October 11, 2012

Blood Cell Phones? Many Companies Must Disclose Source of "Conflict Minerals" under New SEC Rule

Consumer Advertising Law Blog

You've heard about 'blood diamonds,' but did you know that buying a smartphone, drill, or jacket could fund conflict in Africa? A broad array of products, such as appliances, canned foods, cars, electronics, jewelry, medical devices, tools, and even apparel and footwear, often incorporate one or more so-called "conflict minerals" -- tantalum, tin, tungsten, and gold -- and may subject companies that manufacture such products and those that contract to have such products manufactured to onerous regulations recently issued by the Securities and Exchange Commission (SEC).

In Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress created a reporting requirement relating to these minerals that come from certain Central African countries and that may fund armed groups operating out of those countries. In particular, the requirement pertains to the Democratic Republic of the Congo and its nine neighboring states: Angola, Burundi, Central African Republic, the Republic of Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia (Covered Countries). The provision was intended to stem the tide of violence, and especially gender-based and sexual violence, in the region.

It took the SEC, which is responsible for implementing Section 1502, over two years to develop a final rule implementing this unusual provision of the sweeping financial regulatory reform law. As adopted, the final rule will require an estimated 6,000 companies that file annual reports with the SEC to review their supply chains and publicly disclose their use of tantalum, tin, tungsten, and gold, if any of those minerals are "necessary to the functionality or production of a product" that they manufacture or contract to manufacture.

The SEC has created a new form for companies to use for their annual disclosures, known as Form SD. The first Form SD will cover the 2013 calendar year, and will be due by May 31, 2014. As explained in a prior Arnold & Porter Advisory, the SEC envisions compliance as a three-step process.

Step 1. Determine if the rule applies. SEC filers will want quickly to review their product lines to determine if they use any of the four minerals and, if so, if the rule applies. The SEC discussed many aspects of this threshold issue in its lengthy adopting release, but remained short on specifics. For example, it declined to define several key terms -- such as "contract to manufacture" and "necessary to the functionality" of a product -- forcing companies to undertake difficult interpretive work to determine whether the rule applies based on their unique circumstances.

Step 2. Conduct a "reasonable country of origin" inquiry. Covered companies must conduct a "reasonable country of origin" inquiry to determine whether the relevant minerals originated in the Covered Countries. Again, the SEC left the specifics of the requirements for this inquiry vague. In most cases, companies will need to contact suppliers and attempt to identify the smelter or refiner of their conflict minerals so that they can collect information regarding the minerals' country of origin. If the minerals did not originate in the Covered Countries, or came from recycled or scrap sources, the registrant must file a Form SD but need not perform any further due diligence.

Step 3. Perform due diligence regarding the minerals' source. If the filer's minerals may have originated in the Covered Countries (and may not be from scrap or recycled sources), then the filer must design a due diligence program consistent with a nationally or internationally recognized framework. The SEC indicated that currently there is only one such framework, that of the Organisation for Economic Co-operation and Development's Due Diligence Guidance. Having designed such a program, the company must then attempt to identify, among other things, the minerals' source with the greatest possible specificity and whether their purchase financed or benefitted armed groups in the Covered Countries. Companies reaching this step must produce a Conflict Minerals Report to file with the Form SD, and obtain an independent private sector audit of the design and implementation of their due diligence program.

Given the number of affected companies and the complexity of their supply chains, the rule will impose significant burdens on SEC filers. Indeed, the SEC estimates that registrants will collectively spend approximately $3-$4 billion to develop their compliance programs, and between $207 and $609 million annually for ongoing compliance. But the rule will have ripple effects and impact an even greater number of companies not included in this cost estimate, because even companies who do not file reports with the SEC are likely to face new burdens if they form part of a reporting company's supply chain. Navigating the nuances of these new requirements may prove challenging to a broad swath of companies, because companies may not be clear about whether they are subject to the regulations, and may not understand what they are required to do to implement them.

© Arnold & Porter Kaye Scholer LLP 2012 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.


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