Public companies that manufacture products for which “conflict minerals” or their derivatives1 are necessary to the functionality or production should have concluded or be finalizing the “country of origin inquiries” required by the Securities and Exchange Commission (SEC)’s Conflict Minerals Rule. Our previous Client Advisory explained the coverage of the Rule and the country of origin inquiry; this Advisory summarizes the due diligence, disclosure and audit steps that follow.
Finalizing the Country of Origin Inquiry
Ensuring the quality of the data collected and organizing it effectively are critical elements of the foundation for the next steps. You must check your supplier information for reasonableness (i.e., red flags), inconsistencies, and missing pieces. Governmental or industry group data sources will be helpful for this. Appropriate followup must then be undertaken. The data must be managed with the goal of preserving evidence that can be audited at the end of the process.
There is no specified end-point. It’s up to you to decide if you’ve completed a “reasonable” country of origin inquiry, at which point (assuming you’re not required to go on to the due diligence phase), you can stop – until the next year. We expect that outside groups will scrutinize the process descriptions that companies file with the SEC, and their reactions will help shape what companies do in subsequent years.
Deadline for Disclosure
All affected public companies, regardless of their fiscal year, must provide disclosure on Form SD – as discussed below – on a calendar year basis. The report for 2013 is due May 31, 2014.2
- You are required to provide disclosure about conflict minerals necessary to products that were manufactured during the calendar year covered by the report. The key date is the date that the manufacture of a finished product is completed, whether by the reporting company or by its contract manufacturer.3
The disclosure required depends on the results of your country of origin inquiry and, if required, further due diligence. In many cases, the disclosure will have to be audited. Because this will be time-consuming, you are urged to engage with the auditors early in the process to ensure that it is accomplished by the filing deadline.
Is Due Diligence Required?
A company need not take further due diligence steps if, based on its country of origin inquiry, it either:
- has determined that its necessary conflict minerals did not originate in a covered country or did come from recycled or scrap sources;
- has no reason to believe that the conflict minerals may have originated in a covered country; or
- reasonably believes that the conflict minerals did come from recycled or scrap sources.
In that case, the company only need file Form SD on EDGAR and post its conclusions as described under “Reporting the Results” below.
However, if, based on its country of origin inquiry, the company knows or has reason to believe that any of its necessary conflict minerals did or may have originated in a covered country and were not or may not be from recycled or scrap sources, the company will be required to conduct heightened due diligence before making its disclosures.
Due Diligence Design / OECD Framework
Due diligence, as principally intended by the SEC, is a process of identifying the source and chain of custody of the company's conflict minerals that originated or that it has reason to believe may have originated in the covered countries. However, it is broader in scope than merely investigative. The SEC Rule requires a company to conduct due diligence that conforms to a nationally or internationally recognized due diligence framework. Currently, the only general framework that satisfies this standard is the Organization for Economic Cooperation and Development (OECD) Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas.4 This describes due diligence as “the steps companies should take to identify and address actual or potential risks in order to prevent or mitigate adverse impacts associated with their activities or sourcing decisions” (emphasis added).5 The OECD Guidance also prescribes that “all companies should conduct due diligence aimed at ensuring that they do not contribute to human rights abuses or conflict.” This goes well beyond simply discovering the sources of one’s conflict minerals.
The necessary steps will depend on each company’s particular circumstances.
A company following the OECD guidance will need to:
- ensure that its management systems and policy related to the supply chain are strong, that the policy is communicated to suppliers, and that it is backed up by effective controls;
- identify the risks in its supply chain (for which the OECD Guidance Supplements on gold and the 3Ts provide recommendations);
- assess the risks, including actions such as evaluating the compliance procedures of its suppliers and relevant smelters; and
- design and implement a strategy to respond to identified noncompliance and other risks, such as ensuring its suppliers’ compliance with the company’s policy or modifying the company’s relationship with a noncomplying supplier.
The OECD guidance notes that the challenges of due diligence in conflict-affected areas can be met in a variety of ways, including industry-wide cooperation, cost-sharing and other cooperation among industry members that share suppliers, and working with international organizations.
Two additional elements of the due diligence process – an independent third party audit of the process and public reporting on a company’s supply chain due diligence policies and practices – are included as separate parts of the SEC Rule, as described below.
Due diligence is a continuous process; one is never finished unless one can be sure that one’s necessary conflict minerals will never come from a covered country.
Reporting the Results
If, based on the initial country of origin inquiry or after conducting further due diligence, you make the determination(s) described in the bullets under “Is Due Diligence Required?” above, you are required only to file a Form SD that discloses the conclusions and briefly describes the country of origin inquiry and, if applicable, the due diligence (including the company’s sourcing policies for conflict minerals) and its results. You must also post this disclosure on the company’s website for one year and provide a link to the website in the Form SD.
If the company's due diligence leads to any other conclusion, you must also prepare and file a Conflict Minerals Report with the Form SD.
Conflict Minerals Report
The Conflict Minerals Report will be filed as an exhibit to Form SD and posted on the company’s website with a link from the Form SD. The report must (i) describe the measures the company took to exercise due diligence on the source and chain of custody of the company's necessary conflict minerals, (ii) include disclosures about the company's products containing conflict minerals and the origin of those minerals and (iii) include, except as described below, an independent private sector audit report and certain statements about the audit.
The Conflict Minerals Report will have to describe the relevant company products in one of the following ways:
- DRC Conflict Free. If a company determines that the necessary conflict minerals did not directly or indirectly finance or benefit an armed group in a country, it may describe its products as “DRC conflict free.” Conflict minerals obtained from recycled or scrap sources are considered DRC conflict free.
- DRC Conflict Undeterminable. If a company is unable to determine, after exercising due diligence, whether or not its relevant products are “DRC conflict free,” during 2013 and 2014 only (2013-2016 for smaller reporting companies), the company can categorize the relevant products as “DRC conflict undeterminable.” With respect to these products, the Conflict Minerals Report must describe:
- The products containing the relevant minerals.
- The steps it has taken or will take since the end of the period covered by its last conflict minerals report to mitigate the risk that its conflict minerals benefit armed groups, including any steps to improve the company's due diligence.
- If known, the smelter or refiner used to process the conflict minerals in those products, the country of origin of the minerals and the efforts to determine the mine or location of origin with the greatest possible specificity
- Not Found to be DRC Conflict Free. If the company determines that the conflict minerals in its products did directly or indirectly finance or benefit an armed group in a covered country, the Conflict Minerals Report must describe the products containing those minerals as “having not been found to be DRC conflict free.”
- Once the “DRC conflict undeterminable” option is no longer available, if a company still cannot determine whether its products are “DRC conflict free,” it can also describe its products containing the minerals in the Conflict Minerals Report as "having not been found to be DRC conflict free," and may include explanatory disclosure.
Companies whose products have not been found to be “DRC conflict free” (including, for the transition period, “DRC conflict undeterminable”) must also identify the smelter or refiner used to process the conflict minerals in the relevant products, the country of origin of the conflict minerals and the efforts to determine the mine or location of origin with “the greatest possible specificity.”
It should be noted that the Rule requires no physical labeling or description of products outside the Conflict Minerals Report. However, commercial and interest group pressures may have that result.
Unless all of the company's necessary conflict minerals for which a Conflict Minerals Report is required fall within the temporary “DRC conflict undeterminable” category in a given year, the Conflict Minerals Report must be audited and the audit report filed with the Form SD described below.
The audit must be performed in accordance with generally accepted government auditing standards (including the independence standards) established by the Government Accountability Office.6 The audit should express an opinion or conclusion as to whether, for the covered period:
- the design of the company's due diligence process described in its conflict minerals report is in conformity in all material respects with the recognized due diligence framework used by the company, and
- the company's description of the due diligence measures that it performed is consistent with the due diligence process that it undertook.
An audit is not required for any portion of the Conflict Minerals Report dealing with company due diligence on conflict minerals for which a recognized due diligence framework does not exist, and the rule does not require the auditor to express an opinion on the company's conclusion on whether its products are “DRC conflict free.”
Filing and Posting of Form SD and Conflict Minerals Report
Both Form SD and the Conflict Minerals Report must be filed with the SEC via EDGAR and, therefore, could potentially trigger liability under Section 18 of the Exchange Act. However, Form SD will not be incorporated by reference into a company's registration statements under the Securities Act of 1933 (unless the company elects to do so), and the failure to timely file a Form SD will not affect a company's eligibility to use Form S-3. Each company also must post certain disclosure on its website, including a description (including the results) of its reasonable country of origin inquiry and due diligence efforts, a link to the Form SD, and, if required, the Conflict Minerals Report.
1 Cassiterite (tin and tin alloys), columbite-tantalite (tantalum) and wolframite (tungsten) (sometimes referred to as “3Ts”), and gold. Recent research by the International Peace Information Service suggests that gold has become the principal conflict mineral in recent years due to factors such as higher prices, its higher value-to-weight ratio (i.e., easier and more profitable to smuggle), and the greater difficulty of tracing melted gold via its physical properties than with the 3Ts.
2 For (i) new public companies and (ii) any reporting company that acquires a target company using conflict minerals in a way that triggers the rule and such reporting company was not, before the acquisition, required to make conflict minerals disclosure, conflict minerals disclosure will be required for the first calendar year that begins either eight months or more after the effective date of the registration statement or the acquisition, respectively.
3 There is an exemption for stockpiles of conflict minerals existing January 31, 2013. You need not investigate or disclose the origin of conflict minerals that were already outside of the supply chain before that date. This covers any conflict minerals that had been smelted (the 3Ts) or fully refined (gold) and any conflict minerals that, while not smelted or fully refined, were located outside of one of the DRC Countries before that date. However, if you obtained or used conflict minerals that were in the supply chain on or after that date, the Rule applies to them.
4 This site includes the OECD Supplements on gold and the 3Ts and also presents helpful information on implementing the Guidance.
5 “Risks,” in the OECD Guidance, mean “the potentially adverse impacts of a company’s operations, which result from a company’s own activities or its relationships with third parties, including suppliers and other entities in the supply chain. Adverse impacts may include harm to people (i.e. external impacts), or reputational damage or legal liability for the company (i.e. internal impacts), or both.” As used here, “legal liability” appears to refer to the possibility of being engaged in bribery, money laundering, nonpayment of taxes, human rights abuses and similar activities, or being implicated in such activities conducted by parties in the company’s supply chain.
6 The audit need not be performed by the company’s independent registered public accounting firm but, if it is, the company’s Audit Committee must pre-approve it as a “non-audit service.”