Among the many statutory and regulatory changes brought about by the Dodd-Frank Act was the enactment of new Section 13(p) of the Securities Exchange Act of 1934, which requires some reporting companies to determine whether “conflict minerals” are necessary to the production or functionality of any product they manufacture, and if so, to disclose whether those conflict minerals originated in the Democratic Republic of the Congo (DRC) or an adjoining country.
Section 13(p) also directed the SEC to develop new rules under the Exchange Act to implement this new requirement, and on August 22, 2012, the SEC revealed the final version of new Rule 13p-1 and new Form SD under the Exchange Act. Unless otherwise noted, the SEC’s adopting release, which comes in at 356 pages with 917 footnotes, is the source of all quotations in this post. In the adopting release, the SEC endorses a three step framework as a way of thinking about Rule 13p-1:
Step 1: An issuer must determine whether it is subject to the requirements of the conflict minerals statutory provision. The provision applies where “conflict minerals are necessary to the functionality or production of a product manufactured by such person.”
Step 2: Issuers within the scope of step one must conduct a reasonable country of origin inquiry regarding the origin of its conflict minerals. To satisfy the reasonable country of origin inquiry requirement, an issuer must conduct an inquiry regarding the origin of its conflict minerals that is reasonably designed to determine whether any of its conflict minerals originated in the covered countries or are from recycled or scrap sources, and must perform the inquiry in good faith.
Step 3: Step three applies to issuers who know their conflict minerals came from the Democratic Republic of the Congo or have reason to know that may have. An issuer must exercise due diligence on the source and chain of custody of its conflict minerals and provide a conflict minerals report describing its due diligence measures, among other matters.
This post focuses on Step 2: the reasonable country of origin inquiry. By way of refresher, “conflict minerals,” according to the SEC, consist of:
- Columbite-tantalite, or coltan, which is the ore from which tantalum is extracted. Tantalum is used in electronic components found in cell phones, computers, gaming consoles, and digital cameras, and as an alloy for making carbide tools and jet engine components.
- Cassiterite, the ore from which tin is extracted. Tin is used in alloys, tin plating, and solders for joining pipes and electronic circuits.
- Gold, which, apart from its jewelry related applications, is also found in electronic, communications, and aerospace equipment.
- Wolframite, the ore from which tungsten is extracted. Tungsten is found in metal wires, electrodes, and contacts in lighting, electronic, electrical, heating, and welding applications.
Considering the many industries and products that are represented by the manufacture of products containing conflict minerals, the potential scope of Rule 13p-1 is staggering. In what can only be called an understatement, the SEC notes that, “Based on the many uses of these minerals, we expect the Conflict Minerals Statutory Provision to apply to many companies and industries and, thereby, the final rule to apply to many issuers.”
After a company has determined that it is subject to Rule 13p-1 and that it manufactures products for which conflict minerals are necessary, it must conduct a reasonable country of origin inquiry in order to determine whether the conflict minerals in its products originated in a “covered country” – the DRC or one of its adjoining countries, such as Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia.
Reasonable Country of Origin Inquiry
In an effort to make the rules broad, flexible, and adaptable to changing tracing methods that may allow for more accurate determinations of the sources of conflict minerals in the future, the SEC chose to leave the phrase “reasonable country of origin inquiry” undefined in the final rule. The specifics of the reasonable country of origin inquiry and the steps involved in the inquiry “depend on each issuer’s particular facts and circumstances.” Having said that, the SEC does provide some general guidance on the meaning of the phrase:
- The inquiry must be reasonably designed to determine whether the issuer’s conflict minerals originated in a covered country (or came from recycled or scrap sources, which is another avenue out of the due diligence at Step 3).
- The inquiry must be performed in good faith.
- The issuer cannot ignore red flags indicating that its conflict minerals originated in a covered country.
- It isn’t necessary that an issuer hear back from all of its suppliers if it has made the reasonable inquiry in good faith and has a reasonable basis for concluding, based on the responses that it did receive, that its conflict minerals did not originate in a covered country.
- An issuer need not determine with absolute certainty whether conflict minerals originated in a covered country.
Representations from Facilities and Suppliers
An issuer may be able to meet its reasonable country of origin inquiry by asking its facilities or suppliers for representations that the conflict minerals did not originate in a covered country. However, the issuer “must have a reason to believe these representations are true given the facts and circumstances surrounding those representations” and cannot ignore warning signs or red flags. This requires more than trusting your facility manager. The SEC explains:
“An issuer would have reason to believe representations were true if a processing facility received a ‘conflict-free’ designation by a recognized industry group that requires an independent private sector audit of the smelter, or an individual processing facility, while it may not be part of the industry group’s ‘conflict-free’ designation process, obtained an independent private sector audit that is made publicly available.”
On the other hand, a red flag, in the eyes of the SEC, could be something as simple as a company learning that some of the conflict minerals it uses were processed at a smelter that sourced raw material from a variety of countries, including one or more covered countries.
The OECD Guidelines
Issuers looking for some reassurance that their reasonable country or origin inquiry is robust enough to satisfy Rule 13p-1 may look to the Organisation for Economic Co-operation and Development (OECD), which in 2011 published its Due Diligence Guide for Responsible Supply Chains of Minerals from Conflict-Affected and High Risk Areas. The OECD guidance is endorsed throughout the SEC’s adopting release a source of standards for the due diligence to be conducted at Step 3, but also for the reasonable country of origin inquiry. The SEC indicates that the “supplier engagement approach in the OECD guidance where issuers use a range of tools and methods to engage with their suppliers . . . to determine if the further work outlined in the OECD guidance – due diligence – is necessary” is the appropriate analog to the Rule 13p-1 reasonable country of origin inquiry.
After the Reasonable Country of Origin Inquiry
Depending on the outcome of the reasonable country of origin inquiry, the issuer either concludes the conflict minerals exercise, or proceeds to the more rigorous due diligence required at step 3. If the issuer determines that its conflict minerals did not originate in a covered country, or that its conflict minerals came from recycled or scrap materials, or if the reasonable country of origin inquiry is inconclusive, but the issuer “has no reason to believe that its conflict minerals may have originated in the Covered Countries or the issuer reasonably believes that its conflict minerals are from recycled or scrap sources,” then the issuer only needs to disclose this determination in its Form SD filing and briefly describe the reasonably country of origin inquiry and the result the company came to.
If after reading this post you’re thinking that the reasonable country of origin inquiry seems to be a messy, fuzzy, uncertain and potentially very costly endeavor, you should know that the SEC does not share your view: “we believe the reasonable country of origin inquiry standard provides a clear way for issuers to make the necessary determination.”
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