Wednesday, August 22, 2012

SEC Implements Dodd-Frank Conflict Minerals Provision with Specialized Disclosure Requirements and Due Diligence Measures


Implementing Section 1502 of the Dodd-Frank Act, the SEC adopted regulations requiring companies to make specialized disclosure about conflict minerals. The vote to adopt the regulation was 3-2, with Commissioners Paredes and Gallagher dissenting. The requirements apply equally to domestic and foreign issuers.

Section 1502 directs the Commission to issue rules requiring companies to disclose their use of conflict minerals if those minerals are necessary to the functionality or production of a product manufactured by those companies. Under the Act, those minerals include tantalum, tin, gold or tungsten. The SEC rule would apply to a company that uses any of the four designated minerals if the company files reports with the SEC under the Exchange Act and the minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the company. 

A company would be considered to be contracting to manufacture a product if it has some actual influence over the manufacturing of that product.  This determination would be based on the facts and circumstances, taking into account the degree of influence the company exercises over the product’s manufacturing.  A company would not be deemed to have influence over the manufacturing if it merely affixes its brand or logo 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 the product.

Under the final rule, a company that uses any of the designated minerals would be required to conduct a reasonable good faith country of origin inquiry reasonably designed to determine whether any of its minerals originated in the covered countries or are from scrap or recycled sources.  If the inquiry determines that the company knows that the minerals did not originate in the covered countries or are from scrap or recycled sources or the company has no reason to believe that the minerals may have originated in the covered countries and may not be from scrap or recycled sources, then the company must disclose its determination, provide a brief description of the inquiry it undertook and the results of the inquiry on new Form SD filed with the Commission.

The company also would be required to make its description publicly available on its Internet website and provide the Internet address of that site in the Form SD.

Under the final regulations, companies that are required to file a Conflict Minerals Report would have to exercise due diligence on the source and chain of custody of their conflict minerals.  The due diligence measures must conform to a nationally or internationally recognized due diligence framework, such as the due diligence guidance approved by the Organization for Economic Co-operation and Development (OECD).

If a company determines that its products are DRC conflict free, that is the minerals may originate from the covered countries but did not finance or benefit armed groups, then the company would have to obtain an independent private sector audit of its Conflict Minerals Report, certify that it obtained such an audit, include the audit report as part of the Conflict Minerals Report, and identify the auditor. 

The independent audit would verify that the company’s due diligence was conducted in conformity with an internationally recognized due diligence guideline, which essentially means the OECD Due Diligence Guidance, which the staff noted is the only internationally recognized due diligence guideline.

The OECD Due Diligence Guidance for responsible supply chains of conflict minerals is a five-step due diligence regime for use by any company potentially sourcing minerals or metals from conflict-affected areas. Broadly, the guidance recognizes that, while specific due diligence requirements will differ depending on the mineral and the position of the company in the supply chain, companies should review their choice of suppliers and sourcing decisions and integrate into their management systems a five-step framework for risk-based diligence for responsible supply chains of minerals from conflict areas.

The first step is to establish strong management systems under which companies can adopt and communicate to suppliers a policy for the supply chain of minerals originating from conflict areas, a policy incorporating the standards against which due diligence is to be conducted. The company must also structure internal management to support supply chain due diligence and establish a system of controls over the mineral supply chain, including a chain of custody.  

The second and third steps are to identify and assess risk in the supply chain of adverse impacts in light of the standards of the company’s supply chain policy and implement a strategy to respond to identified risks. A risk management plan should be implemented and monitored and the performance of risk mitigation efforts tracked.  

The fourth step is to carry out an independent third-party audit of due diligence at identified points in the supply chain. The fifth step is to publicly report on the company’s supply chain due diligence policies and practices.

If a company’s products have not been found to be DRC conflict free, then the company in addition to the audit and certification requirements would have to describe in its Conflict Minerals Report the products manufactured or contracted to be manufactured that have not been found to be DRC conflict free, the facilities used to process the conflict minerals in those products, the country of origin of the conflict minerals in those products, and the efforts to determine the mine or location of origin with the greatest possible specificity.

For a temporary two-year period, or four-year period for smaller reporting companies, if the company is unable to determine whether the minerals in its products originated in the covered countries or financed or benefited armed groups in those countries, then those products would be considered DRC conflict undeterminable. In that case, the company must describe in its Conflict Minerals Report its products manufactured that are DRC conflict undeterminable, the facilities used to process the conflict minerals in those products, the country of origin of the conflict minerals in those products, the efforts to determine the mine or location of origin with the greatest possible specificity, and the steps it has taken or will take, if any, since the end of the period covered in its most recent Conflict Minerals Report to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve due diligence.

For those products that are DRC conflict undeterminable, the company would not be required to obtain an independent private sector audit of the Conflict Minerals Report regarding the conflict minerals in those products.

There are special rules governing the due diligence and Conflict Minerals Report for minerals from recycled or scrap sources.  If a company’s conflict minerals are derived from recycled or scrap sources rather than from mined sources, the company’s products containing such minerals are considered DRC conflict free.

If a company cannot reasonably conclude after its inquiry that its gold is from recycled or scrap sources, then it would be required to undertake due diligence in accordance with the OECD Due Diligence Guidance, and get an audit of its Conflict Minerals Report.  Currently, gold is the only conflict mineral with a nationally or internationally recognized due diligence framework for determining whether it is recycled or scrap, which is part of the OECD Due Diligence Guidance.  

For the other three minerals, if a company cannot reasonably conclude after its inquiry that its minerals are from recycled or scrap sources, until a due diligence framework is developed, the company will be required to describe the due diligence measures it exercised in determining that its conflict minerals are from recycled or scrap sources in its Conflict Minerals Report.  Such a company is not required to obtain an independent private sector audit regarding such conflict minerals.   

Under the final rule, the issuer would be required to provide the disclosure on the new Form SD.  All issuers will file for the same period, a calendar year, regardless of their fiscal year end.  Companies would be required to file their first specialized disclosure report on May 31, 2014 (for the 2013 calendar year) and annually on May 31 for each calendar year thereafter.
  

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