflict minerals between January 1, 2013 and December 31, 2013 must file a Form SD before May 31, 2014. If the completion of such product happens on or before December 31, 2012 (and no further such products are manufactured), no disclosure is required.
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In light of the Final Rule, all companies that file reports under Section 13(a) or 15(d) of the Exchange Act (including foreign and private issuers) must now determine whether conflict minerals are necessary to the functionality or production of any product manufactured or contracted to be manufactured by them and, if so, take the steps outlined above. Companies should begin analyzing the components of their products and, if necessary, setting up protocols to determine whether any conflict minerals contained in them derive or could derive from the Covered Countries. This will include contacting suppliers. Companies should also seriously consider, going forward, making such inquiries as part of the contracting process with suppliers, and including in such contracts warranties or at least statements from suppliers that they have conducted a due diligence inquiry and no conflict minerals contained in the product to be supplied derive from the Covered Countries.
Suppliers, in turn, even if they do not manufacture products, need to engage in similar inquiries to determine whether any minerals in products that they supply derive from the Covered Country. Even if these suppliers do not themselves manufacture a product or contract to manufacture a product containing conflict minerals, there is little doubt that the companies to which they supply will be seeking information from them with respect to the origins of the minerals contained in any supplied product.