In the run up to this week’s SEC roundtable on the Dodd-Frank conflict minerals provision, Rep. Jim McDermott (D-WA), a co-author of the provision along with Senator Richard Durbin (D-IL), sent a letter to SEC Chair Mary Schapiro on the costs of complying with the provision. In the Oct. 12, 2011 letter noting that the cost to manufacturers of setting up the largest and most crucial link in a conflict-free mineral supply should be very low, Rep. McDermott enclosed the International Tin Research Institute's supply chain initiative, which he said provides useful data and specifics for how much it costs to build a clean supply chain for minerals. Reports show that the cost of cleanly bagged-and-tagged minerals, including taxes, will remain below the world market price. The Congressman noted that tin is the most widely mined and largest volume of the conflict minerals identified in Section 1502 of the Dodd-Frank Act. The costs of setting up of a clean supply chain for tin should serve as a model for doing the same for other identified conflict minerals.
This report is good news, declared Rep. McDermott, coupled with other documents it indicates that the total funding shortfall of $14 million for tin ought to be made up by donations, such as through the State Department's donation fund and other international development money, before the program is self sustaining.
The proposed SEC regulations implementing Section 1502 would require a company, including a foreign private issuer, to undergo a reasonable due diligence process to ascertain whether conflict minerals are used in the manufacture or production of its products and, if they are, disclose in the body of its annual report on Form 10-K, or Form 20-F for foreign private issuers, whether its conflict minerals originated in the Democratic Republic of the Congo or an adjoining country. In addition to disclosure in its annual report, a company must also furnish a separate conflict minerals report as an exhibit to its annual report when it concludes that conflict minerals are used in, or are necessary for the manufacture or functionality of, its products or the company is unable to conclude whether any of the named minerals originate from the DRC or adjoining countries.
Further, any company furnishing a Conflict Minerals Report as an exhibit to its annual report would be required to certify that it obtained an independent audit of the report, furnish the auditor’s report as an exhibit to its annual report, and make the report and the auditor’s report publically available on the company’s internet Web site.
In a 2010 letter both Senator Durbin and Rep. McDermott wrote to Chairman Schapiro to clarify some elements of Section 1502 in order to help inform the SEC rulemaking process. Section 1502 is based on a Durbin bill, which was adopted by unanimous consent and a McDermott bill, H.R. 4128, which went through two mark-ups and was adopted by voice vote in the 72-member House Foreign Affairs Committee. These two bills were combined and incorporated into the Dodd-Frank Act.
The policy goal of Section 1502 is to require transparency of all conflict minerals sourcing in the DRC and its adjoining countries. Greater transparency will help achieve these three goals. If the SEC issues rules that do not require all companies whose products contain conflict minerals from the ORC and its adjoining countries to be transparent, said the lawmakers, then the black market mineral trade will likely continue to fund more violence.
Regarding the term "necessary to the functionality," in Section 1502, they noted that in trade law Congress often includes de minimis rules to simplify the importing process. De minimis rules rely on either a percentage or a by-weight basis per unit that allow an importer to make a declaration or follow a rule on a particular good if it includes only "de minimis" amounts of a prohibited ingredient. Congress carefully considered including a de minimis rule in Section 1502 to accommodate the issues of naturally occurring or unintentional natural inclusion, noted the co-authors, but a de minimis rule would have created an overly generous loophole in the law. Working against a de minimis standerd here is the fact that the weight of the conflict minerals so essential to many products is very small, and the percentage by weight or dollar value of the conflict minerals as a proportion of unit cost is often also very small.
Since it is the policy of Section 1502 to require transparency of all sourcing of conflict minerals, Section 1502 uses the phrase "essential to the manufacture of’’’ to include all uses of conflict minerals coming from DRC, except those that are "naturally occurring" or "unintentionally included" in the product. Dodd-Frank intentionally did not use a de minimis rule. All uses of conflict minerals that originate from DRC and adjoining countries that are not naturally occurring, such as vegetables, or are a purely unintentional byproduct, such as tuna cans, need to be subject to reporting and transparency.
Another area of concern has been over which companies are manufacturers and which are not. Section 1502 is careful not to include companies that only sell manufactured products in the requirements for which entities must report. While pure retailers are exempt from reporting, noted the legislators, there are many retailers that also engage in manufacturing.
These retailers issue requirements for products to be manufactured for them, including design, quality, product life expectancy, and so on. In the view of Sen. Durbin and Rep. McDermott, pure "white label" products, where retailers have no influence in their manufacture, should not be subject to reporting. However, products that the retailer contracts to be manufactured or for which the retailer issues unique product requirements must be included. If retailers that contract the manufacture of goods or influence product design are exempt from reporting, reasoned the co-authors, then a large, non-transparent use of the black market for DRC conflict minerals would remain, directly subverting the policy of Section 1502.
Section 1502 also includes the term "or contracted to be manufactured" when outlining a manufacturing company's responsibilities. Many companies use component parts from several suppliers when assembling their products. This business model for supply chain management can help drive down the price for parts through competition. Yet this business model also creates complexity, which has served as a rationale for not requiring responsibility to date and which has enabled the black market for conflict minerals to grow. It is of paramount importance, emphasized the co-authors, that this business model choice not be used as a rationale to avoid reporting and transparency.
Anticipating that an industry may ask the SEC to limit reporting requirements and due diligence to the conflict mineral processing facility, the co-authors advised against allowing this. All conflict minerals require sophisticated processing in order to be used in manufactured products, they noted, so the processing facility is central to tracking the source and flow of raw conflict minerals. Some processing facilities are beyond the reach of United States law and may not be compelled to provide reliable information. Many companies buy raw conflict minerals and process them themselves for use in their products and for sale to other firms. Also, over time, firms will change their roles in the supply chain. Therefore, a rule relying on the word of processing facilities is not enough. While information provided by processing facilities is important, reasoned the co-authors, it would not cover many companies and cannot be the limit of manufacturers' responsibilities.
Moreover, companies must be able to track whether their conflict minerals come from the DRC and adjoining countries and, if so, where. This needs to be verifiable. If a processing facility provides faulty information to a company, said the co-authors, then the company must take sufficient measures to address this problem. A manufacturer must ensure that the information it provides about the source of its minerals is accurate.
Finally, there has been some question about what constitutes due diligence and the role of private sector auditors. As was debated and ultimately negotiated in H.R. 4128, the Conflict Minerals Trade Act, due diligence requires managing the supply lines and assembly process such that conflict minerals used in products have a known and verifiable origin, regardless of the manufacturing company's business model. If manufacturing is outsourced, suppliers must provide legally required representations of the source of its minerals.
In Section 1502, noted the co-authors, the requirements of an independent outside audit is common sense. Auditors should not have a financial relationship with the audited company, emphasized the co-authors, and they should have expertise in conflict minerals and sourcing. The audit itself, as stated in the legislation, verifies the contents of the report and assesses the validity of its conclusions.