Conflict Minerals Final Rules: What Changed?Jan 22nd, 2013 | By Doug Hileman | Category: Environmental Management, Health and Safety, Sustainability
This is the second of a multi-part series of EHS Journal articles designed to provide meaningful background and guidance on the Dodd-Frank Conflict Minerals rule (DFCM). Other articles in the series include:
- Preface: 5 Myths About Dodd-Frank Conflict Minerals
- Part 1: Background and Proposed Rule
- Part 2: Conflict Minerals Final Rules: What Changed?
- Part 3: DFCM by the Numbers (pending publication)
- Part 4: Suggestions for Effective Compliance and Risk Management Systems (pending publication)
This article is includes the following sections:
- Overview of the final rule’s provisions
- Changes from the proposed rule
- What didn’t change
The U.S. Securities and Exchange Commission (SEC) published the draft DFCM rule on December 15, 2010 and final rules on August 22, 2012. The SEC had two public comment periods. I submitted comments (see http://www.sec.gov/comments/s7-40-10/s74010-377.pdf), which were referenced ten times in the final rule. DFCM requirements are effective for most companies beginning in calendar year 2013.
Overview of Final Rule Provisions
DFCM requires companies that are subject to SEC reporting requirements to determine if they obtain tantalum, tin, tungsten, or gold from entities in their supply chain with ties to warlords in the Democratic Republic of the Congo (DRC) or surrounding countries (“DRC Countries”).
DFCM includes a business process flow diagram that depicts how companies should evaluate their applicability to DFCM and comply with the rule’s provisions. Specified actions include:
- Determine whether DFCM applies
- Conduct a Reasonable Country of Origin Inquiry (RCOI)
- Determine if conflict minerals come from scrap or recycled sources
- Conduct due diligence on the source and chain of custody of conflict minerals
- Prepare a Conflict Minerals Report (CMR) with specified contents
- Procure an independent private sector audit
- File Form SD, with specified additional information
Companies may not be required to conduct all of these actions, depending upon their conclusions as they proceed from one step to the next. If companies can determine that their conflict minerals do not come from DRC Countries earlier in the process, then fewer steps and disclosures are required.
The final rule outlines a three-step process, which may be somewhat misleading, because Step 3 includes several actions that could be considered “steps.” Furthermore, the findings of one step determine what is done for subsequent steps.
Step 1 – Determine Applicability
Step 1 requires companies to determine whether they are subject to DFCM. The final rule provides some changes and clarifications to make this determination easier. The SEC noted that the criteria in the final rule will also likely reduce the number of companies that are subject to DFCM.
Step 2 – Conduct RCOI
Step 2 requires companies to conduct an RCOI. If a company determines that none of the conflict minerals in its supply chain originated in the DRC, then the supply chain is designated as “DRC Conflict Free,” and the company need not conduct further due diligence. This will make the company’s filings under DFCM relatively simple.
Based on the RCOI, companies may arrive at one of three possible conclusions:
- Conflict minerals are in the company’s supply chain
- Conflict minerals from Conflict Countries are not in the company’s supply chain
- It is uncertain whether conflict minerals from Conflict Countries are in the supply chain (“cannot determine”)
This third option is available only on a temporary basis.
Companies will be required to submit their conclusions to the SEC on a new form – Form SD (“Special Disclosure”).
Step 3 – Perform Due Diligence
Step 3 consists of all activities after a company determines that any of the four Conflict Minerals did (or could have) originated in a DRC Country. Activities conducted in Step 3 will be based on the results of Step 2 and may include filing of:
- Form SD, a new SEC form that discloses the issuer’s determination
- Description of RCOI and results of inquiry
- Results of due diligence efforts
- Conflict Minerals Report (CMR)
- Independent private sector audit report, with audit opinion
- Description of products that have not been found to be DRC Conflict Free
- Facilities used to process conflict minerals
- Country of origin, and efforts to determine country of origin
Additional information and/or reports will be required; the extent and type of information depends upon what the company learns with each action.
Conflict Minerals Report
The final rule outlines the contents of the Conflict Minerals Report (CMR), which includes:
- A description of the products manufactured or contracted to be manufactured that are not DRC free
- The facilities used to process the conflict minerals
- The country of origin
- Efforts to determine the mine of origin with greatest possible specificity
Conflict Minerals Audit
To complete the due diligence process, a company must procure an independent audit. The final rule specifies the audit objective, who may conduct the audit, and the extent of liabilities for this independent auditor. The final rule also specifies what must be filed for companies that proceed through the entire due diligence process.
SEC acknowledged in the final rule that the availability of information for many links in the supply chain may be immature, at best. As a result, companies may not be able to determine the source of conflict minerals with certainty. SEC allows a third possibility as an outcome: “cannot determine,” and the final rule specifies the disclosures required for companies that arrive at this conclusion; they are on a par with companies that determine their supply chain to be DRC Conflict Free. No independent audit is required for this determination. The SEC also noted that traceability of conflict minerals in the supply chain will evolve – at least in part due to this regulation. “Bag and tag” systems, where minerals are placed in secured bags and tags are affixed to them, have worked well in other situations, and are a likely outgrowth of DFCM. As a result, the “cannot determine” outcome is permitted for a limited period of time – two years for most companies, and four years for small companies.
DFCM Final Rule — What Changed?
The final rule changed many provisions of the proposed rule. The changes reflected the extent to which SEC sought and considered comments, and attempted to make the rule easier and clearer. Even so, the SEC’s role was to develop a rule to fulfill the statutory mandate of Section 1502 of Dodd-Frank.
Start Dates: DFCM applies to companies beginning with the 2012 calendar year. The time period of coverage was specified as a calendar year, rather than companies’ fiscal years. The final rule exempts conflict minerals outside the supply chain before January 31, 2013.
Reasonable Country of Origin Inquiry: The final rule did not define the methodology or contents of an RCOI, but provided guidance that the RCOI “must be reasonably designed,” “performed in good faith,” and take applicable warning signs into account. The final rule notes that the OECD guidance document for gold uses a range of tools and methods to engage with suppliers. The final rule relieves companies from retaining business records supporting the RCOI; the proposed rule had specified five years.
“Necessary to functionality or production:” The final rule did not define this phrase, but clarified several aspects of it. The final rule excludes materials used in the manufacturing of a product, but not in the product. An example is catalysts used in petroleum refining. Conflict minerals used for decoration of a product are still considered to be part of the functionality of the product for purposes of the rule.
“Contract to Manufacture:” Commenters on the proposed rule sought to be excused from rule compliance if manufacturing were done by others. The final rule provided guidance for the term “contract to manufacture.” Companies can be included, depending upon the degree of influence exercised over materials, parts, or components to be included in any product that contains conflict minerals or their derivatives. “Contract to manufacture” does not include: contracting for provisions unrelated to the contents of the product (e.g., training, intellectual property rights), affixing a logo to a generic product, or servicing a product manufactured by a third party. The Final Rule also removed from regulation the circumstance where a company offers a generic product for sale under its brand name.
“Necessary to production:” Conflict minerals must be contained in the product and necessary to the product’s production. If a conflict mineral is used as a catalyst, or in a similar manner in another process, it is not subject to DFCM. (See Page 22 of the final rule).
Recycled and Scrap Sources: The final rule added a definition of “recycled or scrap.” Recycled / scrap includes materials that have been reclaimed from the end-user or post-consumer products, or scrap created during manufacturing. It includes excess, obsolete, defective, and scrap materials that contained refined or processed metals appropriate to recycle in production of conflict minerals. Minerals partially processed, unprocessed or byproducts from another ore are not included in the definition. The final rule considers products from recycled or scrap sources to be “DRC conflict free.” For conflict minerals from recycled/ scrap sources, some further actions (Conflict Minerals Report and independent audit) are not required.
Undetermined Origin: The final rule provides a temporary transition period for issuers that cannot determine the origin of conflict minerals. Issuers may describe their products as “DRC conflict undeterminable” if they are unable to determine that materials meet the criteria for “DRC conflict free.” The final rule provides a window of two years, and four years for smaller companies. Also, the final rule removed the requirement for an independent audit of the due diligence efforts if the conclusion was “undeterminable.”
Threshold for Step 3: In the final rule, companies that determine in the RCOI that conflict minerals came from recycled / scrap sources, or were not from DRC Countries are not required to proceed to elements of a Conflict Minerals Report. The final rule also specified the standard for making this determination as it found no reason to believe that conflict minerals originated in DRC Countries, rather than definitive proof that they did not originate there.
Standard for Due Diligence Framework: The final rule requires the issuer to use a nationally or internationally recognized due diligence framework, if such a framework is available for the specific conflict mineral. At the time that the final rule was published, the only standard available was “Due Diligence Guidance for Reporting Supply Chains of Minerals from Conflict-Affected and High-risk Areas: Supplement for Gold” issued by the Organization for Economic Cooperation and Development (OECD). The SEC noted that other standards are likely to arise, or the OECD’s standard for gold could be modified to apply to other conflict minerals.
Independent Audit: The final rule made several changes to the independent audit that is required of the due diligence effort as part of Step 3 of the compliance process. Some changes were consistent with my comments (see http://www.sec.gov/comments/s7-40-10/s74010-377.pdf). Changes included:
- Independence criteria: No additional independence criteria were adopted for DFCM. DFCM audits will be considered “non-audit services” for U.S. companies. Sarbanes-Oxley and other rules require that companies disclose fees for their non-audit services in public filings. (See Page 216 of the final rule.) SEC noted that the independence required to audit the Conflict Minerals Report differs from OECD’s independence requirements to audit a smelter.
- Audit Objectives: If an independent audit is required, one objective would be to express an opinion on the design of the issuer’s due diligence measures, and whether it is in conformity, in all material respects, with the criteria of the specified framework. Another objective would be to determine whether the issuer’s description of the due diligence measures is consistent with the procedures it actually undertook. This clarification is a considerable reduction from the proposed rule; note that the objective is not to provide an opinion on the conclusions of the due diligence effort.
- Audit standard: The Government Auditing Standards (GAGAS, or “the Yellow Book”) performance audit standard applies, not the attestation audit standard.
- Who can do audits: Unlike the attestation engagement standard, the GAGAS performance audit standard allows auditors other than CPAs to perform a Performance Audit, provided the auditor complies with applicable qualification requirements in GAGAS. This will increase the number of firms eligible to conduct private sector audits, which should make it less costly for an issuer to obtain such an audit.
Cannot Determine: The proposed rule included provisions for disclosure when the source of conflict minerals could be determined, could not be determined, and was undeterminable. Comments were submitted on the nature, content, and extent of disclosures for all three categories – but notably the “undeterminable” category. The final rule allows this category, but only for two years (for most issuers) or for four years (for smaller issuers). Issuers taking advantage of this category must conduct due diligence and prepare and file a Conflict Minerals Report, but they are no longer required to obtain an independent audit of their efforts. If a company still cannot determine the origin of conflict minerals after this interim period, it must describe the products in its Conflict Minerals report as “not DRC conflict free.”
Reporting Period: The reporting period was standardized as the calendar year, with DFCM disclosures due May 31 for all companies. This change avoided DFCM disclosures occurring year-round, concurrent with their fiscal years. The SEC also noted that the delay of DFCM filing does not overburden financial auditors, freeing them to work on DFCM.
The final rule changed, clarified, or provided guidance on other issues:
- Trigger for when conflict minerals are “manufactured”
- Acquisitions of companies
- Availability of the formal disclosure (Form SD)
- Signature on auditor certification
- Retention of business records
- Exposure for consequences of false or misleading material statements
The final rule changes the substantive disclosures in the specialized disclosure (Form SD) report. If full disclosure (the Conflict Minerals Report and the underlying due diligence) is not required, the issuer must describe the RCOI in its submittal. SEC noted that this approach should allow stakeholders to evaluate the degree of care the issuer used in making this negative determination. [Author’s Note: This change acknowledges a key concern I included in my comments. Under the proposed rules, only companies that confirmed conflict minerals originating in DRC Countries would be required to make substantive disclosures. Companies that confirmed they were DRC Free or couldn’t determine were required to make very limited disclosures. I expressed the concern that this would create a powerful incentive for companies to affirmatively “not know” in order to avoid disclosures. SEC’s change requires more disclosures, regardless of the outcome of their determination.]
Disclosure is to be made using a new form, Form SD. This replaces the proposed requirement to submit information as part of standard financial filings, such as the Form 10-K.
What Didn’t Change?
The SEC let several provisions of the proposed rule stand, including those listed below.
- The definition of “conflict mineral” remains unchanged, although the SEC clarified which derivatives are conflict minerals.
- Step 1 is still “determine if DFCM applies to you,” with the responsibility for appropriate determination squarely on the regulated company.
- The SEC did not create classes of exemptions.
- The SEC declined to define “manufacture.”
- DFCM still applies to issuers that “contract to manufacture” products that contain conflict minerals. As noted above, the applicability is not universal, but depends upon the degree of influence.
- The final rule did not establish a de minimus threshold for the amount of a conflict mineral that must be in a product for it to be considered.
- Issuers must still conduct a “reasonable Country of Origin Inquiry” (COI). Consistent with the proposed rules, the final rule noted that this would depend upon the facts and circumstances for each issuer. The final rule did, however, provide guidance.
- The standard for audit procedures refers to the audit standards established by the Government Accountability Office (GAO), as it did in the proposed rule. These are the Government Auditing Standards (“GAGAS”), which are commonly referred to as the Yellow Book.
- The SEC may determine that an issuer’s independent private sector audit or other due diligence process is unreliable.
- Issuers may add disclosures or clarifications if they wish.
The impact of DFCM can be assessed in part through the number of companies affected, the number of comments received, and the estimated costs to develop conflict minerals compliance programs. I will focus on these data and analyses in Part 3 of this series: “Dodd-Frank Conflict Minerals: By the Numbers.”
The extent of comments, SEC’s analysis, and responses indicates the range and complexity of issues that companies are likely to face as they seek to comply with DFCM, but this is not the complete picture. The final rule depicts compliance as a three-step process. Professionals with enterprise risk or management systems experience know that things are rarely that simple. I maintain there are at least three steps the SEC has not identified. I will focus on these in Part 4 of the series, “DFCM: Suggestions for Effective Compliance and Risk Management Systems,” which will also be published in the EHS Journal.
About the Author
Douglas Hileman, P.E., CPEA, has over 34 years of experience in the environmental, safety and sustainability (ESS) fields. He worked for nine years in industry in environmental operations, corporate ESS program development, and due diligence. He has 25 years of experience in consulting, including six years as an in-house specialist at PricewaterhouseCoopers LLP. While at PwC, he supported financial audit teams for environmental liabilities, Sarbanes-Oxley compliance, and business processes, systems and controls. Mr. Hileman has conducted ESS audits of conformance with consent decrees, sustainability data and claims, and many other elements of ESS and served on the Board of Directors of the Auditing Roundtable. He is a Certified Professional Environmental Auditor, a Qualified Environmental Professional, and a member of the Institute of Internal Auditors. Information on his firm can be found at www.douglashileman.com.
© 2013 Douglas Hileman Consulting LLC
Photograph: Miners, Democratic Republic of the Congo by Mark Craemer, published in Treehugger.com, June 9, 2009. Click here to see the entire slideshow “The Incredible Story of Conflict Mineral Mining in Images.”