SEC Finalizes Conflict Minerals Rules

The Securities Exchange Commission has issued final rules for disclosing the use of conflict minerals originating from the Democratic Republic of the Congo or neighboring countries.  “Conflict minerals” are certain metals commonly mined in the DRC, including gold, tin and tungsten, and are found in many products, especially consumer electronics.   According to the chairman of the SEC, Mary Schapiro:

The [Dodd-Frank Act] explains that the exploitation and trade of conflict minerals by armed groups is helping to finance conflict in the region and that the emergency humanitarian crisis there warrants these disclosure requirements.  As reflected in Section 1502 of the Act, Congress intended to further the humanitarian goal of ending the extremely violent conflict in the DRC, which has been partially financed by conflict minerals originating in the DRC.

Under the rules, all reporting companies will be required to determine if conflict minerals are necessary to the functionality or production of a product manufactured by the company or contracted by the company to be manufactured.  Whether a company “contracts to manufacture” a product will depend on the degree of influence the company has in the parts that are used in the manufacturing process.  In the second step of the compliance process, the company must undertake a “reasonable country of origin inquiry” to determine the origin of conflict minerals used in its products.  This will generally involve obtaining reasonably reliable representations from its suppliers regarding the origin of the conflict minerals and a review of the company’s own sourcing policies.  If the company determines its conflict minerals do not originate in the DRC, the company must file a form SD describing the nature and results of the inquiry, and has no further disclosure obligations.

If the company determines that its conflict minerals did originate in the DRC, the company must undertake the third step of the compliance process: due diligence of its supply chain to determine if the conflict minerals were used to fund armed groups.  The results of the due diligence are disclosed in a conflict minerals report, which is attached as an exhibit to the form SD.   The conflict minerals report must also include an independent private audit as to whether the company’s due diligence framework conformed to SEC guidelines.

The rules, though well intended, may have limited effectiveness in stemming the tide of conflict minerals.  As a threshold matter, the rules will only apply to companies that file reports with the SEC.  If the rules force those companies to eliminate the use of conflict minerals, foreign companies could step in to fill the void.  The conflict minerals rules also contain exceptions that could lessen their effectiveness.  For example, under SEC guidance a company that simply affixes its brand on a “generic” product will not be considered to “contract to manufacture” the product.  With the rise of outsourcing, many products purchased in the U.S. are produced and manufactured abroad by foreign companies who are not subject to the conflict minerals rules.  U.S. companies with foreign suppliers may be able to interpret the term “generic product” broadly and avoid being subject to the rules.  In addition, although retailers heavily influence consumer purchases and could raise awareness of the conflict minerals issue at the point of sale, most retailers will be exempt from the rules because retailers generally do not manufacture products.  Finally, the armed groups in the DRC could ship the conflict minerals outside the country so that they originate in a permitted country.  Companies using these minerals would not have to undertake the due diligence phase of the compliance process and would therefore be unlikely to discover the funding of the armed groups.

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