On August 22, 2012, pursuant to Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 15 U.S.C. § 78m(p), the Securities Exchange Commission (the SEC) adopted a final rule requiring certain publicly traded companies to disclose whether they use “conflict minerals” in their products and describe the efforts that they have undertaken to ensure their use of those minerals does not contribute to the ongoing conflict in the Democratic Republic of Congo and adjoining countries (the Covered Countries). This disclosure is required to be filed annually with the SEC on a new specialized disclosure report (Form SD), and, where applicable, a Conflict Minerals Report must be filed as an exhibit to Form SD.

Three-Step Test

The final rule sets forth a three-step test that potentially-impacted companies must undertake on an annual basis to determine the company’s required level of disclosure, if any. The results of each step determines whether the company is required to make any disclosure regarding the use of conflict minerals, exercise due diligence on the source and chain of custody of its conflict minerals, and file a Conflict Minerals Report.

Step One:  What Companies and Products are Covered?

The final conflict minerals rule is applicable to a company that files reports with the SEC under Sections 13(a) or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act) and determines that “conflict minerals” are actually contained in a product “manufactured or contracted to be manufactured” by it where such minerals are “necessary to the functionality or production of the product.”

“Conflict minerals” are defined to mean four commonly used minerals, regardless of their origin and amount:  cassiterite (and its derivative, tin), columbite-tantalite (and its derivative, tantalum), wolframite (and its derivative, tungsten), and gold.[1] These minerals are commonly used to manufacture appliances, jewelry, and electronics, including products with electronic components such as mobile telephones, computers, video game consoles and digital cameras.

The final rule does not specifically define the terms “manufacture,” “contract to manufacture” or “necessary to the functionality or production of products,” but does provide guidance and factors that companies should consider in making this determination.

“Manufactured” and “contracted to be manufactured.” The new rule notes that, while the term “manufacture” is generally understood, the SEC does not consider a company that only services, maintains or repairs products containing conflict minerals as “manufacturing” a product.

Concerning whether a company has “contracted to manufacture” a product, the new rule provides that this is based on the issuer’s particular facts and circumstances and depends on the degree of influence exercised by the company over the manufacturing of the materials, parts, ingredients, or components of products containing conflict minerals. However, the final rule provides that a company is not considered to contract to manufacture solely by engaging in the following actions:

  • specifying or negotiating terms with the manufacturer not directly relating to the manufacturing of the product (such as training or technical support, price, insurance, indemnity, intellectual property rights, dispute resolution, or other like terms and conditions concerning the product), unless such actions are performed so as to exercise a degree of influence over the manufacturing that is practically equivalent to contracting on terms that directly relate to manufacturing of the product;
  • affixing a company’s brand, marks, logo or label to a generic product manufactured by a third party; or
  • servicing, maintaining or repairing a product manufactured by a third party.

“Necessary to the functionality or production of products.” The new rule provides that a company should consider the following factors in determining whether, based on the company’s particular facts and circumstances, conflict minerals are “necessary to the functionality” of products:

  • whether the conflict mineral is contained in the product, noting that only conflict minerals that are contained in the product can be considered necessary to the functionality of the product;
  • whether the conflict mineral is intentionally added to the product or any component of the product (as opposed to being a naturally occurring byproduct);
  • whether the conflict mineral is necessary to the product’s generally expected function, use or purpose; and
  • if the conflict mineral is incorporated for purposes of ornamentation, decoration or embellishments, whether the primary purpose of the product is ornamentation or decoration.

The new rule provides that a company should consider the following factors in determining whether, based on the company’s particular facts and circumstances, conflict minerals are “necessary to the production” of products:

  • whether the conflict mineral is contained in the product, noting that a conflict mineral used as catalyst in the production process, but not contained in the product, is not considered necessary to the production of the product;
  • whether the conflict mineral is intentionally added in the product’s production process;
  • conflict minerals contained in tools, machinery and equipment used to produce a product are not considered necessary to the production of the product;
  • conflict minerals used in materials, prototypes and other demonstrating devices are not considered products are therefore not subject to the new rule.

If an issuer determines that conflict minerals are not necessary to the functionality or production of products it manufactures (or has contracted to be manufactured), no further inquiry and no conflict minerals-related disclosure are required. However, if an issuer determines that conflict minerals are actually contained in its product and are necessary to the functionality or production of the product it manufactures (or has contracted to be manufactured), the company is subject to the disclosure obligations of the conflict minerals rule and must proceed to the second step of the test.

Step Two:  Reasonable Country of Origin Inquiry and Required Disclosures

If an issuer determines that conflict minerals are necessary to the functionality or production of products it manufactures (or has contracted to be manufactured), the company is required to conduct a reasonable country of origin inquiry regarding its necessary conflict minerals. The final rule does not prescribe the specific actions necessary to constitute “reasonable inquiry,” but provides that the inquiry must be conducted in good faith and “reasonably designed” to determine whether the conflict minerals originated from the Covered Countries or came from recycled or scrap sources.[2]

The new rule sets forth guidance describing the actions that satisfy the “reasonable good faith inquiry” standard. For example, an inquiry is reasonable if the company seeks and obtains reasonably reliable representations from the facilities at which the conflict minerals were processed, and/or from the company’s immediate suppliers, identifying the facility at which the conflict minerals were processed and demonstrating that the conflict minerals did not originate in the Covered Countries (or that they came from recycled or scrap sources). A company may reasonably rely on such representations if it has reason to believe the representations are true under the particular circumstances (e.g., if a processing facility received a “conflict-free” designation from a recognized industry group or obtained an independent private-sector audit that is made publicly available), assuming the company does not ignore warning signs to the contrary. The SEC clarifies that a company is not required to obtain representations from all of its suppliers to satisfy the “reasonable good faith inquiry” standard.

If, based on its reasonable country of origin inquiry, an issuer:  (i) determines that its conflict minerals did not originate in the Covered Countries or did come from recycled or scrap sources, or (ii) has no reason to believe that its conflict minerals may have originated in the Covered Countries or reasonably believes that its conflict minerals are from recycled or scraped sources, no further due diligence on the source or chain of custody and no Conflict Minerals Report (discussed below) are required. The company, however, must disclose its determination, a brief description of its reasonable inquiry efforts and the results of its inquiry on Form SD.

Step Three:  Supply Chain Due Diligence and Conflict Minerals Report

If a company has reason to believe that its conflict minerals may have originated in the Covered Countries (and did not come from recycled or scrap sources) based on the results of its reasonable country of origin inquiry, the company is required to exercise due diligence on the source and chain of custody of its conflict minerals. These due diligence efforts must conform to a nationally or internationally recognized due diligence framework.

The results of the company’s due diligence efforts will determine whether the company is required to prepare and file a Conflicts Mineral Report.

A. No Conflict Mineral Report Required

If a company’s due diligence investigation results in a determination that its conflict minerals did not originate in the Covered Countries (or that the conflict minerals did come from recycled or scrap sources) the company is required to report its determination, a brief description of its country of origin inquiry and its due diligence efforts, and the results of its reasonable inquiry and due diligence efforts on Form SD. No Conflicts Minerals Report is required.

B. Conflict Minerals Report Required

On the other hand, if a company’s due diligence investigation results in a determination that the company’s conflict minerals did originate in the Covered Countries (and did not come from recycled or scrap sources), the company must prepare and file a Conflict Minerals Report, including an independent private sector audit of the report,[3] and provide the Conflict Minerals Report on the company’s website. The Conflict Minerals Report must include the following information:

  • A description of the measures taken to exercise due diligence on the source and chain of custody of the conflict minerals.
  • For all products that have not been found to be “DRC conflict free:”[4]
    • a description of the products;
    • a description of the facilities used to process the necessary conflict materials in those products;
    • the country of origin of the necessary conflict minerals in those products; and
    • the company’s efforts to determine the mine or location of origin with the greatest possible specificity.
  • An audit report prepared by an independent private sector auditor.
  • A statement that the company obtained an independent private sector audit of the Conflict Minerals Report, which constitutes the company’s certification of the audit.

Compliance Dates

The first disclosure reports are due May 31, 2014 (for the 2013 calendar year) and annually on May 31 every year thereafter. All issuers are required to file on a calendar year basis, regardless of their fiscal year. Companies must also disclose on the company’s website all information required to be reported on Form SD.

During an initial two-year transition period (four years for smaller reporting companies), instead of designating products as “having not been found to be DRC conflict free,” a company may instead designate a product as “DRC conflict undeterminable,” if, after completion of the company’s due diligence on the source and chain of custody of its conflict minerals, the company is unable to determine:

  • that its conflict minerals did not originate in the Covered Countries;
  • that its conflict minerals that originated in the Covered Countries did not directly or indirectly finance or benefit armed groups; or
  • that its conflict minerals came from recycled or scrap sources.

During this transition period, for all products that the company has determined as “DRC conflict undeterminable,” the Conflicts Mineral Report must include the following:

  • a description of the measures taken to exercise due diligence on the source and chain of custody of the conflict minerals;
  • a description of the products;
  • a description of the facilities used to process the necessary conflict minerals in those products, if known;
  • the country of origin of the necessary conflict minerals in those products, if known;
  • the company’s efforts to determine the mine or location of origin with the greatest possible specificity; and
  • the steps taken and to be taken to mitigate risk that the necessary conflict minerals benefit armed groups, including any steps to improve its diligence.

Companies are not required to obtain an independent audit of Conflict Mineral Reports regarding the conflict minerals that are “DRC conflict undeterminable” during this transition period. After expiration of the transition period, companies must describe products containing conflict minerals for which the company is unable to make a “DRC conflict free” determination as “having not been found to be ‘DRC conflict free,’” and such companies must include an independent private sector audit of their Conflict Minerals Reports.

Potential Liability

The final rule requires Form SD to be “filed” rather than “furnished,” exposing companies to liability under Section 18 of the Exchange Act. Section 18 imposes liability for material misstatements or omissions in SEC filings, which form the basis for claims by investors to bring suit if companies fail to comply with conflict minerals disclosure requirements.

Issuers would also be subject to potential liability under Sections 10(b), 13(a) and (p) and 15(d) of the Exchange Act.

In addition to the potential liability and compliance costs associated with the conflict mineral rules, issuers should be aware that the new rule will likely lead to increased shareholder activism as a result of the conflict mineral disclosures.

Conclusion

To comply with the final conflict minerals rule, issuers will need to develop procedures designed to identify and monitor the use of conflict minerals in their products. As these procedures are developed and implemented, issuers should carefully document the steps that they have taken to comply with this new rule.

Many of the key defined terms used in the final rule are far from clear and open to different interpretations. The SEC has indicated that it intends to publish a Questions and Answers release addressing questions that it has received, which will hopefully clarify some of these issues.


A copy of the final conflict minerals rule, 77 Fed. Reg. 56274 (Sept. 12, 2012), is available at http://www.gpo.gov/fdsys/pkg/FR-2012-09-12/html/2012-21153.htm. In addition, the SEC Final Release No. 34-67716 (August 22, 2012), Conflict Minerals is available at www.sec.gov/rules/final/2012/34-67716.pdf.

 

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[1] Other minerals or derivatives may be included within this definition if the Secretary of State determines they are financing conflict within the Covered Countries.

[2] Conflict minerals are considered “from recycled or scrap sources”  if they are from recycled metals, which are reclaimed end-user or postconsumer products, or scrap processed metals created during product manufacturing.

[3] The final rule provides guidance regarding the audit objective. The final rule does not require an audit of the entire Conflict Minerals Report. Rather, the audit objective is to evaluate and express an opinion whether the issuer’s due diligence complies with applicable standards. The final rule does not require an audit of whether specific products are or are not DRC conflict free.

[4] A product is “DRC conflict free" if it does not contain conflict minerals necessary to the functionality or production of that product that directly or indirectly finance or benefit armed groups in a Covered Country (i.e., groups identified as perpetrators of serious human right abuses in annual reports prepared by the U.S Department of State); provided that “DRC conflict free” includes conflict minerals obtained from recycled or scraped sources. See Sections 13(p)(1)(A)(ii) and 13(p)(1)(D) of the Exchange Act.

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