3 Steps for Compliance With the SEC's Conflict Minerals Rule

Alexandra Wrage

Corporate Counsel

09-21-2012

A new rule regarding so-called “conflict minerals” that is argued to be an important step towards ending violent conflict in the Democratic Republic of the Congo has created a due diligence quagmire for many companies. Which means it’s time for compliance professionals to add “mineralogist” to their resumes.

Under a final “Conflict Minerals Rule” passed by the Securities and Exchange Commission last month, public companies must disclose their use of conflict minerals (cassiterite,used to make tin; columbite-tantalite,from which tantalum is extracted; gold; and wolframite,used to produce tungsten; or their derivatives) originating in the DRC or an adjoining country—Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia.

In recent weeks, companies have been grappling with how to put in place a plan to gather the information necessary to comply with the new Conflict Minerals Rule. For those companies subject to the Conflict Minerals Rule, disclosures will be required on a calendar-year basis, beginning on January 1, 2013. The first disclosure report is due on May 31, 2014.

The SEC estimates the initial compliance costs for the Conflict Minerals Rule to be about $3 to $4 billion across all affected companies, and ongoing compliance costs at about $200 to $600 million annually. This is a hefty price tag, and although the Conflict Minerals Rule generally outlines a three-step process for compliance, there are few specifics provided.

Where should companies begin? Below is an overview of the three main steps involved in complying with the Conflict Minerals Rule, along with some helpful websites and tools to ease the compliance process.

Step 1: Determine Whether the Conflict Minerals Rule Applies to Your Company’s Products

Under this first step, publicly traded companies must determine if they “manufacture” or “contract to manufacture” products for which conflict minerals are “necessary to the functionality or production” of their products. While the Conflict Minerals Rule does not define these key phrases, the SEC has provided some general guidance.
Overall, in determining whether a company “manufactures” or “contracts to manufacture” a product depends, in large part, on the degree of influence a company has in manufacturing the product, or over the materials, parts, ingredients, or components that are included in that product.

According to the SEC, a company is not considered to manufacture or contract to manufacture a product if the company simply:

affixes its brand, marks, logo, or label to a generic product manufactured by a third party;
services, maintains or repairs a product manufactured by a third party; or
specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of a product.

Thus, companies will have to review their supply chain and determine their company’s degree of influence over the manufacturing of their various products. Are they merely putting their logo on a generic product? Or are they exercising influence over how that product is created?

If a company answers “yes” to this initial part, they then must determine whether conflict minerals are “necessary to the functionality or production” of the product. The SEC lists several factors companies should consider in determining whether conflict minerals are “necessary to the functionality or production” of a product, largely turning on whether the conflict mineral is necessary for the product’s purpose, or is intentionally added to the product or production process.

For this first step, in-house counsel should coordinate a working team including legal, sales, operations, engineering, and other employees with supply- and distribution-chain oversight. They should analyze their product lines to determine which products they manufacture, or contract to manufacture, and which of those contain conflict minerals necessary for the product’s purpose.

Step 2: Conduct a Reasonable Country of Origin Inquiry

If the answer is “yes” to both parts of Step 1, a company must then conduct a reasonable country of origin inquiry to determine whether their company’s conflict minerals originated in the DRC or an adjoining country, or came from recycled or scrap sources. While the SEC does not provide specific procedures to complete this inquiry, it must be reasonable and performed in good faith.

This is a daunting task for most companies. How can it be determined where these minerals originate, especially if the company is several steps removed in the supply chain? And how do companies know they can rely upon the information provided to them by their suppliers?

Companies will need to turn to their suppliers for much of this information, which could be costly and time-consuming. Due diligence products, such as TRAC (which is offered by my firm, TRACE, at no cost), can assist companies in gathering information from thousands of suppliers on the origin of the minerals used in their products, and to determine if these minerals are from recycled or scrap sources.

Companies can also seek a determination from their supplier as to whether the minerals were sourced from a certified conflict-free smelter. Lists of conflict-free smelters are available from such groups as the Electronic Industry Citizenship Coalition.

If a company determines that the conflict minerals it uses did not originate in the DRC or an adjoining country, or came from recycled or scrap sources, or has reason to believe this is the case, its inquiry ends there. The company discloses this determination to the SEC and describes its country of origin inquiry. If, on the other hand, a company knows or has reason to believe that the conflict minerals used in its products originated in the DRC or a neighboring country, it must proceed to Step 3.

Step 3: Conduct Due Diligence on the Source and Chain of Custody of Your Company’s Conflict Minerals

If a company knows, or has reason to believe, that the conflict minerals used in its products originated in the DRC or a neighboring country it must exercise due diligence on the source and chain of custody of the conflict minerals. According to the SEC, this process must conform to a national or internationally recognized due diligence framework, such as the due diligence guidance approved by the Organisation for Economic Cooperation and Development.

Unless a company is able to determine with some confidence that its minerals did not originate in the DRC or a neighboring country, or that its minerals came from recycled or scrap sources, the company will have to file a Conflict Minerals Report, including a private sector audit.

Just as few of us attended law school expecting to become hall monitors for our companies’ gift-giving practices or conversant in the bureaucracies of behemoths like China and India, so too will it surprise many compliance officers that the pedigree of your company’s wolframite is now squarely on your new compliance horizon.

See also: “SEC Rule Mandates Sourcing of 'Conflict Minerals' at U.S. Companies,” CorpCounsel, August 2012.