Securities and Exchange Commission (SEC) Approves Final “Conflict Mineral Rule”
Kelley Drye Client Advisory
If your company manufacturers, or contracts to manufacture, products containing tin, tantalum, tungsten or gold (the 3Ts and G) necessary to the functionality or production of the product, and you file reports with the SEC under the Exchange Act, on May 31, 2014 (for calendar year 2013) and annually on May 31 for each calendar year thereafter, you will be required to file new disclosure reports with the SEC. The SEC established the new reporting requirements by approving its final “Conflict Minerals Rule” during an open hearing on August 22, 2012. The rule will be effective with calendar year 2013 production with reports due to the SEC on May 31, 2014.
Congress directed the SEC to develop the rule in the Dodd-Frank “Wall Street Reform and Consumer Protection Act” of 2010, Section 1502. Its purpose is to discourage the use of the four conflict minerals originating from mines in the Democratic Republic of the Congo and surrounding countries (“covered countries”). Such mines are known to be sources of funding for conflicts in the region.
The SEC first proposed the “Conflict Minerals Rule” in December of 2010. The rule is directly applicable to companies that file reports with the SEC under Sections 13(a) or 15(d) of the Exchange Act if the companies “manufacture or contract to manufacture” products and some of those products contain conflict minerals “necessary to the functionality or production” of the product. The rule is expected to have indirect impacts on a much broader category of businesses as tracing and tracking of the supply chain forces even those not covered by the rule to respond to customer demands for information and certification.
Does the Rule Directly Apply?To determine if the rule applies to it directly, a company should ask the following questions:
1. Under the terms of the rule, does it manufacture or contract to manufacture products? If no, the rule does not apply directly.
2. Is it required to report to the SEC under Sections 13(a) or 15(d) of the Exchange Act? If no, the rule does not apply directly.
3. Are conflict minerals, the 3Ts and G, “necessary to the functionality or production” of the product or products “manufactured or contracted to be manufactured” by the entity? If no, the rule does not apply directly.
4. Were the conflict minerals contained in the product outside the supply chain (smelted, refined, or located outside the covered countries) prior to January 31, 2013. If yes, the rule does not apply directly.
Even if the rule does not apply directly to the company, it should consider if the expected indirect effects will impact its operations.
Will the Rule Have ‘Indirect’ Impact?If a company determines that the rule will not directly apply to it, the company will likely still bear impact from the rule if the company has any of the conflict minerals in its products being supplied to downstream users who are directly covered by the rule. Downstream customers such as manufacturers of electronics, automobiles, and telecommunications, to name just a few, produce thousands of component parts that are purchased from hundreds and even thousands of suppliers. Many members of these industries will be covered directly by the rule and required to report. To do so, they will find it necessary to institute complex supply chain tracing and tracking schemes from the finished product back to the mine/smelter/refiner. Many non-publicly traded companies along the supply chain will be caught in the mineral source-tracking processes, at the insistence of their customers. This pressure throughout the supply chain is expected to culminate in customer demands that suppliers certify that their material is “DRC Conflict Free.”
Direct Requirements of the RuleThose companies who determine that the rule directly applies to them and their products will be required to determine the sources of their conflict minerals using a “reasonable country of origin inquiry” (RCOI). The exact nature of the RCOI is not specified, but requires that the company conduct an inquiry that is “reasonably designed to determine whether any of its conflict minerals originated in the covered countries or are from recycled or scrap sources,” and it must perform the inquiry in good faith. If the product is produced entirely from scrap or recycled materials, it is treated as if it is known not to have originated in the covered countries. The results of the RCOI determine the extent of the disclosures required:
I. WHEN: Based on the RCOI, the company determines that
It knows that the conflict minerals did not originate in the covered countries,
It knows that the conflict minerals originated from scrap or recycled sources,
It has no reason to believe that the minerals may have originated in the covered countries, or
It has no reason to believe that the minerals may not be from scrap or recycled sources, THEN
REQUIRED DISCLOSURES: The company must disclose its RCOI determination, provide a brief description of the inquiry and its results on new SEC Form SD, make this information available on its Internet site, and provide the Internet address in Form SD. No Conflict Minerals Report (CMR), due diligence, or third-party audit will be required.
II. WHEN: Based on the RCOI, the company determines that:
It knows that the conflict minerals did originate or may have originated in the covered countries,
It knows that the conflict minerals did not originate or may not have originated from scrap or recycled materials,
It has reason to believe that the materials originated or may have originated in the covered countries, or
It has reason to believe that the conflict minerals did not originate or may not have originated from scrap or recycled materials, THEN
REQUIRED DISCLOSURES: In addition to filing Form SD as above, the company must undertake “due diligence” on the source and chain of custody of its conflict minerals and file a CMR as an exhibit to the Form SD. The CMR is subject to a third-party audit. Further, the company must make the CMR publicly available on its Internet site and provide the Internet site address on Form SD.
The CMR is the heart of the rule and the most burdensome aspect. Companies required to file CMRs will have to exercise due diligence on the source and chain of custody of their conflict minerals. The due diligence must conform to a nationally or internationally recognized due diligence framework. At present, the only framework existing is the due diligence guidance approved by the Organization for Economic Cooperation and Development (OECD). The Due Diligence step will result in one of three findings: the product is 1) DRC Conflict Free – i.e. may originate from a covered country but does not finance or benefit armed groups, 2) Not DRC conflict Free, or 3) DRC Conflict Undeterminable. In the first case, DRC Conflict Free, the company need only obtain a third-party audit of the CMR, certify it, and include the audit report in the CMR along with the identity of the auditor. In the second case, in addition to the audit and certification, the company will be required to reveal the products produced and found Not DRC Conflict Free, note the facilities used to process the conflict minerals in those products, name the country of origin of the minerals, and the efforts to determine the mine with the greatest possible specificity. For Undeterminable products, the requirements are the same as for those Not DRC Conflict Free except a third-party audit is not required. But, the company must show what steps it has taken to mitigate the risk that armed groups are benefiting.
The final rule deviates from the 2010 proposal in several important aspects. For example:
The Definiation and Treatment of Recycled, or Scrap, MaterialThe proposed rule allowed the classification of product produced using recycled end-product material to be classified as DRC Conflict Free but then required due diligence, a third-party audit, and the filing of a CMR. The definition of recycled material was limited to end-of-life product scrap. The final rule expanded the definition of scrap to include industrial metal scrap from processing and, based on a reasonable country of origin inquiry (RCOI), if the company knows the minerals came from scrap, or has no reason to believe that the materials may not be from scrap, requires only a Form SD be filed – due diligence, third-party audit and a CMR are not required – and the product produced is considered DRC Conflict Free. Again, the exact nature of the RCOI is not specified, but requires that the company conduct an inquiry that is reasonably designed to determine whether any of its conflict minerals originated in the covered countries or are from recycled or scrap sources, and it must perform the inquiry in good faith.
The Definition of Manufacture and Contract to ManufactureUnder the final rule, a company that merely mines the conflict minerals is not treated as manufacturing those minerals unless the company also engages in manufacturing.
The final rule also clarified that to be deemed to have contracted to manufacture a product, the company must have some influence over the manufacturing of the product. Merely affixing its brand, marks, logo or label to a generic product manufactured by a third party; servicing, maintaining or repairing a product; or specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product will not be deemed to be influencing the manufacturing.
Necessary to the Functionality or Production of a ProductIn the final rule, the SEC provided guidance on the fact specific determination of “necessary to the functionality or production of a product.” One of several factors to consider in determining if a conflict mineral is necessary to the functionality of a product is whether the mineral is “intentionally added.” Thus, minerals considered impurities in the product would not be considered necessary to the functionality. While the SEC declined to provide a de minimis exemption under the rule, it established a de facto exemption by specifically recognizing that contaminants and impurities are not necessary to the functionality of the product.
The SEC made clear that “necessary to the production of a product” does not include a physical tool or machine used to make the product. Thus, tungsten carbide saws used to make products do not bring the product under the rule. Further, even catalysts used in the production process do not qualify unless some amount of the catalyst remains in the finished product. The conflict mineral must be contained in the product to trigger the determination that the conflict mineral is “necessary to the production” of the product.
Current Stockpiles of Conflict MineralsThe final rule excludes any conflict minerals that are “outside the supply chain” prior to January 31, 2013. Conflict minerals are outside the supply chain when they have been smelted, refined, or are located outside of the covered countries.
Furnish Versus FileThe proposed rule would have required conflict minerals information to be “furnished.” The final rule will require companies with necessary conflict minerals to “file,” for purposes of Section 18 of the Exchange Act, the conflict minerals information provided in their specialized disclosure reports, including any Conflict Minerals Reports and independent private sector audits. This is significant because filing the reports under Section 18 subjects the filings to potential liability of that section. In the proposed rule, the reports would merely have been furnished, not subject to Section 18 liability.
Uniform Reporting PeriodAs originally proposed, filers would provide required information on a fiscal year basis. In the final rule, the SEC moved to a calendar-year reporting basis applied to all reporting entities regardless of their financial reporting year. The commission designated calendar year 2013 as the first reporting period with the first reports due on May 31, 2014. The requirement to report is triggered when a manufacturer completes production of a product in the applicable calendar year.
ConclusionCompanies should quickly determine whether the Conflict Minerals Rule applies to them, and if so, what will be required to comply with the rule. In many cases, communications up and down the supply chain will be essential to minimizing the impact. Such communications should be undertaken early so each link in the supply chain will be aware of its responsibility.
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