December 5, 2014
As companies prepare for the second year of filings under the Securities and Exchange Commission’s ("SEC") new conflict minerals rule, many companies are looking for guidance from the first annual filings, which were due June 2, 2014. As expected, the inaugural Form SD and conflict minerals report filings reflect diverse approaches to the new compliance and disclosure requirements. We offer below some observations based on the first round of conflict minerals filings for companies to consider as they address their compliance programs and disclosures for the 2014 calendar year. It is important to note, however, that the shape of future compliance and reporting obligations will be impacted by the outcome of the pending litigation challenging the conflict minerals rule, which also is discussed below, and any subsequent action by the SEC.
The SEC’s conflict minerals rule contemplates a three-step compliance process. Under Rule 13p-1 and Form SD, a company is first required to determine whether any "conflict minerals" (tin, tantalum, tungsten and gold) are necessary to the functionality or production of a product the company manufactures or contracts to manufacture (Step 1). If so, the company is required to conduct, in good faith, a reasonable country of origin inquiry ("RCOI") that is reasonably designed to determine whether any of those conflict minerals originated in the Democratic Republic of the Congo or an adjoining country (the "Covered Countries") or came from recycled or scrap sources (Step 2). Companies that have no reason to believe, based on their RCOI, that their necessary conflict minerals may have originated in the Covered Countries, or reasonably believe these minerals came from recycled or scrap sources, must file a Form SD. The Form SD must disclose this determination and "briefly describe the reasonable country of origin inquiry . . . and the results." However, these companies are not required to move to the next step and conduct due diligence or file a conflict minerals report.
Companies that, based on their RCOI, have reason to believe that their necessary conflict minerals may have originated in the Covered Countries, and may not be from scrap or recycled sources, are required to exercise due diligence on the source and chain of custody of those minerals (Step 3). Unless a company then determines that its conflict minerals did not originate in the Covered Countries or that the minerals did come from recycled or scrap sources, it must file a conflict minerals report as an exhibit to its Form SD.
The conflict minerals report must include a description of the measures taken to exercise due diligence on the source and chain of custody of the necessary conflict minerals. In addition, the rule, as adopted, required companies to characterize their products as "DRC conflict free," "not having been found to be ‘DRC conflict free’" or, during a temporary transition period that spans the first two calendar years of reporting (four years for smaller reporting issuers), "DRC conflict undeterminable," if the company is unable to determine whether its conflict minerals originated in the Covered Countries or came from recycled or scrap sources, or is unable to determine whether its conflict minerals financed or benefitted armed groups in the Covered Countries. A company filing a conflict minerals report for products other than those characterized as "DRC conflict free" is required to include: (1) a description of the products; (2) a description of the facilities used to process the conflict minerals in those products and their country of origin; and (3) the efforts to determine the mine or location of origin of those minerals with the greatest possible specificity. A company filing a conflict minerals report for "DRC conflict undeterminable" products also is required to disclose the steps that were taken or will be taken to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve due diligence. A company required to file a conflict minerals report–except a report for "DRC conflict undeterminable" products, during the transition period–must include an independent private sector audit ("IPSA") of the report.
II. Impact of Litigation on Conflict Minerals Filings
The disclosures that companies are required to make in their conflict minerals filings were impacted by the decision issued on April 14, 2014 by the U.S. Court of Appeals for the District of Columbia Circuit in National Association of Manufacturers, et al. v. SEC, et al.–the litigation challenging the SEC’s conflict minerals rule–and the SEC’s subsequent interpretive guidance regarding the effect of the decision. Although the D.C. Circuit rejected the challenges to the rule based on the Administrative Procedure Act and the Securities Exchange Act of 1934, it upheld the First Amendment challenge to the rule. It held that the rule violates the First Amendment to the extent it requires companies to report to the SEC and disclose on their websites that any of their products have "not been found to be ‘DRC conflict free.’"
In the wake of the D.C. Circuit’s decision, the SEC staff issued guidance on April 29, 2014 that relieved companies from the rule’s requirement to characterize their products as "DRC conflict free," having "not been found to be ‘DRC conflict free,’" or "DRC conflict undeterminable" but indicated that companies must comply with other disclosure requirements under the rule. The guidance stated that companies filing only a Form SD must briefly describe their RCOI, and companies filing conflict minerals reports must describe their due diligence measures. In addition, companies filing conflict minerals reports for products that would have been characterized as "DRC conflict undeterminable" or "not found to be ‘DRC conflict free’" must disclose the facilities used to process the conflict minerals in those products and their country of origin, if known, and the efforts to determine the mine or location of origin of those minerals. Further, the guidance provided that an IPSA would not be required unless a company voluntarily elects to describe a product as "DRC conflict free."
The litigation is ongoing. Following the April D.C. Circuit decision, the matter was remanded to the district court for further proceedings, and the D.C. Circuit subsequently denied an emergency motion to stay the conflict minerals rule. The SEC and intervenor Amnesty International separately petitioned the D.C. Circuit for panel rehearing and rehearing en banc in light of the then-pending ruling in American Meat Institute v. U.S. Department of Agriculture, an unrelated case before the D.C. Circuit that bears on the standard of review to be applied by the court in reviewing the First Amendment challenge. The D.C. Circuit has now issued a ruling in American Meat Institute, and recently granted the petition for panel rehearing. It deferred consideration of the petition for rehearing en banc pending disposition of the panel rehearing.
III. Observations Regarding Form SD and Conflict Minerals Report Filings
As of June 27, 2014, approximately 1,305 companies had filed a Form SD with the SEC, and of those, 301 companies (23%) filed only a Form SD. The remainder filed a conflict minerals report with their Form SD. 590 of the filings were made by NASDAQ-listed companies, and 579 of the filings were made by NYSE-listed companies. Notably, only four companies obtained an IPSA of the conflict minerals report.
In order to develop greater insight into the first annual conflict minerals filings, we examined a sample of 70 filings, 35 from companies that filed only a Form SD and 35 from companies that filed a conflict minerals report in addition to a Form SD. Each set of 35 filings was drawn from multiple industries identified through the SEC’s 12 Assistant Director Office review groups. Within each set of 35 filings, we surveyed a mix of large-cap companies (annual revenues greater than $10B) and mid-cap companies (annual revenues between $1B and $10B), with a greater proportion of filings drawn from large-cap companies. Our survey findings, as well as some observations informed by our experience with our client base and comments of senior SEC staff members, are discussed below.
A. Form SD Filers
The Form SD must disclose the company’s determination and "briefly describe the reasonable country of origin inquiry . . . and the results." The requirement for a "brief" description resulted in a variety of approaches to the substance of the required disclosures.
1. Brief Description of RCOI
Although surveyed companies that filed a Form SD without a conflict minerals report ("surveyed SD filers") took a wide range of approaches to drafting their disclosures, their filings were generally consistent in terms of length. Over 70% of the filings were two pages or less, and none of the surveyed filings exceeded three pages. The surveyed SD filers provided RCOI descriptions that ranged from several sentences to several paragraphs. While only approximately 45% of the surveyed SD filers affirmatively indicated that they used the Conflict-Free Sourcing Initiative’s ("CFSI") Conflict Minerals Reporting Template or one based upon it, many of the surveyed SD filers did not disclose whether this template or one based upon it was used. Based on our experience, the actual number of filers that used the Template or a modified form of it was likely higher.
Surveyed SD filers described a variety of approaches to conducting their RCOI. Just under half provided statistics on the number or percentage of suppliers they contacted, and several others that did not provide these statistics indicated that they contacted some subset of suppliers. Many descriptions included only mention of the surveyed SD filer’s initial inquiry and the results of its RCOI, while several described the measures they took in reviewing supplier responses. Some of the surveyed SD filers described circumstances in which they followed up with suppliers (e.g., in the case of an unresponsive supplier, a supplier response indicating possible presence in the supply chain of conflict minerals from the Covered Countries or an unclear response received from a supplier). A few of the surveyed SD filers also mentioned comparing smelters and refiners identified in supplier responses to lists of certified conflict-free smelters and refiners provided by third-party organizations like the CFSI, escalating communications with suppliers, requesting that suppliers conduct their own inquiries, using a third-party service provider and collaborating with direct suppliers.
2. Results of RCOI
In addition to providing a determination on the presence of conflict minerals from the Covered Countries in their products, a vast majority of the surveyed SD filers provided a brief description of their RCOI results. Many of these companies explained that supplier responses provided no indication or reason to believe that conflict minerals from the Covered Countries were contained in their products. Some of the surveyed SD filers went into further detail, including a statistical breakdown of representations made by suppliers or a discussion of non-responsive suppliers or suppliers that were uncertain of the origin of their conflict minerals. A majority (approximately 60%) of the surveyed SD filers also included statistics on the supplier response rate to their inquiries. The SEC’s April guidance was unclear as to whether the requirement for a description of the results of the RCOI continued to apply, which may have contributed to the variance in approach to describing RCOI results.
B. Conflict Minerals Report Filers
1. Description of Due Diligence Measures
The surveyed conflict minerals report filers ("surveyed CMR filers") generally took consistent approaches to describing their due diligence measures. The majority (approximately two-thirds) of conflict minerals reports were between three and seven pages in length, with approximately 15% two pages or less and approximately 20% greater than seven pages. Unlike the surveyed SD filers, a majority of the surveyed CMR filers (approximately 90%) disclosed that they used the survey template created by the CFSI or one based on the CFSI template as part of their due diligence measures. A majority (approximately 60%) structured their narrative discussion in whole or in part based on the five steps of the OECD Guidance. Approximately half of the surveyed CMR filers provided statistics on the percentage or number of suppliers they contacted, which ranged from fewer than 20 to over 3000 contacted suppliers, and approximately the same number of the surveyed CMR filers provided statistics on supplier response rates.
The surveyed CMR filers also indicated that they conducted reviews of their supplier responses in a similar fashion. Almost all reported reviewing supplier responses for completion or consistency, often both. When such initial review revealed red flags, most of the surveyed CMR filers indicated they followed up with relevant suppliers to obtain missing answers and clarify inconsistent responses. A minority of the surveyed CMR filers stated that they reported these red flags to groups or individuals within their organizations designated to assess such supply chain risk. In addition, many of the surveyed CMR filers indicated that they compared the names of smelters and refiners provided by their suppliers against the CFSI’s list of certified conflict-free smelters and refiners or other similar third-party lists.
In describing the results of their due diligence efforts, most of the surveyed CMR filers took one of two approaches. First, many described supplier responses by commenting on the amount or type of data provided by suppliers. For example, some of these companies provided a numerical breakdown of responses, supplying a number or percentage of responses that affirmed that the processing facilities they use are listed on the CFSI’s list of certified conflict-free smelters and refiners. Surveyed CMR filers also frequently disclosed that their supplier responses were not complete or did not provide enough information to support a determination as to the existence in their products of any conflict minerals from the Covered Countries or the status of those conflict minerals. A few of the surveyed CMR filers provided additional detail, discussing individual suppliers or explaining specific instances where they made a determination based on the diligence they conducted and the supplier responses they received.
Second, other surveyed CMR filers did not describe the content of their supplier responses, but rather disclosed only the determinations that they were or were not able to make regarding the origin of the conflict minerals in their products based on their supplier responses.
Additionally, some of the surveyed CMR filers described similar activities in both their RCOI Step 2 and subsequent Step 3 "due diligence" measures, appearing to combine these two processes. Although companies required to file a conflict minerals report are not required to describe their RCOI, many nonetheless provided a description of the RCOI, often describing it as part of the due diligence process. The SEC’s rule, however, distinguishes between the two processes, as the Step 2 RCOI has no mandated set of standards or processes that need to be followed, while the Step 3 due diligence must be executed in accordance with an internationally recognized framework–the OECD Guidance, which is currently the only such framework.
2. Description of Products
The SEC’s rule requires a company filing a conflict minerals report for products that fall into the "DRC conflict undeterminable" or "have not been found to be ‘DRC conflict free’" categories to describe those products in its report. Although the SEC’s April 2014 guidance clarified that companies need not characterize their products using these labels, approximately 23% of the surveyed CMR filers used the term "DRC conflict undeterminable" to describe their products. An additional 63% indicated that they were unable to determine the origin of the conflict minerals in their products without employing the "DRC conflict undeterminable" label.
A majority of the surveyed CMR filers provided a description of products covered by the conflict minerals report. Their descriptions ranged from general descriptions by product category to lists of specific product lines or models. While exact approaches varied across the spectrum, the most common approach was to describe products by high-level category or operating segment (e.g., "decorative accessories") or through a listing of product types (e.g., zippers, buckles and buttons), rather than specific product lines or models. Several of the surveyed CMR filers employed a combination of approaches, describing some products with more specificity than others.
3. Description of Facilities and Country of Origin of Minerals
For products that are "not found to be ‘DRC conflict free’" or "DRC conflict undeterminable," there was significant variation in how the surveyed CMR filers addressed the requirement to describe the processing facilities and countries of origin of the conflict minerals in those products. Approximately one-third of the surveyed CMR filers provided lists of smelters and refiners, in many cases also including the conflict-free certification status of those facilities and country of origin information. A few of the surveyed CMR filers provided more general descriptions of their identified smelters and refiners such as the total number of identified facilities, their location and/or whether they processed minerals sourced from the Covered Countries. Many of the surveyed CMR filers that did not provide smelter and refiner lists expressly noted difficulties in obtaining complete and reliable information from suppliers and indicated that they were unable to identify the smelters and refiners in their supply chains based on the insufficient information received from their suppliers. In this regard, a number of companies noted that many suppliers were able to provide only company-level information as to all smelters and refiners used by the supplier without identifying the smelters or refiners used for a particular part or product supplied to the company.
4. Description of Efforts to Determine Mine or Location of Origin
Approximately half of the surveyed CMR filers specifically described, for products that were "not found to be ‘DRC conflict free’" or "DRC conflict undeterminable," their efforts to determine the mine or location of origin of the conflict minerals with the greatest possible specificity. Most of these companies indicated that such efforts consisted of: (1) conducting the due diligence measures described in the conflict minerals report; and/or (2) requiring suppliers to complete the CFSI’s Conflict Minerals Reporting Template. The remaining surveyed CMR filers appear to have addressed this requirement by describing their due diligence measures in the conflict minerals report, as discussed above.
5. Description of Steps to Mitigate Risk that Minerals Could Benefit Armed Groups
The SEC’s rule requires companies filing conflict minerals reports for products that fall into the "DRC conflict undeterminable" category to describe the steps that were taken or will be taken to mitigate the risk of benefitting armed groups, including any steps to improve due diligence. The SEC’s April 2014 guidance did not address this requirement, but we understand that the SEC informally advised shortly before the June 2, 2014 filing deadline that companies that do not use the specific term "DRC conflict undeterminable" to describe their products are not required to provide a description of their steps to mitigate risks. Nevertheless, many companies–approximately 82% of the surveyed CMR filers–included this disclosure in their reports, even if they did not explicitly use the "DRC conflict undeterminable" label to describe their products.
Some of the most frequently cited mitigation measures included the following:
IV. What Companies Should Do Now
1. Review Peer Companies’ Filings
As an initial matter, companies should review the 2013 calendar year filings of companies in the same industry, as well as published surveys and commentary about those filings, to identify any potential areas of improvement for their 2014 compliance programs and disclosures. Depending on their industry, position in the supply chain and other circumstances, companies also may wish to consider the expectations and observations published by non-governmental organizations ("NGOs") in developing improvements to their conflict minerals programs and disclosures for the 2014 calendar year. In this regard, some NGOs have criticized companies for a lack of detail in their 2013 calendar year filings, including with respect to the countries of origin of their conflict minerals, their methods of assessing suppliers’ due diligence practices, and their steps to identify and mitigate supply chain risks.
As anticipated by the OECD guidance, we expect that many companies will be enhancing their efforts in the 2014 calendar year as a result of increased visibility into their conflict minerals supply chains, the results of the prior year’s diligence efforts, and feedback from NGOs and other constituencies. Thus, in benchmarking their compliance programs and disclosures, companies should keep in mind that peers’ compliance programs and disclosures also are likely to evolve in the current year.
2. Prepare for 2014 Calendar Year Filings
With the second annual conflict minerals reporting year now well underway, companies should continue to focus on their conflict minerals compliance obligations to stay on track for the June 1, 2015 deadline to file 2014 calendar year reports. In this regard, a useful starting point is the disclosures companies or their peers provided of planned steps to mitigate the risk of benefitting armed groups and improve due diligence. These disclosures also are likely to serve as a benchmark for stakeholders to evaluate performance improvement over time.
Of note, Keith Higgins, Director of the SEC’s Division of Corporation Finance, offered several of his own observations at the September 12, 2014 meeting of the American Bar Association’s Business Law Section based on the SEC staff’s review of a sample of conflict minerals filings:
When considering whether and how to take these observations into account when drafting future conflict minerals filings, we note that, as a practical matter, the similarities between companies’ descriptions of their RCOI and due diligence measures are not surprising, given the significant number of companies that relied on the CFSI’s Conflict Minerals Reporting Template for both the RCOI and due diligence processes and the difficulties many companies faced in obtaining sourcing information from suppliers. In addition, we note that there is significant ambiguity as to the degree of certainty necessary to make a determination that a conflict minerals source is "known," especially in light of a recent U.S. Department of Commerce report that underscores the difficulty of confirming the sources of conflict minerals. The report, which lists all known processing facilities of conflict minerals, highlights the "limitations and challenges" encountered in generating the list and expressly acknowledges that the Commerce Department "do[es] not have the ability to distinguish" whether a particular facility processes minerals that are used to finance armed groups in the Covered Countries.
3. Follow Pending Conflict Minerals Litigation
Companies should continue to follow developments in the pending conflict minerals litigation, although the timing and resolution of these proceedings is uncertain. Under the SEC staff’s April 2014 guidance, there is no requirement to obtain an IPSA of the conflict minerals report unless a company voluntarily describes its products as "DRC Conflict Free." While the April guidance will continue to apply until there are further developments, it is likely that the SEC will modify the rule–including with respect to the IPSA requirement–by the time the "DRC Conflict Undeterminable" transition period expires (other than for smaller reporting companies) for 2015 calendar year filings. Companies should be mindful of developments that impact whether and when an IPSA will be required following the transition period, as preparation for an IPSA would require companies to evaluate–and potentially adjust–their compliance programs and disclosures with a view to satisfying the objectives of the IPSA.
 Securities and Exchange Commission, Public Statement of Keith F. Higgins, Director, SEC Division of Corporation Finance, Statement on the Effect of the Recent Court of Appeals Decision on the Conflict Minerals Rule (Apr. 29, 2014), available at http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370541681994#.VGVpgfl4ofw.
 Two of the independent private sector audits (for Intel Corp. and Koninklijke Philips N.V.) were attestation engagements performed by certified public accountants ("CPAs") and two (for Kemet Corp. and Signet Jewelers Ltd.) were performance audits conducted by non-CPAs.
 The CFSI recently released a new Conflict Minerals Reporting Template, version 3.02, which is available at http://www.conflictfreesourcing.org/conflict-minerals-reporting-template/.
 See, e.g., Global Witness, Global Witness Warns that Majority of Inaugural Conflict Mineral Reports Are Inadequate (June 2, 2014), available at http://www.globalwitness.org/library/global-witness-warns-majority-inaugural-conflict-mineral-reports-are-inadequate.
 Department of Commerce Reporting Requirements Under Section 1502(d)(3)(C) of the Dodd-Frank Act: World-Wide Conflict Mineral Processing Facilities (Sept. 2014), available at http://www.ita.doc.gov/td/forestprod/DOC-ConflictMineralReport.pdf.
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