Federal Court Upholds Conflict Minerals Rules, As Time Grows Short To Complete Supply Chain Due Diligence

by K&L Gates LLP

A federal district court in Washington, D.C. has rejected an industry challenge to the Securities and Exchange Commission’s conflict minerals rules (the “Rules”) issued pursuant to Section 1502 of the Dodd-Frank Act. The court’s ruling leaves intact SEC requirements for companies to disclose their use of “conflict minerals” (i.e., gold, tin, tungsten or tantalum) in their products. National Association of Manufacturers, et al. v. Securities and Exchange Commission, C.A. No. 13-cv-635 (RLW) (July 23, 2013). Although the court’s decision could be overturned on appeal, time is running short for companies affected by the Rules to complete the potentially complex and time consuming work necessary to comply. Initial reports under the Rules must be filed on SEC Form SD by May 31, 2014 relating to calendar year 2013 activities.

The Rules affect any company that manufactures products containing any amount of conflict minerals. Although only SEC-reporting companies are required to file conflict minerals reports with the SEC, companies in the supply chain of those businesses – including non-public and even non-U.S. entities – will find themselves effectively compelled to undertake the same kinds of exhaustive product assessments and supply chain due diligence to enable them to respond properly to inquiries from customers subject to the Rules.

By now, many companies will have already received inquiries from customers seeking information about these matters, and the volume of these requests is likely to increase considerably, given the failed court challenge to the Rules and the relatively short time remaining for companies to identify the sources of any conflict minerals that they use.

Businesses affected by the Rules will need to conduct what the Rules refer to as a “reasonable country of origin inquiry” to determine whether the conflict minerals contained in their products may have originated in a “Covered Country,” i.e., the Democratic Republic of the Congo (the “DRC”) or an adjoining country (Angola, Burundi, Central African Republic, Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, or Zambia). If a company is unable to confirm that its “conflict minerals” originated somewhere other than a “Covered Country,” extensive due diligence will be required to determine the precise origin of the products, generally as far up the supply chain as the specific smelter that produced the metal.

Companies that may be subject to the Rules should consider the following steps.

1. Identify each product that contains any conflict minerals. Companies must determine whether conflict minerals are “necessary to the functionality or production” of any products that they manufacture or that they contract to have manufactured for them. Under the Rules, the term “manufacture” is broadly defined.  It includes products manufactured to the company’s specifications by a third party, although it does not include, for instance, generic products to which a third party has simply affixed the company’s logo.

2. Determine the supplier of any conflict mineral contained in the company’s products since January 1, 2013, and contact each such supplier to inquire about the source of that material. The Rules require a “reasonable country of origin inquiry.” The SEC did not mandate any particular methodology for conducting such an inquiry, but rather stated only that it must be conducted in “good faith” and be “reasonably designed to determine whether any of the conflict minerals originated” in the DRC or any other Covered Country, or are from recycled or scrap sources. Conflict minerals obtained from recycled or scrap need not be traced back beyond the recycler or scrap source, in recognition of the impracticality of tracing the source beyond that point.

Determinations about the source of conflict minerals may be based upon what the SEC described as “reasonably reliable representations indicating the facility at which its conflict minerals were processed and demonstrating that those conflict minerals did not originate in the Covered Countries or came from scrap or recycled sources.” These standards would seem to require that a company make inquiry of its suppliers and other entities further up the supply chain. According to the SEC, those representations “could come either directly from that facility or indirectly through the issuer’s immediate suppliers, but the issuer must have reason to believe these representations are true given the facts and circumstances surrounding those representations.”

3. Determine whether any minerals that originated in a Covered Country can be certified to be “conflict- free.” If a company can affirmatively determine that its conflict minerals originated outside the Covered Countries, or after reasonable inquiry either has no reason to believe that they did so originate, or reasonably believes that they came from scrap or recycled sources, no further inquiry is required. An SEC-reporting company will need to file a “Form SD” containing disclosures concerning its determination and describing the nature of its inquiry

Such a conclusion, however, may not always be possible, and if a company either knows that its conflict minerals originated in a Covered Country and did not come from scrap or recycled sources, or the company has reason to believe that its conflict minerals may have originated in a Covered Country or that they did not come from scrap or recycled sources, extensive additional due diligence and disclosure will be required. The Rules require that such due diligence must be conducted in conformity with detailed guidance issued by the Organization for Economic Cooperation and Development (“OECD”), which has issued general guidance for such inquiries, and mineral-specific supplements for particular conflict minerals.

As a result of this due diligence, the company will need to characterize its products in one of three categories.

  • “DRC conflict-free,” i.e., the company affirmatively determines that the product contains no conflict minerals from a Covered Country. In this case, the company need only describe on Form SD its determination and the due diligence efforts that it has undertaken.
  • “Not DRC conflict-free” or “Has not been found to be DRC conflict- free.” In this case, an SEC-reporting company must file a “conflict minerals report” along with its Form SD, containing certain disclosures regarding the smelter or refiner of the conflict minerals involved, the country of origin of the minerals, and the efforts undertaken to determine the mine or other origin of the minerals with the greatest possible specificity. This conflict minerals report must undergo a private-sector audit according to specified standards, and the audit report must be filed with the Form SD.
  • “Conflict Undeterminable.” For reports covering calendar years 2013 and 2014, a third category, “conflict undeterminable,” will be available for items as to which no conclusion can be reached as to their origin. This category will remain available to certain small companies for 2015 and 2016 reports.

In light of the enormous complexity of efforts to collect and synthesize information from throughout worldwide supply chains, various industry groups have been cooperating to pool resources and information among their members. For example, the electronics industry has undertaken an initiative to certify certain smelters as “conflict- free,” and the automotive industry has designed a common set of tools to perform the necessary supply chain inquiries.

Companies that have not yet considered their potential obligations under the Rules should do so promptly, and those that have begun the process should develop plans to complete their work by early 2014. The Rules contain various technical definitions (such as what it means to “manufacture” a product) and other requirements that, for some companies, can either simplify or complicate compliance with the Rules. Given that the SEC will scrutinize the process followed by SEC-reporting companies, and that multiple third parties in the supply chain may rely upon a company’s findings, it will be especially critical to take an approach that the SEC and customers will view as reasonable and in good faith.


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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