In a controversial 3-2 vote on August 22, the Securities and Exchange Commission issued final rules designed to cut off funding to groups committing human rights violations in central Africa. The new rules were created pursuant to an obscure provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and require manufacturers and other affected issuers to account for the use of so-called conflict minerals — including tungsten, tantalum, tin, and gold (3T+G) — in their products.
While intended to create greater transparency and accountability among companies that use conflict minerals sourced from the Democratic Republic of Congo (DRC) and adjoining countries, compliance with this new law is expected to be costly and may raise new compliance challenges for some manufacturers.
Affected issuers will need to spend a substantial amount to make an initial determination on whether such conflict minerals exist in their supply chains and, if so, whether these minerals originated from the DRC or adjoining countries. They will also need to incur further costs to monitor their supply chains and to prepare the required annual report to the SEC. The first reports are due on May 31, 2014.
The final conflict-mineral rules require a three-step process. First, manufacturers and issuers who “contract to manufacture” products containing conflict minerals must determine if these minerals “are necessary to the functionality or production of a product.” While the SEC did not define what it means to “contract to manufacture,” or when such minerals are “necessary to the functionality or production of a product,” it instead provided guidance for what it concluded must be a fact- and circumstance-specific determination. Companies will need to look closely at any products that include 3T+G minerals to determine whether the new filing requirement applies.
In determining whether an issuer is subject to these rules, the SEC will look at whether conflict minerals were intentionally included in any of the company’s products, particularly if the mineral’s primary function is for ornamentation or decoration (for jewelry in particular), as well as the function the conflict minerals serve in the products and the products’ intended use or purpose.
For example, if a conflict mineral is required for any one of the myriad functions that today’s smartphones can perform, it will be considered “necessary to the functionality” of the entire phone. Whether an issuer “contracts to manufacture” products containing conflict minerals will depend on how much control or influence the issuer has over the manufacturing process. For retailers and resellers of products that contain conflict minerals, the SEC granted an express exemption if the retailer or reseller does not exercise any control or influence over the manufacturing process. A similar exemption was granted for companies that mine or contract to mine conflict minerals.
The second step for an issuer that uses 3T+G minerals in any of its products is to conduct a “reasonable country of origin inquiry,” or one that is reasonably designed to determine whether the 3T+G minerals used in the products originated in the covered countries or whether they came from scrap or recycled sources. The results of this inquiry must be reported on the SEC’s new Form SD and on the company’s Internet web site, the address for which must also be included on Form SD.
Third, if the company knows or has reason to believe that any of the 3T+G minerals originated in the covered countries and are not from scrap or recycled sources, the issuer must file and post to its web site an independently private sector–audited “Conflict Minerals Report.” The report must detail the steps taken to ensure that the 3T+G minerals used in its products did not benefit the militias committing atrocities in the DRC and surrounding countries and identifying any products that are not “DRC conflict free.”
While these rules do not require any product labeling, manufacturers are able to certify in their Conflict Minerals Report if their products use “DRC conflict free” minerals, if that label applies. If, after its reasonable country of origin inquiry, a company cannot determine the origin of the conflict minerals used in its products, it can report its products as “Conflict Mineral Undeterminable” for the first two years of the reporting requirement (four years in the case of small issuers). That effectively gives such issuers a two-year (or four-year) phase-in period during which to construct supply-chain tracking systems.
These new rules effectively require a full accounting of a manufacturer’s entire supply chain, which may be complex or multilayered. Issuers need to be able to trace the conflict minerals used in their products back to the smelters where they originated.
The SEC estimates that at first, compliance costs will be $2 billion–$3 billion, and the annual continuing cost of compliance will be $206 million–$609 million. The final rules (unlike the draft rules) require companies to “file” the new Form SD with the SEC instead of merely “furnishing” it. Thus, failure to comply with the new rules may subject reporting issuers to potential Section 18 liability under the Exchange Act. Noticeably absent from the final rules, however, are any penalties on issuers that use conflict minerals that are not “DRC conflict free.”
The two dissenting votes cast were by the commission’s Republican members who contended the SEC did not conduct a thorough-enough cost-benefit analysis and suggested the rules could amount to a de facto embargo of 3T+G minerals from the region. That, they reasoned, may worsen conditions in the DRC by depriving people who depend on mining activities for work.
In a related action, the SEC also issued final rules requiring resource extraction issuers engaged in the commercial development of oil, natural gas, or minerals to publicly disclose payments made to the federal government and foreign governments. This rule would also affect mining and energy companies doing business in Africa and elsewhere.
Companies that may be subject to the new conflict-minerals rules should begin the process of determining whether they fall under their authority as soon as possible and consult with compliance specialists regarding any reporting obligations they may have.
Obiamaka P. Madubuko is a partner in the New York office of McDermott Will & Emery LLP and is co-chair of the firm’s FCPA and International Anti-Corruption practice. Adam M. Taylor is an associate in the firm’s Washington, D.C., office.