The Securities and Exchange Commission’s recently issued rule requiring companies to disclose their use of minerals from the war-torn Democratic Republic of the Congo could be an early indication of a future direction of regulators, prodding companies into providing more disclosures of environmental, social, humanitarian and labor issues.
The rule was issued last week, but was actually mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (see SEC Requires Disclosure of Conflict Minerals). The SEC issued the rule on the same day as a related rule, also mandated by the Dodd-Frank Act, requiring companies engaged in extracting oil, natural gas or minerals to disclose any payments they make to the U.S. government or foreign governments (see SEC Requires Disclosure of Payments by Oil, Gas and Mineral Developers to Governments).
However, while the latter rule stems from concerns about bribery and corruption, and could lead to investigations of whether a company violated the Foreign Corrupt Practices Act, the so-called “conflict minerals” rule comes from a more humanitarian motive. The Congo and surrounding countries in Central Africa have long been embroiled in civil wars involving armed groups in which sales of minerals such as gold, cassiterite, wolframite and coltan have been used to finance the conflicts. Adults and children alike are reportedly forced to work in long shifts in unsafe mines that are subject to dangers such as mudslides and tunnel collapses, facing threats of violence if they refuse.
Former Sen. Sam Brownback, R-Kan., proposed legislation in 2009 requiring electronics companies to disclose their use of such minerals, and the proposal was eventually included in the Dodd-Frank Act. The rule issued by the SEC last week also includes third-party auditing requirements that could provide business for accounting firms with experience in this area.
Chip Johnson, a geologist who is senior manager of Ernst & Young’s climate change and sustainability services practice in Chicago, said his firm is considering getting into this area for certain clients.
“If you look at the SEC’s economic analysis, they assume that 75 percent of the respondents will require an independent audit of the conflict minerals report,” he pointed out.
“The services we can provide depend on various independence requirements for our clients,” Johnson added. “But the rule does explicitly state that for financial audit clients, we would be allowed to engage in that effort. Whether we as a firm decide to on a given engagement would be a client-specific matter.” E&Y would assess that on a case-by-case basis.
Johnson noted that the SEC did soften the original conflict minerals rule somewhat in response to industry requests, including providing a two-year window for large companies to comply with the rule. In addition, firms that have affixed their brand or logo to generic products manufactured by a third party are no longer considered to be "contracting to manufacture"; that is, a company is not deemed to have influence over the manufacturing if it merely affixes its brand, marks, logo or label to a generic product manufactured by a third party.
Johnson sees the SEC rule as part of an ongoing trend, following on the heels of an earlier SEC rule pertaining to mine safety, also mandated by the Dodd-Frank Act.
“What previously were voluntary corporate responsibility measures for sustainability-related measures are now becoming regulatorily required,” he said. “We’re seeing that not only with these Dodd-Frank amendments or sections, but also in France, where there’s another law called Article 225, which also requires some corporate responsibility type disclosures. This is part of a broader trend that we’ve seen in industry where a lot of clients are now moving toward what we call an integrated report, in which the financial report is combined with other corporate responsibility type information, and both are subject to an audit.”
Johnson does not think the SEC is ready to require integrated reporting, but he sees more of an effort by socially responsible investment groups to push for this type of reporting, as well as broader efforts by international organizations.
The Global Reporting Initiative has identified a number of specific environmental performance indicators, such as water usage, greenhouse gas emissions, and energy conservation, he noted, as well as social metrics such as community giving, labor relations, worker health and safety, and product responsibility information that they are seeking from public companies. Audit firms could also help companies and investors verify such reports.
“There’s a been an increasing trend in a number of companies that are producing these Global Reporting Initiative, or GRI, reports that are seeking to have third-party audits and opinions expressed on those reports,” said Johnson. “There are a number of ranking agencies that use that information to score these various companies on their social performance. And by getting a third-party opinion or verification on those reports, they’re often able to prove their core ranking in those different forums.”
However, it is not likely that accounting firms will begin providing audits of human rights or labor conditions at factories. Apple, for example, turned to an outside group known as the Fair Labor Association earlier this year to provide a third-party assessment of worker conditions at the Foxconn factories in China used to assemble Apple products such as iPads and iPhones. The FLA report uncovered numerous problems with excessive hours, health and safety, and overtime pay.
Former Assistant U.S. Attorney Jeff Vaden, now a partner at the law firm Bracewell & Giuliani in Houston, sees the SEC’s conflict minerals rule as part of a broader trend as well. “I think there are probably some parts of those sanctions that require companies to make certain accounting and auditing [changes],” he said. “It will increase the due diligence that companies engage in. I think any time you have a government spotlight on an area or industry, there is always a potential that government spotlight will identify some other activity beyond the one that’s initially being looked at.”
He noted that companies and their auditors may find violations of the Foreign Corrupt Practices Act once they begin examining their supply chains to see where they are sourcing raw materials such as minerals.
Conversely there is also the possibility that an auditing firm may find itself exposed to liability if it helps cover up the source of materials such as conflict minerals.
“If a company hired a financial or accounting firm to conduct an audit to run the supply chain or help advise on how they can comply with this regulation, and if something goes amiss months or years down the road, and the SEC gets involved, and if they issue subpoenas or letters requesting information, I think that any accounting firm that has helped in that process is going to be under the spotlight to some degree because they are part and parcel,” said Vaden. “Hopefully no reputable accounting firm would get involved in helping their client or company to evade U.S. sanctions or disclosure requirements. That would certainly cause law enforcement or regulators like the SEC to take a dim view of that activity.”
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