October 20, 2011
On October 18, 2011, the Securities and Exchange Commission ("SEC" or "Commission") held a public roundtable (the "Roundtable") to address the agency’s required conflict minerals rulemaking under Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The SEC issued proposed rules, available at www.sec.gov/rules/proposed/2010/34-63547.pdf, to implement Section 1502 in December 2010. Chairman Schapiro indicated at the Roundtable that the agency has held over 90 meetings and received over 250 comments to date from issuers, nongovernmental organizations ("NGOs"), and other stakeholders concerned with the proposed rules. In connection with the Roundtable, the Commission has extended the comment period until November 1, 2011, and it will accept comments relating to the issues addressed in the Roundtable as well as its Section 1502 rulemaking more broadly. At the Roundtable, SEC staff indicated particular interest in receiving comments addressing cost estimates of the proposed rules and, particularly, how various possible implementations of the rules would affect issuers’ cost of compliance.
The Proposed Rules
Section 1502 requires an issuer that uses "conflict minerals" originating in the Democratic Republic of Congo (the "DRC") or its adjoining countries (the "DRC countries") to provide an annual report to the SEC ("Conflict Minerals Report"). Conflict minerals include gold, columbite-tantalite, cassiterite, and wolframite–the metal ores used to produce tantalum, tin, and tungsten–or their derivatives, or any other mineral or its derivatives determined by the Secretary of State to be financing conflict in the DRC countries.
Under the SEC’s proposed rules, there are three steps to consider with respect to the conflict minerals disclosure requirement. First, issuers must determine whether they are subject to the conflict minerals rules. Issuers are subject to the rules only if conflict minerals are necessary to the functionality or production of a product the issuer manufactures or has contracted to manufacture. If so, the issuer moves to step two. If not, no further action, and no disclosure, is required.
At step two, the issuer must conduct a reasonable country of origin inquiry to determine whether its conflict minerals originated in the DRC countries. If the issuer determines that its conflict minerals did not originate in the DRC countries, the issuer must disclose this determination and the inquiry it undertook to make this determination in its annual report on Form 10-K. If the issuer is unable to determine that its conflict minerals did not originate in the DRC countries, it moves to step three.
Step three requires issuers unable to determine that their conflict minerals did not originate in the DRC countries to disclose this fact in the Form 10-K, and furnish a Conflict Minerals Report as an exhibit to the Form 10-K. The Conflict Minerals Report also must be published on the issuer’s website. The Conflict Minerals Report must include, with respect to the period covered: (1) a description of the measures taken to exercise due diligence on the source and chain of custody of the conflict minerals, including a certification that the issuer obtained an independent private sector audit of the Conflict Minerals Report; (2) a description of the products manufactured or contracted to be manufactured that are not conflict minerals free; (3) the facilities used to process the conflict minerals; (4) the country of origin of the conflict minerals; and (5) the efforts undertaken to identify the mine or location of origin with the greatest possible specificity.
The Roundtable featured two panels discussing key issues related to the SEC’s proposed rules, including the scope of the rules, the steps that will be required to comply, and reporting under the rules. Panelists represented NGOs, issuers that will be affected by the reporting requirements, and providers of products and services to support issuers’ obligations. The full list of panelists is available at www.sec.gov/spotlight/conflictminerals/conflictmineralsroundtable101811-participants.htm. Each panelist gave brief opening remarks, and the staff of the Division of Corporate Finance questioned the panelists on the issues set forth below. The Chairman and three sitting Commissioners attended the Roundtable. The Roundtable also included remarks by Senator Richard J. Durbin and Representative Jim McDermott, who co-authored Section 1502.
During the Roundtable discussion, consensus emerged around the need for transparency and disclosure of the process issuers are undertaking to satisfy their conflict minerals disclosure obligations. Panelists were divided, however, over the current availability of infrastructure necessary to facilitate implementation of the rules and the feasibility of meaningful reporting under the rules in the first year following their adoption. Issuers expressed concern about the broad applicability and reporting requirements of the proposed rules, while NGOs generally urged the speedy adoption and implementation of final rules. Both Commission staff and panelists signaled that the reporting standards would evolve over time, along with the development of supply chain infrastructure.
Key Roundtable Topics
Definition of "Conflict Minerals"
Commission staff inquired whether the rules should define "conflict minerals" as gold plus the derivatives of columbite-tantalite, cassiterite, and wolframite: tantalum, tin, and tungsten. Panelists generally agreed that limiting the coverage of the rules to these defined derivatives would be the most effective means to accomplish the purpose of Section 1502, given that the economic power to exert pressure on the supply chain lies primarily with these derivatives.
Necessary to Functionality or Production
Commission staff asked whether they should define when a conflict mineral is necessary to the functionality or production of a product, thus triggering application of the rules. The staff was interested, for example, in whether conflict minerals that are incorporated in a product or its packaging as embellishment or decoration should implicate reporting requirements under the rules. Panelists generally expressed the view that a more appropriate focus was whether the conflict mineral was intentionally included in the product. Issuers expressed support for a simple approach and clarification of the rules.
De Minimis Exception
Noting that they have received comments urging a de minimis exception for products containing small amounts of conflict minerals, Commission staff questioned whether there should be such an exception and how it would interact with the rules’ triggering condition that conflict minerals be necessary to a product’s functionality or production. The panelists generally were opposed to a de minimis exception, given the small amount used in many products, such as cell phones and computer chips, and the difficulty of the definition. The concern of several panelists was that, given the total production of products containing de minimis amounts of conflict minerals, the aggregate effect of these products in the supply chain is significant.
Mining as Manufacturing
Noting that Section 1502 does not define "manufacturing" and that the proposed rules consider issuers that mine conflict minerals to "manufacture" those minerals, Commission staff asked whether mining issuers should be subject to the rules. An NGO expressed the view that the rules should cover mining because it is the first link in the supply chain, while a leading gold mining company indicated that mining is a separate endeavor from manufacturing.
Contract to Manufacture
Commission staff expressed interest in the extent to which the rules should encompass retail issuers and whether they should cover only those non-manufacturer issuers that exercise direct contractual control over the sourcing or manufacturing of a product. The staff inquired as to whether influence over the manufacturing process should be key to further inclusion of non-manufacturer issuers under the rules. The view expressed by NGOs was that any exemption for those who contract to manufacture products would create a loophole in the reporting rules that is not justified in light of the influence such issuers exert on the supply chain. An issuer suggested, however, that the overall level of disclosure is not at stake on the outcome of this issue because manufacturers would still make all required disclosures for the products at issue.
Reasonable Country of Origin Inquiry
In response to the Commission staff’s question as to whether the rules should define "reasonable country of origin inquiry," one NGO suggested that such definition is essential to ensuring the quality of reporting. Another NGO stressed that a reasonable inquiry should not rely solely on the representations of smelters but should require third-party verification of the smelter’s assurances. Issuers suggested that some examples as to what inquiry is reasonable would aid compliance. Panelists generally recognized that the rules should require a good faith effort, rather than perfection in compliance.
Some issuers indicated that a multi-year phase-in period was appropriate given that the supply chain infrastructure was not yet mature. They also suggested that, in order to facilitate meaningful reporting, the final rules should include, for a limited time, an "indeterminate" category of reporting, in addition to "DRC conflict free" and "not DRC conflict free." During the phase-in period, issuers would disclose their efforts and progress in supply chain tracking. While NGOs were not in favor of an "indeterminate" category, they recognized that the standard of reasonable inquiry would change over time as additional infrastructure developed.
Commission staff asked whether the final rules should define a specific due diligence standard. The consensus view was that the Commission should allow issuers flexibility in conducting the due diligence process in light of supply chain complexity. Many panelists supported reliance on the OECD due diligence guidelines, available at www.oecd.org/dataoecd/62/30/46740847.pdf. Several suggested that the OECD guidelines should be a non-exclusive safe harbor. Thus, the rules also should allow reliance on other processes, including supplier contractual obligations, conflict-free smelter validation programs, statistical sampling, and other industry initiatives.
Issuers noted that the rules must reflect that, depending on the complexity of an issuer’s products and the length of its supply chain, issuers are subject to varying due diligence burdens. Panelists explained that contractual obligations on an issuer’s contractors and suppliers to verify the origin of their conflict minerals would increase pressure down the supply chain to develop the infrastructure to enable more complete reporting. It could take much longer, however, for communications with suppliers to yield information on the smelter of origin for all conflict minerals in all components of the issuer’s products, given that it may take years for issuers to be able to negotiate provisions in their supplier contracts and for suppliers to be able to trace conflict minerals to the smelter.
Audit of Conflict Minerals Report
Recognizing the uncertainty in the proposed rules as to the required private sector independent audit, Commission staff sought views on whether the audit should be of the due diligence process of the issuer in determining the supply chain of its conflict minerals or the conclusions reached in the Conflict Minerals Report. Panelists generally urged the Commission to clarify in its final rules that the required audit concerns the process used in generating the report.
Commission staff next inquired as to whether the required audit, which is to be conducted under standards established by the Government Accountability Office, should be based either on attestation standards or performance standards. If it is based on attestation standards, it could be performed only by accountants, while if it is based on performance standards, non-accountants would be allowed to perform the audit. The staff noted that flexibility in terms of the parties authorized to perform the audit may facilitate a more cost-effective process. However, a performance audit may require that the final rules provide a standard for the conduct of the audit in order to ensure consistency. Panelists supported allowing performance audits under the rules, and one suggested allowing a choice of the attestation or performance standard.
Treatment of Gold
A few panelists urged that the delay in the issuance of OECD due diligence guidelines for gold necessitates a delay in the statute’s reporting obligations concerning this conflict mineral. Others argued that the gold supply chain is not more complex than that of other conflict minerals and gold should not receive disparate treatment.
Recycled and Scrap Materials
Commission staff inquired as to whether its final rules should require an audited Conflict Minerals Report from issuers that obtain conflict minerals from a recycled or scrap source. In light of the difficulty of ascertaining the origin of recycled or scrap conflict minerals, the proposed rules allow issuers to treat conflict minerals from these sources as DRC conflict free. While there was some NGO concern about creating a reporting loophole if there are no definitions of "recycled" and "scrap" sources and no verification of the issuer’s determinations, the majority of panelists were of the view that the Commission should not disincentivize the use of recycled and scrap minerals.
Form and Timing of Reporting
Commission staff requested discussion on whether additional time is needed after the end of an issuer’s reporting period to make Section 1502 disclosures and whether a different form than the 10-K should be the vehicle for conflict minerals disclosure. Issuers expressed widespread support for using a separate filing, whether a new Form CM, or a new Form 8-K item. They also urged a filing delay of several months from the filing of the Form 10-K, given the time pressure that would accompany the simultaneous preparation of the Form 10-K, proxy statement, and Conflict Minerals Report. The panel also supported the idea of synchronizing the timing of all issuers’ disclosure, enabling the efficient coordination of supply chain information.
Commission staff also sought views on whether its final rules should include a transition period as to stockpiled conflict minerals or conflict minerals in the pipeline from mine to smelter. Both issuers and NGOs supported a transition period for such minerals, emphasizing the impracticability of tracing the origin of stocks and products already in existence and the forward-looking purpose of Section 1502. Panelists also suggested that the effective date of the rules should mark the point at which subsequently mined conflict minerals would become subject to the rules.
Remarks by Senator Durbin and Representative McDermott
Senator Durbin emphasized that Section 1502 seeks to appeal to the corporate social responsibility values of issuers and to alert U.S. consumers to the violence and exploitation in the DRC countries fueled by the demand for products containing DRC conflict minerals. Representative McDermott elaborated that the aim of the statute is to encourage practical due diligence and reasonable efforts by issuers to understand their supply chains, enabling companies to make better sourcing decisions and improve productivity. He called attention to the swift growth of the clean conflict minerals market in the DRC countries, and noted that implementation of the final rules would further speed progress.
While the Commission staff gave no indication at the Roundtable as to the timing of the final rules, they indicated they would work expeditiously after the end of the comment period (November 1) to prepare recommendations for Commission approval.
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