The Securities and Exchange Commission’s (SEC) final rule on conflict minerals (Conflict Minerals Rule) entered into effect on January 1, 2013. The rule directly or indirectly imposes new requirements on a broad spectrum of companies. Companies should strongly consider taking steps now to comply with this rule.
Many companies assume they will not be affected by the Conflict Minerals Rule’s reporting requirements because they are not publicly traded, they are not major users of conflict minerals or they think the rule will be overturned by the courts. However, as discussed in greater detail below, failing to take steps now to assess your company’s use and sourcing of conflict minerals may create legal or commercial risks down the road.
Background
The Conflict Minerals Rule implements statutory requirements enacted as part of the Dodd-Frank Act. Under the rule, certain publicly-traded companies (“issuers”) are required to determine whether their products contain conflict minerals – columbite-tantalite, cassiterite, gold or wolframite – or certain designated derivatives of those minerals – tin, tantalum or tungsten. If an issuer’s products contain conflict minerals that are “necessary to the product’s functionality or production,” the issuer must, with certain narrow exceptions, submit annual disclosures concerning the source of these minerals. Unless a company reasonably determines that the conflict minerals contained in its products do not originate in one of the “covered countries” – the Democratic Republic of Congo and adjoining countries – it must conduct due diligence and prepare a detailed Conflict Minerals Report. In the report, the company must disclose whether the minerals come from “conflict-free” mines.
Since the Conflict Minerals Rule was issued in August 2012, numerous questions have arisen regarding the rule’s applicability and requirements. Some of the more salient questions are discussed below.
Frequently Asked Questions
Do non-issuers have to comply with the Conflict Minerals Rule’s reporting requirements?
The Conflict Minerals Rule directly applies only to issuers. However, the rule makes it clear that if an issuer’s product contains a conflict mineral in a part or component the issuer purchased from a supplier – even a non-issuer supplier – that conflict mineral may be subject to disclosure requirements. Therefore, an issuer must rely on its suppliers to assess their respective use of conflict minerals in the items they supply to the issuer, including any use of conflict minerals by the suppliers’ suppliers. Thus, entire supply chains will be affected by the Conflict Minerals Rule. Issuers must be able to rely on supplier representations and documentation concerning the source of conflict minerals used in their products. If the issuer cannot rely on the thoroughness or veracity of a supplier’s assessment, the issuer may seek an alternative supplier.
The Conflict Minerals Rule permits issuers to report conflict minerals as “conflict undeterminable” for two years, or four years if they are considered a small issuer. During these interim periods, can companies avoid determining the origin of their conflict minerals by answering all inquiries as conflict undeterminable?
Issuers are required to make a good-faith effort to determine the source country of the conflict minerals subject to the disclosure requirements. If an issuer believes its conflict minerals may have originated from covered countries, it must then undertake due diligence to determine the source or chain of custody of the conflict minerals. Issuers using the conflict undeterminable label must disclose their efforts to reduce the risk that any conflict minerals it uses benefit armed groups in covered countries. Thus, an issuer will want to avoid reporting its conflict minerals as conflict undeterminable both to avoid unnecessary due diligence and to avoid negative publicity associated with such a disclosure. Consistent with this, issuers should not accept conflict undeterminable as a supplier response in the absence of good-faith efforts by that supplier to determine the source country.
Is there a de minimis exemption for use of conflict minerals?
No. The Conflict Minerals Rule explicitly provides that there is no exemption for products containing only de minimis levels of conflict minerals. Although the rule incorporates the statute’s limitation that an issuer need only report on conflict minerals that are necessary to the functionality or production of a product, the SEC has interpreted that statutory phrase very broadly – e.g., even trace levels of a conflict mineral remaining after manufacturing a product may be sufficient to cross the statutory threshold.
Our supplier says it does not manufacture or contract to manufacture the product containing conflict minerals. How should I proceed?
The Conflict Minerals Rule applies only to issuers that manufacture or contract to manufacture a product containing a conflict mineral. It is possible that your supplier does not manufacture or contract to manufacture the product it supplies to your company – e.g., if your supplier is simply a distributor. But that does not absolve your company from determining the origin of conflict minerals used in your products, including in any parts or components from that supplier. Thus, companies often will need to insist that their suppliers, including distributors, determine the source of conflict minerals they use in the parts or components they supply.
My company has not yet received conflict minerals inquiries from our customers. Does that mean that we will not be involved in all of this?
Not necessarily. The first conflict minerals disclosures are due to the SEC on May 31, 2014. It is possible that some issuers have not yet realized their products are covered by the Conflict Minerals Rule, or do not understand that they cannot wait until a couple weeks before the due date to gather the necessary information, or they are hoping the courts will vacate the rule or remand it to the SEC for major revisions. As discussed below, the latter hope – that the courts will come to the rescue – may be in vain. In any case, if you know that your company uses conflict minerals, you should consider determining the source of those minerals now, and not wait until asked by a customer. This will help avoid last-minute “fire drills” that may ensue if your customer does not request conflict minerals information until much closer to the reporting deadline.
Our supplier provides us a certificate of origin for Customs purposes. Can I rely on that representation for Conflict Minerals Rule reporting purposes?
No. The country of origin determination under the Conflict Minerals Rule is different than, and often will be at odds with, country of origin determination under Customs law. Customs law applies a substantial transformation or tariff shift rule to determine a product’s country of origin. The Conflict Minerals Rule, in contrast, contemplates obtaining representations as to the country and facility where the conflict minerals were processed irrespective of the product containing the mineral. After processing, a conflict mineral might go through many substantial transformations or tariff shifts under Customs law without changing its origin for purposes of reporting under the Conflicts Minerals Rule.
What consequences might non-issuers face for failing to reply or providing an inaccurate statement to a customer?
Although non-issuing companies are not subject to the Conflict Minerals Rule, issuers risk civil and criminal penalties and also may face civil liability under Section 18 of the Securities Exchange Act of 1934 for fraudulent or false disclosures relating to conflict minerals. Therefore, some issuers may stop purchasing from suppliers that fail to provide reliable information necessary for the issuer’s disclosures to the SEC. In addition, some issuers – and even non-issuing customers further down the supply chain – may seek agreement from their suppliers to indemnify them from any fines, legal fees and other costs incurred from violations of the rule or civil liability resulting from information provided by the supplier. Thus, non-issuer suppliers that provide responses without exercising adequate diligence may jeopardize their future business with customers and/or incur an obligation to reimburse customers’ fines, legal fees and other costs.
The Conflict Minerals Rule is being challenged in court. Shouldn’t my company wait and see the results of this litigation before undertaking potentially time-consuming compliance efforts?
The lawsuit challenging the Conflict Minerals Rule is National Association of Manufacturers et al. v. SEC, No. 12-1422 (D.C. Cir.) (NAM v. SEC). Although NAM is challenging key aspects of the statutory provisions and the Conflict Minerals Rule, it is unlikely that a court will invalidate all of the rule’s disclosure and reporting requirements. Moreover, even a partial victory by the petitioners might not happen soon enough to make a difference for compliance purposes.
First, the petitioners in NAM v. SEC assert that the conflict minerals provision of Dodd-Frank itself is unconstitutional. Specifically, they argue that the statute’s requirement that issuers must disclose whether their conflict minerals are “conflict free” compels speech in violation of the First Amendment. But courts do not apply a stringent standard of review for claims of compelled speech relating to commercial information. In its response brief, the SEC notes that there are numerous reporting requirements under various federal laws, that these have been repeatedly upheld by courts and that nothing particularly distinguishes the conflict minerals reporting requirements in Dodd-Frank from these other reporting requirements. In any case, the petitioners’ argument in this regard pertains only to the last step in the required disclosures: whether the minerals are conflict free. Thus, regardless of the court’s decision on this issue, some, if not all, of the statute’s other, uncontested conflict minerals disclosure and reporting requirements could remain intact.
Second, the petitioners in NAM v. SEC allege that the SEC failed to adequately consider the economic effects of the rule and have interpreted the statute impermissibly in several respects. The court will review these claims in a posture deferential to the SEC. But, assuming for the sake of discussion that the petitioners win one or more of these claims, that result may not materially change the timing and scope of the disclosure and reporting obligations for many issuers. The court could simply remand the Conflict Minerals Rule to the SEC for further explanation, a process that may not result in actual changes to the disclosure and reporting requirements for many issuers.
Third, a win by the petitioners in NAM v. SEC likely will not occur quickly enough for companies to comfortably avoid taking compliance steps. Although NAM initially filed the case in October 2012 with the D.C. Circuit, it was transferred to the D.C. District Court on May 2, 2013 – a time-consuming setback. A ruling on the merits will now almost certainly not be until late 2013 or 2014, leaving too small a window for most issuers to wait and see the outcome of the case before developing their compliance policies and preparing disclosures.
Therefore, companies should not delay implementation of compliance measures on the assumption that the petitioners may win in NAM v. SEC.
Should companies simply avoid all conflict minerals from Central Africa?
There may be some merit to this approach, but it depends on each company’s individual circumstances. On the one hand, companies may face difficulties in sourcing conflict minerals from countries other than covered countries. For example, according to the SEC, up to 20 percent of the global supply of tantalum is sourced from covered countries. Thus, companies that decide, as a matter of corporate policy, not to source conflict minerals from covered countries and not to buy from suppliers unless they do the same, could experience logistics problems or otherwise pay a higher cost to produce their products.
On the other hand, there is also a cost of continuing to source conflict minerals from covered countries. Under the Conflict Minerals Rule, the issuer that sources conflict minerals from covered countries must undertake additional due diligence and prepare and file a Conflict Minerals Report. The report must, inter alia, describe the chain of custody of the conflict minerals and whether the minerals came from mines used to finance armed groups in covered countries. The report must be audited by an independent private sector source.
Given these trade-offs, companies may decide that a more cost-effective approach is to adopt a company policy only to use conflict minerals that are conflict free. Companies can confirm that the conflict minerals that they use are conflict free by, for example, verifying that the source is compliant according to the Conflict-Free Smelter Program created by the Electronic Industry Citizenship Coalition and Global E-Sustainability Initiative (EICC/GeSI). Companies taking this approach would still have to file a Conflict Minerals Report annually, but once they have established that their sources are conflict free, the effort and cost of compliance will decrease considerably over time.
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Contributing author David J. Townsend is an associate in the International Trade & Customs group. Townsend counsels multinational corporations on export controls, economic sanctions, conflict minerals and customs matters. He also represents clients in antidumping and countervailing duty proceedings, and advises on matters arising under the World Trade Organization (WTO). Prior to law school, Townsend worked on the Senate Agriculture, Nutrition and Forestry Committee as the Press Secretary for then-Ranking Member Senator Tom Harkin.
