Don’t Panic, At Least Not Yet
On August 22, 2012, the SEC adopted final rules relating to required disclosures by public companies that utilize so-called “conflict minerals” if the conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the company. Conflict minerals initially include columbite-tantalite (coltan), cassiterite (tin), gold, wolframite (tungsten) and their derivatives. While, with the exception of gold, these minerals are not well-known by the general public, they are present in almost all electronic and other equipment, ranging from watches and iPads to cars and turbines. You are certain to have a few, and maybe all, within a few feet of where you are reading this alert.
As part of the Dodd-Frank Act, Congress required the rules and related disclosures because of concerns that the exploitation and trade of conflict minerals by armed groups are helping to finance conflict in the Democratic Republic of the Congo region and are contributing to a humanitarian crisis. The goal of the rules is to force companies to implement a supplier audit trail sufficient to avoid sourcing conflict minerals from inappropriate sources in the DRC and adjacent countries. The rules do this by requiring each company to perform a “reasonable country of origin inquiry” with respect to the conflict minerals that it uses.
If either (i) the company knows that none of the conflict minerals originated in the DRC countries or are from scrap or recycled sources, or (ii) if the company has no reason to believe that the conflict minerals may have originated in the DRC countries or may not be from scrap or recycled sources, it would be required to make a series of disclosures reflecting this. If, after the reasonable inquiry, the company determines that its conflict minerals originated or may have originated in the DRC countries, or if the company learns or has reason to believe that its conflict minerals may not be recycled or scrap, the company will be required to conduct due diligence on its supply chain to determine if the conflict minerals financed or benefited armed groups in the covered countries and will have to make a different series of disclosures, including the publishing of a “conflict minerals report.”
In turn, and this is the most onerous requirement of the rules, the conflict minerals report would have to include an independent private sector audit.
While it will take some time to fully digest the entire 356-page final SEC release, there is some good news. First, the final rules do not require these disclosures until May 31, 2014, and the initial disclosures would relate to the calendar year beginning January 1, 2013. Second, for a temporary two-year period (or four-year period for smaller reporting companies), if a company is unable to determine whether the conflict minerals in its products originated in the DRC countries or financed or benefited armed groups in those countries, then those products are considered “DRC conflict undeterminable.” In such case, while the company must still provide a conflicts mineral report, the company is not required to obtain an independent private sector audit of the conflict minerals report regarding the conflict minerals in those products. Third, there are special rules governing the due diligence and conflict minerals reports for conflict minerals from recycled and scrap sources that are less onerous on a company, and, in particular, if a company can determine its conflict minerals are derived from recycled or scrap sources then its products will be considered “DRC conflict free.” Fourth, increasingly it appears that the supply channels for conflict minerals are exploring control and audit solutions that would be available to end users. We doubt that this will provide a universal solution, but for many end users it might work fine.
As an initial task, each company needs to carefully assess what conflict minerals it uses in its business. In this regard, it is important to keep in mind two aspects of the SEC rules. First, is the conflict mineral “necessary to the functionality or production of a product”? If it is, it is covered. Second, the rules cover conflict minerals that are not only included by a company in a product, but also those that are included in a component that the company has “contracted to manufacture.” The determination of whether a company has contracted to manufacture is based on facts and circumstances, taking into account the degree of influence a company exercises over the product’s manufacturing. A company is not to be deemed to have influence over the manufacturing if it merely:
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affixes its brand, marks, logo, or label to a generic product manufactured by a third party,
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services, maintains, or repairs a product manufactured by a third party, or
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specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product.
For example, if a utility contracts with a company in China to manufacture smart meters for which it exercises significant influence over the manufacturing process, possibly even specifying the design, and those smart meters contain conflict minerals, the rules could apply. Correspondingly, if the utility simply purchases, say, GE transformers without providing GE any design guidance, any conflict minerals in those transformers should not be covered by the new rules. Given the breadth of coverage of these two triggers, it is critical that companies exhaustively and promptly determine whether the rules are applicable. And it is important to note that the rules cover foreign and not just domestic production.
As a second task, companies need to actively discuss with their suppliers of conflict minerals the sources of those conflict minerals and how the suppliers can document that. We very much believe that as an initial matter, every user of conflict minerals should impose as much of the compliance responsibility as possible on its suppliers, and we expect this to be the near-universal approach. Consistent with this, some companies will want to review the terms of the agreements that they have with their suppliers in order to determine whether changes are appropriate.
Lastly, we think that companies are well advised to work with their trade associations in order to determine whether their particular industry is developing a common approach. In light of antitrust concerns, we believe that working through a trade association where these concerns are carefully considered is much more advisable that working directly with competitors or other purchasers of conflict minerals.
We expect a range of practicable solutions to evolve over the next several months. As they do, we will keep you updated.
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