The controversial conflict minerals rule, which went into effect on January 1 this year, could become one of the biggest compliance undertakings for many firms – and an even a bigger headache for some that may not realize it affects them.
The controversial conflict minerals rule, which went into effect on January 1 this year, could become one of the biggest compliance undertakings for many firms – and an even a bigger headache for some that may not realize it affects them. The regulation, passed as part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act and issued by the SEC last year, requires companies to make ‘reasonable’ efforts to publicly disclose whether their products contain conflict minerals. Issuers now have until May 2014 to research their supply chains and disclose whether they use tin, gold, tungsten or tantalum from the Democratic Republic of Congo (DRC) or nine neighboring African countries.
The rule is considered particularly costly and wide-ranging, and the SEC estimates around 6,000 companies will be affected. A February report by SiliconExpert Technologies finds one in four electronic parts contains at least one of the four conflict minerals, placing electronics manufacturers directly in the crosshairs of the legislation. Many firms are ill-prepared to research lengthy supply chains, which can run 20 companies deep. Most troublingly, some sectors, such as food and toy manufacturers, may not even realize they are affected by the rule due to their use of tin in product packaging.
‘Companies are all over the map in terms of compliance,’ says Dynda Thomas, a corporate transactions attorney at Squire Sanders who has focused much of her practice on this area. ‘Some industries have been focused on this for a long time; others face a more difficult road.’
Electronics, computer and automotive manufacturers are all heavy users of conflict minerals. Companies in these industries sometimes use all four, and have for years been the target of socially responsible investors looking to minimize risk and non-governmental organizations hoping to curtail what is seen as war profiteering.
‘We talk to a lot of companies about this rule, and they believe they have no choice but to comply,’ says Fern Abrams, director of government relations and environmental policy at IPC, a leading electronics manufacturers’ association. ‘The top companies would admit this is one of the cases where the more you know, the less you realize you actually know.’
Looking for SEC guidance
Compliance is expected to be costly. Government estimates place costs at anywhere from $3 billion to $4 billion, but the US Chamber of Commerce and the National Association of Manufacturers (NAM) predict a price tag of nearly $16 billion. That higher estimate is thought to include the cost of shareholder reaction to firms that report having used conflict minerals. Losses due to potential shareholder lawsuits, reputational damage and consumer backlash could be substantial.
In October 2012 the NAM and other associations sued the SEC in an attempt to overturn or modify the conflict minerals rule. According to a statement by the NAM, the SEC rule ‘is no solution’ to the conflicts in the DRC and ‘creates an unworkable system… with no clear benefits to the people of the DRC or the neighboring countries.’ The lawsuit alleges that the SEC’s enforcement of the rule may violate several federal laws, and even the First Amendment. A decision on the lawsuit may come later this year, but waiting out the resolution before taking action is a dicey strategy as the lawsuit targets only the regulation, not the underlying law. ‘The problem is the law, not the regulation,’ Abrams says. ‘And the law isn’t going anywhere.’
Some corporations are also hoping for additional SEC guidance on what constitutes ‘a reasonable investigation’ into their supply chains, but so far the agency has been relatively silent on the issue. Indeed, many experts predict it won’t offer any substantial guidance until after the first round of disclosures in mid-2014.
A legal response to the lawsuit filed by the SEC in March may offer some scant extra guidance, Thomas says. A footnote in the brief seems to give companies some leeway when it comes to conflict minerals potentially used in packaging. But ambiguity remains – for instance, repairs are technically not covered by the rule, but if a firm uses replacement parts that include conflict minerals, they may be covered. ‘Companies need to think through what is outside and inside the scope of the rule, and document it,’ Thomas says.
Red herrings and red flags
Companies disclosing the use of conflict minerals in their products must file additional paperwork with the SEC. A strategy some companies may employ for the first year of compliance is to claim that it is ‘undeterminable’ whether some of their products use conflict minerals. Under the law, large issuers are allowed to do this for the first two reporting years starting in 2014; smaller issuers can do it from next year to 2016. But over-reliance on this option may provide false comfort.
Simply amending contracts to prohibit conflict minerals isn’t a long-term solution either – companies still need to conduct an analysis of their supply chains and have an independent third party audit those analyses. Waiting until year two to state whether conflict minerals are used in their supply chains will put companies ‘behind the eight-ball’ in making a reasonable effort to disclose, Abrams warns.
Instead of resisting, firms should view supply chain analyses as a good thing. Santiago Reich, a consultant with NAVEX Global, stresses that companies shouldn’t default into just citing materials as being of ‘indeterminate origin’. If you do that, ‘you’re missing the opportunity to know aspects of your business,’ he says, noting that directors may have to push for greater examination of supply chains if management is resistant.
‘Companies can’t ignore red flags,’ Thomas warns. ‘The SEC seems to imply that it expects some understanding of the market, so if a company is ill-informed, it might fall on the wrong side of the regulation.’
Existing models
‘This is not a brand new issue,’ Reich says, pointing to existing standards developed regarding the use of so-called ‘blood diamonds’, as well as other initiatives aimed at stemming the tide of conflict minerals. ‘But the SEC rule created no penalty for having minerals from a conflict zone. Statements that say the rule will cost billions are scare tactics.’
He points to the Kimberley Process, which was started in 2000 to halt the trade in blood diamonds by creating an international certification. ‘It was very similar and not absurdly expensive,’ he says.
One model for compliance companies can follow when considering how to monitor their supply chains is the 2009 guidelines on conflict minerals issued by the Organization for Economic Cooperation and Development. The SEC rule was modeled largely on these guidelines, though it is stricter.
Another excellent approach during the first year is to conduct a pilot project, suggests Thomas. Companies can focus on a particular line of business or supplier, and collect information about procurement practices and data-gathering capabilities. ‘You want to see how quickly these suppliers respond, and how well,’ she says.
A pilot project would then help companies figure out how much training they’d need to give suppliers, and whether any in the chain are raising red flags. ‘Don’t just receive the information and check a box,’ Thomas warns, as the SEC wants to see diligence in attempting to verify information given by suppliers.
A wide range of employees should be involved in the supply chain examination process, according to Abrams. Legal and compliance departments should take on a heavy role in assessing the risks, the procurement department can identify red flags in supplier documentation, engineering departments can point out the potential use of conflict minerals, and the CFO and finance department should determine whether auditing or financial reporting is necessary.
The corporate secretary is crucial to the process, too. ‘Corporate secretaries need to be involved at the disclosure end and also help to streamline the process of reporting,’ Thomas says. ‘They want to be up on the rule, so when somebody from the board, or the general counsel or CFO looks them right in the eye and asks, Where are we on this?, they have a good answer.’
Some certified conflict-free tin and tantalum mines have opened up in the DRC and elsewhere, but they are few and far between. Some firms have taken the reins of their supply chains in an effort to simplify the process. Kemet, an electronics manufacturer that relies heavily on tantalum to make its capacitors, now runs nearly every aspect of its production cycle internally, from its mines to its smelters and assembly lines.
Vertical integration may not be possible for many companies, though. ‘In Kemet’s case, it owns everything, so it can trace every step,’ Thomas says. ‘It’s hard for all companies to do that because they use a lot of different minerals. Some may not be in that business.’
Car makers, for example, are not in the business of mining, so they’ve collaborated with each other and industry associations to formulate best practices. Ford and Toyota are both hailed as leaders on the issue, having prepared surveys of all their suppliers to determine the amount of conflict minerals in their supply chains.
Most of the work should be done in-house, and some experts warn against over-reliance on third-party vendors offering traceability programs, as many such resources are in their infancy. ‘It’s open season for consultants with this rule,’ Abrams says. ‘Some of the accounting firms see it as the next gold rush after Sarbanes-Oxley. Anybody can claim to be an expert.’
