After multiple delays and extensions, the SEC appears poised to issue final rules implementing Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), which requires the SEC to establish new disclosure rules regarding companies’ uses of “conflict minerals” from the Democratic Republic of the Congo (the “DRC”) and adjoining countries (Angola, Burundi, Central African Republic, Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia). This bipartisan addition to the Dodd-Frank Act represents an attempt by Congress to create public pressure on corporate practice(s) at companies that use minerals derived from this region. Congress believes “the exploitation and trade of conflict minerals originating in [the DRC and adjoining countries] is helping to finance conflict characterized by extreme levels of violence…, particularly sexual- and gender-based violence, and contributing to an emergency humanitarian situation therein.”
The Dodd-Frank Act required the SEC to adopt rules relating to conflict minerals by April 2011. The SEC issued a proposed rule in December 2010 and comments on this proposal were originally due by January 31, 2011. In response to the large number of comments received, the SEC extended the public comment period until March 2, 2011. Then the SEC announced that it would miss the statutory deadline of April 15, 2011, and many expected final rules to be issued in late 2011. Now, based on comments from SEC Chairman Mary Schapiro during a March 6, 2012 congressional budgeting hearing, final rules are expected in “the middle of” 2012. Chairman Schapiro cited the complexity and extraordinary nature of the rule as a reason for the delay.
Overview of the SEC’s Proposed Rules
What is a Conflict Mineral?The proposed rules define 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 DRC countries:
- 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.
- Gold – Gold is used in electronic, communications and aerospace equipment.
- Wolframite – Tungsten is derived from wolframite and used in metal wires, electrodes and electronic, electrical, heating and welding applications.
In its proposed rule, the SEC estimated that the DRC and adjoining countries account for approximately 15-20% of the world’s tantalum and a smaller percentage of the other three conflict minerals.
Which Companies are Affected?
Industries that use tin, tantalum, tungsten or gold include the electronics, communication, medical devices, lighting, aerospace, manufacturing and automotive industries. When offering the proposed rules for comment, the SEC acknowledged that, based on the many uses of these minerals, many companies and industries would be subject to these new disclosure requirements.
A company will be impacted by the SEC’s rules relating to conflict minerals if (i) the company files reports with the SEC under the Securities Exchange Act of 1934, as amended, and (ii) conflict minerals are “necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company. An issuer would be considered to be “contracting to manufacture” a product if: (i) it has any influence over the product’s manufacturing, or (ii) it has contracted to have the product manufactured specifically for itself regardless of whether the issuer has any influence over the manufacturing specifications of the product.
The proposed rules will not apply to “pure retailers,” or companies that only sell products manufactured by others and have no influence over the products’ manufacturing or specifications. In addition, even if a conflict mineral is not found in the company’s final product, the provisions of this rule may still apply if the mineral is necessary to the manufacturing process. However, the provisions of the proposed rule do not apply if the only use of a conflict mineral is in a machine or tool is used as part of the production process, even if that tool or machine is “necessary” to the process.
What Steps Does a Reporting Company Have to Take to Determine if Disclosure is Required?The proposed rules have a three-step process for determining a company’s disclosure obligations which will not only create costs for issuers, but also 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 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.
- Step #2: Inquire whether the conflict minerals used by the company are sourced from the DRC or adjoining countries. A company for whom conflict minerals are necessary (per the above) must conduct a reasonable country of origin inquiry to determine its conflict minerals did not originate in the DRC or adjoining countries. If a company concludes the conflict minerals it uses did not originate in the DRC or adjoining countries, it will disclose this conclusion in new Item 4(a) of its Annual Report on Form 10-K (or Item 16(a) of its Annual Report on Form 20-F) under the heading “Conflict Minerals Disclosure” along with a brief description of the inquiry the company conducted to make this conclusion. A company must also publish this conclusion on its website and include a reference to the website address within this disclosure in its Annual Report. If a company uses conflict minerals that originated in the DRC or adjoining countries, or is unable to conclude that its conflict minerals did not originate in the DRC or an adjoining country, the company must prepare a Conflict Minerals Report.
- Step #3: Prepare a Conflict Minerals Report. A company must include in its Conflict Minerals Report: (i) a description of the due diligence efforts undertaken in connection with its country of origin inquiry; (ii) specifics of the independent private sector audit performed on the supply chain and source; and (iii) a description of the products and facilities where conflict minerals may have been used. No specific standards for due diligence were included in the proposed rule, but the SEC referenced the standards set by the Organization for Economic Cooperation and Development (“OECD”). The Conflict Minerals Report will be posted to such company’s website and included as an exhibit to a company’s Annual Report, although it is uncertain whether or not the report will be “furnished” or “filed” with the SEC.
- No De Minimis Exception: Given the wide variety of uses of the minerals in question, some manufacturers have requested that the SEC establish a de minimis quantity for which reporting is not required. However, Ms. Schapiro stated that “I don't believe a de minimis exception is possible under the statute.”
- Length of the Phase-in Period: In light of the time and effort associated with identifying all minerals used not only in a company’s products, but also those used in the production process or by third-party contract manufacturers, companies want the final rules to contain a reasonable phase-in period during which they can scope the issue and establish the required supply chain audit programs and reports. With respect to a phase-in period, Ms. Schapiro stated, “We will have a phase-in period, I don’t know how long, that will... give sufficient time for some of the supply chain due diligence mechanisms to be developed and put in place.”
- Failed but Good Faith Effort to Trace: In February 2012, Senator Patrick Leahy (D-VT) and other co-sponsors of the conflict minerals provision sent a letter to the SEC arguing that the final rule should not allow companies to state that their due diligence findings were “indeterminate.” However, manufacturers’ global supply chains are often very complex and there can often be little to no transparency beyond those suppliers with which a company has direct contact. In addition, parts and components are often sourced from different suppliers and different countries. Ms. Schapiro acknowledged these difficulties in her comments to Congress, noting that the rules will contain “latitude and flexibility in some areas” to try to address these issues. However, it is unclear what the SEC will do to address these realities and what the consequences will be of a failed, but good faith, effort by manufacturers in tracing conflict minerals.
- Exemption for Recycled or Reclaimed Minerals: Companies have argued that Congress was attempting to reduce the amount of minerals mined in the DRC and adjoining countries, so a rule that exempted companies from using recycled or reclaimed minerals (which would not require any additional mining) would be consistent with this goal. Furthermore, companies have argued that they would have virtually no way of tracking the original source of the minerals used in the metals collected from diverse collections of scrap dealers and consolidators.
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In anticipation of the final rules, companies should determine if “conflict minerals are necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company, and, if so, evaluate the level of such use, consider the difficulties of sourcing the minerals and begin formulating a strategic response. For example, companies may consider revising supply or manufacturing contracts to require tracing data on the conflict minerals used in the production of their products.We will issue an additional alert upon issuance by the SEC of final rules. Please contact your Goodwin Procter LLP attorney or any of the attorney contacts listed here with questions or concerns.