SEC Adopts Final Rules on Conflict Minerals Disclosure
Corporate Services Law Update 10/26/12 Steven P. Emerick, Kenneth V. Hallett, Joseph D. Masterson, Ryan P. Morrison
On August 22, 2012, the Securities and Exchange Commission ("SEC") adopted a final rule implementing the conflict mineral disclosure requirements mandated by Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The final rule requires supply chain diligence and specialized reporting by companies that manufacture or contract to manufacture products that contain certain minerals originating from the Democratic Republic of the Congo and adjoining countries, if the minerals are necessary to the functionality or production of the products. The subject minerals, referred to as "conflict minerals," include gold, cassiterite (the metal ore from which tin is extracted), columbite-tantalite (the metal ore from which tantalum is extracted), wolframite (the metal ore from which tungsten is extracted), and their derivatives. The first reporting period for all issuers will be calendar year 2013, and the first required report must be filed by May 31, 2014.
The final rule, as characterized by the SEC, involves three steps. In an attempt to illustrate the operation of the rule, the SEC provided a flow chart, which is reproduced below.
Step One: Determine Whether the Rule Applies
The rule applies only if conflict minerals are necessary to either the functionality or the production of products that are manufactured or contracted to be manufactured by an issuer that is required to file reports with the SEC under Section 13(a) or Section 15(d) of the Exchange Act.
Issuers That File Reports Under the Exchange Act. The final rule applies to any issuer that files reports with the SEC under Section 13(a) or Section 15(d) of the Exchange Act, including domestic companies, foreign private issuers, and smaller reporting companies.
Issuers That Manufacture or Contract to Manufacture Products Containing Conflict Minerals. The rule applies to issuers that manufacture or contract to manufacture products containing conflict minerals. The final rule does not define the term "manufacture" because the SEC believes the term to be generally understood. However, the final rule does clarify that "manufacturing" a product requires more than merely servicing, maintaining or repairing a product containing conflict minerals. Despite the SEC's confidence that the term "manufacturing" is well-understood, determining whether an issuer manufactures a product is not straightforward and will be very challenging for many issuers.
Determining whether an issuer "contracts to manufacture" a product that contains conflict minerals is even less clear. It depends on the degree of influence the issuer exercises on the product's manufacture, considering the facts and circumstances surrounding the issuer's business and industry. The final rule specifies, however, that the following actions by an issuer are not considered to be contracting to manufacture a product:
- specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product;
- affixing its 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.
The Conflict Minerals Are Necessary. The final rule does not define when a conflict mineral is "necessary to the functionality" or "necessary to the production" of a product. This determination will depend on the relevant facts and circumstances. The final rule does provide that the following considerations should be taken into account by an issuer in making this determination:
- in determining whether its conflict minerals are "necessary to the functionality" of a product, an issuer should consider: (a) whether a conflict mineral is contained in and intentionally added to the product or any component of the product and is not a naturally occurring byproduct; (b) whether a conflict mineral is necessary to the product's generally expected function, use or purpose; and (c) if a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration;
- in determining whether its conflict minerals are "necessary to the production" of a product, an issuer should consider: (a) whether the conflict mineral is intentionally added in the production process and is contained in any amount, including trace amounts, in the finished product; and (b) whether the conflict mineral is necessary to produce the product; and
- although there is no de minimus quantity exception, the finished product must contain the conflict mineral.
For many issuers, making the necessary determination about manufacturing, contracting to manufacture and the necessity of the conflict minerals for functionality or production of a product will involve many significant judgments in light of the very limited guidance provided by the SEC. Accordingly, it is likely that issuers will initially vary widely in their interpretations of the rule and only over time will basic standards emerge to assist in these analyses. Issuers should document their bases for the many determinations that must be made and revisit these determinations as standards and best practices emerge.
Step Two: Perform Country of Origin Inquiry
If the rule applies, issuers will be required to perform a reasonable inquiry in good faith to determine the conflict minerals' country of origin. The final rule does not specify what is necessary to satisfy this inquiry requirement because what is necessary will depend on each issuer's particular circumstances. The final rule does provide, however, that an issuer will satisfy the inquiry standard if it seeks and obtains reasonably reliable representations, either directly from the smelter or refining facility or indirectly through the issuer's immediate suppliers, indicating that the conflict minerals either did not originate in a covered country or came from recycled or scrap sources. The final rule does not require an issuer to receive representations from all of its suppliers so long as it does not ignore warning signs or other circumstances that would indicate that its conflict minerals originated or may have originated in the covered countries or did not come from recycled or scrap sources.
If, after a reasonable country of origin inquiry is performed, the issuer concludes that it either (a) knows that the conflict minerals did not originate in the covered countries or are from scrap or recycled sources; or (b) has no reason to believe that the conflict minerals may have originated in the covered countries or may not be from scrap or recycled sources, the issuer must disclose this determination on Form SD. The issuer must also describe the process it used in reaching this determination and disclose the results of the process to provide a basis for its conclusion. The issuer must also make the Form SD available on its website and provide the internet address where this disclosure is posted.
Step Three: Supply Chain Due Diligence
If, after performing a reasonable country of origin inquiry, the issuer concludes that it either (a) knows that the conflict minerals originated in the covered countries and did not come from scrap or recycled sources; or (b) has reason to believe that the conflict minerals may have originated in the covered countries and may not have come from scrap or recycled sources, the issuer must exercise due diligence on the source and chain of custody of its conflict minerals. An issuer's due diligence must follow a nationally or internationally recognized due diligence framework. Presently, the only nationally or internationally recognized due diligence framework available is the due diligence guidance approved by the Organisation for Economic Cooperation and Development.
If, as a result of the due diligence, an issuer determines that its conflict minerals did not originate in the covered countries or that its conflict minerals came from recycled or scrap sources, the issuer must disclose this determination on Form SD, describe its due diligence process, and describe the results of the due diligence.
If, after due diligence, an issuer cannot determine that its conflict minerals did not originate in the covered countries or that its conflict minerals came from recycled or scrap sources, the issuer must file a Conflicts Minerals Report as an exhibit to its Form SD. The Conflicts Minerals Report must include a description of each product that is not determined to be "DRC conflict free", the identity of the smelter or refining facility that processed such conflict minerals, the country of origin of such conflict minerals and the "efforts to determine the mine or location of origin with the greatest possible specificity."
Moreover, issuers must obtain an independent private sector audit of their Conflicts Minerals Report that expresses an opinion as to whether the design of the issuer's due diligence framework conforms with the criteria set forth in the nationally or internationally recognized due diligence framework used by the issuer, and whether the issuer's description of its due diligence measures are consistent with the actual due diligence measures the issuer performed.
For a temporary two-year transition period (four years for smaller reporting companies), issuers that are unable to determine whether their conflict minerals originated in the covered countries or are unable to determine whether their conflict minerals that originated in the covered countries are "DRC conflict free," may describe their products containing such conflict minerals as "DRC conflict undeterminable." Issuers will not be required to obtain an independent private sector audit of their Conflict Minerals Report with respect to conflict minerals contained in products classified as "DRC conflict undeterminable."
Effective Date and Reporting Period
The final rule requires each issuer to provide its conflict minerals information on a calendar year basis regardless of its fiscal year end. The information for each calendar year must be filed on Form SD by May 31 of the following year. The first reporting period for all issuers will be calendar year 2013, and the first Form SD report must be filed by May 31, 2014.
Compliance with this new rule will be costly, time consuming and difficult for many issuers and their suppliers. The rule has many challenging interpretive issues, and it is unlikely that the SEC will provide meaningful guidance in the near future. Issuers should establish procedures to help identify and track conflict minerals as soon as possible and, if feasible, seek alternative sources for conflict minerals if the current supply for such minerals would require the issuer to file a Conflict Minerals Report that would be the subject of an independent private sector audit.
On October 19, 2012, the U.S. Chamber of Commerce and the National Association of Manufacturers filed a lawsuit in the U.S. Court of Appeals for the District of Columbia Circuit challenging the validity of the final rule. We believe it is unlikely that the SEC will stay the rule pending resolution of this appeal because the first report is not due to be filed until May 2014, and because the SEC has limited rulemaking flexibility under the Dodd-Frank Act.
If you have questions about the subject matter of this update, please contact Steven P. Emerick at (602) 230-5517 / [email protected], Kenneth V. Hallett at (414) 277-5345 / [email protected], Joseph D. Masterson at (414) 277-5169 / [email protected], Ryan P. Morrison at (414) 277-5401 / [email protected] or your Quarles & Brady LLP attorney.