By the Securities and Exchange Commission’s (SEC’s) own estimates, a last-minute addition buried in the Dodd-Frank Wall Street Reform and Consumer Protection Act is set to affect an estimated 6,000 SEC registrants when it takes effect Jan. 1, 2012. Compliance is estimated to cost companies billions, and many are starting to come to terms with what it will require of them.
But at an Oct. 18 SEC roundtable on the rule in question, it became clear that many companies have been caught off guard by the U.S. Conflict Minerals Act in Section 1502 of Dodd-Frank, which requires public companies to disclose any use in their products of conflict minerals—tin, tungsten, tantalum and gold that originate from the Democratic Republic of the Congo (DRC) and surrounding countries.
There’s no question that the rule comes in response to a true humanitarian crisis.
Sen. Dick Durbin, D-Ill., a co-sponsor of the provision with Sens. Barney Frank, D-Mass., and Russ Feingold, D-Wis., told the SEC panel about some of the effects of conflict mining on the war-ravaged DRC and areas around it. Slave labor and warring militias abound, and rape is a major weapon in the war.
“[W]hat’s fueling this war more and more is pursuit of precious minerals,” Durbin said. “Why are these so valuable? Because of our insatiable appetite for iPads and BlackBerries and cell phones that use these minerals.”
But it’s not just the usual suspects that will be covered by the rules, and therein lies the surprise.
Irma Villarreal, chief securities counsel and assistant secretary at Kraft Foods Inc., told the roundtable that before receiving industry letters warning companies to pay attention to the conflict minerals rule, the company had no idea the legislation would cover it. “[M]ost of the writings in this area were pointing to the usual companies—electronics, jewelry companies—the companies that you know would have those minerals in them,” she said. “This legislation covers [packaging, promotional materials]. Whoever would have thought that?”
Indeed, the conflict minerals rule is broader than many people would think. Kraft is among the affected because, while it doesn’t produce tungsten-containing computer processors or gold necklaces, the packaging it uses—a can, say, or a Capri Sun pouch—may contain conflict minerals. Kraft also is affected because it markets its products with promotional materials such as branded USB drives and flashlights, which may contain the minerals. The rule’s effects go beyond publicly traded companies because private and foreign companies will have to perform their own inquiries. And at this point, the rule provides no de minimis exemption for trace amounts.
It’s not that companies like Kraft are necessarily using conflict minerals in their products, but many don’t know with certainty, and determining whether they do will be a complex and expensive process. Kraft, for instance, has supply chains consisting of 100,000 suppliers that contribute in some way to turning the company’s 40,000 products.
The SEC has proposed diligence requirements consisting of three deceptively straightforward steps. First, companies must determine whether conflict minerals are “necessary to the functionality or production of a product” it has manufactured. Next, they must determine whether the conflict materials originate in the DRC region. If so, companies must then disclose the determination of origin, conduct supply chain due diligence and prepare a report.
At the SEC roundtable, Lawrence Heim, director of Elm Consulting Group International, described what the supply chain-tracing process has been like for affected companies and their suppliers. “More frequently than perhaps is recognized, these suppliers look at [an inquiry] and say, ‘We don’t even really know what these questions mean, but we’ll pass it on to our supplier.’ … What this means is delays,” Heim said.
Companies have asked the SEC for a delay of the implementation date, a transition period, a phasing-in of the rule and other flexibility to help companies adjust to the new challenges. At press time, the provision was still set to take effect Jan. 1, 2012.
Frank Zarb, a partner at Proskauer Rose, says that SEC staff members understand the issues and will consider them as they craft their final rules and deliver more certainty on just how and when the rules must be implemented. “They will do what they can to put in parameters to make the rule operate in as common sense a way as it can, but compliance will still be challenging,” he says.
To Be Finalized
At press time the final rules were still a “big question mark,” in the words of Michael Littenberg, a partner at Schulte Roth & Zabel. Companies don’t know exactly what diligence, auditing and reporting requirements will be required. Littenberg advises that despite the uncertainty, companies should already be focused on the rule. “Internal teams should start addressing the rule, figuring out which products in the supply chain may be implicated, educating people internally and thinking about making changes to contracts with their vendors,” he says.
At the roundtable, companies also asked for clarity from the SEC on defining terms in the statute, such as what classifies materials as being “functionally necessary to the product” and whether “manufacturing” encompasses mining, for purposes of the rule.
“The SEC is not an agency that has spent lots of time defining terms like ‘manufacture,’” says Jane Luxton, a partner at Pepper Hamilton. “There are so many terms of art written into the statute that the SEC is struggling [to define].”
After supply lines are tracked and certified, the disclosure report process that companies will have to go through if they use minerals from the DRC is elaborate, says Cydney Posner, special counsel at Cooley and co-chair of the firm’s securities regulation group. “That’s a bit intimidating,” she adds. The hope, and the intention of the rule, is that companies will instead avoid conflict minerals and use materials from suppliers they have certified to be clean.
Already there are indications that the DRC region is feeling the effects as companies trace materials through supply chains and eliminate conflict materials from their products. Some groups have expressed concern that the rules are a de facto embargo on the region, resulting in economic hardship for civilian populations. But in late October, the United Nations Group of Experts on the DRC wrote to the SEC to urge the implementation of strong regulations on conflict minerals as soon as possible. Since Dodd-Frank’s signing, they wrote, a higher proportion of tin, tungsten and tantalum mined in the DRC is not funding conflict.
“Dodd-Frank has had a massive and welcome impact so far, requiring chain participants all over the world to take due diligence and conflict financing seriously,” the letter read.