The Conflict Minerals Report’s Content and Supply Chain Due Diligence

by Stinson Leonard Street - Dodd-Frank and the Jobs Act
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The SEC describes application of the conflicts mineral rule as a three step process:

  • Step 1:  An issuer must determine whether it is subject to the requirements of the conflict minerals statutory provision.  The provision applies where  “conflict minerals are necessary to the functionality or production of a product manufactured by such person.”
  • Step 2:  Issuers within the scope of step one must conduct a reasonable country of origin inquiry regarding the origin of its conflict minerals.  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.
  • Step 3:  Step three applies to issuers who know their conflict minerals came from the Democratic Republic of the Congo or have reason to know that may have.  An issuer must exercise due diligence on the source and chain of custody of its conflict minerals and provide a conflict minerals report describing its due diligence measures, among other matters.

This blog post will focus on step three.

Content of the Conflict Minerals Report

The final rule requires any issuer that, after its reasonable country of origin inquiry, knows that its conflict minerals originated in the covered countries and did not come from recycled or scrap sources to provide a conflict minerals report.  The report must include a description of the measures the issuer has taken to exercise due diligence on the source and chain of custody of those conflict minerals.

The final rules also require an issuer that, after its reasonable country of origin inquiry, to include a conflict minerals report if the issuer:

  •  had reason to believe that its minerals may have originated in the covered countries and may not have come from recycled or scrap sources and,
  • after the exercise of due diligence, still has reason to believe that its minerals may have originated in the covered countries and may not have come from recycled or scrap sources.

The final rule does not require a physical label on any product. Instead, the final rule requires that an issuer describe in its conflict minerals reports any products that have not been found to be “DRC conflict free,” as defined in the final rule.

The  rule also requires, unless an issuer’s products are “DRC conflict free,” that the conflict minerals report to include a description of the facilities used to process those conflict minerals, the country of origin of those conflict minerals, and the efforts to determine the mine or location of origin with the greatest possible specificity.

There is special temporary relief for step three issuers.  Issuers that have proceeded to step three may not be able to determine that their:

  •  conflict minerals did not originate in the covered countries,
  •  their conflict minerals that originated in the covered countries did not directly or indirectly finance or benefit armed groups, or
  •  conflict minerals came from recycled or scrap sources.

The final rule permits such issuers to describe products containing those conflict minerals as “DRC conflict undeterminable.” An issuer with products that are “DRC conflict undeterminable” is required to exercise due diligence on the source and chain of custody of its conflict minerals and submit a conflict minerals report:

  • describing its due diligence;
  • the steps it has taken or will take, if any, since the end of the period covered in its most recent prior conflict minerals report to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve its due diligence;
  • the country of origin of the conflict minerals, if known;
  • the facilities used to process the conflict minerals, if known; and
  • the efforts to determine the mine or location of origin with the greatest possible specificity, if applicable.

The “undeterminable” reporting alternative, however, is only permitted temporarily. For all issuers, this alternative will be permitted during the first two reporting cycles following the effectiveness of the final rule, which includes the specialized disclosure reports for 2013 through 2014. For smaller reporting companies, this alternative will be permitted during the first four reporting cycles following the effectiveness of the final rule, which includes the specialized disclosure reports for 2013 through 2016. Beginning with the third reporting period, from January 1, 2015 to December 31, 2015, for all issuers and the fifth reporting period, from January 1, 2017 to December 31, 2017, for smaller reporting companies, every such issuer will have to describe products in its Conflict Minerals Report as having “not been found to be ‘DRC conflict free.’

The final rule requires an issuer with conflict minerals that originated in the covered countries to determine whether those minerals directly or indirectly financed or benefited armed groups in the covered countries. The conflict minerals statutory provision states that products are “DRC conflict free” when those products do not contain conflict minerals that “directly or indirectly finance or benefit armed groups” in the covered countries.  An “armed group” is defined as “an armed group that is identified as perpetrators of serious human rights abuses in the annual Country Reports on Human Rights Practices under sections 116(d) and 502B(b) of the Foreign Assistance Act of 1961,” as they relate to the covered countries.

Due Diligence Standard

The rule requires that an issuer describe the due diligence it exercised in determining the source and chain of custody of its conflict minerals. The rule requires that an issuer’s due diligence follow a nationally or internationally recognized due diligence framework.

The OECD’s “Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas” satisfies the SEC’s criteria and may be used as a framework for purposes of satisfying the final rule’s requirement that an issuer exercise due diligence in determining the source and chain of custody of its conflict minerals.

Independent Private Sector Audit Requirements

For issuers who reach step three, an independent private sector audit is generally required except:

  • for issuers relying on the temporary “undeterminable” reporting alternative regarding the products that are DRC conflict undeterminable; and
  • step thee issuers that ultimately determine the conflict minerals did not originate in the covered countries.

 In circumstances in which an independent private sector audit is required, the final rule requires that an issuer include a certified independent private sector audit conducted in accordance with the standards established by the Comptroller General of the United States as part of its due diligence on the source and chain of custody of its conflict minerals. Further, the final rule states that the audit constitutes a critical component of due diligence. To implement the conflict minerals statutory provision’s requirement that issuers “certify the audit,” an issuer must certify that it obtained an independent private sector audit of its conflict minerals report and include that certification in the conflict minerals report. The issuer’s audit certification need not be signed by an officer.  Instead, the certification takes the form of a statement in the conflict minerals report that the issuer obtained an independent private sector audit.

Under the conflict minerals statutory provision, the GAO is to establish the appropriate standards for the independent private sector audit. The GAO staff has indicated to SEC staff that the GAO does not intend to develop new standards for the independent private sector audit of the Conflict Minerals Report. GAO staff have also informed the staff that existing Generally Accepted Government Auditing Standards, or GAGAS, such as the standards for Attestation Engagements or the standards for Performance Audits will be applicable.

Entities performing an independent private sector audit of the conflict minerals report must comply with any independence standards established by the GAO, and any questions regarding applicability of GAGAS on this point should be directed to the GAO. The SEC did not adopt any additional independence requirements.

The final rule states that the audit’s objective is to express an opinion or conclusion as to whether the design of the issuer’s due diligence framework 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.

Recycled and Scrap Materials

Under the final rule, if an issuer has reason to believe, as a result of its reasonable country of origin inquiry, that its conflict minerals may not have been from recycled or scrap sources, it must exercise due diligence. The issuer would then be required to provide a conflict minerals report if it is unable to determine that the conflict minerals came from recycled or scrap sources.

Conflict minerals are considered to be from recycled or scrap sources if they are from recycled metals, which are reclaimed end-user or post-consumer products, or scrap processed metals created during product manufacturing. Also, based on the OECD definition, the final rule states that recycled metal includes excess, obsolete, defective, and scrap metal materials that contain refined or processed metals that are appropriate to recycle in the production of tin, tantalum, tungsten and/or gold. The final rule states further, however, that minerals partially processed, unprocessed, or a byproduct from another ore will not be included in the definition of recycled metal.

The final rule only requires an issuer with conflict minerals from recycled or scrap sources to exercise due diligence if it has reason to believe, following its reasonable country of origin inquiry, that its conflict minerals that it thought were from recycled or scrap sources may not be from such sources. If so, as is true for issuers with conflict minerals from newly mined sources, the issuer must exercise due diligence that conforms to a nationally or internationally recognized due diligence framework, if such a framework is available.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

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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