On Wednesday, August 22, 2012, the U.S. Securities and Exchange Commission (SEC), by a 3-2 vote, issued final rules designed to cut off funding to groups committing human rights violations in central Africa. The new rules, issued pursuant to a congressional mandate in the Dodd-Frank Wall Street Reform and Consumer Protection Act, require issuers to account for the use in their products of so-called “conflict minerals”—including gold, tungsten, tantalum and tin (3T+G). These rules are intended to create greater transparency and accountability from companies that use conflict minerals by requiring them to disclose whether any such minerals were sourced from the Democratic Republic of Congo (DRC) and adjoining countries (the covered countries). The two dissenting votes were cast by the SEC’s Republican members who contended that the SEC did not conduct a thorough enough cost-benefit analysis and that the rules could amount to a de facto embargo of covered minerals from the region that may have the unintended consequence of worsening conditions in the DRC by depriving of their livelihood many affected persons who depend on mining activities.
The new final rules differ in several material respects from the draft rules previously issued by the SEC. Most significantly, the rules create a new Form SD to facilitate conflict minerals reporting, rather than requiring the reporting to be included in each issuer’s annual report to the SEC. The new form will cover each calendar year and must be filed by May 31 of the year following the covered year. The first filing deadline will be May 31, 2014.
The final rules maintain the three-step framework of the draft rules, but modify several triggers and mechanisms contained within the framework. An issuer will first need to determine whether it is subject to conflict minerals reporting requirements: only companies that manufacture or contract to manufacture products for which conflict minerals are necessary for the functionality or production of a product must file the new Form SD. The SEC has declined to precisely define the terms used in this test, instead issuing guidance and examples for a fact- and circumstances-specific determination. Companies will need to look closely at any products that utilize 3T+G minerals to determine whether the new filing requirement applies. In determining whether an issuer is subject to the rule, the SEC will look at whether conflict minerals were intentionally included in any of the company’s products, including as ornamentation or decoration, as well as the function the conflict minerals serve in the products and the products’ intended use or purpose. Issuers who “contract for manufacture” of products containing 3T+G could also be subject to the new rules, although, again, the SEC did not define what “contract for manufacture” entails, leaving companies to make another fact-specific determination.
If an issuer does use 3T+G minerals in any of its products, it will be required to conduct a “reasonable country of origin inquiry,” i.e., one that is reasonably designed to determine whether the 3T+G minerals used in the products originated in the covered countries or whether they were scrap or recycled. The results of this inquiry must be reported on Form SD as well as on the company’s internet website, the address for which must also be included on Form SD. If the inquiry provides reason to believe that any of the 3T+G minerals used originated in the covered countries, the issuer will be required to file and post to its website an independently audited Conflict Minerals Report detailing the steps taken to ensure the 3T+G minerals used in its products did not benefit the militias committing atrocities in the DRC and surrounding countries. This represents a softening of the proposed rule’s language, which would have required preparation of the audited Conflict Minerals Report in any case where an issuer could not affirmatively determine that its 3T+G minerals did not originate in the covered countries. It also provides a mechanism for affected issuers to certify that the 3T+G sourced from the DRC is “conflict-free.” Significantly, the final rule also removes a requirement from the proposed rules that issuers using recycled or scrap 3T+G minerals provide the Conflict Minerals Report. If after its reasonable country of origin inquiry a company cannot determine the origin of the conflict minerals used in its products, it will be allowed to report its products as Conflict Mineral Undeterminable for the first two years of the reporting requirement (four years in the case of small issuers), effectively giving issuers a two- or four-year phase-in period during which to construct supply-chain tracking systems.
Though the new rules will not require any product labeling, the compliance costs to issuers—and to any private companies in their supply chains—will be substantial. The rule effectively requires a full accounting of an entire supply chain, which may be complex or multi-layered, with issuers needing to be able to trace the conflict minerals used in their products back to the smelters where they originated. The SEC estimates the initial compliance costs will be between $2 and $3 billion, and the annual continuing cost of compliance will be between $206 and $609 million. Because the final rules (unlike the draft rules) require companies to “file” the new Form SD with the SEC—instead of merely “furnishing it—failure to comply with the new rules may subject reporting issuers to potential Section 18 liability under the Securities Exchange Act.
On the same day, the SEC also issued final rules on Section 1504 of the Dodd-Frank Act, which require resource extraction issuers to publicly disclose payments made to the federal government or foreign governments as they relate to the commercial development of oil, natural gas or minerals. (View McDermott’s 2012 Dodd-Frank Act Compliance Checklist for Resource Extraction Issuers and “Conflict Mineral” Manufacturers for more information on compliance with Section 1504.)
Due to the complex supply chain inquiries that will be necessary for compliance, 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.