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The SEC’s Final Conflict Minerals Rule Will Impose Broad Diligence and Reporting Obligations on Manufacturers

Friday, August 24, 2012

After missing multiple statutory and internal deadlines, on August 22, 2012, the Securities and Exchange Commission (SEC) adopted, by a 3-2 vote, a final rule laying out the obligations that publicly traded companies must meet under the “Conflict Minerals” provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Those statutory requirements obligate SEC-reporting manufacturers and companies that “contract for manufacture” to conduct far-reaching inquiries into their upstream supply chains in furtherance of a congressionally mandated initiative intended to cut off sources of cash for violent warlords in central Africa. If companies find that their products contain even small amounts of gold, tin, tantalum, or tungsten – metals used in a vast array of products – they must undertake a search designed to ascertain whether any of those materials originally came from the Democratic Republic of the Congo (DRC) or any of its neighboring countries.

Unless the answer is clearly “no” (e.g., the source was recycled metal or another region than central Africa), the company must file a Conflict Minerals Report with the SEC and conduct additional diligence, potentially including an independent private-sector audit.

The compliance costs of this program are expected to be very significant, and a broad cross-section of U.S. companies should be taking steps now to ensure compliance mechanisms are in place by the time the initial reporting period begins in January 2013, with the first reports due in May 2014.

While the SEC’s final regulation relaxed some provisions compared to its 2010 proposal, most of these changes relate to clarifying or simplifying implementation of the rule, but the basic process and most stringent requirements remain unchanged. For example, the final rule includes no exemptions, either for de minimis quantities of conflict minerals in a product, particular uses of the minerals, or types of companies, and small businesses must meet the same requirements as larger entities, except for one extended time limit noted below.

The one important area in which the SEC softened the rule’s requirements is to allow companies that have a reasonable basis to believe their conflict materials came from recycled or scrap metals to avoid the most onerous diligence efforts, but they will still need to undertake and document some type of supply-chain review to make this determination.

In addition, the final rule allows a two-year transition period (four years for small businesses) during which companies can, if necessary after a reasonable inquiry, report the source of their conflict minerals as “DRC conflict indeterminable”; this temporary period is meant to allow time for development of infrastructure that will facilitate tracing of the sources of the specified minerals used in their products. As with the eased recycled metals requirement, however, the transition period provision still requires companies to go through the upfront processes of assessing all of their products to see if they contain conflict minerals, investigating upstream supply chains, and preparing and filing a report with the SEC.

As with the proposal, the final rule establishes a three-step process:

  1. Companies that are required to file reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 must determine whether they manufacture or contract to manufacture products that contain conflict minerals. The final rule does not define key terms necessary to make this determination, but does provide guidance on how to approach this assessment.
  2. Those companies that manufacture or contract to manufacture products that contain conflict minerals must conduct a reasonable country-of-origin inquiry of their supply chains to ascertain whether any of the metals originated in the DRC or adjacent countries (Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia); regardless of what the company learns about the origin of its conflict minerals – including if it finds they came from recycled or scrap materials – it must prepare a disclosure statement explaining the basis for its determination and providing a brief explanation of the inquiry it undertook. The disclosure statement must be filed with the SEC as part of a new Form SD.
  3. If a company knows or has reason to believe its conflict minerals originated in the DRC or an adjoining country, it must undertake more stringent due diligence on the source and chain of custody of these materials, and must provide a Conflict Minerals Report attached to the new Form SD. The report must set forth the diligence effort undertaken by the company, include an independent private-sector audit conducted in a manner consistent with nationally or internationally recognized audit criteria, and describe the company’s products that “have not been found to be ‘DRC conflict free’,” that is, those that cannot be shown to have come from mines that are outside the control of warlords. For the transition period noted above, those materials that are “DRC conflict undeterminable” are relieved of the independent audit requirement.

The SEC rejected calls to incorporate the new reporting requirements in existing Forms 10-K, 20-F, or 40-F, instead establishing the new Form SD and Conflict Minerals Report. The new form must be “filed,” which makes it subject to potential Exchange Act Section 18 liability.

Other provisions of the final rule offer some improved clarity to retailers concerned with the scope of the term “contract for manufacture.” The final rule suggests in guidance that retailers must play some active role in the design of the product – rather than merely putting their brand names on an already developed product – in order to be subject to the rule’s diligence obligations, but the exact point at which a company crosses the line and becomes subject to the rule will be a judgment call.

The rule also provides helpful references to international guidance documents that companies can reasonably rely upon in conducting diligence and audits under the rule. Specifically, the regulation cites the due diligence framework of the Organisation for Economic Co-operation and Development (OECD) and the audit standards established in the Government Accountability Office’s Government Audit Standards (Yellow Book).

While there is every reason to believe the rule will draw legal challenges, the SEC is keenly aware of harsh criticism from the D.C. Circuit for its inadequate cost-benefit analysis in a recent rulemaking and included a 90-page economic analysis specifically intended to buttress the administrative record for this rule and shore up its defensibility. Accordingly, companies subject to the rule should not assume it will be stayed or overturned.

Many businesses have already been preparing for more than a year to assess whether their products contain conflict minerals and to put in place upstream supply-chain diligence programs to trace the origins of the four metals. However, many companies have not yet begun this resource-intensive effort, and must move quickly to establish reliable systems that will allow them to meet the fast-approaching reporting requirements. At the SEC’s October 2011 Roundtable, representatives of sophisticated companies spoke eloquently of the complexity of their supply chains and the difficulty in obtaining reliable information from their upstream suppliers on the origins of common, commodity metals like tin, tantalum, tungsten, and gold in purchased components and materials. In short order, many more businesses must become ready to provide formal reports to the SEC that will require determinations on these critical questions and the basis for their conclusions about the origins of conflict minerals in their products.

Jane C. Luxton

Written by



Jane C. Luxton

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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