On August 22, 2012, the U.S. Securities and Exchange Commission (SEC) adopted its final rule to implement Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Act) regarding reporting obligations for the use of conflict minerals originating in the Democratic Republic of the Congo and adjoining countries (Covered Countries). Originally proposed by the SEC in December 2010, the rule was subject to a lengthy and controversial public comment process. As adopted by the SEC, the rule addresses a number of issues that will be of particular interest to mining companies, manufacturers and retailers. Among other things, new Rule 13p-1 under the U.S. Securities and Exchange Act (Exchange Act) establishes a framework governing the disclosure obligations that any issuer that files reports with the SEC must meet with regard to conflict minerals. The rule provides that mining activity will not be subject to the conflict mineral reporting requirements, establishes a transition period for products that are “DRC Conflict Undeterminable” and implements a separate reporting standard for recycled and scrap materials. All issuers subject to the requirement to file Form SD will be required to file it on or before May 31 each calendar year covering any conflict mineral use during the prior calendar year irrespective of the issuer’s fiscal year end. The first Form SD filing must be made no later than May 31, 2014 covering the 2013 calendar year. In light of the complexity of the new rule, issuers should begin immediately considering how their legal, audit and IT functions will need to adapt to the new reporting and disclosure requirements. We offer at the conclusion of this article some recommendations to help start this process.
Conflict Minerals Disclosure Requirements
As in the proposed rule, the final rule retains a three-step process for determining what disclosure requirements, if any, apply to an issuer, but with a number of significant modifications.
Any issuer that files reports with the SEC must determine whether any conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the issuer. “Conflict minerals” consist of:
columbite-tantalite (commonly used in electronic components)
wolframite (used to produce tungsten which is commonly used in metal wires)
cassiterite (tin) and
If the issuer does not manufacture or contract to manufacture any products, or if no conflict minerals are necessary to the functionality or production of the product, then the issuer is not required to take any further action, make any disclosures or file any Form SD report with the SEC relating to conflict minerals.
Consistent with the proposal, the final rule does not define the phrases “contract to manufacture,” “necessary to the functionality” of a product, and “necessary to the production” of a product. In response to comments, however, the SEC provided additional guidance in its adopting release for Exchange Act Rule 13p-1 for issuers to consider regarding whether those phrases apply to them. The guidance states that whether an issuer will be considered to “contract to manufacture” a product depends on the degree of influence it exercises over the materials, parts, ingredients, or components to be included in any product that contains conflict minerals or their derivatives.
Further, the SEC has not defined the term “manufacture,” stating that the generally understood meaning will apply. An issuer will not be considered to “contract to manufacture” a product if it does no more than take the following actions: (1) the issuer specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product (unless it specifies or negotiates taking these actions so as to exercise a degree of influence over the manufacturing of the product that is practically equivalent to contracting on terms that directly relate to the manufacturing of the product); (2) the issuer affixes its brand, marks, logo, or label to a generic product manufactured by a third party; or (3) the issuer services, maintains, or repairs a product manufactured by a third party.
Similarly, the determination of whether a conflict mineral is deemed “necessary to the functionality” or “necessary to the production” of a product depends on the issuer’s particular facts and circumstances. In determining whether a conflict mineral is “necessary to the functionality” of a product, an issuer should consider: (1) whether the conflict mineral is intentionally added to the product or any component of the product and is not a naturally-occurring by-product; (2) whether the conflict mineral is necessary to the product’s generally expected function, use, or purpose; and (3) if a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration.
In determining whether a conflict mineral is “necessary to the production” of a product, an issuer should consider: (1) whether the conflict mineral is intentionally included in the product’s production process, other than if it is included in a tool, machine, or equipment used to produce the product (such as computers or power lines); (2) whether the conflict mineral is included in the product; and (3) whether the conflict mineral is necessary to produce the product. For a conflict mineral to be considered “necessary to the production” of a product, the mineral must be both contained in the product and necessary to the product’s production.
The adopting release indicates that the SEC does not consider a conflict mineral “necessary to the production” of a product if the conflict mineral is used as a catalyst, or in a similar manner in another process, that is necessary to produce the product but is not contained in that product.
Mining Will Not Be Subject To Conflicts Minerals Reporting Obligations
Citing the “plain reading” of the statute and its legislative history, the adopting release states that an issuer that mines or contracts to mine conflict minerals will not be considered to be manufacturing or contracting to manufacture those materials unless the issuer also engages in manufacturing, whether directly or indirectly, in addition to mining. It is not clear, however, what role mining companies may be required to play in connection with supplier certification processes and any supply chain due diligence undertaken by reporting issuers subject to the rule.
Exempt Conflict Minerals
The final rule exempts from any disclosure requirements any conflict minerals that are “outside the supply chain” prior to January 31, 2013. Under the final rule, 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.
If an issuer uses conflict minerals, then it must determine if they originated in Covered Countries by undertaking a reasonable country of origin inquiry. To satisfy the reasonable country of origin inquiry requirement, an issuer must conduct an inquiry regarding the origin of its conflict minerals 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 must perform the inquiry in good faith.
Conflict Minerals That Do Not Originate in Covered Countries or Come from Recycled or Scrap Sources
If as a result of its inquiry the issuer determines that any conflict minerals it uses (Necessary Conflict Minerals) (i) did not originate in a Covered Country or (ii) did come from recycled or scrap sources or (iii) it has no reason to believe its Necessary Conflict Minerals may have originated in a Covered Country or (iv) it reasonably believes its Necessary Conflict Minerals did come from recycled or scrap sources, then the issuer must disclose in Form SD under a heading “Conflict Minerals Disclosure” its determination and briefly describe the reasonable country of origin inquiry it used in reaching its determination and the results of the inquiry. The issuer must also disclose this information on its website and under its “Conflict Minerals Disclosure” heading on its Form SD, provide a link to its website.
If, as a result of its reasonable country of origin inquiry, an issuer knows it has Necessary Conflict Minerals which originated in the Covered Countries and are not from recycled or scrap sources, or if an issuer has reason to believe that its Necessary Conflict Minerals may have originated in the Covered Countries and has reason to believe they may not have come from recycled or scrap sources, then the issuer must exercise due diligence on the source and chain of custody of its conflict minerals. Its due diligence must conform to a nationally or internationally recognized due diligence framework, if such a framework is available for that particular conflict mineral.
If as a result of its due diligence an issuer determines that its conflict minerals (i) did not originate in a Covered Country or (ii) did come from recycled or scrap sources, than the issuer must disclose on its Form SD under the heading “Conflict Minerals Disclosure” its determination and briefly describe the reasonable country of origin inquiry and the due diligence efforts it undertook in making its determination and the results of the inquiry and due diligence efforts it performed. The issuer must also disclose this information on its website and under its “Conflict Minerals Disclosure” heading on its Form SD, provide a link to its website.
In all other circumstances an issuer will be required to prepare a report (Conflict Minerals Report) regarding its use of the conflict minerals. The final rule requires an issuer to provide its Conflict Minerals Report as an exhibit to a new separate report on its Form SD, instead of as an exhibit to its annual report on Form 10-K, Form 20-F, or Form 40-F, as proposed. The issuer must also provide its Conflict Minerals Report on its website and disclose on its Form SD that it has filed its Conflict Minerals Report with the SEC and provide a link to its website.
The Conflict Minerals Report must include:
a description of the measures taken by the issuer to exercise due diligence on the source and chain of custody of its conflict minerals
a description of its products that are not “DRC conflict free” (which the rules define to mean a product which does not contain conflict minerals that directly or indirectly finance or benefit armed groups in Covered Countries), the country of origin of those conflict minerals, and the facilities used to process those minerals
a description of the efforts and procedures taken to determine the mine or location of origin of the minerals with the greatest possible specificity
a certification by the issuer that it obtained an independent private sector audit of its Conflict Minerals Report and
the audit report and the identity of the auditor
Generally, the required content of the Conflict Minerals Report is substantially similar to the SEC’s original proposal. One significant modification from the proposal is that the final rule requires an issuer to use a nationally or internationally recognized due diligence framework, if such a framework is available for the specific conflict mineral. The SEC expressed the view that doing so will enhance the quality of an issuer’s due diligence, promote comparability of the Conflict Minerals Reports of different issuers, and provide a framework by which auditors can assess an issuer’s due diligence. Presently, it appears that the only nationally or internationally recognized due diligence framework available is the due diligence guidance approved by the Organization for Economic Co-operation and Development (OECD).
Independent Private Sector Audit
As proposed, the final rule requires an independent private sector audit of an issuer’s Conflict Minerals Report, except as described below in the case of products that are “DRC conflict undeterminable”. The final rule now also specifies an audit objective. The audit’s objective is to express an opinion or conclusion as to whether the design of the issuer’s due diligence measures as set forth in the Conflict Minerals Report, with respect to the period covered by the report, is in conformity with, in all material respects, the criteria set forth in the nationally or internationally recognized due diligence framework used by the issuer, and whether the issuer’s description of the due diligence measures it performed as set forth in the Conflict Minerals Report, with respect to the period covered by the report, is consistent with the due diligence process that the issuer undertook. Also, consistent with the proposal, the final rule refers to the audit standards established by the Government Accountability Office (GAO). The GAO staff has indicated to the SEC staff that the GAO does not intend to establish new standards for the Conflict Minerals Report audit. Instead, the GAO plans to look to its existing Government Auditing Standards, which is commonly referred to as “the Yellow Book.”
Transition Period for Products that are DRC Conflict Undeterminable
The final rule also modifies the proposal by providing a temporary transition period for two years for all issuers and four years for smaller reporting companies during which issuers may describe their products as “DRC conflict undeterminable” if they are unable to determine that their minerals meet the statutory definition of “DRC conflict free” for either of two reasons: first, they proceeded to Step Three based upon the conclusion, after their reasonable country of origin inquiry, that they had conflict minerals that originated in the Covered Countries and, after the exercise of due diligence, they are unable to determine if their conflict minerals financed or benefited armed groups in the Covered Countries; or second, they proceeded to Step Three based upon the conclusion, after their reasonable country of origin inquiry, that they had a reason to believe that their Necessary Conflict Minerals may have originated in the Covered Countries and may not have come from recycled or scrap sources and the information they gathered as a result of their subsequently required exercise of due diligence failed to clarify the conflict minerals’ country of origin, whether the conflict minerals financed or benefited armed groups in those countries, or whether the conflict minerals came from recycled or scrap sources. These issuers will have already conducted a reasonable country of origin inquiry, and their undeterminable status would be based on the information they were able to gather from their exercise of due diligence. However, if these products also contain conflict minerals that the issuer knows directly or indirectly financed or benefited armed groups in the Covered Countries, the issuer may not describe those products as “DRC conflict undeterminable.” Also, during the transition period, issuers with products that may be described as “DRC conflict undeterminable” are not required to have their Conflict Minerals Report audited. Such issuers, however, must still file a Conflict Minerals Report describing their due diligence, and must additionally describe the steps they have taken or will take, if any, since the end of the period covered in their most recent prior Conflict Minerals Report, to mitigate the risk that their necessary conflict minerals benefit armed groups, including any steps to improve their due diligence.
Recycled and Scrap Minerals
The rule establishes different treatment of conflict minerals obtained from recycled and scrap sources (it adopts a definition of conflict minerals from recycled or scrap sources that mirrors the OECD definition of recycled metals).
Unlike the proposed rule, the final rule requires issuers with Necessary Conflict Minerals exercising due diligence regarding whether their conflict minerals are from recycled or scrap sources to conform the due diligence to a nationally or internationally recognized due diligence framework, if one is available for a particular recycled or scrap conflict mineral. A gold supplement to the OECD’s due diligence guidance has been approved by the OECD. This gold supplement is presently the only nationally or internationally recognized due diligence framework for any conflict mineral from recycled or scrap sources of which the SEC is aware. The SEC anticipates that issuers will use the OECD gold supplement to conduct their due diligence for recycled or scrap gold.
Other Conflict Minerals
The SEC is not aware that the OECD or any other body has a similar recycled or scrap due diligence framework for the other conflict minerals. Issuers with conflict minerals without a nationally or internationally recognized due diligence framework are still required to exercise due diligence in determining that their conflict minerals were from recycled or scrap sources. The due diligence that must be exercised regarding such conflict minerals focuses only on whether those conflict minerals are from recycled or scrap sources. In such circumstances where a nationally or internationally recognized due diligence framework becomes available for any such conflict mineral, issuers will be required to utilize that framework in exercising due diligence to determine that conflict minerals are from recycled or scrap sources.
As an accommodation to suppliers who will need to respond to informational requests from companies regarding the origin of any conflict minerals used in manufactured products, the rule provides that all issuers involved in the manufacture of a product for which a conflict mineral is necessary to the functionality or production of such product must file their Form SD on or before May 31st covering the use of conflict minerals in the prior calendar year irrespective of the issuer’s fiscal year end. The rule further provides that issuers must file their initial disclosure report on or before May 31, 2014 for the 2013 calendar year.
Form SD Will Be Filed For Exchange Act Purposes
The final rule requires Form SD, including any Conflict Minerals Report and independent private sector audit report, to be filed for Exchange Act purposes. As a result, an issuer will be liable for any false or misleading statements, but it can avoid liability if it can demonstrate that it acted in good faith without knowledge that its Form SD contained false and misleading information. In addition, the Form SD can be filed with the SEC without the need to be accompanied by the officer certification that applies to Form 10-K / 20-F / 40-F annual reports and Form 10-Q quarterly reports. Finally, the information and documents in the Form SD will not be deemed to be incorporated by reference into any filing under the U.S. Securities Act or the Exchange Act, unless the issuer specifically incorporates it by reference into a filing under these acts.
Implications for Issuers and Suppliers
Reporting issuers that manufacture or contract to manufacture mobile telephones and other telecommunications devices, computers, industrial manufacturing tools, food packaging, light bulbs, jewellery or other products utilizing conflict minerals will likely experience repercussions across the breadth of their operations, including the legal, audit and IT functions. In light of the complexity of the rule, these issuers should begin implementing policies and procedures to collect and analyze data that will enable them to determine whether any products they manufacture or contract to manufacture utilize conflict minerals and, if so, whether any of the conflict minerals are or may be sourced from Covered Countries. In addition, any person or company that serves as a supplier, even if that person or company is not itself subject to SEC reporting requirements, will in all likelihood need to implement procedures that will enable it to provide an appropriate certification regarding the source of any conflict minerals it supplies. As a result, companies subject to the new rule should immediately assess the following:
whether contracts with suppliers should be modified to include specific provisions mandating the disclosure of information that will permit compliance with the requirements of Exchange Act Rule 13p-1
whether any information systems need to be modified to gather the type of data necessary to the preparation of a Conflict Minerals Report
whether any “Risk Factors” disclosure in filings with the SEC will need to be revised to indicate that (i) the issuer may have difficulty obtaining supplies that are “DRC conflict free” in sufficient quantities or at competitive prices; (ii) it may experience shipping delays or the cancellation of orders for its products; (iii) implementation of the rule may adversely affect its business, results of operations or financial condition; and (iv) it may suffer reputational damage in the event the issuer determines that its products do incorporate conflict minerals from DRC countries or conclude that such products are “DRC conflict undeterminable”
who might be retained to perform any required independent private sector audit and
what will the estimated legal, audit and IT expenses be in the initial year to implement policies and procedures to address these issues
Osler will continue to monitor and update our clients on any new issues related to Section 1502 of the Act. We would also be pleased to discuss any aspect of Exchange Act Rule 13p-1 and Form SD.
For more information about these developments, please contact the authors of this article.
The authors gratefully acknowledge the contributions of Benjamin Metzler, Osler Summer Associate, in the preparation of this article.