SEC Adopts Conflict Minerals Rules

August 28, 2012

On Aug. 22, 2012, the SEC adopted, by a 3-2 vote of the Commissioners, the final form of its controversial Rules implementing Section 1502 of the Dodd-Frank Act, which aimed to reduce funding of armed groups in the Democratic Republic of the Congo (DRC) through their exploitation of the four Conflict Minerals — the ores used to produce tantalum, tin and tungsten, and gold.1 Those armed groups have engaged in years of extremely violent conflict in the eastern regions of the DRC that have created a humanitarian crisis. The Rules will apply to all SEC reporting companies (including foreign issuers and Smaller Reporting Companies) that manufacture or contract to manufacture products if any Conflict Mineral, even in a de minimis amount, is “necessary to the functionality or production” of a product, regardless of the source of the Conflict Mineral. Those companies will be required to file a new Form SD (for “specialized disclosure”) by the following May 31, for every calendar year starting with 2013, with specified information about their use of Conflict Minerals and their due diligence as to countries of origin or whether their Conflict Minerals came from recycled or scrap materials.

The SEC acknowledges that these rules will impose major and expensive burdens on thousands of public companies and indirectly on nonpublic companies that supply public companies. In 80 pages of Economic Analysis, the SEC estimates that initial compliance costs will be approximately $3 billion to $4 billion, with an annual cost of ongoing compliance between $207 million and $609 million. (Various commenters submitted estimates ranging from $388 million to $16 billion.) The two Commissioners who voted against these Rules criticized the Staff’s failure to make any attempt to assess whether the final Rules will in fact advance the statutory objective of alleviating the humanitarian crisis in the DRC or whether that objective might be achieved in a more cost-efficient fashion. It seems distinctly possible that similar arguments may be made in litigation challenging these Rules, which business groups are reported to be contemplating.

Three-Step Due Diligence Process

The Rules and Adopting Release describe a three-step due diligence process for a public company that uses any Conflict Mineral, which may be quite complicated as evidenced by a tangled decision-tree flowchart that occupies page 33 of the Release.

Step One — Are Conflict Minerals Necessary to the Functionality or Production of a Manufactured or Contracted Product? If any Conflict Mineral is present — even in a de minimis amount — in a finished product, the company will need to proceed to Step Two unless it can demonstrate that the Conflict Mineral was not necessary to the production or functionality of the product, which is likely to be difficult. Even if the Conflict Mineral is purely ornamental, that may not suffice if the product itself is primarily ornamental. If a Conflict Mineral is merely used in production,  (e.g., as a catalyst), but is not present in the finished product, Step Two would be avoided, which is a change from the proposed rules. In another change, companies that contract for the manufacture of products, such as retailers with respect to private-label goods, would not be covered if they do not specify terms to the degree that they are influencing the manufacture of those products. Also, the mining of Conflict Minerals will not be considered their “manufacture.”

Step Two — Did the Conflict Minerals Originate from a Covered Country or Are They from Scrap or Recycled Sources? In a helpful change from the proposed rules, companies need not make this inquiry with respect to any Conflict Minerals that were “outside the supply chain” prior to Jan. 31, 2013, which means that they were smelted, refined or outside the Covered Countries before that date. (The “Covered Countries” are the DRC and the nine nations that border the DRC.) Moreover, Conflict Minerals from scrap or recycled sources are in effect treated as if they originated from outside the Covered Countries. As to Conflict Minerals not outside the supply chain prior to Jan. 31, 2013, a company would be required to undertake a reasonable “country of origin” inquiry, which would not lead to Step Three if the company determines that it has no reason to believe that the Conflict Minerals:

  • May have originated in a Covered Country, or
  • May not be from scrap or recycled sources.

So, a company that has no reason to believe that its Conflict Minerals are not from scrap or recycled sources based on special procedures described for that inquiry would not need to proceed to Step Three. A company that can make that determination, or alternatively determines that it has no reason to believe that any of its non-scrap/recycled Conflict Minerals may have originated in a Covered Country, would, however, still be required to file a Form SD, in which it would briefly describe its inquiry and the inquiry’s results and conclusions, and would also be required to post the substance of that disclosure on its website.

Step Three — Conflict Minerals Report, Including Audit. If a company’s “country of origin” inquiry leads it to both of the following conclusions, it must perform the additional measures required by Step Three, including preparation and filing of a Conflict Minerals Report accompanied by an independent private sector audit of that Report:

  • It knows or has reason to believe that any of its Conflict Minerals may have originated in the Covered Countries; and
  • It knows or has reason to believe that some of its Conflict Minerals may not be from scrap or recycled sources.

Step Three companies must perform due diligence on the source and chain of custody of their Conflict Minerals, which (in another change from the proposed rules) must conform to a nationally or internationally recognized due diligence framework. At present, that is tantamount to the due diligence guidance that has been approved by the Organisation for Economic Cooperation and Development (OECD). Even if a company determines that its Conflict Minerals are “DRC Conflict Free,” which means that they did not finance or benefit armed groups in the Covered Countries, it will be required to obtain and include as part its Conflict Minerals Report (filed with its Form SD) an independent private sector audit of its Conflict Minerals Report, but subject to the two/four year grace period described below for “DRC Conflict Undeterminable” materials. The audit report would be required to express an opinion or conclusion whether the design of the company’s due diligence measures is in conformity with the criteria set forth in the due diligence framework and whether the description of the company’s due diligence is consistent with the process it undertook.

If a Step Three company’s due diligence gives it reason to believe that any of its Conflict Minerals did finance or benefit armed groups in the Covered Countries, it would be required to state that those materials have not been found to be “DRC Conflict Free,” describing them, where they were processed, and what efforts the company made to determine the mine or location of origin with greatest possible specificity.

DRC Conflict Undeterminable. For a grace period of two years (that is, for calendar years 2013 and 2014), if a Step Three company is unable to determine whether its Conflict Minerals originated in a Covered Country or financed or benefited armed groups in those countries, it would be permitted to describe its Conflict Minerals as “DRC Conflict Undeterminable,” and although it would be required to prepare and file a Conflict Mineral Report, it would not be required to obtain an audit of the Report. For Smaller Reporting Companies, this grace period from the audit requirement is four years. The grace period will not, however, be available to any company that knows that its Conflict Minerals financed or benefitted armed groups in the Covered Countries. Companies relying on the grace period must make the same disclosures that would apply if the Conflict Minerals were found not to be “DRC Conflict Free” and must also describe the steps that the company has taken or will take, if any, since the end of the year covered by the Report to mitigate the risk that its Conflict Minerals will benefit armed groups.

Payments by Mineral Resource Extractors

The SEC also adopted at its Aug. 22, 2012, meeting — by a divided vote — final rules to implement Section 1504 of the Dodd-Frank Act, which will apply to approximately 1,100 public companies that are involved in exploration, extraction, processing or export of oil, natural gas or minerals or acquiring licenses to conduct any of those activities. These companies will be required to make detailed disclosure of payments by them to governments, which, like the Conflict Minerals disclosures, will be made on the new Form SD. For a calendar year issuer, its initial filing must cover the period from Oct. 1, 2013, through Dec. 31, 2013.


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This article was originally published by Bingham McCutchen LLP.