Conflict Minerals Rule Imposes Big Burdens on Manufacturers

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[author: Jane C. Luxton]

This article was originally published on August 23, 2012 as a guest post on Forbes.com.

Some initial reactions to the Securities and Exchange Commission’s August 22 adoption of its controversial “Conflict Minerals” rule expressed relief at the moderation of some of the harsher provisions of the Commission’s 2010 proposal. But a close look at how companies must implement this program suggests these changes will not significantly relieve the heavy compliance burden. This is particularly true for mid-size and smaller companies that have not already started to build the necessary internal diligence infrastructure they will need to ensure they are meeting their new SEC reporting obligations.

Basically, the Conflict Minerals rule requires publicly traded and other SEC-reporting companies that manufacture products containing four widely used metals – tin, tungsten, tantalum, and gold – to trace the origins of these materials to see if they came from the Democratic Republic of the Congo or adjoining central African countries (Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia). This Congressionally-mandated initiative is designed to pressure U.S. companies to “deselect” metals mined by violent warlords in the DRC and thereby cut off financial lifelines that allow atrocities to continue.

Compliance involves a three-step process:

  1. The company must examine all of its products to see if they contain any of the four specified minerals. There is no de minimis exemption for these metals if they are necessary for the functionality or production of the product, so even trace amounts count.
  2. If the answer to question #1 is yes, the company must conduct a reasonable inquiry to determine the country of origin of the conflict minerals. This inquiry must be designed to ascertain whether the metals originated (a) in the DRC or neighboring countries, (b) in another geographic region, or (c) from recycled or scrap metals. The company must disclose the results of this research and describe the nature of its inquiry in a report to be filed with the SEC. If the answer to these questions is (b) or (c), the company’s obligations then end for the current reporting year.
  3. If the answer to question #2 is (a), or if the company does not know the origin of the materials, the company must undergo more stringent due diligence on the source and chain of custody of its conflict minerals, and must commission an independent private sector audit of its due diligence findings. These findings and audit report must be filed with the SEC. For an initial two-year “transition period” after the rule goes into effect, companies will be permitted if necessary to report that their conflict minerals are “DRC conflict undeterminable” and will not have to conduct an audit; small businesses will have four years for this “transition period,” providing these businesses with more time to develop reliable programs for tracing the origins of these metals.

The eased measures the SEC incorporated in the final rule include the early offramp for recycled materials and the transition period noted above for “undeterminable” metals. These will undoubtedly relieve some of the compliance burden, but not at the front end of the process, when all companies subject to the rule will have to undergo the resource-intensive efforts required in steps 1 and 2.

Representatives of large, sophisticated companies that have been actively working to implement the expected requirements spoke eloquently at an October 2011 SEC Roundtable discussion of the complexity of their supply chains and the difficulty in obtaining solid information from their upstream suppliers on the origins of common, commodity metals like tin, tantalum, tungsten and gold in purchased products and components. One emphasized that its purchasing department was caught completely by surprise to learn that purchased items contained small amounts of one of these metals. Many strongly urged the SEC to adopt exemptions for minimal quantities, particular uses or small businesses, but the Commission rejected these requests.

Between the proposed and final rule, the SEC revised its cost estimate from $71 million to $3-4 billion initially and $206-609 million annually thereafter, and it is noteworthy that these final numbers take into account the SEC’s modifications to reduce burden. Industry estimates range as high as $16 billion.

The final rule is complex, with many undefined terms and critical judgment calls. It will require all companies subject to the regulation to conduct a comprehensive review of their product lines to determine whether their manufactured products contain conflict minerals – and will even sweep in many retailers if they “contract to manufacture” products. Once this first step is complete, those with conflict minerals in their products must carry out a reasonable country of origin assessment of their upstream supply chains, another significant undertaking. While many may be able to stop at this point, they must still file SEC reports on their diligence and results. The reports have to be accurate; they fall within the liability provisions of Section 18 of the Securities Exchange Act of 1934.

Businesses that started early to establish conflict minerals compliance programs are still expressing worry over their ability to meet the new reporting obligations in time. Many more companies have not yet even begun. While the first report is not due until May 2014, the reporting period it covers begins in January 2013. Those subject to the rule need to move now to meet these new requirements, and should brace themselves for a significant amount of work.


 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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