Conflict Minerals. David M. Spooner Dynda A. Thomas Squire Sanders. November 8, Offices in 18 Countries

Transcription

1 Conflict Minerals David M. Spooner Dynda A. Thomas Squire Sanders November 8, Offices in 18 Countries

2 Overview Section 1502 of the Dodd-Frank Act required the Securities and Exchange Commission (SEC) to promulgate new disclosure and reporting requirements relating to the use of certain minerals originating in several central African countries that were helping to finance extraordinary violence in the Democratic Republic of the Congo (DRC). This violence continues to contribute to a growing humanitarian crisis, and Congress hoped that these rules would help bring an end of that violence. August 22, 2012, the SEC promulgated the long-awaited Conflict Minerals Rule. 2

3 Statement of Rule The Conflict Minerals Rule requires any reporting company having conflict minerals that are necessary to the functionality or production of a product manufactured or contracted by that [reporting company] to be manufactured, shall file a report on Form SD within the period specified in that Form disclosing the information required by the applicable items of Form SD as specified in that Form. Exchange Act Rule 13p-1 3

4 Key Terms 4 Conflict Minerals are: tantalum (derived from columbite-tantalite), used in electronic components, including mobile telephones, computers, video-game consoles, and digital cameras, and as an alloy for making carbide tools and jet engine components tin (derived from cassiterite), used in alloys, tin plating, and solders for joining pipes and electronic circuits tungsten (derived from wolframite), used for metal wires, electrodes, and contacts in lighting, electronic, electrical, heating, and welding applications gold (used for making jewelry, in electronic, communications, and aerospace equipment) any other minerals or derivatives thereof that the U.S. Secretary of State may conclude are financing conflict in the Covered Countries. The listed minerals are "conflict minerals" whether or not they actually financed or benefitted armed groups. The Conflict Minerals Rule applies to thousands of reporting companies and hundreds of thousands of suppliers.

5 Key Terms 5 "Recycled or Scrap Materials" Products with conflict minerals from recycled or scrap sources are deemed to be "DRC conflict free," and there is no requirement to discuss their processing facilities, countries of origin, or efforts to determine mine or location of origin. Because of this special treatment, the Rule only requires a reporting company with conflict minerals from recycled or scrap sources to exercise due diligence if it has reason to believe, following its reasonable country of origin inquiry, that its conflict minerals that it thought were from recycled or scrap sources may not be from such sources (on-ramp to due diligence). Recycled and scrap minerals are given special treatment under the Rule due to the difficulty of looking through the recycling or scrap process to determine the mine or other location of origin of the minerals. Conflict minerals are considered to be from recycled or scrap sources if they are from recycled metals, which are reclaimed end-user or postconsumer products, or scrap processed metals created during product manufacturing. The Rule s definition of recycled or scrap sources is the same as the definition for such term used by the OECD.

6 Key Terms Covered Countries Covered Countries are the Democratic Republic of the Congo, Zambia, Angola, Republic of the Congo, Central African Republic, South Sudan, Uganda, Rwanda, Burundi and Tanzania. 6 According to the Release, the Covered Countries include the Democratic Republic of the Congo and its "adjoining countries." The term "adjoining country" is defined as a country that shares an internationally recognized border with the Democratic Republic of the Congo.

7 Key Terms Exceptions to the Rule Outside the supply chain before January 31, 2013 Even if a product contains a conflict mineral, if the conflict mineral in the product was outside the supply chain before January 31, 2013, the Rule does not apply to such product. The SEC concluded that such minerals would not contribute further to armed conflict, so there is no reason to subject them to the Rule. Conflict minerals are "outside the supply chain" only: after tantalum, tin, or tungsten have been smelted, after gold has been fully refined, or after any conflict mineral that has not yet been smelted or fully refined is located outside of the Covered Countries. 7

8 Key Terms Exceptions to the Rule Recycled or Scrap Sources Conflict minerals that are from recycled or scrap sources are deemed to be DRC conflict free and require disclosure only about the inquiry that led the reporting company to conclude that they were from recycled or scrap sources. 8

9 Key Terms Reporting Company Any entity that files reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (i.e., Forms 10-Q, 10-K, 20-F, and 8-K). There is no exception for foreign private issuers, emerging growth companies or smaller reporting companies. Non-reporting companies are impacted by the Rule because their suppliers will ask them to provide information and may make procurement decisions based on that information. 9

10 Key Terms Filing / Reporting Disclosures required by the Conflict Minerals Rule must be made by reporting companies on a new Form SD ( specialized disclosure ). Form SD is due for every calendar year by May 31st of the following year, with the first reports due on May 31, The disclosure requirements apply to all reporting companies on a calendar year basis, regardless of the reporting company's fiscal year. The reporting company must make its Form SD (with the Conflict Minerals Report if required) available on its website for one (1) year. 10

11 Key Terms Filing / Reporting The Conflict Minerals Rule provides that Form SD (and any required Conflict Minerals Report, filed as an exhibit to Form SD) is to be filed, not furnished. Reporting companies will be subject to liability under Section 18 of the Exchange Act for false or misleading statements in their Form SD. Section 18 does not create strict liability for filed information. The reporting company will not be liable for a false or misleading statement in the Form SD if the reporting company can establish that it acted in good faith and had no knowledge that the statement was false or misleading. 11

12 3-Step Analysis The Conflict Minerals Rule requires a reporting company to undertake a 3-step analysis of the use and origin of its conflict minerals. Step 1 -- Does the Rule apply to us? Step 2 -- Do our conflict minerals come from the Covered Countries? Step 3 -- Do our conflict minerals benefit or finance armed groups in the Covered Countries? 12

13 Step 1: Does the Rule Apply to Us? The Rule applies to: a reporting company having conflict minerals that are necessary to the functionality or production of a product manufactured or contracted to be manufactured by that reporting company. Must meet both requirements. Most of the terms used in the Rule are not specifically defined. 13

14 Step 1: Does the Rule Apply to Us? "Product" If a reporting company does not manufacture or contract to manufacture a "product," the Rule does not apply and the reporting company has no further obligations under the Rule. The SEC has chosen not to define the term "product," presumably because it believes the concept to be intuitive. Further, the SEC does not even provide any guidance relating to the term "product." Because the term is not defined, it is unclear how the SEC will interpret it. Thus, reporting companies should consider carefully when determining that they do not manufacture a "product." Possible tests that could be used to determine what is a product under the Rule: Revenue Test Content Test 14

15 Step 1: Does the Rule Apply to Us? "Necessary to the functionality" If the conflict minerals contained in the product are not "necessary to the functionality" of the product, the Rule does not apply and the reporting company has no further obligations under the Rule with respect to that product. The Rule does not define when conflict mineral is "necessary to the functionality" of a product. But the SEC has provided guidance as to the meaning of the term. Whether a conflict mineral is deemed "necessary to the functionality" of a product depends on the reporting company s particular facts and circumstances. Only a conflict mineral that is contained in the product can be "necessary" to the functionality of that product (even in trace amounts). 15

16 Step 1: Does the Rule Apply to Us? 16 Necessary to the functionality In determining whether its conflict minerals are "necessary to the functionality" of a product, a reporting company should consider: whether a conflict mineral is contained in and internationally added to the product or any component of the product and is not a naturallyoccurring by-product, whether a conflict mineral is necessary to the product's generally expected function, use, purpose, if a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration, when any conflict mineral is contained in a product and intentionally added in the production process of the product or in the production process of any component of the product. Based on the applicable facts and circumstances, any of these factors, either individually or in the aggregate, may be determinative as to whether conflict minerals are "necessary to the functionality" of a given product.

17 Step 1: Does the Rule Apply to Us? "Necessary to the functionality" A conflict mineral is "necessary" to the product whether it was added by the reporting company or added to a component of the product that the reporting company receives from a third party. To be "necessary" to the product, the conflict mineral need not be limited to the product s "basic function" or "economic utility." When there are multiple functions and uses, the conflict mineral need only be necessary for one function to be "necessary to the functionality of that product. 17

18 Step 1: Does the Rule Apply to Us? "Necessary to the Production" If the conflict minerals contained in the product are not "necessary to the production" of the product, the Rule does not apply and the reporting company has no further obligations under the Rule with respect to that product. The Rule does not define when a conflict mineral is "necessary to the production" of a product. But the SEC has provided guidance as to the meaning of the term. Whether a conflict mineral is deemed "necessary to the production of a product depends on the reporting company s particular facts and circumstances. 18

19 Step 1: Does the Rule Apply to Us? "Necessary to the Production" To be "necessary to the production" of a product, the conflict mineral must be contained in the product and intentionally added in the production process of the product (including the production process of any component of the product) and the conflict mineral must be necessary to produce the product. The conflict mineral is considered to be in the product even if the product contains only trace amounts of the conflict mineral. In determining whether a conflict mineral is "necessary to the production of a product, a reporting company must consider any conflict mineral contained in its product, even if that conflict mineral is only in the product because it was included as part of a component that was manufactured by a third party. 19

20 Step 1: Does the Rule Apply to Us? "Manufacture" If a reporting company does not "manufacture" or "contract to manufacture" a product, the Rule does not apply and the reporting company has no further obligations under the Rule. The SEC has chosen not to define the term "manufacture" because it believes the term is generally understood. However, the SEC has provided guidance regarding the meaning of the term. Because the term is not defined, it is unclear how the SEC will interpret the term. Thus, reporting companies should consider carefully when determining that they do not "manufacture" a product. 20

21 Step 1: Does the Rule Apply to Us? "Contract to be Manufactured" If a reporting company does not "manufacture" or "contract to manufacture" a product, the Rule does not apply and the reporting company has no further obligations under the Rule. The SEC has chosen not to define the term "contracts to manufacture" because it believes the concept to be intuitive. The SEC, however, provided guidance regarding whether a reporting company is considered to "contract to manufacture" a product. Because the term is not defined, it is unclear how the SEC will interpret the term. Thus, reporting companies should consider carefully when determining that they do not "contract to manufacture" a product. A reporting company may be contracting to manufacture a product depending on the degree of influence it exercises over the materials, parts, ingredients, or components to be included in any product that contains conflict minerals. The degree of influence necessary for a reporting company to be considered to be contracting to manufacture a product is based on each reporting company s individual facts and circumstances. 21

22 Step 2: Do Our Conflict Minerals Come From Covered Countries? Reasonable Country of Origin Inquiry Once a reporting company determines that conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the reporting company, the reporting company must conduct a reasonable country of origin inquiry to determine if the minerals originated in the Covered Countries or if they came from recycled or scrap sources. In order to make such disclosure, the reporting company must make a reasonable country of origin inquiry in good faith. The Rule does not specify what steps and outcomes are necessary to satisfy the reasonable country of origin inquiry requirement because such a determination depends on each reporting company s particular facts and circumstances. A reasonable country of origin inquiry can differ among reporting companies based on the reporting company s size, products, relationships with suppliers, or other factors. 22

23 Step 2: Do Our Conflict Minerals Come From Covered Countries? Reasonable Country of Origin Inquiry The Rule includes general standards governing the inquiry and the steps required in the reasonable country of origin inquiry. The Rule provides that a reporting company s reasonable country of origin inquiry must be reasonably designed to determine whether the reporting company s conflict minerals did originate in the Covered Countries, or did come from recycled or scrap sources, and it must be performed in good faith. The reasonable country of origin inquiry standard does not require a reporting company to determine to a certainty that all its conflict mineral did not originate in the Covered Countries because the standard required is a reasonable inquiry, and requiring a certainty in this setting would not be reasonable and may impose undue costs. A reporting company may conclude that its conflict minerals did not originate in the Covered Countries even if it does not receive responses from all its suppliers as long as it does not ignore warning signs or other circumstances that indicate that the rest of its conflict minerals originated or may have originated in the Covered Countries. 23

24 Step 2: Do Our Conflict Minerals Come From Covered Countries? Conclusions from Reasonable Country of Origin Inquiry After conducting a reasonable country of origin inquiry, the reporting company could reach one of four conclusions: its necessary conflict minerals did not original in the Covered Countries or did come from recycled or scrap sources, which would require the reporting company to file a Form SD describing its reasonable country of origin inquiry and the results thereof, it has no reason to believe that its conflict minerals may have originated in the Covered Countries or it reasonably believes that its conflict minerals are from recycled or scrap sources, which would require the reporting company to file a Form SD describing its reasonable country of origin inquiry and the results thereof, it knows that it has necessary conflict minerals that originated in the Covered Countries and did not come from recycled or scrap sources, or it has reason to believe that its necessary conflict minerals may have originated in the Covered Countries and may not have come from recycled or scrap sources, which would require the reporting company to exercise due diligence on the source and chain of custody of its conflict minerals and provide a Conflict Minerals Report, it originally thought its conflict minerals were from recycled or scrap sources but comes to believe, following its reasonable country of origin inquiry, that such conflict minerals are not from recycled or scrap sources, which would require the reporting company to exercise due diligence on source and supply chain and provide a Conflict Minerals Report. (This is an on-ramp to further due diligence.) 24

25 Step 2: Do Our Conflict Minerals Come From Covered Countries? DRC Conflict Undeterminable During a limited transition period, a reporting company that performs its reasonable country of origin inquiry but is unable to determine whether its conflict minerals are from the Covered Countries and whether they benefit or finance armed groups is permitted to conclude that its products are DRC conflict undeterminable. The DRC conflict undeterminable classification is permitted for a two-year period (four-year period for smaller reporting companies ). During the limited transition period, a reporting company will not be burdened by the costs and effort in obtaining an independent private sector audit as to products that are DRC conflict undeterminable. The reporting company, however, will still be required to file a Conflict Minerals Report. 25

26 Step 2: Do Our Conflict Minerals Come From Covered Countries? DRC Conflict Undeterminable For products that are DRC conflict undeterminable, the reporting company s Conflict Minerals Report must include: A description of the actions taken to exercise due diligence on the source and chain of custody of the reporting company s conflict minerals, The steps it has taken or will take to mitigate the risk that its necessary conflict minerals benefit armed groups, Other details about the countries, facilities, and mines of origin of the conflict minerals. For products that are DRC conflict undeterminable, an independent audit of the Conflict Minerals Report is not required as to those products. 26

27 Step 2: Do Our Conflict Minerals Come From Covered Countries? DRC Conflict Undeterminable After the initial transition period, when the "undeterminable" reporting alternatives is no longer available, a reporting company that cannot determine that its conflict minerals did not originate in the Covered Countries, or that they did not benefit or finance armed groups, or that they came from recycled or scrap sources, will be required to describe relevant products as having "not been found to be 'DRC conflict free.'" Such reporting companies will be required to provide a private sector audit of their Conflict Minerals Report as to such products. 27

28 Step 3: Do Our Conflict Minerals Benefit or Finance Armed Groups in the Covered Countries? Due Diligence on Sources and Supply Chain If, after completing its reasonable country of origin inquiry, the reporting company: knows or has reason to believe that the conflict minerals it uses originated in the Covered Countries, or knows or has reason to believe that the conflict minerals it uses are not from recycled or scrap sources, or cannot determine the source of the conflict minerals it uses. The reporting company must exercise further due diligence on the source or chain of custody of the conflict minerals it uses. 28

29 Step 3: Do Our Conflict Minerals Benefit or Finance Armed Groups in the Covered Countries? Due Diligence on Sources and Supply Chain If, after such heightened due diligence, the reporting company determines that its conflict minerals did not originate in a Covered Country or determines that its conflict minerals did come from recycled or scrap sources, that reporting company is required to file a Form SD (disclosing its determination, briefly describing its reasonable country of origin inquiry and due diligence and results of that inquiry demonstrating why the reporting company believes that the conflict minerals did not in fact, originate in a Covered Country or that the conflict minerals did come from recycled or scrap sources), but it is not required to file a Conflict Minerals Report. This is an off-ramp from the Conflict Minerals Report requirement. 29

30 Step 3: Do Our Conflict Minerals Benefit or Finance Armed Groups in the Covered Countries? Due Diligence Framework Reporting companies must exercise due diligence on the source and chain of custody of their conflict minerals. Reporting companies must use due diligence measures that conform to a nationally or internationally recognized due diligence framework if one exists. A nationally or internationally recognized due diligence framework is one that: has been established by a body or group that has followed due process procedures, including the broad distribution of the framework for public comment, and is consistent with the criteria standards in Generally Accepted Governmental Auditing Standards established by the GAO. 30

31 Step 3: Do Our Conflict Minerals Benefit or Finance Armed Groups in the Covered Countries? Due Diligence Framework As of the date the Rule was issued, only one nationally or internationally recognized due diligence framework existed the due diligence guidance approved by the Organisation for Economic Co-operation and Development (OECD), available at tinationalenterprises/ pdf If a nationally or internationally recognized framework becomes available for any of the conflict minerals, reporting companies will be required to utilize that framework for that mineral. 31

32 Step 3: Do Our Conflict Minerals Benefit or Finance Armed Groups in the Covered Countries? Conflict Minerals Report Unless a reporting company s products are "DRC Conflict Free," a Conflict Minerals Report must include a description of the facilities used to process those conflict minerals (that is, the smelter or refinery through which the conflict minerals passed), the country of origin of those conflict minerals, and the efforts to determine the mine or location of origin with the greatest possible specificity. Also, the Conflict Minerals Report should include a description of the reporting company s products that have "not been found to be 'DRC conflict free.'" Products are considered "DRC conflict free" if they do not contain minerals that finance or benefit armed groups in the Covered Countries. 32

33 Step 3: Do Our Conflict Minerals Benefit or Finance Armed Groups in the Covered Countries? Conflict Minerals Report The Conflict Minerals Report must include: a description of the due diligence measures that the reporting company undertook to determine the source and chain of custody of its conflict minerals, or diligence measures that the reporting company undertook in determining that the conflict minerals came from recycled or scrap sources, a certification by the reporting company that it obtained an independent private-sector audit, a description of the reporting company's products that have not been found to be DRC conflict free, " the country, facilities and mines of origin of those conflict minerals. 33

34 Step 3: Do Our Conflict Minerals Benefit or Finance Armed Groups in the Covered Countries? Private Sector Audit The reporting company is required to provide an independent private sector audit report of its Conflict Minerals Report. The objectives of the independent private sector audit are to express an opinion as to whether: the due diligence measures conform to a nationally or internationally recognized due diligence framework, and the due diligence measures described in the Conflict Minerals Report were actually performed. The audit is not required to state any opinion as to the conclusions reached by the reporting company. 34

35 Step 3: Do Our Conflict Minerals Benefit or Finance Armed Groups in the Covered Countries? 35 Private Sector Audit A certified public sector audit must be conducted in accordance with standards of the US Comptroller General. It would not be inconsistent with the independence requirements in Rule 2-01 of Regulation S-X for the reporting company s independent public accountant also to perform the independent private sector audit of the Conflict Minerals Report. When reporting companies describe their products as "DRC conflict undeterminable," no independent private sector audit report is required as to such products. If a reporting company describes products in its Conflict Minerals Report as having "not been found to be 'DRC conflict free,'" that reporting company will be required to provide an independent private sector audit of its Conflict Minerals Report. The audit is not required to cover the description of the products themselves that have "not been found to be 'DRC conflict free.'" The independence required for the independent private sector audit of the Conflict Minerals Report is not the same as the OECD's independence requirements for auditors who conduct audits of conflict minerals smelters.

36 Special Issues for Apparel Brands and Retailers Necessary to the functionality or production of a product Is metal ornamentation necessary to the functionality of an item of apparel? What about snaps, buttons, clasps that may or may not be used by the consumer? 36

37 Special Issues for Apparel Brands and Retailers Necessary to the functionality or production of a product Are metallic threads necessary to the production of an apparel item? Are fabric treatments that affect the look or hand of the fabric necessary to the production of apparel? 37

38 Special Issues for Apparel Brands and Retailers Contract to manufacture How much influence and control must a brand exercise over choice of inputs in order for the SEC to deem the brand subject to the rule? 38

39 Special Issues for Apparel Brands and Retailers Recycled and scrap material If zippers, buttons, and clasps are made from recycled and scrap material, are brands and retailers exempt from the rule? Is it enough to know that all, or virtually all, zippers, buttons and clasps come from recycled goods, or must a company inquire as to the source inputs? 39

40 Special Issues for Apparel Brands and Retailers Hundreds of products and dozens of factories Must an apparel brand conduct due diligence for every input of every fashion item and accessory for every season? 40

41 Worldwide Locations North America Latin America Europe & Middle East Asia Pacific Cincinnati Northern Virginia Bogotá+ Beirut+ Leeds Beijing Cleveland Palo Alto Buenos Aires+ Berlin London Hong Kong Columbus Phoenix Caracas+ Birmingham Madrid Perth Houston San Francisco La Paz+ Bratislava Manchester Seoul Los Angeles Tampa Lima+ Brussels Moscow Shanghai Miami Washington DC Panamá+ Bucharest+ Paris Singapore New York West Palm Beach Rio de Janeiro Budapest Prague Tokyo Santiago+ Frankfurt Riyadh Santo Domingo Kyiv Warsaw 41 + Independent Network Firm