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Report: Conflict Minerals and the Supply Chain
Sept. 25, 2012


Background

The trade in minerals from the Democratic Republic of the Congo (“DRC”) financially contribute to conflict that continues to cause suffering among the people of the region. Militant groups in the region sell minerals including columbite-tantalite (coltan), cassitirite (tin), wolframite (tungsten), gold, and their derivatives on the international market to purchase arms to maintain control over the region. These minerals are primarily used to manufacture electrical components found in cellular telephones, video game consoles, digital cameras, and other electronic products. They are also used to manufacture tools, jet engine components, jewelry, solder, electronic circuits, electrical and lighting equipment, and many other products.

To bring public awareness to the issues involving the conflict, to provide transparency into the supply chains of large companies, to help investors and consumers make informed decisions, and to promote peace and security in the DRC, Congress, in 2010, passed the Dodd-Frank Wall Street Reform and Consumer Protection Act including Section 1502 dealing with conflict minerals from the DRC. The law was meant to further the humanitarian goal of ending extremely violent conflict in the DRC partially financed by the exploitation of these minerals and to promote peace and security in the region. To implement this section of Dodd-Frank, the U.S. Securities and Exchange Commission has adopted regulations requiring publicly traded companies to disclose and report whether the products they manufacture, or sell contain minerals originating in the DRC or adjoining countries including Angola, Burundi, Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda, and Zambia. These are the so-called “conflict minerals.”

Summary of Regulations

The new regulations implemented by the SEC require companies that file reports with it under Sections 13 and 15 to disclose whether the products they manufacture or contract to manufacture contain conflict minerals. If they do, these companies must disclose the extent to which the minerals are used, whether they are mined in the DRC or a neighboring country, and whether the minerals directly or indirectly contribute to the conflict in the region. The disclosure must also include a report on the steps taken to obtain the information being disclosed. It is important to note that the regulations do not ban the use of conflict minerals in the manufacture of products, but merely require companies to disclose their use in its products.

The regulations promulgated by the SEC apply to issuers that file reports under the Securities and Exchange Act Sections 13(a) or 15(d) and file 10-K, 20-F or 40-F annual disclosure reports. Companies subject to these regulations will not only include domestic concerns, but also foreign issuers.

Under the law, companies that manufacture products or contract to manufacture products that contain the above minerals, or their derivatives, must review their supply chains to determine whether their products contain conflict minerals obtained from the DRC or neighboring countries and disclose their findings in annual reports.

“Contract to manufacture” applies to companies that have contracted with third parties for the manufacture of the products they sell and exert actual control or influence over manufacturing processes. Those companies that merely enter into contractual agreements for the manufacture of the product, but have no other control over processes are not included. Similarly companies that merely affix their brand or logo on a product, or service, maintain, or repair products containing conflict minerals are excluded from any reporting requirements.

Specifically, the requirements apply to companies that manufacture or sell products containing conflict minerals if the minerals are necessary to the functionality of the product. Minerals are “necessary to the functionality or production of a product” if the mineral is intentionally added to the product; the minerals are necessary to the product’s generally expected function, use or purpose; or the mineral is added for decoration and the primary purpose of the product is decorative.

Those companies meeting the above requirements must make a reasonable inquiry into whether the minerals used in the manufacture of their products originate in the DRC or an adjoining country. The results of the origin inquiry must be disclosed in the form of a report filed with the SEC. If the company makes a reasonable inquiry into the origin of the minerals found in their products and determines that that the minerals do not originate in the covered countries, or originate from recycled or scrap sources, the method used to make this determination must be described in a disclosure and no other reporting is required.

Conversely, if a company finds that the conflict minerals found in their products may originate in a covered country, then it must conduct due diligence to determine the origin of the conflict mineral, the mine from which it originates, and whether the minerals contributed directly or indirectly to conflict in the DRC and report their findings. The amount of due diligence companies are required to undertake must meet national or international standards. For example, the OECD has issued guidance on a due diligence framework with respect to conflict minerals. Companies are required to adopt a similar framework. In that case, if a company finds that their products contain conflict minerals originating in the DRC or a neighboring country, their findings must be audited and certified by a third party. If the company determines that their products contain conflict minerals that are not DRC conflict free, it must publish the report filed with the SEC on their website.  

Finally, there is a two-year transitional period. If a company finds that it cannot determine whether the conflict minerals used in its products originate in the covered countries, or financed the conflict, the company may state this in its report and is not required to audit or certify the findings until 2015.

Effect on the Supply Chain

            Although the new regulations promulgated by the SEC do not prohibit the use of conflict minerals originating from the DRC or other covered countries, companies subject to the regulations must audit their supply chains to assess risks involved with sourcing from domestic and foreign suppliers to determine whether the conflict minerals or components containing conflict minerals originate in the DRC and financially contribute to the armed conflict in the region. Because the information obtained must be reported to the SEC and publicized on company websites, issuers may want to amend the language used in their supplier contracts to avoid using conflict minerals originating in a covered country in the manufacture their products. Consequently, these companies may need to renegotiate contractual language that closely reflects the language of the regulations and require suppliers to conduct their own due diligence to ensure that products they supply do not contain conflict minerals originating in the covered areas.

           

Indirect Effect on Importers and Privately Held Companies

At first glance, it appears that privately held corporations and similarly situated importers may be exempt from the requirements of these regulations. However, if these companies act as suppliers and importers for companies subject to the regulations, they may be forced to obtain the required information and meet the same standards applicable to larger issuers under the law. For example, origin inquiries only need be reasonably conducted. Under the reasonable inquiry standard a company subject to the regulations may rely on the statements of their suppliers.

Consequently, companies required to file reports with the SEC may shift the burden of inquiry to their suppliers. These companies may alter the language in their supplier contracts to closely mirror the language of the regulations. They request that their suppliers certify that the components they supply do not contain conflict minerals from a covered country. In these circumstances, small suppliers may need to audit their own supply chains, and alter with whom they do business to ensure that their products and materials do not originate in the DRC or any other covered country. The requirements may be costly and may require these smaller companies to alter their own supply chains to meet the standards set by the regulations. 

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