On August 22, 2012, nearly 20 months after issuing proposed regulations, the Securities and Exchange Commission (SEC) issued its final rule on disclosure regarding the use of conflict minerals required by Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.1 Section 1502 of Dodd-Frank requires issuers2 to determine whether any of its products contain conflict minerals, and if so, to disclose that annually to the SEC. The term "conflict mineral" is defined under the Act to include "(A) columbite-tantalite (coltan) [also known as tantalum], cassiterite [also known as tin ore], gold, wolframite [also known as tungsten], or their derivatives; or (B) any other mineral or its derivatives determined by the Secretary of State to be financing conflict in the [Democratic Republic of the Congo] ("DRC") or an adjoining country."3
If an issuer uses conflict minerals in its products that originate in the DRC or an adjoining country, it must submit a report to the SEC that includes: (i) a description of the due diligence process, which must be independently audited, conducted to determine the source and supply chain of those conflict minerals;4 and (ii) a description of the products manufactured or contracted to be manufactured that are not DRC conflict free, the identity of the independent auditor, the facilities the issuer uses to process the conflict minerals, the source country of the conflict minerals, and the efforts used to determine their origin or the specific mine from which the minerals were obtained.5 For a product to be considered "DRC conflict free," the product must not contain minerals that finance, directly or indirectly, any armed group in the DRC or adjoining countries.6
As noted above, the requirement extends to any individual or company required to file reports under the 1934 Act who use conflict minerals in the production of any product manufactured or contracted to be manufactured.7 In addition, those subject to these regulations must post the required disclosures on their company websites.8
Three Steps for Compliance
A. Step One: Determining if the Provision Applies
The SEC's final rule sets out three steps issuers should follow in order to comply with requirements of Section 1502. First, issuers must determine whether Section 1502 applies to them. According to the rule, issuers that both directly manufacture products using conflict minerals, as well as those that contract for the manufacturing of their products, are subject to the rule. The final rule states that a company is considered to be "contracting to manufacture" a product if it has influence over the manufacturing of that product. The rule clarifies that a company is NOT deemed to have influence over the manufacturing of a product if it: (1) merely affixes its brand or logo to a generic product manufactured by a third party; (2) services, maintains, or repairs a product manufactured by a third party; or (3) specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product.
In assessing whether it is subject to the conflict minerals disclosure rules, an issuer must determine if the conflict minerals are "necessary to functionality of the product."9 The SEC did not define when a conflict mineral is necessary to the functionality or production of a product. However, the two Congressional sponsors of Section 1502 opined in a comment letter that the provision should cover "all uses of conflict minerals coming from the DRC - except those that are 'naturally occurring' or 'unintentionally included' in the product."10 Notably, the final rule did not carve out an exception for the de minimus presence of conflict minerals in products. Instead, all products with any amount of conflict minerals "necessary to the functionality or the production of the product" are the of subject to the regulation.
B. Step Two: Performing a Reasonable Country of Origin Inquiry
Once an issuer has determined that its products contain minerals listed in Section 1502, it must determine if these minerals are truly conflict minerals, as defined by the statute, and conduct an inquiry into the origin of the contents of their products.11 The SEC stated in its rule that, in determining the origin of the minerals, the regulation requires a "reasonable country of origin inquiry," executed in good faith.12 However, the SEC did not set forth guidelines as to what constitutes a reasonable country of origin inquiry. Rather, it noted that it would consider an issuer to have satisfied the inquiry requirement it if sought and received reasonably reliable representations from the facility at which its minerals were processed that those minerals did not originate from the DRC or a neighboring country.
If, after completing a reasonable country of origin inquiry, the company knows or has reason to believe that the minerals did not originate in any of the listed countries, or are from scrap or recycled sources, the company must provide a brief description of the basis for its determination on newly created Form SD, which will be required to be filed with the Commission. The issuer must post that description on its website and disclose the website address to the Commission on Form SD.
On the other hand, if a company knows or has reason to believe that the minerals may have originated in one of the listed countries, or may not be from scrap or recycled sources, the company must perform due diligence on the source and chain of supply of its minerals and submit a Conflict Minerals Report ("CMR") as an exhibit to Form SD. The CMR must also be posted on the company website.13
C. Step Three: Creating a Conflict Minerals Report
The CMR itself must include proof that the company conducted due diligence on the source and chain of supply of the conflict minerals. The due diligence must meet a standard that is nationally or internationally recognized, such as the due diligence guidance approved by the Organisation for Economic Cooperation and Development ("OECD").
A company's products can still be labeled "DRC conflict free" if the minerals originate from one of the listed countries but did not finance or benefit armed groups. If a company determines, after conducting due diligence, that its products are "DRC conflict free," it must certify its findings by: (1) obtaining an independent private sector audit of its CMR; (2) certify that it obtained the audit; (3) identify the auditor; and (4) append a copy of the audit report as part of the CMR.
If a company cannot assert that its products are "DRC conflict free," then, in addition to the audit and certification requirements listed above, the company must state in its CMR: (1) that the products manufactured or contracted to be manufactured have not been found to be "DRC conflict free"; (2) the facilities used to process the conflict minerals; (3) the country of origin of the conflict minerals; (4) the efforts to determine the mine or location of origin with the "greatest possible specificity."14
Finally, if a company is unable to determine if its products are "DRC conflict free" because it cannot determine the country of origin, or it cannot determine if the minerals in its products financed or benefited armed groups, it will be subject to a temporary two-year transition period during which time its products will be labeled "DRC conflict undeterminable." The company must still file a CMR, stating: (1) the facilities used to process the conflict minerals; (2) the country of origin, if known; (3) the efforts to determine the mine or location of origin with the greatest possible specificity; (4) the steps the company has taken or will take to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve its due diligence process. The company is not required, however, to obtain an independent private sector audit of its CMR.
As issuer with a disclosure obligation must file its first report by May 31, 2014, regardless of its filing date for other SEC reports.
Even though the new rule imposes an onerous disclosure and due diligence requirement, it does not preclude an issuer from using conflict minerals. Rather, it only requires investigation and accurate reporting of such use. If an issuer intentionally files misleading disclosures regarding its use of conflict minerals, or fails to make a required disclosure, it could face liability under Section 10(b)(5) of the Exchange Act or potential shareholder litigation. Thus, an issuer that suspects it might have diligence and disclosure obligations under the new rule should take immediate steps to identify each of the products it manufactures and contracts to manufacture, and determine if any of those products contain conflict minerals. If an issuer determines that conflict minerals are present in its products, and that the conflict minerals are necessary to the functionality of those products, the company should undertake immediate efforts to map the supply chain of the minerals to their original source. Companies should request that their suppliers communicate with any sub-suppliers throughout the supply chain to advise them of the company's obligation to inquire and, in certain instances, audit the entire supply chain regarding the presence of conflict minerals. If an issuer is unsure about its ability to conduct adequate diligence or is uncertain about its ability to file accurate disclosures, it may want to consider locating potential alternative sources of minerals, or obtain products from suppliers who can certify that they supply "DRC conflict free" products.
Please contact Ray Banoun, Jodi Avergun, Paul Pantano, or Karen Woody, in the Business Fraud and Energy & Commodities groups at Cadwalader, Wickersham & Taft LLP if you have any questions about compliance with the new rule.
1 Press Release, SEC Adopts Rule for Disclosing Use of Conflict Minerals, Release No. 2012-163 (Aug. 22, 2012).
2 An issuer is any reporting company with registered publicly held securities.
3 78m(p)(1)(A). "Adjoining countries" include Angola, Burundi, Central African Republic, Republic of Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia.
4 This independent audit must be certified by the disclosing party, which is an integral part of the due diligence process. Section 78m(p)(1)(B). Additionally, this audit must be considered reliable by the SEC. See Section 78m(p)(1)(C).
5 § 78m(p)(1)(A)(i)-(ii).
6 § 78m(p)(1)(D).
7 § 78m(p)(2)(A)-(B).
8 § 78m(p)(1)(E).
9 § 78m(p)(1)(A).
10 17 CFR 229, 249; Release No. 34-63547; File No. S7-40-10, December 2010 at 20.
11 Id. at 27.
12 Id. at 34.
13 Press Release, SEC Adopts Rule for Disclosing Use of Conflict Minerals, Release No. 2012-163 (Aug. 22, 2012).