Dodd-Frank Conflict Minerals by the NumbersJul 27th, 2013 | By Doug Hileman | Category: Featured Articles
The Securities and Exchange Commission (SEC) published final rules for Dodd-Frank Conflict Minerals (DFCM) on August 22, 2012. DFCM requirements are effective for most companies beginning in calendar year 2013. This is the fourth in a series of EHS Journal articles:
Part 3: Dodd-Frank Conflict Minerals by the Numbers
Part 4: Suggestions for Environmental Leaders
Numbers influence how companies are managed, and how we make investment decisions. Numbers are used to evaluate companies’ non-financial performance as well: air emissions; waste disposed of; materials recycled; energy consumption.
What numbers are associated with DFCM? Do they [only] mark the path to this point, or do they offer insights into what lies ahead? The numbers come from a variety of sources:
- the preamble to the final rule
- online research
- this author’s analysis
These numbers may influence how companies develop compliance programs. They may also affect how non-governmental organizations (NGOs) or investors view companies’ disclosures, or how SEC elects to monitor disclosures or enforce the final rule. The numbers could influence court cases or proposals to modify the rule. Either way, numbers tell an interesting story. What story do you see?
DFCM Preamble and the Final Rule
The preamble and the final rule included some numbers that describe the path up to August 22, 2012.
This level of interest was expressed in DFCM despite (or perhaps because of) the unusual route for regulating social / sustainability issues via financial reporting. This signals a considerable interest in what companies will be disclosing on the required Forms SD in May 2014.
Figure 1, Number of Pages in DFCM Final Rule
There are only fourteen pages of the final rule. One could simply ready it, and then proceed to develop and implement a compliance program. However, this would deprive the reader of knowledge of the issues raised during the comment period, who commented on what, and the SEC’s thought process in addressing the comments. The preamble offers useful insights for the design, implementation, and monitoring of compliance programs.
Once a company has completed the rush to comply with the initial filing or the effort to justify that it does not need to file, the effort starts all over. Facts and circumstances can change from year to year. This will be an annual obligation for many companies.
For companies that cannot determine the origin of DFCM in their supply chain, the level of effort will increase in subsequent years — until the sources are identified. For companies that remove Conflict Countries from their supply chain, the level of effort will not cease; they will need to maintain diligence, because companies in their supply chain will change.
The range of numbers indicate how little was known about the number of affected companies. The SEC settled on 278,000 in the final rule.
DFCM doesn’t just affect the publicly-traded companies subject to SEC rules; it affects every company that sells metal-containing products to them. And the companies that sell to them. And so on and so on. Companies are likely to send questionnaires (which will probably all look different) to all their suppliers, whether you sell metal-containing products to them or not. It will be up to the supplier to determine applicability, complete the questionnaires, and return them to satisfy their customers.
DFCM provides business process flow chart to help companies evaluate applicability and outcome of the final rule. Much of the rule describes the decisions and the end points.
People familiar with Sarbanes-Oxley will recognize the business process flow chart. People familiar with ISO management systems frameworks will recognize some commonalities with management systems. Following the process — and documenting it — is equally important. Table 4 shows how many decisions and paths must be supported with suitable documentation.
The preamble included discussion of nearly 60 issues where commenters had proposed changes. The SEC agreed to change over half of them. SEC took care to describe their rationale, to follow the statutory language, and to act within its mission of protecting investors.
The proposed rule included estimates of costs to comply with the proposed rule. Several entities submitted their own cost estimates, or challenges to SEC’s estimates (in whole or in part). The final rule included estimates of costs to comply with the final rule based upon the initial estimates, comments received, and changes made for the final rule.
Table 6 shows some of the cost estimates provided in the Economic Analysis section of the preamble to the final rule. The figures vary widely, reflective of the extent of uncertainties in the rule.
Table 7 shows cost estimates for four elements of DFCM, as included in the final rule. Many companies preparing for DFCM have already spent this much or more — before the mid-point of the first year of applicability. The distinction between small and large companies may be useful; another distinction would be the number of products that have any of the four conflict metals in them. Some service providers have indicated that the costs for the independent audit of the due diligence effort in the CMR could be in the US$ 300,000 to US$ 400,000 range. Cost estimates for in-house efforts could be under-estimated by similar factors or more.
Figure 2, SEC’s Changes & Clarifications from Draft to Final rule, and their Effect on Cost of Compliance
While the cost estimates published in the final rule (see Table 7) may be wildly off, it shows that SEC’s changes and clarifications of the proposed DFCM rule overwhelmingly went in favor of reducing the overall cost of compliance. In many instances, SEC mentioned these considerations specifically. In other instances, cost considerations were not mentioned, but the effect of the change required less effort, provided more options, increased competition among service providers — all of which have the effect of reducing costs.
There were relatively few changes that could increase costs, and the extent of cost increases is much less. For example, SEC acknowledged that companies with fiscal year ends other than December 31 could incur slightly increased costs as a result of efforts required to prepare and submit appropriate documentation on a calendar year basis.
Figure 3, Number of Comments Discussed in Preamble to DFCM Final Rule for Several Issues
The SEC took considerable pains to list distinct, different comments, and to explain their rationale for the decision in the final rule.
There were more comments on the audits of the Conflict Minerals Report than any other subject, with the required reporting and public disclosure of the CMR a close second. There were very few comments or questions on definitions, scope, objective, or the activities related to the CMR itself. There were zero comments or questions concerning what companies must or should do with the contents of the CMR.
Commenters focused primarily on where the CMR interfaces with entities outside the organization (auditors, the SEC). It is likely that commenters who are external to companies (auditors, non-governmental organizations, consultants, public) focused only on these interactions because that is where they will be involved. Companies did not focus on the CMR content or preparation process due to other priorities, because they were responding to issues already being discussed, or lack of time. As companies embark on scoping, compiling information, reviewing contents, and preparing the CMR, they will undoubtedly encounter issues they did not realize were problematic. There will be no simple answers, as was the case with developing compliance programs with Sarbanes-Oxley, other accounting rules, and disclosures in Management Discussion & Analysis (MD&A) on climate change.
Figure 4, Number of Comments on Due Diligence in Preamble to DFCM Final Rule
SEC required only that the framework for the due diligence effort consist of an internationally-recognized standard. At publication of the DFCM final rule, only the Organization for Economic Co-Operation and Development (OECD)’s Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas (“OECD Due Diligence Guidance”) had been published. SEC allowed for other frameworks meeting similar criteria for recognition to be adopted.
Figure 5, Analysis of Comments on Independent Private Sector Audit Requirements
More commenters addressed the audit objective than any other aspect of auditing. Most commenters that addressed the issue of whether the auditor should state whether the due diligence documentation is accurate opposed it. The SEC responded in kind, reducing the scope of the objective. Two commenters (including this author) addressed the issue of independence. SEC did not strengthen or specify what constituted independence, leaving this to standard practice and the body of auditors. The only notable SEC response was that these independent audits would be considered non-audit services under Sarbanes-Oxley, and if the financial auditors performed these services, the fees must be included in that category and reported per existing regulations and procedures.
Commenters raised issues throughout the life cycle of the independent audit, from setting the objective of the audit to qualifications of the auditor to the contents of the audit report. For all the fuss about the audits, it is a relatively minor cost burden to the regulated community. The relative number of comments on audits was out of proportion to the total cost to the regulated community, as compared to the same ratio for IT systems and controls. This could suggest that companies already have suitable IT systems and controls, or that they do not fully recognize the burden of the requirements of DFCM.
Issues in the NAM lawsuit included the SEC’s economic analysis, the lack of a de minimis exception, and the basis for the “reasonable country of origin inquiry.” The SEC discussed commenters’ viewpoints —and their rationale for decision — in the preamble to the final rule. The economic heft of the plaintiffs and the amici (amici is a legal term meaning “friends”) of the plaintiffs substantially outweigh the SEC and the defendants. The numbers — the costs — could be a significant factor in how the case is decided, or what changes are proposed for the rule. The SEC made many decisions in order to reduce the economic impact, so this would not be without precedent.
There are other ways to gather, analyze, and interpret data related to DFCM. It remains to be seen how DFCM will influence companies’ operations and disclosures, investors’ perceptions in the companies, or the effect on the global supply of the covered minerals, and the human rights and living conditions of affected populations in DRC Countries.
The costs could provide impetus for industry collaboration to share costs. Industry collaboration could lead, in turn, to revised contracts, litigation, or changes in business relationships to protect intellectual property. The likely costs suggest where companies should be focusing their attention and efforts; this may not be where they are devoting resources yet. Part 4 of this series will provide some suggestions on how an organization should approach DFCM issues.
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.
Photograph: Armed Guard, 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.”