On April 7 2014, the Securities and Exchange Commission (the "SEC") issued additional guidance on the Conflict Minerals1 disclosure requirements contained in Section 1502 (the "Rule") of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"). The SEC updated its Dodd-Frank Frequently Asked Questions guidance by adding nine questions and corresponding answers to the Conflict Minerals Section. The new guidance addresses important topics for Issuers,2 such as the structure of Conflict Minerals Reports, the alternative disclosure options available during the temporary transition period, and the scope of independent private sector audits ("IPSA").
The SEC's new guidance reinforces the Rule's extensive due diligence and independent audit requirements as well as the Rule's disclosure requirements. The new guidance answers some very practical questions on issues affecting Issuers under the Rule, such as:
Do independent auditors need to be certified public accountants?
Can an Issuer label a mineral "DRC conflict free" without obtaining an IPSA?
Must an independent auditor verify the completeness and reasonableness of the Issuer's due diligence?
Synopsis of the Rule
The SEC adopted the final version of the Rule on August 22, 2012. The Rule went into effect on November 13, 2012 and requires Issuers subject to the Rule to submit disclosures for the 2013 calendar year no later than May 31, 2014.
The Rule requires Issuers to disclose their use of Conflict Minerals, which originate from the Democratic Republic of the Congo ("DRC") or an adjoining country ("Covered Countries"). Disclosure is required by Issuers that: (i) file reports with the SEC under Section 13(a) or Section 15 (d) of the Securities Exchange Act of 1934, and (ii) use Conflict Minerals that are necessary to the functionality or production of a product manufactured or contracted to be manufactured by that Issuer.
Issuers must make various disclosures based on the origin of their Conflict Minerals and whether those minerals were used to finance or benefit armed groups. For Conflict Minerals mined after January 31, 2013, an Issuer must conduct a "reasonable country of origin inquiry" to determine if it knows or has reason to know that its Conflict Minerals may have originated in a Covered Country. If an Issuer makes that determination, the Issuer must exercise due diligence on the source and chain of custody of the Conflict Minerals following a nationally or internationally recognized framework to determine if the Conflict Minerals are from a scrap or recycled source. The Issuer must disclose Conflict Minerals from a scrap or recycled source by submitting a Form SD to the SEC. This form should disclose the source of the Conflict Minerals and briefly describe the due diligence measures taken by the Issuer to determine the source.
For Conflict Minerals that are not from a recycled or scrap source, in addition to submitting a Form SD with the required disclosures, the Issuer must exercise additional due diligence to determine whether the Conflict Minerals financed or benefitted armed groups. The Issuer must also submit a Conflict Minerals Report detailing the additional due diligence measures taken.
In the Conflict Minerals Report, the Issuer must label the Conflict Minerals as: (1) "DRC conflict free," meaning that the minerals were not used to finance or benefit armed groups in Covered Countries; or (2) "have not been found to be DRC conflict free." Additionally, the Issuer must obtain an IPSA to verify the due diligence framework and measures taken by the Issuer.
Lastly, the Rule provides a grace period ("Temporary Transition Period") of two years for Issuers and four years for Smaller Reporting Companies.3 During this time only, Issuers may label Conflict Minerals in the Conflict Minerals Report as "DRC undeterminable." An Issuer may use this label if it is unable to determine the origin of the Conflict Mineral, or is unable to determine whether the mineral directly or indirectly financed or benefitted armed groups in a Covered Country. In this case, the Conflict Minerals Report must include a description of the products and minerals, what facilities processed the minerals, and the steps taken by the Issuer to mitigate the risk that any of these minerals benefitted armed groups, including any steps to improve its due diligence. Notably, in this case, the Issuer is not required to obtain an IPSA.
SEC's recent guidance reinforces extensive due diligence requirements
The SEC previously issued 13 Frequently Asked Questions and corresponding answers to its Dodd-Frank Conflict Minerals guidance section.4 The newly added nine questions and answers provide guidance on the disclosure requirements in anticipation of the upcoming deadline for Issuers' first disclosure reports, which is less than 60 days away. This guidance addresses the following.
Temporary Transition Period benefits expanded in favor of issuers: The SEC's recent guidance expands the benefits of the Rule's Temporary Transition Period by omitting the IPSA requirement for any Conflict Minerals Report that contains a product with a Conflict Mineral that is categorized as "DRC conflict undeterminable."5
The "DRC conflict undeterminable" label is attractive to Issuers because, under the Rule, they are not required to obtain an IPSA of the measures taken for any product that contains Conflict Minerals that are categorized as "DRC conflict undeterminable." In its new guidance, the SEC clarifies that this "no IPSA" requirement is broadly interpreted: if an Issuer's Conflict Minerals Report contains any Conflict Minerals that are labeled as "DRC conflict undeterminable," the Issuer is not required to include an IPSA in that Conflict Minerals Report.6
During the Temporary Transition Period, Issuers are not required to incur the costs of an IPSA for Conflict Minerals Reports that contain even one Conflict Mineral that has an undeterminable origin or undeterminable financial connection to armed groups. Nonetheless, Issuers should remain cognizant that if an Issuer chooses to label Conflict Minerals as "DRC conflict undeterminable," it must still disclose what facilities processed the minerals, the country of origin of the minerals (if known), and what steps it has taken or will take to mitigate risk.
Expansive interpretation of due diligence requirements for "DRC conflict free" labeling: The SEC now provides that before an Issuer can label a Conflict Mineral as "DRC conflict free," it must obtain an IPSA.7
The Rule instructs that the label "DRC conflict free" means that the minerals were not used to finance or benefit armed groups in Covered Countries. The new guidance reinforces the Rule and increases the difficulty of labeling Conflict Minerals as "DRC conflict free" by requiring that the Issuer confirm, through due diligence, including an IPSA, that the minerals were not used to finance or benefit armed groups in a Covered Country .8
This interpretation greatly affects Issuers because, as noted by the SEC in its adopting release of the Rule, IPSAs are costly.9 The new guidance clarifies that at the end of the Temporary Transition Period, Issuers will have to include an IPSA in every Conflict Minerals Report that they provide.
Dual Disclosure Requirements for Products with Conflict Minerals from Both Recycled and Non-Recycled Sources: The SEC now instructs that if an Issuer has a product that contains Conflict Minerals from both recycled sources and non-recycled sources, the Issuer must adhere to dual disclosure requirements.10
The Rule states that Issuers are not required to file a Conflict Minerals Report for Conflict Minerals that are from recycled or scrap sources. However, the Issuer is still required to submit a Form SD containing the applicable disclosures. The new guidance explains that if an Issuer's product contains both Conflict Minerals from recycled or scrap sources and Conflict Minerals from non-recycled sources, the Issuer must: (1) submit a Form SD containing the required disclosures for the recycled Conflict Minerals, and (2) submit a Conflict Minerals Report containing the required disclosures for the product's non-recycled Conflict Minerals, as well as obtain an IPSA.11
Moving forward, Issuers must properly trace the origin of every Conflict Mineral in a product to ensure that the appropriate disclosures are made for recycled and non-recycled Conflict Minerals.
Due diligence measures described in the Conflict Minerals Report may begin before or extend after the calendar year: The SEC guidance explains that when an Issuer submits a Conflict Minerals Report, it must describe the due diligence measures that were undertaken during the calendar year that the report covers.12 However, this does not mean that Issuers must start and finish their due diligence measures during that calendar year.13
Based on the Rule, it was uncertain whether an Issuer's Conflict Minerals Report could include due diligence measures that were not fully completed in the calendar year covered by that report. The Rule provides that in conducting an IPSA, auditors are required to express opinions and conclusions about the Issuer's due diligence measures taken for Conflict Minerals in the "period covered by the report," which is the calendar year that the product was manufactured. This requirement created the misperception that Issuers were required to: (1) constantly undertake due diligence throughout the year, and (2) complete the due diligence for a Conflict Mineral before the end of the calendar year.
In the new guidance, the SEC instructs that although the due diligence measures described in the Conflict Minerals Report must apply to the Conflict Minerals in products manufactured during the calendar year that the report covers, it is possible that the Issuer's due diligence may begin before or extend beyond the calendar year.14 Additionally, as long as the due diligence is undertaken at some point in the calendar year that the report covers, the Issuer has met its burden and does not need to continually carry out due diligence on those minerals throughout the year.15
Narrowing the responsibility of independent auditors in conducting IPSAs: The SEC now confirms that the scope of an IPSA does not include: (1) verifying the completeness or reasonableness of the Issuer's due diligence, or (2) attesting to whether a reasonable inquiry was made to determine a Conflict Mineral's country of origin.16
Instead, the new guidance provides that the purpose of an IPSA is to express an opinion or conclusion as to: (1) whether the design of the Issuer's due diligence stands up to nationally or internationally recognized due diligence framework standards, and (2) whether the Issuer's description of the due diligence measures it performed matches the due diligence process that it actually undertook.17 Any additional conclusion reached in an IPSA is outside the scope and purpose of an IPSA.18
Neither issuers nor auditors need to disclose due diligence design: The new guidance instructs that neither the IPSA nor the Conflict Minerals Report needs to contain a full description of the design of the due diligence conducted by an Issuer.19
This interpretation may appear counterintuitive because in section one of an IPSA, the auditor must provide an opinion or conclusion that compares the design of the Issuer's due diligence to national or international standards. In order to reach that conclusion, the auditor must review the design of the Issuer's due diligence. Thus, because an auditor considers an Issuer's due diligence structure, the Rule was unclear as to whether the SEC wanted access to all the information considered by the auditor in reaching its conclusion. Nevertheless, the new guidance instructs that neither the auditor nor the Issuer needs to provide a full description of the Issuer's due diligence structure.20 Consequently, the auditor's opinion or conclusion about the comparison of the Issuer's structure to national or international standards is sufficient to satisfy section one of an IPSA.
Although the Issuer's due diligence design need not be submitted to the SEC, auditors should be aware that in fulfilling their IPSA duty of explaining whether the Issuer's description of the due diligence measures it performed matches the due diligence process that it actually undertook, the auditor will still need to provide the descriptions of the due diligence measures the Issuer actually undertook.21
Independent auditors must meet the eligibility requirements of the US Government Accountability Office's ("GAO") Government Auditing Standards: The SEC has clarified that although independent auditors conducting an IPSA must be qualified to conduct performance audits as outlined by the Performance Audit Provisions of the GAO's Government Auditing Standards, the auditor is not required to be a certified public accountant.22 The GAO's audit requirements can be found at www.gao.gov/yellowbook.
The SEC's new guidance on the Dodd-Frank Conflict Minerals Rule clarified a number of due diligence and disclosure requirements that companies subject to the Rule should consider. As the Rule is implemented, and during the Temporary Transition Period, companies that manufacture products that may be sourced from the Democratic Republic of the Congo and adjoining countries should continue to stay abreast of updates and best practices for fulfilling their disclosure requirements and seek guidance as necessary to understand the evolving best practices in the area.
1 "The term 'conflict mineral' is defined in Section 1502(e)(4) of the Rule as (A) columbite-tantalite, also known as coltan (the metal ore from which tantalum is extracted); cassiterite (the metal ore from which tin is extracted); gold; wolframite (the metal ore from which tungsten is extracted); or their derivatives; or (B) any other mineral or its derivatives determined by the Secretary of State to be financing conflict in the Democratic Republic of the Congo or an adjoining country." See Conflict Minerals, Adopting Release No. 34-647716, 17 C.F.R. Parts 275 and 249b, n.6 (Aug. 22, 2012).
2 The term "Issuer" means any natural person, company, government, political subdivision, agency, or instrumentality of a government that issues or proposes to issue any security. See Securities Act of 1933, § (2)(a)(4), 15 U.S.C. § 77B(a)(4).
3 A "Smaller Reporting Company" is defined as an Issuer that is not an investment company, an asset-backed Issuer, or a majority-owned subsidiary of a parent that is not a Smaller Reporting Company and that meets the public float requirements in the Securities and Exchange Act of 1934. See 17 C.F.R. § 240.12B-2.
7 See id. at Question (15).
9 See Conflict Minerals, Adopting Release No. 34-647716, 17 C.F.R. Parts 275 and 249b, p. 12 (Aug. 22, 2012).
10 See id. at Question (19).
12 See id. at Question (20).
16 See id. at Question (17), (18).
17 See id. at Question (17).
18 See id. at Question (18).
19 See id. at Question (21).
22 See id. at Question (13).