Legal Alert

SEC Adopts Final Rule on Conflict Minerals Disclosure Requirements

August 24, 2012

On Aug. 22, 2012, the U.S. Securities and Exchange Commission (SEC) adopted a long-awaited final rule requiring public companies to disclose their use of certain “conflict minerals” (CM) originating in the Democratic Republic of the Congo (DRC) and all adjoining nations (“Covered Countries”). Because the final rule applies broadly to domestic and foreign issuers, not just to companies engaged in pure manufacturing, it is expected to pose significant compliance costs and disclosure obligations for public companies that use or supply conflict minerals.

Those issuers covered by the final rule will be required to provide the disclosure in a new Form SD to be filed with the SEC, and thus subject to securities liabilities. As explained below, some companies will be required to file their first CM disclosure report on May 31, 2014 (for the 2013 calendar year) and on May 31 every year thereafter. Under the final rule, issuers are required to file for the same period — a calendar year — regardless of when their fiscal year ends.

Overview and Scope

Section 1502 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) directed the SEC to implement a rule compelling issuers to assess and disclose their use of conflict minerals under the Securities Exchange Act of 1934. The term CM is defined as coltan (tantalum), cassiterite (tin), gold and wolframite (tungsten); their respective derivatives; and any other mineral determined by the Secretary of State to be financing conflict in the Covered Countries. The final rule covers issuers whose CMs are “necessary to the functionality or production of a product manufactured or contracted by that issuer to be manufactured.” Whether an issuer will be considered to contract to manufacture a product depends on the degree of influence it exercises over the manufacturing of that product. Similarly, whether a CM is deemed necessary to the functionality or production of a product is fact-specific, but for a mineral to be necessary for production of a product, SEC has clarified that the mineral must be both contained in the product and necessary to its production. The SEC in the final rule rejected requests to exempt reporting for products that contain de minimus amounts of CM because of the aggregate impact of those products.

If an issuer does not meet the threshold for oversight, it is not required to take any action under the final rule. Moreover, the final rule exempts any CMs that are “outside the supply chain” prior to Jan. 31, 2013 (i.e., smelted or fully refined or already outside the Covered Countries).

Due Diligence and Reporting Requirements

An issuer caught in the oversight net is subject to complicated due diligence and reporting requirements.

Under the final rule, a company must conduct a reasonable, good faith inquiry to determine the “country of origin” of the CM it uses in manufacturing its products. The final rule does not prescribe the actions for a reasonable country of origin inquiry, but does provide general standards. The inquiry must be designed to reasonably determine whether the CM originated in the Covered Countries or is from recycled or scrap sources. If the CM did not originate in the Covered Countries, the issuer must disclose in its specialized disclosure report its determination and briefly describe the inquiry it used in reaching the determination and results. The description must also be publicly available on the company’s website, but retention of business records used to support the origin conclusion is not required.

If, however, a company knows or has reason to believe its minerals may have originated in the DRC or are from scrap or recycled sources, it must conduct due diligence on the source and chain of custody of the minerals. The due diligence must conform to a nationally or internationally recognized due diligence framework, such as the due diligence guidance approved by the Organisation for Economic Co-operation and Development.

After completing its due diligence, in some instances a company will then be required to prepare a Conflict Minerals Report and have it audited by an independent private-sector auditing firm. If required, the CM Report must be filed as an exhibit to Form SD and made publicly available on the company’s website. Generally, the Conflict Minerals Report must detail the due diligence the company undertook on the source and chain of custody of its conflict minerals. The final rule also refers to audit standards established by the U.S. General Accountability Office as being employed at the auditing stage.

Disclosing the use of “DRC Conflict Free,” Not “Conflict Free” and “Undeterminable” Minerals

If a company determines that the minerals used to manufacture or be included in its products originated in the Covered Countries but did not finance or benefit armed groups — then the CM Report must disclose as much by identifying them as “DRC Conflict Free” minerals. Products made from minerals that derive from recycled or scrap sources (i.e., not mined sources) are deemed DRC Conflict Free. The company will still be required to obtain an audit of its CM Report, but the auditor will not be required to opine on the company’s conclusion about the status of its products.

If, however, a company determines that its products have not been found to be DRC Conflict Free, then in addition to the audit requirements, the company must describe in its CM Report:

  • The specific products that are not DRC Conflict Free;
  • The facilities used to process the conflict minerals in those products;
  • The country of origin of the conflict minerals in those products; and
  • Its efforts to determine the mine or location of origin.

However, in an effort to ease the initial compliance burden, the final rule provides an alternate option during a two-year transition period. During the grace period, if a company is unable to determine whether the minerals in its products are DRC Conflict Free, it may classify those products as “DRC Conflict Undeterminable.” A company with products that are classed DRC Conflict Undeterminable will still need to include in its CM Report the foregoing details required for products that are not DRC Conflict Free, as well as the steps the company took or will take to mitigate the risk that its conflict minerals benefit armed groups. But that company will not be required to obtain an independent audit of its CM Report. The “DRC Conflict Undeterminable” disclosure option is not permanent, and upon expiration if a company is still unable to determine whether its products are DRC Conflict Free it will have to obtain an independent audit.

Implications

In a previous McGuireWoods legal update detailing the draft conflict minerals rule, we noted that compliance with the final rules will be a painstaking and potentially costly undertaking. Indeed, according to Law360 and the L.A. Times, SEC staffers estimate that companies will spend $3-$4 billion in creating programs capable of conducting the required due diligence, and another $200-$600 million annually on compliance programs.

Many believe the final rule did not go far enough to control costs, and some suspect business groups are likely to launch a legal challenge to the final rule. As Bloomberg reported earlier this year, business groups have launched a series of challenges against SEC rulemakings, arguing that the SEC has failed to undertake an adequate cost-benefit analysis in crafting and implementing rules required by Dodd-Frank. At least one SEC rule (the proxy access rule) has been struck down on that ground, and Commissioner Paredes seems to argue that the balance is off in this case.

The release of the final rule has been years in the making and has wide-ranging implications for U.S. companies and competitive industries. Issuers that may be subject to the rule’s oversight and disclosure requirements but have not already begun to establish a compliance and due diligence management framework should consider doing so. The efforts involved with product component identification, supply chain mapping, data collection, country of origin inquiry, preparation of disclosure descriptions and CM Reports are not a small undertaking for some issuers. There is a growing trend to develop industry “best practices” composed of detailed, clear guidance on CM due diligence procedures and standards. Several NGOs and corporations are already collaborating to build additional conflict-free standards and certifications.

Ready to Assist

McGuireWoods has been actively monitoring the conflict minerals disclosure rulemaking process and has assembled an experienced legal team to help companies analyze their reporting and disclosure obligations under the new rules. This team includes members of various subject-matter and industry-specific groups, including energy, sustainability, resource management, securities, and government and regulatory investigations and enforcement.