Summary
The SEC has adopted final rules that require specialized disclosures for companies that manufacture goods utilizing "conflict minerals" from certain African countries. The rules are estimated to affect approximately 6,000 reporting companies.

On August 22, 2012, the United States Securities and Exchange Commission (the "Commission") adopted final rules requiring certain issuers that file reports with the Commission under the Securities Exchange Act of 1934 (the "Exchange Act") to file specialized disclosures, on a new Form SD, related to the use of certain minerals known as conflict minerals. The new rule implements Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Conflict Minerals Statutory Provision"), which requires issuers to annually disclose whether any conflict minerals are used in their products and, if so, whether or not those minerals originated in the Democratic Republic of the Congo or any of its adjoining countries. The countries covered by this provision include Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia (the "Covered Countries"). The Commission estimates that approximately 6,000 reporting companies have products containing conflict minerals and will therefore need to file disclosures on Form SD. The Commission further estimates that 4,500 of the approximately 6,000 disclosing issuers use conflict minerals originating in the Covered Countries, and therefore will be required to supplement Form SD disclosures with a "Conflict Minerals Report."

The Conflict Minerals Statutory Provision defines the term "conflict minerals" as certain metal ores and their derivatives, which are determined by the Secretary of State to be financing armed conflicts in the Covered Countries. The conflict minerals listed in the final rule are as follows:

In the final rule, the Commission has provided issuers with a compliance framework consisting of the three steps summarized below. Compliance is required for the calendar year beginning January 1, 2013 and issuers must file their first Form SD and any required Conflict Minerals Report with the Commission by May 31, 2014.

STEP ONE: Determine Whether the Company is Covered by the Conflict Minerals Statutory Provision

Step one requires the issuer to determine if it meets the definition of a company covered by the Conflict Minerals Statutory Provision. An issuer is only covered by the new rule if it is (1) a reporting issuer under Section 13(a) or 15(d) of the Exchange Act and (2) conflict minerals are "necessary to the functionality or production of a product" that the issuer either manufactures or contracts with a third party to manufacture. Whether a conflict mineral is deemed necessary to the functionality of a product or to the production of a product is determined based on the particular facts and circumstances related to the issuer. The rule does not define the phrases "contract to manufacture," "necessary to the functionality," or "necessary to the production" of a product. However, the Commission has provided additional guidance for issuers to consider when determining if they are subject to the new rule, which can be accessed here. If the issuer determines that it does not meet the definition of a company subject to the Conflict Minerals Statutory Provision, then it is not required to take any action, make any disclosures or submit any reports under the new rule. However, if the issuer determines that it does meet such definition, then it must proceed to step two.

STEP TWO: Conduct a Reasonable Country of Origin Inquiry Regarding Company's Conflict Minerals

Step two requires the company to conduct a good faith inquiry into the origin of its necessary conflict minerals to determine if those minerals originated in the Covered Countries or are from recycled or scrap sources. If the company determines that its conflict minerals did not originate in the Covered Countries or that such minerals came from scrap or recycled sources, then the rule requires the company to disclose its determination along with a brief description of the inquiry used in reaching its determination on Form SD. However, if based on its inquiry, the company determines or has reason to believe that it has necessary conflict minerals that (1) originated in the Covered Countries and (2) did not come from recycled or scrap sources, then the company must proceed to step three.

STEP THREE: Exercise Due Diligence on Source and Chain of Custody of Conflict Minerals; File Conflict Minerals Report

Step three requires the issuer to exercise due diligence on the source and chain of custody of its conflict minerals using a nationally or internationally recognized due diligence framework to determine if its conflict minerals financed or benefited armed groups in the Covered Countries. The rule references the Organization for Economic Cooperation and Development (the "OECD") framework as the only known due diligence framework that meets the recognition standard. OECD has released due diligence guidance which can be accessed here. The rule requires any issuer who must exercise due diligence on the source and chain of custody of its conflict minerals to also provide the Commission with a Conflict Minerals Report describing its due diligence method. The rule further requires the issuer to obtain an independent private sector audit of its Conflict Minerals Report. The Commission stated that the audit is intended to express an opinion or conclusion as to (1) whether the design of the issuer's due diligence measures as set forth in the Conflict Minerals Report is in conformity with the criteria set forth in the nationally or internationally recognized due diligence framework, and (2) whether the company's description of its due diligence measures as set forth in the Conflict Minerals Report is consistent with the due diligence process it undertook.

The Form SD and Conflict Minerals Report will be filed with the Commission under the Exchange Act. If an issuer is unable to determine whether or not the minerals used in its products financed or benefited armed groups in the Covered Countries, then the rule provides a temporary transition period of two years for all issuers and four years for smaller reporting companies, during which time, such companies may describe their products as "DRC conflict undeterminable." The Commission has included a flow chart in the final rule that visually maps the three-step compliance process. This flow chart can be accessed here.

NEXT STEPS

Reporting companies now face the complex undertaking of creating a level of transparency throughout their supply chains that may extend all the way back to the mines where the minerals used in their products originated. Compliance with the new rule will require significant cross-organizational focus and impose significant costs on companies that use or supply conflict minerals. Given that the required disclosures apply to activities in the chain of custody beginning on January 1, 2013, and there is no de minimis exemption in the final rule, every public reporting company should initiate efforts now to determine whether it is subject to the Conflict Minerals Statutory Provision. Impacted companies should engage with their suppliers to assess their risks and then make the necessary legal determinations and business decisions that support the required transparency in the chain of custody.

For private companies that are supplying products to public reporting companies, cooperation with compliance efforts will likely become a standard business practice as issuers require suppliers to provide the necessary substantive disclosures on sourced products. Those suppliers that can best meet their customers' emerging needs can gain a competitive advantage. Those that fail to provide the required transparency could lose customers. Therefore, private companies should also begin to engage in this process.

Reporting companies will need to begin to address this process now as there will need to be significant coordination with all of their suppliers to gather the information required to meet the filing deadlines of the rule.