Originally published by the Journal of Commerce in October 2012

The Securities and Exchange Commission (SEC) issued the long-awaited conflict minerals regulations on September 12, 2012. See http://www.gpo.gov/fdsys/pkg/FR-2012-09-12/html/2012-21153.htm for the full text. They take effect on November 13, 2012 and cover products that include tantalum, tin, gold or tungsten. The goal of the law is to end human rights abuses in the Democratic Republic of the Congo (DRC) by governing the trade in what are described as conflict minerals. Specifically, the affected countries also include Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia, all countries which have some internationally recognized border with the DRC (referred to as “covered countries”). Recognizing the disruption these changes will cause, in limited circumstances described in more detail below, the SEC is allowing a temporary provision for the first two reporting years for all issuers and a total of four (4) years for small companies.  These new regulations apply to all companies which file with the SEC, whether foreign or domestic.

The SEC began by creating a new reporting form, Form SD. The taxonomy file has been released for comment, see http://www.sec.gov/info/edgar/edgartaxonomies_d.shtml. The Form SD is to be filed starting in 2014 to cover the calendar year 2013, and will be due each year on May 31, regardless of the company’s fiscal year.

As was perhaps to be expected given the controversy the deliberative process garnered, the SEC published regulations which are more general in some places than industry might have liked.  The starting point for any publicly traded company is to figure out if it is covered by these regulations. So, does your company manufacture or contract to manufacture goods which contain conflict minerals? This is an area where the SEC was very general, leaving the analysis to turn on the facts of a given company’s situation. The SEC defined “contracting to manufacture” as based on whether the company has some actual influence over the manufacturing of the given product. The SEC was quick to add a company is deemed to not have influence over manufacturing if it only affixes its brand, marks, logo or label to a generic product made by a third party; or services, maintains or repairs a product made by a third party; or specifics or negotiates contractual terms with the maker that do not directly relate to the manufacturing of the product.

Companies are now required to conduct a “reasonable” country of origin inquiry which must be performed in good faith and be reasonably designed to determine whether any of the minerals originate in the covered countries or are from scrap or recycled sources. Scarp and recycled minerals are treated differently, see below for more details.

So, if a company knows the minerals did not originate or are scrap or recycled sources; or has no reason to believe the minerals may have originated in a covered country or may not be from scrap or recycled sources; then it must disclose its determination, provide a brief description of the inquiry it performed and the results, and report these details on the Form SD. In addition, the company is required to make the description publicly available on its Internet website and provide the link on its Form SD.

On the other hand, if the inquiry determines the company knows or has reason to believe the minerals may have originated in a covered country and the company knows or has reason to believe the minerals may not be from scrap or recycled sources, then the company must undertake a reasonable due diligence to determine the country of origin and chain of custody of the minerals and file a Conflict Minerals Report as an exhibit to the Form SD. Additionally, as before, the company must make the report available on its website and provide a link on the Form SD filing.

The outcome of the due diligence could be a finding the minerals are “DRC Conflict Free”, which could mean they originate from a covered country but did not finance or benefit armed groups; then the company must obtain an independent private sector audit of its Conflict Minerals Report; certify it obtained such an audit; include the audit report as part of its Conflict Minerals Report and identify the author.

A “not found to be DRC Conflict Free” determination could also be the outcome. In such a case, in addition to the audit and certification requirements, the company must also describe on its Conflict Minerals Report, the products manufactured or contracted to be manufactured and covered by the finding; the facilities used to process the conflict minerals in those products; and the specific efforts to determine the mine or location of origin.

The temporary provision mentioned above relates to an outcome where the findings is “DRC Conflict Undeterminable”. Companies will be given two years to get their supply chains in order (unless they are small companies which will have a total of four (4) years). During this period, if the company is unable to determine the origin of the minerals or if from a covered country, whether the minerals financed or benefited armed groups in those countries, the products are considered DRC Conflict Undeterminable.  In such a case, the company must describe the following in its Conflict Minerals Report: its finding the products it manufactures or contracts to manufacture are DRC Conflict Undeterminable; the facilities where they are produced, if known; the origin of the conflict minerals, if known; the specific efforts undertaken to determine the mine or location of origin; the steps taken or which will be taken to mitigate the risk that its necessary conflict minerals benefit armed groups, and any steps to improve due diligence, since the end of the period covered by the most recent Conflict Minerals Report.

Regarding recycled or scrap minerals, if the company’s conflict minerals are from these sources rather than from mined sources, the company’s products containing such minerals are considered DRC Conflict Free even if originating from covered countries. Only in the case of recycled or scrap sources is a company not required to obtain an independent private sector audit.

Beside not providing a clear definition of what is meant by “contracting to manufacture”, in terms of the due diligence requirement, the SEC was equally unclear, saying only the due diligence measures must conform to a nationally or internationally recognized framework such as that developed by the Organisation for Economic Cooperation and Development (OECD).  At this juncture, the OECD has only issued a due diligence program for gold.  As a result, the SEC goes on to say, until a due diligence framework is developed for the other minerals, companies are required to describe the due diligence measures they exercise in determining the source of their conflict minerals.

This leaves us to be guided by the OECD gold supplement. It makes the following recommendations:

1)  Adopt and commit to a supply chain policy for identifying and managing risks for gold potentially from conflict-affected and high-risk areas;

2)  Structure internal management systems to support supply chain due diligence;

3)  Establish a system of transparency, information collection and control over the gold supply chain;

4)  Strengthen company engagement with suppliers;  and

5)  Establish a company and/or mine level grievance mechanism.

There are then additional specific recommendations for each entity in the supply chain.  For exporters, the OECD recommends:

A)  Assign a unique internal reference number to all inputs and outputs, by bar, ingot and/or batch of gold accepted and produced, and affix and/or imprint that reference number on all outputs in such a manner that tampering or removal will be evident;

B)  Coordinate and support physical security practices used by other upstream companies. Promptly report any indications of tampering with shipments and unseal and open shipments only by authorized personnel;

C)  Preliminarily inspect all shipments for conformity to the information provided by the supplier on the types of gold… Verify weight and quality information provided by the gold producer and/or shipper, and make a business record of such verification. Report any inconsistency between initial inspection of a shipment and information provided by the shipper promptly to internal security and those responsible in the company for due diligence, with no further action until the inconsistency is resolved;

D)  Physically segregate and secure any shipment for which there is an unresolved inconsistency; and

E)  Seek to deal directly with legitimate artisanal and small-scale gold producers or their representatives where possible in order to exclude gold offered by persons that exploit them.

For downstream companies, the OECD recommends:

F)  Request suppliers provide the identification of the upstream gold refiner/s for gold-bearing materials and products, either by direct sourcing or via marks imprinted on a refined gold product if available, or from information provided by other downstream product suppliers on bullion banks.

G)  If gold refiner/s are identified, request verification that the refiner/s has conducted due diligence in accordance with this Supplement. Where possible, seek reference to recognized audits by Industry Programmes or Institutionalised Mechanisms that incorporate in their auditing protocols the standards and processes contained in the Guidance; and

H)  Pass on information on the identification of the upstream gold refiner/s for gold-bearing materials and products to downstream customers.

It seems reasonable to expect that companies will be governed by these guidelines regardless of the conflict mineral in questions, but at the same time, these recommendations seem to be common sense security protocols that would be the types of measures companies would regularly have in place to better manage their supply chain and lower the risk of pilferage.

Even the SEC admits it may cost “billions” for companies to comply, so whether or not your company is publicly traded, it is reasonable to expect that any company which touts itself  as concerned about human rights and states publicly one of its goals is seeking comply with all human rights laws can expect to draw attention to itself and so we are left to ask – could these conflict minerals regulations lead to more shareholder derivative, class action or other types of lawsuits?  It certainly could lead to reputational damage, but no doubt, it will be very expensive for companies to comply. Perhaps this is why supplier changes began even before the final regulations were published.