Last minute developments are causing companies to reevaluate their conflict mineral disclosures under the rules that the SEC adopted as required by Dodd-Frank as the disclosure’s deadline is only a month away. Most recently, on April 14, 2014, the D.C. Circuit struck down the requirements of the rules that required “entities to report to the Commission and to state on their website that any of their products have ‘not been found to be “DRC conflict free.”’” This ruling prompted two SEC Commissioners to issue a joint statement urging the SEC delay implementing the conflict minerals rules. Earlier in April, the SEC released new FAQs on its website that interprets the conflict mineral rules to support the position that if a company concludes that any of its products are “DRC conflict undeterminable” during the reporting period, “the issuer is not required to obtain an IPSA [independent private sector audit] of its Conflict Minerals Report.”
Conflict Mineral Reporting: Overview
Despite good intentions, Dodd-Frank’s conflict mineral reporting requirements require substantial effort to determine whether reporting companies use minerals that support conflicts in Africa. The end goal, to qualify as “DRC conflict free,” requires companies to look back at their products sold in 2013 and establish that these products did not contain “conflict minerals” (gold, tantalum, tin, or tungsten) from the Democratic Republic of Congo or adjoining countries that directly or indirectly finance armed groups. If a company determines that a product contains a conflict mineral, the company must conduct a “reasonable country of origin inquiry” to assess whether the conflict mineral came from the DRC or adjoining countries. If the company determines that, based on this inquiry, its conflict minerals did not come from the DRC or adjoining countries, then the company must file a “Conflict Mineral Disclosure” with the SEC that “briefly describes the reasonable country of origin inquiry” the company undertook to make its determination.
In the event that a company has reason to believe that any conflict minerals in its products originated in the DRC or adjoining countries, then the company must “exercise due diligence on the source and chain of custody” of its conflict mineral that conforms to “a nationally or internationally recognized due diligence framework . . . .” If, after the due diligence, the company still cannot say that the conflict minerals did not come from the DRC or adjoining countries (or come from scrap or recycled sources) the company must file a “Conflict Mineral Report” with the SEC.
The Conflict Mineral Report requires a description of the due diligence steps taken by the company and also a description of products that are not “DRC conflict free.” The description of the due diligence must include an independent private sector audit. However, the SEC included an exception to the IPSA requirement. For two years (or four years for smaller reporting companies), the SEC will allow companies to declare products “DRC conflict undeterminable” if after completing due diligence the company cannot determine whether the product is not DRC conflict free. Unless a company has determined that a product is DRC conflict free, the SEC’s rules require the company to identify those products in its Conflict Mineral Report. Again, an exception to this rule is that companies may declare products to be “DRC conflict undeterminable” during the initial transition period and avoid declaring them not DRC conflict free.
Ultimately the goal of the complicated conflict mineral rules is to take a “name and shame” approach by forcing companies to either refrain from using minerals that support wars in Africa or publicly state that their products are conflict free. In the words of the D.C. Circuit in its recent ruling on this issue, the conflict minerals rules compel “an issuer to confess blood on its hands . . . .”
D.C. Circuit Reject “DRC Conflict Free” Label
On April 14, 2014, the D.C. Circuit held that SEC’s final conflict mineral rule “violates the First Amendment to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have ‘not been found to be “DRC conflict free.”’” It is still unclear how the SEC will apply this ruling. Senator Dick Durbin downplayed the impact of the Court’s ruling, stating “[w]hile I am disappointed the court rejected the one narrow reporting requirement included in the rule, today's decision will allow the key provisions of this law to be implemented.”
However, it is worth noting that the entire concept of the Conflict Mineral Report does not make sense if there is no obligation to state whether the products at issue are not DRC conflict free. All that is left in the report is for the company to describe which products are DRC conflict undeterminable (during the transition period of 2-4 years) and to describe its due diligence process and possible independent private sector audit. For that reason, there may be a need for the SEC to revise the conflict mineral rules if the D.C. Circuit’s ruling stands.
While companies still have the option of declaring products DRC conflict undeterminable, the Court’s ruling will not have much of an impact on most companies’ conflict mineral compliance burden. The majority of companies have already completed the most burdensome requirements of the conflict mineral rules and all that is now left to do is to fulfill reporting obligations. While the Court struck down the requirement that companies identify their products as “not found to be ‘DRC conflict free’” in the Conflict Mineral Report and on the company website, companies still have to report their conflict mineral undeterminable product and their due diligence to make this determination. Given the widespread difficulties that companies have experienced in tracing the origins of their conflict minerals, most companies will still have to make DRC conflict undeterminable designations. Thus, the Court’s ruling does not impact much of the time and expense for this year’s filing.
SEC Signals use of DRC Conflict Undeterminable to Ease Reporting Burdens
Perhaps the most noteworthy recent development is the SEC’s increasing reliance on the “DRC conflict undeterminable” to address the problems that companies are having implementing the conflict mineral rules. As the reporting deadline looms, it has become increasingly apparent that it simply will not be possible to obtain reliable information from some suppliers as to whether the conflict minerals in their products come from DRC conflict mineral free smelters. As a result, the SEC appears to be signaling that companies should make use of the “DRC conflict undeterminable” designation when they run into unexpected problems complying with the new rules. The allowance for use of this declaration recognizes that it will still be a few more years before both the rules and companies understanding of the rule’s requirements are solidified.
On April 7, 2014, the SEC further increased the benefits of declaring products DRC conflict undeterminable when it released its latest update to its FAQs. According to the SEC, “[i]f any of an issuer’s products are ‘DRC conflict undeterminable’ during [the transition] period, the issuer is not required to obtain an IPSA [independent private sector audit] of its Conflict Minerals Report.” As a result, few companies will have to conduct audits on their conflict mineral assessment for the first two years of implementation.
Embrace the Uncertainty
Despite the looming reporting deadline of May 31st (actually June 2nd, because May 31st is a Saturday), expect more updates and uncertainty with conflict mineral reporting. On May 19, 2014, the D.C. Circuit will hear oral arguments, en banc, in the American Meat Institute case which concerns a similar “mandatory disclosure” rule such as the rule at issue in Court’s recent conflict mineral ruling. In dissenting from the Court’s ruling rejecting the DRC conflict free label, Judge Srinivasan noted that the Court’s ruling in American Meat Institute might undercut its conflict mineral ruling. In addition, it is likely that the SEC will release more FAQs, thought this may not be until after the reporting deadline.
Based on the uncertainty caused by the litigation involving the rules, SEC Commissioners Daniel Gallagher and Michael Piwowar urged the SEC to suspend implementation of the rules. However, a dozen House and Senate Democrats wrote a letter to the SEC requesting that it move ahead with implementation. In the meantime, companies will just have to do their best with the information that they have been able to gather and be cognizant of the option to declare products DRC conflict undeterminable.