Securities and Exchange Commission Adopts Final Rule on Conflict Minerals
On August 22, 2012, a divided Securities and Exchange Commission (SEC) voted three-to-two in favor of adopting a final rule regarding disclosure and reporting obligations with respect to the use of conflict minerals to implement the requirements of Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Not surprisingly, the vote was along party lines with Chairwoman Shapiro and Commissioners Aguilar and Walter voting in favor and Commissioners Paredes and Gallagher (Republicans) opposing. The rule is effective as to products for which manufacturing is completed in 2013, and the first annual reports are due May 31, 2014, and on May 31 every year thereafter.
Congress enacted Section 1502 of the Act in response to concerns that the exploitation and trade of conflict minerals by armed groups is helping to finance conflict in the Democratic Republic of the Congo (DRC) and adjoining countries and is contributing to an emergency humanitarian crisis. The controversial provision inspired significant debate when enacted, and intensified with issuance of proposed SEC rules in December 2010. Part of the controversy involved the broad scope of the proposal, the precedent-setting nature of the supply-chain due diligence requirements, the inclusion of recycled and scrap materials, and the expected cost of implementation verses the quantified social benefits that derive from the rule’s implementation, which the SEC concedes cannot be “readily [quantified] with any precision.” The final rule will become effective 60 days after it is published in the Federal Register. A pre-publication version of the rule is available online. SEC has also developed a Fact Sheet on the final rule that is available online. The webcast of the hearing is available online.
Scope of the Final Rule
The final rule applies to companies that use minerals identified to date as conflict, which include tantalum, tin, gold, or tungsten if:
- The company files reports with the SEC under Sections 13(a) or 15(d) of the Securities Exchange Act; and
- The conflict minerals are “necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company.
A company is considered to be “contracting to manufacture” a product if it has some actual influence over the manufacturing of that product. This determination is based on facts and circumstances, taking into account the degree of influence a company exercises over the product’s manufacturing. A company is not deemed to have influence over the manufacturing if it merely:
- Affixes its brand, marks, logo, or label to a generic product manufactured by a third-party;
- Services, maintains, or repairs a product manufactured by a third-party; or
- Specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product.
The requirements apply equally to domestic and foreign companies that file reports with the SEC, but do not apply to companies that strictly mine conflict minerals, unless the company also engages in manufacturing. As noted, the rule does not apply to conflict minerals that are “outside the supply chain” prior to January 31, 2013. Conflict minerals are “outside the supply chain” if they have been smelted or fully refined or, if they have not been smelted or fully refined, they are outside the covered countries. Companies subject to the final rule must comply beginning with the calendar year commencing January 1, 2013, with first reports due May 31, 2014.
Given the specified conflict minerals and the broad scope of the rule’s application, many sectors of the economy will be impacted. These include electronics, automotive, construction, and many others. The SEC estimates the cost of initial compliance to be $3-$4 billion, with ongoing implementation costs to be $206-$609 million per year.
Country of Origin Inquiry
Under the final rule, a subject company that uses any of the designated minerals is required to conduct a reasonable “country of origin” inquiry that must be performed in good faith and be reasonably designed to determine whether any of its minerals originated in the covered countries or are from scrap or recycled sources. If the inquiry determines that the company knows that the minerals did not originate in the covered countries or are from scrap or recycled sources or it has no reason to believe that the minerals may have originated in the covered countries or may not be from scrap or recycled sources, then the company must disclose its determination, provide a brief description of the inquiry it undertook, and the results of the inquiry on a new form to be filed with the SEC (Form SD). The company also is required to make its description publicly available on its Internet website and provide the address of that site on the Form SD. Once the form is filed, the company’s obligations under the rule are satisfied.
If the inquiry otherwise determines that the company knows or has reason to believe that the minerals may have originated in the covered countries and it knows or has reason to believe that the minerals may not be from scrap or recycled sources, then the company must undertake “due diligence” on the source and chain of custody of its conflict minerals and file a Conflict Minerals Report as an exhibit to Form SD. The company also is required to make the Conflict Minerals Report publicly available on its Internet website and provide the address of that site on the Form SD.
Contents of Conflict Minerals Report
After conducting the country of origin inquiry, companies that determine a Conflict Minerals Report must be filed are required to exercise “due diligence” on the source and chain of custody of their conflict minerals. The due diligence measures must conform to a nationally or internationally recognized due diligence framework, such as the due diligence guidance approved by the Organization for Economic Cooperation and Development (OECD), which is repeatedly mentioned through the rule and preamble. If the due diligence measures determine that although the minerals originated from the covered countries, they did not finance or benefit armed groups, then the company may designate the minerals as “DRC Conflict Free.” To confirm this designation, the company must obtain an independent certified private sector audit of its Conflict Minerals Report and include the audit report and identify the auditor in its Conflict Minerals Report.
Companies that determine their products are not found to be “DRC Conflict Free” must also, in addition to the audit requirements described above, describe in their Conflict Minerals Report:
- The products manufactured or contracted to be manufactured that have not been found to be “DRC Conflict Free”;
- The facilities used to process the conflict minerals in those products;
- The country of origin of the conflict minerals in those products; and
- The efforts to determine the mine or location of origin.
Companies that are unable to determine whether the minerals in its products originated in a covered country or financed or benefited armed groups may designate their products as “DRC Conflict Undeterminable” for a temporary period of two years after the final rule’s effective date. The period for small businesses is four years. Under this temporary designation, the company must include the following information in its Conflict Minerals Report:
- Its products manufactured or contracted to be manufactured that are “DRC Conflict Undeterminable”;
- The facilities used to process the conflict minerals in those products, if known;
- The country of origin of the conflict minerals in those products, if known;
- The efforts to determine the mine or location of origin with the greatest possible specificity; and
- 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.
Minerals from Recycled or Scrap Materials
Under the final rule, if during the due diligence a company determines its conflict minerals are derived from recycled or scrap sources rather than from mined sources, its products are considered “DRC Conflict Free.” This is an important concession that diverges from the proposed rule. Only when a company cannot reasonably conclude after the country of origin inquiry that its minerals are from recycled or scrap must it undertake due diligence to affirm this determination. For gold, a company must use the OECD Due Diligence Guidance and obtain an independent audit of its Conflict Minerals Report. For all other minerals, the company must describe the due diligence measures it used to determine its conflict minerals are from recycled or scrap sources in its Conflict Minerals Report, but an independent private sector audit is not required.
The much anticipated final SEC rule is an improvement over the proposed rule both in terms of scope and in anticipating and lessening practical implementation issues. Credit for this goes to the many stakeholders that worked with the SEC to drill down into the weeds to identify alternatives to the proposed rule.
Importantly, the final rule includes a two-year phase-in period, a welcome relief to industry and a regrettable delay according to the Enough Project, an organization dedicated to fighting genocide and crimes against humanity, and an ardent supporter of the conflict minerals provisions. Also significant is the change from the proposed rule to exempt scrap and recycled materials. Under the final rule, companies that determine the covered minerals derive from scrap or recycled materials are exempted from providing additional information to SEC. On what the company based this determination, however, must still be disclosed on the new Form SD. Due diligence is required if the company believes the minerals may have originated from a conflict area or that the materials did not originate from scrap or recycled materials. The company would also need to prepare a Conflict Minerals Report and submit it to the SEC.
Whether a judicial challenge is likely is unclear, but stakeholders would not be surprised if lawsuits are filed challenging the rule. The SEC is required to estimate the economic implications of the rule and given the somewhat open-ended implications of this final rule, some suspect the SEC may be vulnerable on this point and others. Reviewing courts provide extraordinary deference to federal agencies, however, and where, as here, the SEC doubled-down on supporting the rule with substantial record evidence, public comment, and stakeholder meetings over a protracted period, opponents may have a tough time arguing the rule is arbitrary and capricious as a matter of law.