The Securities and Exchange Commission has adopted a rule mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act requiring companies to publicly disclose their use of conflict minerals that originated in the Democratic Republic of the Congo or an adjoining country, and independently audit the reports.

The financial reform law directed the SEC to issue rules requiring certain companies to disclose their use of conflict minerals that include tantalum, tin, gold or tungsten if those minerals are “necessary to the functionality or production of a product” manufactured by those companies. Companies are required to provide this disclosure on a new form to be filed with the SEC called Form SD.

Humanitarian organizations have urged companies to avoid selling so-called “conflict minerals” and “blood diamonds” that have originated from the decades-long fighting in the Congo and other war-torn parts of Africa, where children and adults are often forced to work in the mines under brutal conditions for warlords who receive payments from multinational corporations.

Congress enacted Section 1502 of the Dodd-Frank Act because of concerns that the exploitation and trade of conflict minerals by armed groups was helping to finance conflict in the Democratic Republic of the Congo region and was contributing to an emergency humanitarian crisis. Section 1502 of the Act amends the Securities and Exchange Act of 1934 to add Section 13(p).

Section 1502 requires companies that use conflict minerals from central Africa in their products to report to the SEC annually on what measures, if any, they are taking to make sure those minerals are not funding armed conflict.

After proposing the rule to implement the provision in 2010, the SEC hosted a roundtable in October 2011 to assist in finalizing the rule.

[IMGCAP(1)]“I am pleased that the Commission has finalized this very challenging project in such a thoughtful manner,” said SEC chair Mary L. Schapiro in a statement Wednesday. “We have received significant public input on this rulemaking, and in response we incorporated many changes from the proposal that are designed to address concerns about the costs. I believe the final rule faithfully implements the statutory requirement as mandated by Congress in a fair and balanced manner.”

Under the final rule, issuers are required to file for the same period—a calendar year—regardless of when their fiscal year ends. Companies will file their first specialized disclosure report on May 31, 2014 (for the 2013 calendar year) and annually on May 31 every year thereafter.

Two of the authors of the conflict minerals provisions in the Dodd-Frank Act, Senator Dick Durbin, D-Ill., and Congressman Jim McDermott, D-Wash., praised the SEC for issuing its final rule on how companies who use these minerals should file their reports.

“The SEC has issued a commonsense and thoughtful rule that shines a light on the sourcing of conflict minerals that helps fuel some of the most vicious and violent groups in the world,” said Durbin in a statement Wednesday. “We as a nation, as consumers and as industry have a responsibility to ensure that our activity in the global marketplace does not support or perpetuate violence. The rules announced today will provide transparency and accountability to an area of the market that long existed in the shadows; give consumers and investors much-needed source information about the products they buy; and will help lead to important and lasting changes on the ground in the Democratic Republic of Congo and areas throughout Central Africa.”

McDermott said he was happy to see the SEC had issued a final rule for how companies should disclose their use of conflict minerals. “The people of Central Africa, especially African women and children, need companies to act responsibly—and investors and consumers around the world need to know if companies are using a black market or a transparent market to manufacture their products,” said McDermott. “I am proud that many companies have already started reporting and the SEC has now created the kind of certainty everyone needs. Now that the U.S. has acted, it’s time for China to do its part. The 30 percent of the black market that’s still operating in Central Africa is mostly run by Chinese companies. This kind of irresponsibility—the funding of conflict through black markets for natural resources—has to end.”

However, McDermott added that he believed the cost estimate for complying with the new rule was too high. The SEC estimated that it would cost $3 billion to $4 billion initially to comply, and $200 million a year afterward, up from an initial estimate of just $71 million. “While we are still examining the rule, I am concerned that the SEC ignored the investor benefits of this law and that the SEC’s cost estimate is far too high,” he said. “The SEC went far in acknowledging this when they noted they made very conservative assumptions; many think the final compliance costs will be much less. Hopefully the industry associations and far-right groups won’t sue the SEC, essentially suing for the right to foment war in Central Africa. It’s time to get on with the transparency that is so badly needed here.”

KPMG Weighs In
KPMG LLP expressed its reservations about the new law. “Approval of these rules creates a challenge for many companies whose products or suppliers use or are exposed to the so-called ‘conflict minerals’ in the manufacturing process,” said Jim Low, who leads the Americas' Financial Services Center of Excellence at the firm. “The SEC has estimated the rules will affect as many as 6,000 public listed companies, both domestic and foreign, while private companies may also be affected if they are suppliers to SEC registered companies. Companies will need to have a much better handle on their supply chains, tracing the use of these minerals to the raw materials from the mines or the smelters.”

KPMG noted that in most companies, C-level executives are handling compliance, with the board and the CEO driving strategy. 

Since conflict minerals reports may be subject to an independent audit that would be filed in a company's public filings (Form-SD, created specifically for this rule) with the SEC, it is expected that a company’s SEC reporting group will take responsibility. The compliance process may involve at least four corporate departments: supply chain and procurement, legal counsel, finance, and the internal audit group.

The head of sustainability or corporate social responsibility may also be involved in companies that have such a position. In addition, given the requirement for an independent audit of the conflict minerals information, the audit committee of the board should be fully engaged in the same way as with other audit requirements.

Most executives that KPMG has spoken with believe it will take at least two years to implement compliance fully. Under the rules, starting in 2013, companies will file a Form SD (Specialized Disclosures) by May 31 covering the reporting period from Jan. 1 through Dec. 31, irrespective of a company’s fiscal year.

A number of companies have already set up a framework of compliance, including, for example, setting goals to become “conflict free,” KPMG noted. At least 77 companies have published a conflict minerals statement online, and 63 organizations included conflict minerals information in their 2011 SEC filings.

Humanitarian Motive
[IMGCAP(2)]Former Assistant U.S. Attorney Jeff Vaden, a partner at the law firm Bracewell & Giuliani in New York, said he believes the rule shows the SEC’s continuing trend of blending anticorruption controls with the use of economic sanctions. The rule is designed to increase transparency in global commodities markets and make the governments of resource-rich countries more accountable to their citizens, Vaden noted. The rule is also an active use of U.S. economic sanctions to further humanitarian policy interests, he pointed out, even where our national security interests are not as directly impacted. He noted that the SEC decision will require companies to exercise more due diligence upfront to be able to meet the annual reporting requirements. The U.S. government is continuing its path of legislating greater corporate transparency for the benefit of potential investors and existing shareholders, he noted.

“I was an Assistant U.S. Attorney in Houston for almost 12 years, and in the latter part of that I focused on investigating and prosecuting individuals and companies that violated the U.S. government’s export controls and economic sanctions laws,” Vaden said in an interview Thursday. “If you look at the history of our country’s enforcement, it’s typically focused on companies and individuals that posed some national security issue or counterterrorism issue that the government is trying to alleviate or minimize. I think the conflict minerals rule is clearly more of an economic sanction, but it seems to be furthering the humanitarian policy interest, particularly in that part of the world, the Congo and the war-torn region in Central Africa. That is where the conflict has been over the last decade or more.”

Vaden sees the new rule as an example of financial regulations being used for humanitarian reasons.

“I would really be hard-pressed to find a direct national security interest for the United States in trying to somehow legislatively try to change behaviors in that part of the world,” he said. “That is why I characterize it as a humanitarian effort on the part of our government. I’m not saying there is something wrong with that endeavor, but I distinguish it in that way from many of the U.S. sanctions that are out there.”

Vaden said he sees that trend continuing in the future and perhaps expanding. “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. For example, if you put a spotlight on companies in this region, you increase their compliance efforts in this area, and you’re probably going to find in some instances they’re going to discover some other activity of interest to U.S. law enforcement that may not be directly connected to conflict mineral audits. The example that comes to mind is checking up and down your supply chain trying to identify whether you’re sourcing a supplier of conflict minerals, you may well run up across a Foreign Corrupt Practices Act issue in that endeavor. It’s hard to keep these things in a neat box because things tend to spill over in this type of investigation audit enforcement world.”

SEC Rule Details
The final SEC rule applies to a company that uses minerals including tantalum, tin, gold or tungsten if:

•    The company files reports with the SEC under the Exchange Act.
•    The minerals are “necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company.

Contracting to Manufacture
The rule requires a company to provide the disclosure on a new form to be filed with the SEC (Form SD). A company is considered to be “contracting to manufacture” a product if it has some actual influence over the manufacturing of that product. This determination 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 be 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.
•    Services, maintains, or repairs a product manufactured by a third party.
•    Specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product.

The requirements apply equally to domestic and foreign issuers.

Determining Whether Conflict Minerals Originated in the DRC or Other Covered Countries
Under the final rule, a company that uses any of the designated minerals is required to conduct a reasonable ‘country of origin’ inquiry that must be performed in good faith and be reasonably designed to determine whether any of its minerals originated in the covered countries or are from scrap or recycled sources.

If the inquiry determines either of the following to be true:

•    The company knows that the minerals did not originate in the covered countries or are from scrap or recycled sources.
•    The company has no reason to believe that the minerals may have originated in the covered countries or may not be from scrap or recycled sources.

… then the company must disclose its determination, provide a brief description of the inquiry it undertook and the results of the inquiry on Form SD.

The company also is required to:

•    Make its description publicly available on its Internet Web site.
•    Provide the Internet address of that site in the Form SD.

If the inquiry otherwise determines both of the following to be true:

•    The company knows or has reason to believe that the minerals may have originated in the covered countries.
•    The company knows or has reason to believe that the minerals may not be from scrap or recycled sources.

… then the company must undertake “due diligence” on the source and chain of custody of its conflict minerals and file a Conflict Minerals Report as an exhibit to the Form SD.

The company also is required to:

•    Make publicly available the Conflict Minerals Report on its Internet Web site.
•    Provide the Internet address of that site on Form SD.

What Must Be Included in the Conflict Minerals Report
Under the final rule, companies that are required to file a Conflict Minerals Report must exercise due diligence on the source and chain of custody of their conflict minerals. The due diligence measures must conform to a nationally or internationally recognized due diligence framework, such as the due diligence guidance approved by the Organization for Economic Co-operation and Development.

If a company determines that its products are “DRC conflict free”—that is the minerals may originate from the covered countries but did not finance or benefit armed groups—then the company must undertake the following audit and certification requirements:

•    Obtain an independent private sector audit of its Conflict Minerals Report
•    Certify that it obtained such an audit.
•    Include the audit report as part of the Conflict Minerals Report.
•    Identify the auditor.

If a company’s products have not been found to be “DRC conflict free,” then the company in addition to the audit and certification requirements must describe the following in its Conflict Minerals Report:

•    The products manufactured or contracted to be manufactured that have not been found to be “DRC conflict free.”
•    The facilities used to process the conflict minerals in those products.
•    The country of origin of the conflict minerals in those products.
•    The efforts to determine the mine or location of origin with the greatest possible specificity.

For a temporary two-year period (or four-year period for smaller reporting companies), if the company is unable to determine whether the minerals in its products originated in the covered countries or financed or benefited armed groups in those countries, then those products are considered “DRC conflict undeterminable.”

In that case, the company must describe the following in its Conflict Minerals Report:

•    Its products manufactured or contracted to be manufactured that are “DRC conflict undeterminable.”
•    The facilities used to process the conflict minerals in those products, if known.
•    The country of origin of the conflict minerals in those products, if known.
•    The efforts to determine the mine or location of origin with the greatest possible specificity.
•    The steps it has taken or will take, if any, since the end of the period covered in its most recent Conflict Minerals Report to mitigate the risk that its necessary conflict minerals benefit armed groups, including any steps to improve due diligence.

For those products that are “DRC conflict undeterminable,” the company is not required to obtain an independent private sector audit of the Conflict Minerals Report regarding the conflict minerals in those products.

There are special rules governing the due diligence and Conflict Minerals Report for minerals from recycled or scrap sources. If a company’s conflict minerals are derived from recycled or scrap sources rather than from mined sources, the company’s products containing such minerals are considered “DRC conflict free.”

If a company cannot reasonably conclude after its inquiry that its gold is from recycled or scrap sources, then it is required to undertake due diligence in accordance with the OECD Due Diligence Guidance, and get an audit of its Conflict Minerals Report. Currently, gold is the only conflict mineral with a nationally or internationally recognized due diligence framework for determining whether it is recycled or scrap, which is part of the OECD Due Diligence Guidance.

For the other three minerals, if a company cannot reasonably conclude after its inquiry that its minerals are from recycled or scrap sources, until a due diligence framework is developed, the company is required to describe the due diligence measures it exercised in determining that its conflict minerals are from recycled or scrap sources in its Conflict Minerals Report. Such a company is not required to obtain an independent private sector audit regarding such conflict minerals.

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