Beveridge & Diamond
 

SEC Issues Proposed Regulations Requiring Disclosure of Conflict Minerals

Beveridge & Diamond, P.C., December 17, 2010

On December 15, 2010, the Securities and Exchange Commission (“SEC”) issued proposed regulations implementing section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act” or “Act”), which requires certain companies to make disclosures about the source of conflict minerals in their manufactured products.  The proposed regulations address some—but by no means all—of the numerous open questions regarding the scope and applicability of the Act's requirements.

These requirements are likely to affect a wide spectrum of manufacturing companies and their suppliers, and will result in new supply chain management challenges.

Stakeholders have until January 31, 2011 to submit comments on the proposed rules to the SEC.

Background

“Conflict minerals” are defined under the Act to include columbite-tantalite, also known as coltan (used to produce tantalum), cassiterite (used to produce tin), wolframite (used to produce tungsten), gold, and other minerals designated by the Secretary of State.  As discussed in a previous client alert, the Dodd-Frank disclosure requirements are part of a U.S. effort to reduce the market for minerals that may directly or indirectly finance armed conflict in the Democratic Republic of Congo (“DRC’) and adjoining countries.  These minerals are widely used in the electronics, jewelry, industrial machinery, automotive, and aeronautics industries, among many others.

Proposed Rules

Under the proposed rules, any issuer for which conflict minerals are “necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by that issuer” would be required to disclose in the body of its annual report1 whether those conflict minerals originated in the [DRC] or an adjoining country.”  

The proposed rules would essentially require a three-step process.

First, companies must assess whether they are subject to the statutory due diligence and disclosure requirements.  They do so by determining:

a.  if they are issuers that file reports with the SEC pursuant to sections 13(a) or 15(d) of the Securities Exchange Act of 1934; and

b.  if any conflict minerals (or their derivatives) are necessary for the production or functionality of products they manufacture. 

Addressing one significant question regarding the applicability of the requirements – what does it mean to “manufacture” a product? -- the proposal clarifies that the rules apply to any entity that has “any influence” over a product’s manufacturing.  This clarification presumably encompasses any company that sets product specifications for a product or component that is produced by a contract manufacturer.  

The proposed rules also clarify that the obligation applies to any entity that offers a generic product under its own brand name, even if it had no influence over the specifications, as long as it contracted to have the product manufactured for itself. 

Second, if a company meets the criteria in the first step, the company must determine whether the conflict minerals originated in the DRC or an adjoining country.  This assessment requires a "reasonable country of origin inquiry.” If the company determines that the conflict minerals did not originate from the DRC or adjoining countries, the company must disclose that information along with a description of the enquiry it used to reach this conclusion: (1) on its website; and (2) in its annual report to the SEC.

The SEC chose not to specify what constitutes a “reasonable country of origin inquiry” in its proposed rules.  But the preamble to the proposed rule suggests that the “reasonable inquiry” would likely require less than the full due diligence process required under Step 3, that the reasonableness standard does not require absolute accuracy, and that the inquiry might (at least for the time being) be based on reasonably reliable representations from the supply chain that the conflict minerals did not originate in DRC countries (including if the source smelter had been identified as a “DRC conflict free” smelter pursuant to  recognized and audited standards).

Third, if, after completing a reasonable country of origin inquiry, a company determines that conflict minerals in its products originated from the DRC or adjoining countries or cannot determine that its conflict minerals did not originate in the region, then the company must "furnish" to the SEC a “Conflict Minerals Report.”  This report must include:

  • a description of any of its products containing conflict minerals that directly or indirectly finance or benefit armed groups in the DRC or adjoining countries;
  • the facilities used to process those conflict minerals;
  • the country of origin of those conflict minerals; and
  • a description of the company’s efforts to identify the source and chain of custody of its conflict minerals, including the due diligence standard that they used in making the above determinations. 

The report must be accompanied by an independent private sector audit of the report and a certification by the company that it obtained such an audit.

As with the country of origin inquiry at Step 2, the SEC declined to “dictate the standard for, or otherwise provide guidance concerning, due diligence that issuers must use in making their supply chain determinations.”  Instead, the proposed rules would require issuers to disclose the due diligence used, including whether they followed recognized standards or guidance of supply chain due diligence.  The rules specifically suggest that issuers that follow internationally recognized standards -- such as those under development under OECD auspices (as described below) -- “would provide evidence that the issuer used due diligence in making its supply chain determinations.” 

The disclosure, due diligence, and reporting requirements are effective with respect to the company’s activities in the first full fiscal year following the SEC’s promulgation of final regulations (likely in April 2011). 

Several issues raised by industry in comments to the SEC remain unresolved.  For example, the SEC expressly declined to read a materiality threshold into the requirement that conflict minerals be necessary to the functionality or production of a product.  Instead, the SEC requested additional comments on whether the final rule should adopt a de minimis threshold “based on the amount of conflict minerals used by issuers in a particular product or in their overall enterprise.”

The proposed rule provides special treatment for recycled metals, recognizing the inherent impossibility in tracing the country and mine of origin for such inputs, but it does not exempt such minerals from the burdensome supply chain due diligence and reporting requirements that apply to virgin minerals.  If a company’s conflict minerals originated from recycled or scrapped sources rather than from mined sources, the company would be required to disclose that in its annual report.  In addition, the company would have to furnish a Conflict Minerals Report that describes the measures taken to exercise due diligence in determining that their conflict minerals were recycled or scrap.  Under the proposed rule, such products would be considered DRC conflict free.  The result of the proposed rule is that the presence of recycled or scrap metals in a manufacturer’s supply chain would trigger the more burdensome “Step 3” due diligence measures than the use of virgin minerals that could, based on a “reasonable inquiry,” be considered to come from non-DRC sources.  The SEC specifically requested comments on this proposed approach.

Context and Implications

The U.S. conflict minerals disclosure requirements will necessarily entail a sweeping review of and revision to many companies’ supply chain management policies, in order to implement the source-of-origin and due diligence requirements that the presence or use of these common materials will trigger.  The rules have already generated significant activity along the entire supply chain of many products manufacturers.

The new rules provide little concrete guidance regarding the degree and type of source-of-origin tracking and other conflict minerals policies that will constitute due diligence.  Instead, companies are likely to look to external standards for benchmarking and guidance.  Significant work in this area has already been accomplished through OECD-sponsored efforts to develop responsible supply chain management standards for conflict minerals.  The OECD guidance, which was recently endorsed by a UN expert group on the DRC conflict and which the SEC preamble specifically pointed to as a reference standard, is available here.

Because it is not currently possible to trace the source of origin of metals back up the supply chain prior to the smelter, the source of origin and due diligence measures for downstream users will turn in large measure on their ability to rely on smelters that have adopted responsible and auditable policies regarding the source of minerals.  Ongoing work by industry groups such as the Electronic Industry Citizenship Coalition (“EICC”) and Global e-Sustainability Initiative (“GeSI”) to develop a Conflict Free Smelter program, and related standards, will likely play a central role in the implementation of these new requirements.  We will report on those developments in the future as they are further developed and released.

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For more information, please contact Paul Hagen at (202) 789-6022 or PHagen@bdlaw.com, Russ LaMotte at (202) 789-6080 or RLamotte@bdlaw.com, Laura Duncan at (415) 262-4003 or LDuncan@bdlaw.com, or Erica Zilioli at (202) 789-6078 or EZilioli@bdlaw.com.

Please click here for a printable PDF of this article. 


1  Form 10-K for a domestic issuer; Form 20-F for a foreign private issuer; or Form 40-F for an eligible Canadian issuer.

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