JULIE BLACKMORE & JOE BUCCIERO – 2013 was the first year public that companies dealt with the conflict minerals rule. This year, we can review which companies chose to report, how they did so, and what the future will look like for conflict mineral disclosures. The rule is relatively self-contained, so it is an easy way to dip your toe into the securities laws without feeling in over your head.
The Conflict Minerals Law and Rule
Section 1502 of the Dodd-Frank Act added Section 13(p) to the Securities Exchange Act, requiring the Securities and Exchange Commission (“SEC”) to issue rules requiring publically traded companies reporting under the Exchange Act to disclose their use of conflict minerals if those minerals are “necessary to the functionality or production of a product manufactured or contracted to be manufactured by those companies.” The potential scope of the rule was huge because conflict minerals included fairly common materials such as tantalum, tin, gold, tungsten, and their derivatives. In August 2012, the SEC adopted a rule that took effect at the beginning of 2013. The rule requires companies that fall under its scope to disclose certain information on a new form to be filed with the SEC—Form SD.
|Tantalum||Electronic components such as capacitors and resistors|
|Tin||Solder to connect electrical circuits, plating, and batteries|
|Gold||Electronic components, jewelry|
|Tungsten||Hard materials, alloys, chemicals, electronics, and high-performance counterweights|
Determining If the Conflict Minerals Law Applies to Your Company
The first step for a company is to determine whether it “manufactures or contracts to manufacture” any products that contain conflict minerals. To help public companies determine if they are subject to conflict minerals disclosures, the SEC published a Fact Sheet, answered Frequently Asked Questionsand issued an Adopting Release. While the rule does not define the term “manufacture,” the Adopting Release indicates that the term captures companies that assemble products out of materials that are not in raw form (e.g., auto and electronics manufacturers). “Manufacture” does not include companies that merely engage in the importing, exporting, or selling of products that contain conflict minerals. A company is considered to be “contracting to manufacture” a product if it has some actual influence over the materials, parts, ingredients, or components to be included in any product that contains conflict minerals; specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product is not enough to subject a company to the rule. Additionally, companies that merely engage in product service and maintenance are not “manufacturing” in the context of the rule.
The next step is to determine if the mineral is “necessary to the functionality or production” of the product. Again, the Adopting Release gives some guidance: (i) whether the mineral is contained in and intentionally added to the product; (ii) whether a conflict mineral is necessary to the product’s generally expected function, use, or purpose, or is necessary to produce the product; and (iii) if a conflict mineral is incorporated for purposes of ornamentation, whether the primary purpose of the product is ornamentation or decoration. If after taking these factors into consideration a company determines that it does manufacture or contract to manufacture a product that contains conflict minerals “necessary to the functionality or production” of the product, then it is subject to the rule’s disclosure requirements.
If a company is subject to the disclosure requirements, it must conduct a reasonable country of origin inquiry (“RCOI”) regarding the conflict minerals. The RCOI is designed to determine whether the covered materials came from some allowable source or if they originated in the Democratic Republic of the Congo or an adjoining country. If the company concludes the materials came from some allowable source, the company must disclose this determination and provide a brief description of the inquiry it undertook on Form SD and on its website. See McDonald’s Form SD. Alternatively, if a company determines that the minerals may have originated in the covered countries the company must undertake “due diligence” on the source and chain of custody of the conflict minerals, file a Conflict Minerals Report as an exhibit to its Form SD, and make the Conflict Minerals Report publicly available on its website. See Apple’s Form SD.
In the Rule’s original form, a company was required to label their products as either “DRC Conflict Free,” “DRC Conflict Undeterminable,” or “Not Found to be DRC Conflict Free.” The company’s due diligence measures could have been subject to an independent audit depending on this label. In April 2014, the United States Court of Appeals for the District of Columbia Circuit issued a decision in National Association of Manufacturers, et al. v. SEC, et al. eliminating these requirements based on the First Amendment. Subsequent to the decision, the SEC put out guidance that relieved companies of the labeling obligation altogether. In addition, pending further action, the SEC relieved companies from an independent audit, unless a company voluntarily elects to describe a product as “DRC Conflict Free.”
The First Reporting Round
The first reporting round was bumpy. The final rule did not prescribe a standard form of reporting, so companies and their lawyers submitted a variety of disclosure forms with differing levels of disclosure. In the view of Keith Higgins, the Corporate Finance Director at the SEC, many RCOI descriptions filed on Form SD were inadequate. The SEC estimated that 6,000 issuers would file a Form SD. Instead, only 1,200 companies filed.
The disclosure levels varied. On the low end, Wendy’s and Burger King did not file a Form SD. McDonalds filed a Form SD, identified that some of its Happy Meal toys contain covered materials, and reported that its suppliers said they did not obtain covered materials from the covered countries. Tim Hortons, a Canadian breakfast restaurant franchise, also sent questionnaires to suppliers. It determined that some of its commercial kitchen equipment and drive-thru communication systems contained covered materials. Tim Hortons plans to continue surveying suppliers and challenging them to verify that they will not source materials from RCOI countries.
Apple made a similar promise. In 2013, Apple said it planned to assist the smelters and refiners in its supply chain by publishing their names and helping them comply with the Conflict-Free Smelter Program. Apple attached an annex of 205 possible smelters and refiners in its supply chain. Apple determined that its due diligence efforts did not provide enough information to conclusively determine the country of origin of its materials, but reported that 17 of its 21 sourcing countries were compliant with the Conflict-Free Smelter Program. In 2014, the list of reporting smelters and refiners responding to Apple’s requests grew to 235 companies.
Considerations This May
The conflict minerals rule is a nice slice of the securities laws to use as a model for more complex requirements. Congress enacted the law, the SEC adopted a rule with various forms of guidance, and now the companies and lawyers are complying with the rule, both through challenging parts of the law in court and interpreting the SEC’s guidance. This year, the process will continue, with each company looking to the other companies’ prior filings for guidance. As a result, many have predicted that this year’s reporting will be more standardized. The typical report tracks the following outline: (a) Description of the company’s conflict minerals program; (b) Due Diligence process description; (c) Due Diligence results; (d) Risk Mitigation and Future Plans; and (e) Conclusion.
This year (disclosing for 2014’s operations), Apple was the first U.S. firm to file its conflict minerals report. It filed its Form SD on February 12, 2015, almost three and a half months before it had to. Apple is the type of company the conflict minerals disclosure requirements target—a technology hardware producer that sources components from Chinese and Indonesian producers, which, in turn, source their raw materials from African mines— and many firms will probably follow its lead in 2015.
More firms may report now that they understand the limits of the rule and have a better framework for compliance. After the SEC expressed its disappointment at the level of disclosure in last year’s filings, companies filing this year should be prepared for additional scrutiny from the SEC. For the 1,200 companies that filed a Form SD in 2014, it will be worth revisiting their diligent efforts to properly document their processes. Suppliers will be better able to respond to filers’ requests for information now that they have completed one round of diligence.
The content of this post does not reflect the views of Greenberg Traurig LLP. Additionally, the content shall not be taken or construed as legal advice.