Compliance with the SEC's Conflict Minerals Rule

A little more than two years ago, “conflict minerals” were certainly well-known in humanitarian circles, but had not yet caught on handily as a “cause” within the public capital markets, not to mention mainstream industry and the broader supply chain. Enter the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, and “conflict minerals” has become a household word, often holding far less favor than the intended humanitarian goal to put a squeeze on the flow of funds to militant groups in the Congo and adjoining countries (DRC).

Securities and Exchange Commission (SEC) issuers are forming high-level internal compliance teams with representatives from legal, finance, internal audit and purchasing involved to assess the extent, if any, that the company's products contain conflict minerals within the ambit of Rule 13p-1 under the Securities Exchange Act of 1934, adopted last August under Section 1502 of the Dodd-Frank Act. Diligence efforts are not confined to SEC issuers, however, with supply chain participants deeply involved in determining and certifying the original source of supplies of tantalum, tin, tungsten and gold (3TGs), and their numerous derivatives, sold to their customers.

As a result, both reporting and non-reporting companies, such as original equipment manufacturers and electronic manufacturing service providers that supply parts to issuers, are affected by the new rule. Corporate counsel in public companies will need to organize a robust compliance team with representatives from legal, finance, internal audit, purchasing and manufacturing, among others. This team will be responsible for developing and implementing a program to assess application of Rule 13p-1 to the company's products in order to file the required Form SD by May 31, 2014. Corporate counsel will play a key role in interpreting the Rule's broad requirements and impact on the company. The following provides some key background information on the new rule.

Impact on Manufacturers Across Diverse Industries

The SEC has stated that approximately 6,000 companies may be subject to the reporting requirement, and the National Association of Manufacturers (NAM) estimates that initial compliance costs industry-wide are likely to range from $9 billion to $16 billion. These figures do not include suppliers whose customers may request product information as part of their compliance due diligence. Central to the application of the Rule is whether a conflict mineral contained or used in a public company's product and “necessary to the functionality or production of a product manufactured or contracted by that registrant to be manufactured” originated in the DRC.

For companies covered by the Rule, the diligence process required for compliance with the Rule will be long, expensive and arduous. Companies are wise to get onboard and begin the process now. The substantial majority of 3TGs are reported by the U.S. Geological Survey to be sourced outside of the DRC, as the mineral reserves in the DRC represent only a small percentage of the worldwide supply. Certain of the minerals are expected to be fully mined worldwide in the next 40-50 years.

Industry and trade associations representing general manufacturers, retailers, jewelers, the automotive sector, electronics sector and others engaged early on by developing compliance templates and tools, as well as sample policies and procedures, for their members in anticipation of the inevitable compliance frenzy. In the electronics industry, EICC combined forces with the Global e-Sustainability Initiative (GeSI) to take the lead in establishing tools and resources for compliance. A quick search of the Internet shows that savvy consultants have joined in, offering additional resources from online reporting tools to full-scale on-site compliance programs. Business appears to be booming, at least for some segments of the economy.

May 31, 2014 is the current SEC-mandated compliance date for companies to file their initial conflict minerals disclosure on Form SD for the calendar year 2013 and, if necessary, an independently audited Conflict Minerals Report.

Conflict Minerals Rules Faces a Legal Challenge

The National Association of Manufacturers, the U.S. Chamber of Commerce and The Business Roundtable have launched a legal challenge to the SEC Rule in the D.C. Court of Appeals. Oral argument for the Conflict Minerals case was currently set for July 1, 2013, but pundits do not expect a judicial decision before the end of the year. It is widely expected that the key components of the Rule will be allowed to stand, given the Congressional mandate under which the Rule was adopted. Whether the SEC will be required to rethink the availability of limited exemptions ' there is currently no class of issuer exempted and no de minimus exemption for trace amounts of minerals contained in a product ' remains to be seen. If the legal challenge fails, renewed lobbying efforts may be initiated to secure some relief from the Rule's stringent requirements.

The SEC Issues FAQs

As companies undertake the diligence exercise for compliance with Rule 13p-1, interpretation of key terms used by the SEC has created issues for issuers as they attempt to navigate the SEC's broad-based rules. After repeated requests from industry groups and issuers, on May 30, 2013, the Division of Corporation Finance finally issued a set of Frequently Asked Questions (FAQs).

• The FAQs confirm that the conflict minerals disclosure requirements apply to a reporting company and all of its consolidated subsidiaries.
• The packaging and container for a product are not considered to be part of the product, even if the packaging or container is necessary to preserve the usability of the product up to and following the product's purchase. (Packaging and containers sold independently of the product are considered products in their own right.)
• If a company manufactures a product, there is no distinction in the required analysis and disclosure between the components that the issuer manufactures itself and “generic” components that the issuer purchases for inclusion in the product.
• An issuer must determine the origin of conflict minerals, and make any required disclosures regarding conflict minerals, for itself and all of its consolidated subsidiaries.
• Services are not products, and equipment that an issuer may manufacture or contract to manufacture to allow it to provide a service is not itself a product.
• Tools, machines and other equipment that an issuer manufactures or contracts to manufacture for use in the manufacture of other products are not themselves products, even if the issuer later sells them.
• Mining companies that only engage in those activities customarily associated with mining, including gold mining of lower-grade ore, are not considered to be manufacturing those minerals.
• Following an IPO, an issuer may begin providing conflict minerals disclosure for the first calendar year that begins no sooner than eight months after the effective date of the IPO registration statement.

'Scope of Compliance

In addition to deploying human and financial resources to the diligence undertaking in preparation for the 2014 filing date, many companies are sharpening their pens in 2013 as they prepare to include conflict minerals-related disclosures in their registration statements and their Annual Reports on Form 10-K or Form 20-F (or Form 10-Qs for companies with a year-end other than Dec. 31). Key sections subject to a fresh review include the business description, MD&A, risk factors, disclosure controls, corporate governance, and the notes to the financial statements.' Corporate websites are also being updated to include corporate policies on conflict mineral sourcing and other issues of social responsibility.

What's at Risk?

From a practical perspective, the SEC confirmed in the FAQs that non-compliance will not subject an issuer to the loss of its eligibility to use Form S-3. Enforcement action is still an option, however, as is public pressure from special interest groups. Given that a company can, after reasonable good faith diligence, declare itself “DRC conflict undeterminable” for the initial two calendar years of reporting (the first four years for a smaller reporting company) and thereby avoid submitting an independent audit report of its Conflict Minerals Report, this “grace period” eases the burden on cash-stretched companies or those that have hundreds of products that must be accounted for through uncooperative suppliers along the chain. Inevitably as the efforts to identify “conflict-free smelters” are expanded and certifications from suppliers become more customary and reliable, compliance procedures and associated costs should be reduced over time, much as the industry experienced after the initial years of Sarbanes-Oxley compliance.

Unfortunate Consequences Along the Supply Chain

An interesting consequence of the mandated diligence and reporting is emerging ' some companies are seeking to impose requirements in their supply contracts to ensure that 3TGs are not sourced from the DRC at all, or are considering alternatives to these minerals in the manufacture of their products. The effort is not driven by humanitarian concerns; rather, it is a cost-benefit analysis designed to ultimately avoid the rigorous diligence requirements of Rule 13p-1, particularly given the current economic climate. Management's concern is with an increasingly challenging bottom line; further administrative costs and the diversion of management time from the core business create internal pressure to pursue alternative measures.

Although these efforts will not always be successful, the intentional decrease of business with any DRC source of 3TGs runs completely counter to the original humanitarian purpose of the lobbying efforts that ultimately led to the inclusion of the conflict minerals provisions in the Dodd-Frank Act. Many U.S. and non-U.S. companies along the supply chain, whether public or private, remain at risk of losing business if they are unable to provide the requisite certifications to their customers. Smaller companies are at particular risk, as their customers seek to consolidate sources of “certifiable” supply. In addition, some companies are using this exercise to streamline their operations by reorganizing internal operations to minimize functional overlap and rethink product specifications.

The resulting costs to industry are potentially far greater than the aggregate numbers initially put forth by the SEC in its adopting release for the Rule, estimating initial compliance costs of approximately $3 billion to $4 billion, with annual ongoing compliance costs between $207 million and $609 million.

Recall that NAM puts the initial cost at between $9 billion and $16 billion. And, let's not forgot the consumers who are likely to see increases in the prices of some of their favorite products as companies try to recoup a portion of their compliance costs. Some pundits have even suggested it would perhaps be more cost-efficient for U.S. industry (and more effective for humanitarian efforts) if industry were required to provide financial aid to a fund that would support the DRC government or humanitarian groups in the region to fight the local battle directly.

Ultimately, the Rule (notwithstanding its admirable underlying humanitarian purpose) may reignite the fire over the competitiveness of U.S. stock exchanges, given the ever-increasing regulatory burdens, with the likes of Hong Kong and London. Existing registrants must assess the continuing burden of being a SEC-reporting company in challenging economic times and potential new registrants continue to question whether an entry into the U.S. public markets will yield the intended benefits without significant cost or burden. Certainly the bar continues to creep ever higher. However, compliance initiatives have already been adopted in Australia and proposals are expected later this year in the EU.

Adopted by a 3-2 vote of the SEC, the Rule was clearly as controversial within the confines of the Commission as more broadly throughout industry. While the controversy will no doubt continue in the courts, as well as in the halls of Congress and the SEC, companies must push forward with their diligence and compliance efforts, using this as an opportunity to rethink certain aspects of their operations and derive efficiencies where possible. Ironically, in this case, the humanitarian benefit may end up as little more
than a footnote.

Barbara A. Jones is a shareholder in Greenberg Traurig LLP's Corporate and Securities practice group and a member of the Global practice group and the Emerging Technologies Team. She is a co-coordinator of the firm's cross-disciplinary Conflict Minerals Compliance Initiative as well. Ms. Jones can be reached at 617-310-6064 or [email protected].

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A little more than two years ago, “conflict minerals” were certainly well-known in humanitarian circles, but had not yet caught on handily as a “cause” within the public capital markets, not to mention mainstream industry and the broader supply chain. Enter the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, and “conflict minerals” has become a household word, often holding far less favor than the intended humanitarian goal to put a squeeze on the flow of funds to militant groups in the Congo and adjoining countries (DRC).

Securities and Exchange Commission (SEC) issuers are forming high-level internal compliance teams with representatives from legal, finance, internal audit and purchasing involved to assess the extent, if any, that the company's products contain conflict minerals within the ambit of Rule 13p-1 under the Securities Exchange Act of 1934, adopted last August under Section 1502 of the Dodd-Frank Act. Diligence efforts are not confined to SEC issuers, however, with supply chain participants deeply involved in determining and certifying the original source of supplies of tantalum, tin, tungsten and gold (3TGs), and their numerous derivatives, sold to their customers.

As a result, both reporting and non-reporting companies, such as original equipment manufacturers and electronic manufacturing service providers that supply parts to issuers, are affected by the new rule. Corporate counsel in public companies will need to organize a robust compliance team with representatives from legal, finance, internal audit, purchasing and manufacturing, among others. This team will be responsible for developing and implementing a program to assess application of Rule 13p-1 to the company's products in order to file the required Form SD by May 31, 2014. Corporate counsel will play a key role in interpreting the Rule's broad requirements and impact on the company. The following provides some key background information on the new rule.

Impact on Manufacturers Across Diverse Industries

The SEC has stated that approximately 6,000 companies may be subject to the reporting requirement, and the National Association of Manufacturers (NAM) estimates that initial compliance costs industry-wide are likely to range from $9 billion to $16 billion. These figures do not include suppliers whose customers may request product information as part of their compliance due diligence. Central to the application of the Rule is whether a conflict mineral contained or used in a public company's product and “necessary to the functionality or production of a product manufactured or contracted by that registrant to be manufactured” originated in the DRC.

For companies covered by the Rule, the diligence process required for compliance with the Rule will be long, expensive and arduous. Companies are wise to get onboard and begin the process now. The substantial majority of 3TGs are reported by the U.S. Geological Survey to be sourced outside of the DRC, as the mineral reserves in the DRC represent only a small percentage of the worldwide supply. Certain of the minerals are expected to be fully mined worldwide in the next 40-50 years.

Industry and trade associations representing general manufacturers, retailers, jewelers, the automotive sector, electronics sector and others engaged early on by developing compliance templates and tools, as well as sample policies and procedures, for their members in anticipation of the inevitable compliance frenzy. In the electronics industry, EICC combined forces with the Global e-Sustainability Initiative (GeSI) to take the lead in establishing tools and resources for compliance. A quick search of the Internet shows that savvy consultants have joined in, offering additional resources from online reporting tools to full-scale on-site compliance programs. Business appears to be booming, at least for some segments of the economy.

May 31, 2014 is the current SEC-mandated compliance date for companies to file their initial conflict minerals disclosure on Form SD for the calendar year 2013 and, if necessary, an independently audited Conflict Minerals Report.

Conflict Minerals Rules Faces a Legal Challenge

The National Association of Manufacturers, the U.S. Chamber of Commerce and The Business Roundtable have launched a legal challenge to the SEC Rule in the D.C. Court of Appeals. Oral argument for the Conflict Minerals case was currently set for July 1, 2013, but pundits do not expect a judicial decision before the end of the year. It is widely expected that the key components of the Rule will be allowed to stand, given the Congressional mandate under which the Rule was adopted. Whether the SEC will be required to rethink the availability of limited exemptions ' there is currently no class of issuer exempted and no de minimus exemption for trace amounts of minerals contained in a product ' remains to be seen. If the legal challenge fails, renewed lobbying efforts may be initiated to secure some relief from the Rule's stringent requirements.

The SEC Issues FAQs

As companies undertake the diligence exercise for compliance with Rule 13p-1, interpretation of key terms used by the SEC has created issues for issuers as they attempt to navigate the SEC's broad-based rules. After repeated requests from industry groups and issuers, on May 30, 2013, the Division of Corporation Finance finally issued a set of Frequently Asked Questions (FAQs).

• The FAQs confirm that the conflict minerals disclosure requirements apply to a reporting company and all of its consolidated subsidiaries.
• The packaging and container for a product are not considered to be part of the product, even if the packaging or container is necessary to preserve the usability of the product up to and following the product's purchase. (Packaging and containers sold independently of the product are considered products in their own right.)
• If a company manufactures a product, there is no distinction in the required analysis and disclosure between the components that the issuer manufactures itself and “generic” components that the issuer purchases for inclusion in the product.
• An issuer must determine the origin of conflict minerals, and make any required disclosures regarding conflict minerals, for itself and all of its consolidated subsidiaries.
• Services are not products, and equipment that an issuer may manufacture or contract to manufacture to allow it to provide a service is not itself a product.
• Tools, machines and other equipment that an issuer manufactures or contracts to manufacture for use in the manufacture of other products are not themselves products, even if the issuer later sells them.
• Mining companies that only engage in those activities customarily associated with mining, including gold mining of lower-grade ore, are not considered to be manufacturing those minerals.
• Following an IPO, an issuer may begin providing conflict minerals disclosure for the first calendar year that begins no sooner than eight months after the effective date of the IPO registration statement.

'Scope of Compliance

In addition to deploying human and financial resources to the diligence undertaking in preparation for the 2014 filing date, many companies are sharpening their pens in 2013 as they prepare to include conflict minerals-related disclosures in their registration statements and their Annual Reports on Form 10-K or Form 20-F (or Form 10-Qs for companies with a year-end other than Dec. 31). Key sections subject to a fresh review include the business description, MD&A, risk factors, disclosure controls, corporate governance, and the notes to the financial statements.' Corporate websites are also being updated to include corporate policies on conflict mineral sourcing and other issues of social responsibility.

What's at Risk?

From a practical perspective, the SEC confirmed in the FAQs that non-compliance will not subject an issuer to the loss of its eligibility to use Form S-3. Enforcement action is still an option, however, as is public pressure from special interest groups. Given that a company can, after reasonable good faith diligence, declare itself “DRC conflict undeterminable” for the initial two calendar years of reporting (the first four years for a smaller reporting company) and thereby avoid submitting an independent audit report of its Conflict Minerals Report, this “grace period” eases the burden on cash-stretched companies or those that have hundreds of products that must be accounted for through uncooperative suppliers along the chain. Inevitably as the efforts to identify “conflict-free smelters” are expanded and certifications from suppliers become more customary and reliable, compliance procedures and associated costs should be reduced over time, much as the industry experienced after the initial years of Sarbanes-Oxley compliance.

Unfortunate Consequences Along the Supply Chain

An interesting consequence of the mandated diligence and reporting is emerging ' some companies are seeking to impose requirements in their supply contracts to ensure that 3TGs are not sourced from the DRC at all, or are considering alternatives to these minerals in the manufacture of their products. The effort is not driven by humanitarian concerns; rather, it is a cost-benefit analysis designed to ultimately avoid the rigorous diligence requirements of Rule 13p-1, particularly given the current economic climate. Management's concern is with an increasingly challenging bottom line; further administrative costs and the diversion of management time from the core business create internal pressure to pursue alternative measures.

Although these efforts will not always be successful, the intentional decrease of business with any DRC source of 3TGs runs completely counter to the original humanitarian purpose of the lobbying efforts that ultimately led to the inclusion of the conflict minerals provisions in the Dodd-Frank Act. Many U.S. and non-U.S. companies along the supply chain, whether public or private, remain at risk of losing business if they are unable to provide the requisite certifications to their customers. Smaller companies are at particular risk, as their customers seek to consolidate sources of “certifiable” supply. In addition, some companies are using this exercise to streamline their operations by reorganizing internal operations to minimize functional overlap and rethink product specifications.

The resulting costs to industry are potentially far greater than the aggregate numbers initially put forth by the SEC in its adopting release for the Rule, estimating initial compliance costs of approximately $3 billion to $4 billion, with annual ongoing compliance costs between $207 million and $609 million.

Recall that NAM puts the initial cost at between $9 billion and $16 billion. And, let's not forgot the consumers who are likely to see increases in the prices of some of their favorite products as companies try to recoup a portion of their compliance costs. Some pundits have even suggested it would perhaps be more cost-efficient for U.S. industry (and more effective for humanitarian efforts) if industry were required to provide financial aid to a fund that would support the DRC government or humanitarian groups in the region to fight the local battle directly.

Ultimately, the Rule (notwithstanding its admirable underlying humanitarian purpose) may reignite the fire over the competitiveness of U.S. stock exchanges, given the ever-increasing regulatory burdens, with the likes of Hong Kong and London. Existing registrants must assess the continuing burden of being a SEC-reporting company in challenging economic times and potential new registrants continue to question whether an entry into the U.S. public markets will yield the intended benefits without significant cost or burden. Certainly the bar continues to creep ever higher. However, compliance initiatives have already been adopted in Australia and proposals are expected later this year in the EU.

Adopted by a 3-2 vote of the SEC, the Rule was clearly as controversial within the confines of the Commission as more broadly throughout industry. While the controversy will no doubt continue in the courts, as well as in the halls of Congress and the SEC, companies must push forward with their diligence and compliance efforts, using this as an opportunity to rethink certain aspects of their operations and derive efficiencies where possible. Ironically, in this case, the humanitarian benefit may end up as little more
than a footnote.

Barbara A. Jones is a shareholder in Greenberg Traurig LLP's Corporate and Securities practice group and a member of the Global practice group and the Emerging Technologies Team. She is a co-coordinator of the firm's cross-disciplinary Conflict Minerals Compliance Initiative as well. Ms. Jones can be reached at 617-310-6064 or [email protected].

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