Blog: State Department ventures into conflict minerals

by Cooley LLP
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Bloomberg BNA is reporting that the State Department has launched a new review of  “how best to support responsible sourcing of conflict minerals,” which will continue through April 28. Although it’s not known whether the SEC is involved in the State Department’s efforts, BNA suggests that the review “could help determine the next step in a potential rethink” of the SEC conflict minerals rule.

The Dodd-Frank conflict minerals rule requires reporting by public companies if they manufacture or contract to manufacture products that use conflict minerals that are necessary to the functionality or production of those products. Those companies are required to conduct a “reasonable inquiry” to determine if the conflict  minerals used were from a covered country. If, based on that inquiry, the company knows or has reason to believe that the conflict minerals originated in the covered countries (or if the company learns or has reason to believe that its minerals may not be recycled or scrap), the company is required to conduct substantial due diligence on its supply chain to determine if the conflict minerals financed or benefited armed groups in the covered countries and to file a “Conflict Minerals Report” with the SEC.

As reported in August 2016 by the GAO, for most companies, the sources of their conflict minerals remains a mystery, notwithstanding several years of effort. BNA reports that, “[w]hile armed groups are not absent from the mining sector, field research by the International Peace Information Service shows their presence has been reduced at mines in eastern DRC for three of the minerals—tin, tantalum and tungsten—but they remain common and have even reportedly increased in the gold sector.”

SideBar: As discussed in this PubCo post, the GAO, which is required to report annually on the effectiveness of the SEC’s conflict minerals rule in promoting peace and security in the DRC and adjoining countries, as well as on the rate of sexual violence in war-torn areas of these countries, outlined in its most recent report the many challenges to supply chain due diligence. These challenges arise, in part, out of the fraud risk associated with reliance by processing facilities on documentary evidence from upstream stakeholders, compounded by the complexity of processing operations and the lack of infrastructure and government support. In addition to fraud, the GAO report describes problems of smuggling, falsified source-of-origin documentation, black market sales and other challenges to the integrity of the programs designed to assure responsible sourcing.

Although the GAO’s reviews “indicate some progress in companies’ efforts to comply with some key provisions of the rule, they also indicate that companies continue to face some challenges in their supply chain due diligence efforts.” According to the GAO, for 2015, 79% of companies filing conflict minerals Form SD with the SEC performed due diligence and, of those, 67% reported they were unable to confirm the source of the conflict minerals in their products, while 97% reported that they could not determine whether the conflict minerals financed or benefited armed groups in the covered countries (the due diligence test for determining whether or not products are conflict-free.) In interviews, the GAO heard that companies experienced difficulties in obtaining sufficient information from all suppliers to enable them to determine the country of origin of all conflict minerals in their products, that some suppliers did not respond to requests for information and that some information from suppliers was incomplete (although supplier follow-ups helped mitigate that problem in some cases).

Earlier this year, Michael Piwowar, the acting SEC Chair, issued a statement indicating that he had directed “the staff to consider whether the 2014 guidance is still appropriate and whether any additional relief is appropriate in the interim.”  (The 2014 Guidance was issued by then-Corp Fin Director Keith Higgins advising companies on conflict minerals compliance requirements in light of recent litigation.)  In that regard, he welcomed the submission of public comments during the next 45 days, which comment period has now closed. (See this PubCo post.) He also issued an additional statement warning that, in his view, the rule was misguided, had resulted in unintended negative consequences for the region and had also undermined U.S. national security interests. Subsequently, various media leaked a purported draft of an executive order that, in effect, would have suspended the conflict minerals disclosure rule based on the national security waiver provision in Dodd-Frank.  But no action has yet been taken. (See this PubCo post.)

Where is this headed now? Will the current rules be revised based on comments received? Or could the State Department review cause the issue to be moved outside of the SEC’s jurisdiction entirely to a different agency that would employ a different regulatory framework?  According to BNA, the current administration

“seemed poised to suspend or rework the reporting rule—until [a number of] major corporations said they would continue rooting out conflict minerals from their supply chains regardless. ‘That gave them pause,’ said Arvind Ganesan, who leads Human Rights Watch’s work on abuses linked to business and other economic activity. Instead, the agencies’ month-long request for feedback could be an attempt to ‘repeal and replace’ the SEC reporting requirement with other government policies or programs, said Sasha Lezhnev, associate director of policy at the nonprofit Enough Project. Doing so would address one of the main criticisms leveled at the rule by groups like the U.S. Chamber of Commerce and the National Association of Manufacturers. ‘We think it’s a fundamentally flawed rule and the SEC is the wrong agency to try to solve this kind of problem,’ the Chamber’s Brian O’Shea told Bloomberg BNA. ‘So involving the agencies that do have expertise is an important step,’ he said.”

SideBar: Perhaps State or other agencies will take a look at the model for conflict minerals compliance adopted earlier this month by the European Parliament. While more prescriptive than the U.S. rules adopted under Dodd-Frank, the EU rules approach the issue from a different angle. Unlike the U.S. provisions, which apply to companies that manufacture, or have manufactured, products that contain necessary 3TG, the EU rules apply to EU-based “Union importers” of 3TG at the “metal stage,” whether in the form of mineral ores, concentrates or processed metals  — they will not apply to companies that import products, such as electronic devices, that contain the minerals. Similarly, while the U.S. rules have no de minimis exceptions, the EU rules contain annual import threshold levels for the various minerals and metals. In addition, EU state authorities are to play a more active role. For example, the European Commission will create a “white list” of global smelters and refiners that it has confirmed source responsibly, applying supply chain due diligence schemes recognized by the Commission. And, unlike Dodd-Frank, which is primarily disclosure-based, EU Member State authorities will verify compliance by EU importers by examining documents and audit reports and, if necessary, carrying out on-the-spot inspections of an importer’s premises. (See this PubCo post.)

Or, the rule could vanish, either temporarily or permanently. Even if the purported executive order suspending compliance were signed, the exemption would be limited by statute to two years.  However, the conflict minerals provision in Dodd-Frank was identified for repeal in the original Financial CHOICE Act and could be jettisoned under the Financial Choice Act 2.0 — if it passes through Congress unscathed that is. (See this PubCo post.)

As of now, however, as confirmed by Acting Corp Fin Director Shelley Parratt in February,   conflict minerals filings are still due on May 31. (See this PubCo post.)

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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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