Conflict Minerals Diligence

Transcription

1 Resource ID: Conflict Minerals Diligence Michael Littenberg, Ropes & Gray LLP, with Practical Law Corporate & Securities Search the Resource ID numbers in blue on Practical Law for more. This Note explains and offers guidance on the diligence required by the conflict minerals rule, Rule 13p-1 under the Exchange Act and Form SD. Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to adopt rules requiring SEC reporting companies to make specialized disclosure and conduct related diligence concerning specified minerals and their derivative metals contained in the companies products. The minerals and metals covered by the rule, which are included in many common products, include: Cassiterite. Columbite-tantalite (coltan). Wolframite. Tin, tantalum and tungsten, which are derivatives of these minerals. These metals are often referred to as the three Ts. Gold. Other minerals or derivatives the US Secretary of State may designate in the future. The Secretary of State has not indicated that it intends to designate additional minerals or derivatives, and is not expected to do so. The sale of these minerals, which are collectively referred to as conflict minerals (regardless of their origin), is believed to be financing conflict in the Democratic Republic of the Congo (DRC). The intent of Section 1502 is to reduce a significant source of funding for armed groups that are committing human rights abuses and contributing to conflict in the DRC. Under the SEC s rule implementing Section 1502, Rule 13p-1 under the Exchange Act and Form SD (together referred to as the conflict minerals rule), companies that manufacture or contract to manufacture products that contain conflict minerals that are necessary to the products functionality or production must file a report on Form SD. These companies are required to make specific disclosures which vary depending on the origin of conflict minerals in the particular company s products. The rule also requires different levels of inquiry under different circumstances. For brevity, this Note refers to the overall inquiry companies must conduct under the rule as diligence. This Note discusses: Which companies are affected by the conflict minerals rule. When conflict minerals diligence must be conducted and filings must be made. The three main steps of conflict minerals diligence that reporting companies may need to conduct depending on whether their products contain conflict minerals and, if so, the minerals country of origin. Modifications to the disclosure requirements of the conflict minerals rule implemented through an SEC order and guidance. These modifications address the results of a legal challenge to the conflict minerals rule. The independent private sector audit (IPSA) that the rule requires under certain circumstances. Currently, the IPSA requirement has been stayed for most companies pending further SEC guidance. In April 2014, the US Court of Appeals for the District of Columbia Circuit largely upheld the conflict minerals rule against a legal challenge. However, the Court of Appeals concluded that certain of the rule s disclosure requirements violate the First Amendment to the US Constitution. In August 2015, the Court of Appeals reaffirmed this holding on petitions for rehearing, and in November 2015 denied petitions to rehear the August 2015 decision en banc. The SEC does not plan to appeal the holding to the US Supreme Court. In response to the April 2014 holding, SEC guidance and a formal agency order indicate that the SEC expects companies to comply with the rule s substantive requirements, with certain modifications discussed in this Note. Currently, the SEC guidance and agency order remain in effect. For a discussion of the legal challenge and practical implications for companies affected by the rule, see Legal Challenge to the Conflict Minerals Rule.

2 Covered Companies and Compliance Dates This section discusses the broad range of companies that are affected by the conflict minerals rule and details when filings under the rule must be made. Who Must Conduct Conflict Minerals Diligence? The conflict minerals rule applies only to reporting companies, meaning in this context companies that file reports with the SEC under Section 13(a) or 15(d) of the Exchange Act. This includes voluntary filers, but excludes companies exempt from Exchange Act reporting requirements under Rule 12g3-2(b). Unlike some other Dodd-Frank rule-making initiatives, the conflict minerals rule does not exempt foreign private issuers (FPIs) or smaller reporting companies (SRCs). The conflict minerals rule also does not offer any special relief for emerging growth companies, although a newly public company is only required to start reporting for the first calendar year that begins no sooner than eight months after the effective date of the company s IPO registration statement (see When Must Companies Conduct Diligence and Make Disclosure?). A reporting company must conduct conflict minerals diligence and, if it has products that fall within the scope of the rule, make disclosure with respect to its operations and the operations of its consolidated subsidiaries (Question 3, Dodd-Frank Wall Street Reform and Consumer Protection Act Frequently Asked Questions: Conflict Minerals (conflict minerals FAQs)). In this Note, the term company refers to a company and its consolidated subsidiaries. Because every reporting company must determine whether it uses conflict minerals in a way that triggers the rule (see Diligence Step 1: Ascertain the Company s Use of Conflict Minerals), all reporting companies must conduct some level of inquiry under the conflict minerals rule. Companies that do use conflict minerals in this way must conduct a reasonable country of origin inquiry concerning the conflict minerals they use and make some disclosure on Form SD and on their website (see Diligence Step 2: Determine Minerals Country of Origin). Depending on the results of this inquiry, most companies must go on to conduct more detailed supply chain due diligence and prepare a conflict minerals report to be filed as an exhibit to Form SD, among other requirements (see Diligence Step 3: Detailed Due Diligence and Reporting on Supply Chain). In this Note, companies that are required to make any form of conflict minerals disclosure because they use the minerals in a way that triggers the rule are referred to collectively as affected companies. Although only reporting companies have diligence and disclosure obligations under the conflict minerals rule, the rule also significantly impacts non-reporting companies worldwide that are directly or indirectly a part of the supply chains of reporting companies. This is because affected companies must collect information from companies in their supply chains to complete their diligence under the rule. Some estimates place the number of affected non-reporting companies in the hundreds of thousands, ranging from small businesses to large companies, both domestic and foreign. Therefore, many non-reporting companies also must be familiar with the rule. When Must Companies Conduct Diligence and Make Disclosure? Under the conflict minerals rule, all affected companies, regardless of their fiscal year, must make conflict minerals disclosure annually by May 31 (General Instruction B.1, Form SD). If May 31 falls on a Saturday, Sunday or SEC holiday, the filing deadline is extended to the next business day (General Instruction B.2, Form SD and Exchange Act Rule 0-3(a)). Annual Form SD disclosure must cover the company s most recently-completed calendar year. Some new reporting companies can take advantage of an extension (see Acquired and New Public Company Extension). Disclosure Requirements The conflict minerals rule requires affected companies to make disclosure on Form SD and in many cases in a conflict minerals report that must be included as an exhibit to the form. Both Form SD and this exhibit must be filed, rather than furnished, with the SEC. This means companies have potential liability under Section 18 of the Exchange Act for their conflict minerals disclosure. Form SD is not, however, incorporated by reference into a company s registration statements under the Securities Act unless the company elects to do so. In addition, failure to timely file a Form SD does not impact a company s eligibility to use Form S-3 (Question 12, conflict minerals FAQs). For more information on S-3 eligibility, see Practice Note, Registration Statement: Form S-3: Eligibility Requirements for Form S-3 ( ). Affected companies also must post certain conflict minerals disclosure on their websites. The rule requires increasing levels of diligence and disclosure depending on a company s use of conflict minerals and country of origin of the minerals (see Box, Diligence Flow Chart). Diligence Requirements Under the rule, an affected company must make disclosure about conflict minerals contained in the company s applicable products that were manufactured during the calendar year covered by the report (Instruction 5 to Item 1.01, Form SD). The key date here is the day that the manufacture of each finished product containing conflict minerals is completed. Therefore: A company that manufactures its own products must look to the date it completes manufacture of each product containing conflict minerals. Even if the conflict minerals in a company s product are included in component parts of the product that were themselves manufactured by a third party, a company must always look to the date the manufacture of its own final product was completed. A company that is required to report on conflict minerals manufactured by a third-party contract manufacturer must look to the date that third party manufacturer completes manufacture of the company s product, and not to the date of delivery. This means that companies must conduct diligence and report on conflict minerals in their products that had a completion of manufacture during the calendar year immediately preceding the filing of the report. Conflict minerals that were outside the supply chain before January 31, 2013 fall outside the rule s scope, meaning that any product or product component manufactured before January 31, 2013 is not covered by the rule (see Outside the Supply Chain Exception). 2

3 Acquired and New Public Company Extension The conflict minerals rule provides relief to any reporting company that acquires a target company that both: Uses conflict minerals in a way that triggers the rule. Was not, before the acquisition, required to make conflict minerals disclosure. In this situation, the acquirer is not required to make conflict minerals disclosure about the target company s conflict minerals until the end of the first calendar year beginning eight months or more after the effective date of the acquisition (Instruction 3 to Item 1.01, Form SD). The staff of the SEC s Division of Corporation Finance (staff) has stated that it will not object if a newly public company begins making conflict minerals disclosure on this same timeline (Question 11, conflict minerals FAQs). In other words, a new public company can make its first conflict minerals disclosure for the first calendar year that begins eight months or more after the effective date of its IPO registration statement. For example, a company that goes public during June 2015 will not have to make conflict minerals disclosure for 2016 and will become subject to the rule beginning with the 2017 calendar year. Legal Challenge to the Conflict Minerals Rule On April 14, 2014, the US Court of Appeals for the District of Columbia Circuit issued its opinion in a legal challenge to the conflict minerals rule (Nat l Ass n of Mfrs. v. S.E.C., 748 F.3d 359 (D.C. Cir. 2014)). The challenge was brought by several business groups against the SEC seeking to strike down or modify the conflict minerals rule and Section 1502 of the Dodd-Frank Act. These business groups appealed their action to the Court of Appeals after the conflict minerals rule and Section 1502 were upheld in a July 2013 District Court ruling. In its ruling, the Court of Appeals: Held that the conflict minerals rule and Section 1502 violate the First Amendment to the US Constitution, to the extent they require companies to report to the SEC and state on their websites that any of their products have not been found to be DRC conflict free. As adopted, the conflict minerals rule requires this disclosure under certain circumstances (see Disclosure About Company s Products and Conflict Minerals Origin). Rejected all of the business groups other arguments, upholding the other provisions of the rule. These other arguments challenged the SEC s rulemaking under the Administrative Procedure Act and the Exchange Act as arbitrary and capricious on several grounds. In response, on April 29, 2014, the SEC staff issued a staff statement (SEC staff statement) on its expectations for conflict minerals reporting in light of the ruling. That statement was followed by a May 1, 2014 SEC order that, consistent with the SEC staff statement, formally stays certain provisions of the rule. The SEC later requested rehearing of the Court of Appeals decision. On August 18, 2015, the Court of Appeals issued an opinion on petitions for panel rehearing reaffirming its April 14, 2014 ruling in the conflict minerals rule case. Then, on November 9, 2015, the Court of Appeals issued an order denying the SEC s petition for en banc rehearing of the August 18, 2015 decision. In a March 2016 letter, Attorney General Loretta E. Lynch advised that the Department of Justice has decided, in consultation with the SEC, not to file a petition for a writ of certiorari with the US Supreme Court to seek review of the Court of Appeals decision (for a discussion of the practical implications of this series of events, see SEC Guidance on the Ruling and Practical Implications). For more information on the litigation, including links to and summaries of key court documents, see Practice Note, Conflict Minerals Rule Challenge: Litigation Tracker ( ). Status of the Case and Next Steps The November 2015 denial of rehearing en banc effectively preserves the legal status of the rule that has been in place for the 2014 and 2015 reporting cycles. Consistent with the Court of Appeals August 2015 ruling, the case is remanded to the District Court for further proceedings. It remains to be seen whether the SEC will formally amend the conflict minerals rule so that it is consistent with the Court of Appeals ruling or issue additional guidance. SEC Guidance on the 2014 Ruling and Practical Implications The 2014 Court of Appeals ruling only struck a part of the disclosure requirements of the conflict minerals rule, which contains many other diligence and disclosure requirements. In light of this, the SEC staff statement describes the staff s expectations for company reporting under the rule. The guidance: Instructs companies to report in accordance with the rule s filing deadlines. Companies are required to file Form SD and a conflict minerals report, as applicable. Filings under the rule are required to address the portions of the rule and form upheld by the Court of Appeals in Describes permitted modifications to the disclosure required by the rule and form to account for the 2014 Court of Appeals ruling. These modifications affect the disclosure obligations of companies that are required to conduct Step 3 of the rule s diligence process (see Diligence Step 3: Detailed Due Diligence and Reporting on Supply Chain). Indicates that, pending further SEC guidance, an IPSA of a company s conflict minerals report is not required unless a company voluntary elects to describe its products as DRC conflict free in its conflict minerals report (see Diligence Description). On May 2, 2014, the SEC issued a formal order partially staying the conflict minerals rule. Consistent with the SEC staff statement, the order only stays discrete elements of the conflict minerals rule. The SEC statement and formal order remain in effect. Steps of the Conflict Minerals Diligence Process This section discusses the steps of the conflict minerals diligence process. Depending on what the company learns in each step, the rule may or may not require the company to continue to the next step. For a flow chart depicting the three steps of conflict minerals diligence, see Box, Diligence Flow Chart. 3

4 Diligence Step 1: Ascertain the Company s Use of Conflict Minerals Step 1 of the diligence process involves determining whether conflict minerals are contained in products manufactured or contracted to be manufactured by the company and, if so, whether those conflict minerals are necessary to the functionality or production of the products. If they are not, the company has no obligations to make disclosure or conduct further diligence under the rule. This question can be broken down into three principal diligence inquiries, discussed in this section. If the company answers all three of these questions affirmatively, it must move on to diligence Step 2, the reasonable country of origin inquiry, with respect to in-scope conflict minerals (see Diligence Step 2: Determine Minerals Country of Origin). Does the Company Manufacture or Contract to Manufacture Products? The conflict minerals rule only applies to companies that manufacture or contract to manufacture products. The rule does not define these terms, and the adopting release for the conflict minerals rule notes the term manufacture is generally understood (SEC Release No (Aug. 22, 2012) (adopting release)). Companies engaged in fabricating products are in most cases covered by the rule, even if the products they make contain components themselves manufactured by third parties. However, it often is less clear whether companies that sell products but do not make them (such as retailers) are covered. These companies must determine whether they contract to manufacture products using the guidance in the adopting release. According to the adopting release, whether a company has contracted to manufacture a product depends on the degree of influence the company exercised over the product s manufacture, meaning its materials, parts, ingredients or components. While this standard is not triggered by the company having simply any influence over the manufacture, it can be triggered by a level of influence less than substantial. In addition, if a company makes specifications for the inclusion of a particular conflict mineral in a product to a manufacturer that it contracts with, the company generally would have contracted to manufacture that product. Furthermore, there is no distinction between the components of a product that a company directly manufactures or contracts to manufacture and generic components that are included in a product. Therefore, if a product is manufactured or contracted to be manufactured by a company, that company would have to conduct diligence with respect to the conflict minerals included in generic components included in the product to the same extent as the conflict minerals contained in other portions of the product (Question 5, conflict minerals FAQs). The release goes on to specify that a company generally has not contracted to manufacture a product if it does no more than: Specify or negotiate contract terms with a manufacturer that do not directly relate to the manufacturing of the product (for example, technical support or indemnity terms). Affix the company s brand, marks, logo or label on a generic product manufactured by a third party, including contracting to have the company s logo etched into a generic product (see additional guidance in Question 4 of the conflict minerals FAQs). Service, maintain or repair a product manufactured by a third party. Mining companies should note that, under the rule, companies that mine conflict minerals or contract for conflict minerals to be mined are not covered by the rule solely because of their mining activities (Instruction 1 to Item 1.01, Form SD). The staff has confirmed that companies that engage in certain activities associated with mining (such as transporting, crushing and milling ore) are also not covered by the rule solely because of these activities (Question 2, conflict minerals FAQs). To fall within the scope of the rule, an item must be a product or considered part of a product. While the term product is not defined in the conflict minerals rule, the staff has offered limited guidance on its meaning. The guidance clarifies that packaging or containers used in the display, transport or sale of a product are not considered part of the product under the rule. The guidance states that this is true even when a product s packaging is necessary to preserve the product up to and following the product s purchase. The guidance notes that once the consumer starts to use a product, the packaging is generally discarded (Question 6, conflict minerals FAQs). In addition, the guidance states that a company s used capital equipment that it later sells is not considered to be the company s product for purposes of the rule (Question 8, conflict minerals FAQs). The guidance also clarifies that equipment a company uses to provide a service to its customers is not considered a product to the extent that the equipment is retained by the service provider, is to be returned to the service provider or is intended to be abandoned by the customer following the terms of service. Therefore, for example, a cruise line operator (the example included in the FAQ) would not be required to report on conflict minerals contained in its ships (Question 7, conflict minerals FAQs). While the conflict minerals FAQs resolved several uncertainties about the meaning of product for purposes of the rule, many companies face uncertainty when applying the rule to circumstances not directly covered by the guidance. Resolving this uncertainty is necessarily fact-specific. Are Conflict Minerals Contained in the Products? A company also must determine if any conflict minerals are contained in the products it manufactures or contracts to be manufactured. The question of whether a product the company manufactures or contracts to be manufactured contains conflict minerals may not be obvious from a visual inspection. In some cases, this information will be available in, for example: Material content data forms. Engineering specifications. Bills of materials. Product part codes. However, in many cases, a company does not know all the materials included in its products, for example, because it purchases component parts from third parties or is not familiar with all 4

5 component materials in products manufactured for it. Most companies need their suppliers assistance to determine whether and to what extent their products contain conflict minerals. To obtain this information from suppliers, companies typically request that suppliers complete and return a Conflict-free Sourcing Initiative (CFSI) Conflict Minerals Reporting Template. This template was created by the CFSI, an initiative of the Electronic Industry Citizenship Coalition and the Global e-sustainability Initiative, as a common means for the collection of sourcing information related to conflict minerals. The questions contained in the template are also relevant to other aspects of the conflict minerals diligence process. For more information on the template, see the CFSI website. Conflict minerals are used in a diverse range of products and in many industries. For a table listing some common uses of conflict minerals, see Box, Conflict Minerals: Industries and Applications. Many companies that assumed their products would not fall within the scope of the rule have discovered after a preliminary inquiry that at least some of their products contain conflict minerals. Similarly, some companies that knew they had some in-scope products were surprised to learn that other products contained conflict minerals. Reporting companies therefore should not assume that they are not covered by the rule. A significant number of reporting companies will need to conduct some diligence to determine whether their products contain conflict minerals. Are Conflict Minerals Necessary? Conflict minerals contained in a product will not trigger the rule, and are therefore out of the rule s scope, unless the minerals are either: Necessary to the product s functionality. Necessary to the production of the product. Companies must determine whether their products that contain conflict minerals meet either standard. The conflict minerals rule does not contain a bright-line standard for determining if a conflict mineral is necessary to the functionality of a product. This determination is based on the particular facts and circumstances. The adopting release states that, in making this determination, companies should consider: Whether the conflict minerals in the product were intentionally added (as opposed to being naturally-occurring by-products or contaminants). For example, tin is sometimes found as an unintentional contaminant in some forms of steel, even though it is not a specification of the steel. Whether the conflict minerals in the product are necessary to the product s generally expected function, use or purpose. The adopting release notes that if a product has multiple generally accepted functions (for example, a smartphone s functions may include making and receiving calls, checking , browsing the internet and listening to stored music), a conflict mineral only must be necessary to one function to be considered necessary to the functionality of the product as a whole. If conflict minerals are in the product for decorative purposes, whether decoration is a primary purpose of the product itself. For example, gold in a gold necklace would be necessary to the necklace s functionality. The rule also does not define the concept of necessary to the production of a product, and this determination is also based on the particular facts and circumstances. Importantly, the adopting release indicates that even if a conflict mineral was used in, and necessary to, the product s production process, the rule will not be triggered by this use unless the conflict mineral is also contained in the final product. This guidance recognizes that it may be impossible for a company to determine whether a conflict mineral was used in the production process of a product when the product no longer has any physical trace of this use. This guidance means that using a conflict mineral (such as gold) as a catalyst in a product s production process will not, standing alone, trigger the rule. In addition, the rule is not triggered by the fact that a physical tool or machine used to produce a product itself contained conflict minerals. This prevents the rule from being triggered solely by the fact that, for example, capital equipment used in the production of a product contains conflict minerals. Likewise, indirect equipment containing conflict minerals, such as power lines and computers used in a production process, will not trigger the rule. The rule has no de minimis exception for very small amounts of conflict minerals included in a product that otherwise meets this standard. Therefore, even a very small amount of a conflict mineral in a product can trigger the rule. Outside the Supply Chain Exception If the company answers all three of the above questions affirmatively, it must move on to diligence Step 2 unless it qualifies for the so-called outside the supply chain exception for all of the conflict minerals in its products that would otherwise fall within the rule s scope. In most cases, companies are not able to rely on this exception. However, if this exception applies to the conflict minerals in a company s products, the company does not have to make any conflict minerals disclosure or take any further action concerning those conflict minerals. If only a portion of the conflict minerals contained in a company s products qualify for this exception, those conflict minerals will not be within the rule s scope. The company is, however, required to move on to diligence Step 2 with respect to the other conflict minerals contained in its products. Conflict minerals are considered outside the supply chain if, before January 31, 2013, the minerals were either: Fully smelted (in the case of the three Ts) or refined (in the case of gold). Located outside the covered countries (for a discussion of this term, see Diligence Step 2: Determine Minerals Country of Origin). (Item 1.01(d)(7) and Instruction (4) to Item 1.01, Form SD). Diligence Step 2: Determine Minerals Country of Origin If a company determines in diligence Step 1 that conflict minerals contained in the products that it manufactures or contracts to manufacture are necessary to their functionality or production, and the outside the supply chain exception does not apply, the company must move on to diligence Step 2 with respect to those conflict minerals. In Step 2, the company must conduct a reasonable country of origin inquiry to determine whether those conflict 5

6 minerals originated in the DRC or an adjoining country (a covered country) or whether the minerals originated from recycled or scrap sources. The covered countries include: The DRC. Angola. Burundi. Central African Republic. The Republic of the Congo. Rwanda. South Sudan. Tanzania. Uganda. Zambia. Recycled and scrap conflict minerals are treated differently than newly mined minerals under the rule. A company is not required to trace the origin of recycled and scrap conflict minerals further back than the determination that they come from recycled or scrap sources. This recognizes that it is impossible, as a practical matter, to trace the source of minerals past the recycling or scrap process. Conflict minerals are from recycled or scrap sources if the minerals meet the detailed definition in Item 1.01(d)(6) of Form SD. Generally, the minerals must be from reclaimed end-user or post-consumer products or scrap processed metals created during product manufacturing, and cannot be partially processed or unprocessed minerals, or minerals that are a byproduct from another ore. Reasonable Country of Origin Inquiry The rule does not contain a bright-line standard for conducting the reasonable country of origin inquiry. The adopting release indicates that the specific steps of the inquiry will depend on: The issuer s facts and circumstances, including its size, products, relationships with suppliers and other factors. The available infrastructure at the time. However, in order to satisfy the rule, the inquiry must be: Reasonably designed to determine whether the conflict minerals originated in a covered country or are from recycled or scrap sources. Performed in good faith. (Item 1.01(a), Form SD). The adopting release specifically notes that one way a company could conduct the inquiry would be for the company to obtain a representation indicating the facility that processed the conflict minerals (the smelter or, in the case of gold, the refiner) about the source of the minerals. The company could obtain this directly from the processor or indirectly from immediate suppliers in its supply chain. Most companies seek to obtain sourcing information from their suppliers by asking them to complete and return the CFSI Conflict Minerals Reporting Template. As part of this process, each tier in the supply chain is, in turn, expected to request this information from its suppliers. The company would need to have a reason to believe a processor s representation is true given all facts and circumstances, including any red flags that raise doubt. The adopting release notes that a company would have reason to believe a representation is true if the processor was identified as processing only conflict free minerals by a recognized industry group that requires an independent audit of processors (or the processor had independently obtained an audit of it sourcing operations). Notably, the adopting release states that a company is not necessarily required to receive representations covering all of its conflict minerals in order for its inquiry to be reasonable and in good faith. Companies typically use the same framework for conducting both their reasonable country of origin inquiry (diligence Step 2) and detailed supply chain due diligence (diligence Step 3). The adopting release indicates that the reasonable country of origin inquiry approach under the conflict minerals rule is consistent with the supplier engagement approach under the Organisation for Economic Co-operation and Development s (OECD) Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High- Risk Areas (see Practice Note, Conflict Minerals Rule Compliance Resources: OECD Guidance and Related Resources ( )). In some cases, companies have sought to prohibit suppliers from sourcing conflict minerals from the covered countries, as this would allow the company to stop its diligence efforts after the reasonable country of origin inquiry (see Next Steps). Putting aside the practical issues presented by this approach, this approach has been strongly discouraged by the NGO community. Relatively few companies are still taking this approach. Instead, companies have communicated to their suppliers that, to the extent they do source from the covered countries, the companies expect the suppliers to do so responsibly. Next Steps A company does not need to go on to Step 3 of the diligence process if either: It affirmatively determines that all of its in-scope conflict minerals either originated outside the covered countries or came from recycled or scrap sources. Based on its reasonable country of origin inquiry, with respect to all of its in-scope conflict minerals, it has no reason to believe that they may have originated in a covered country or it reasonably believes that they are from recycled or scrap sources. However, the company must file a Form SD that discloses its determination and briefly describes its reasonable country of origin inquiry. The adopting release recognizes that the length and content of this description will vary among companies and will vary over time as visibility of mineral supply chains improves. The release indicates the purpose of the description is to allow stakeholders to assess, track the progress over time of and form their own views on, the company s efforts. The adopting release also states that this description generally must include a discussion of the company s conflict mineral sourcing policies. The company must include this same disclosure on its website, and include a link to its website in the Form SD. The SEC staff statement indicates that, in the staff s view, these disclosure requirements are not affected by the 2014 Court of Appeals ruling in National Association of Manufacturers v. SEC. 6

7 A company must go on to Step 3 of the diligence process if either: It knows that some or all of its in-scope conflict minerals originated in a covered country and did not come from recycled or scrap sources. Based on its reasonable country of origin inquiry, it has reason to believe that some or all of its in-scope conflict minerals may have originated in a covered country and may not have come from recycled or scrap sources. A company s obligation to proceed to Step 3 of the diligence process may be triggered by some of the conflict minerals in its products but not others. For example, a company might determine in its reasonable country of origin inquiry that some of its conflict minerals came from recycled sources, while others originated within the covered countries and are not from recycled or scrap sources. In this circumstance, the Step 3 diligence process and related conflict minerals report disclosure must only cover the conflict minerals that triggered the requirement to proceed to Step 3 (Question 19, conflict minerals FAQs). Diligence Step 3: Detailed Due Diligence and Reporting on Supply Chain The conflict minerals rule requires heightened due diligence and disclosure if, based on the company s reasonable country of origin inquiry (diligence Step 2), it knows that any of its in-scope conflict minerals originated in a covered country and were not from recycled or scrap sources, or if it has reason to believe that any of its in-scope conflict minerals may have originated in a covered country and that they may not be from recycled or scrap sources. Purpose and Design of the Diligence The goal of diligence Step 3 is to gather information on the source and chain of custody of the company s conflict minerals that did or it has reason to believe may have originated in the covered countries. Under the rule, a company is required to conduct diligence Step 3 in conformance with a nationally or internationally recognized due diligence framework, if one is available for the relevant conflict mineral. Currently, the only general framework that satisfies this standard is the OECD guidance (see Practice Note, Conflict Minerals Rule Compliance Resources: OECD Guidance and Related Resources ( )). For the foreseeable future, the OECD guidance is likely to be the only framework that companies will be able to use for their due diligence. Companies will need to refer to the OECD s general guidance and mineral-specific supplements to conduct Step 3 due diligence. The OECD guidance, including supplements, has approximately 40 different discrete compliance procedures that reporting companies must consider, implement and document. As the adopting release notes, Section 1502 gives the SEC the ability to determine that a company s due diligence process is unreliable. If the SEC makes this determination, the company s conflict minerals report will not satisfy the requirements of the conflict minerals rule. This would subject the company to potential liability for violations of Sections 13(a) or 15(d) of Exchange Act. Results of the Due Diligence A company has a lesser disclosure obligation if, after Step 3 due diligence, it determines that some or all of its conflict minerals either: Did not originate in a covered country. Did come from recycled or scrap sources. In this situation, with respect to these minerals, the company only must file a Form SD that discloses its determination and briefly describes its Step 2 reasonable country of origin and Step 3 due diligence efforts and their results. The company must include this same disclosure on its website, and include a link to its website in the Form SD. If the company s Step 3 due diligence leads to any other conclusion with respect to some or all of its conflict minerals, the company must prepare a conflict minerals report and file it as an exhibit to its Form SD (see Conflict Minerals Report). Conflict Minerals Report Companies that must prepare a conflict minerals report must file it as an exhibit to the Form SD and make the report available on the company website. The body of the Form SD must disclose that a conflict minerals report is being filed and include a link to the company website. The report must describe the company s due diligence process (see Diligence Description). The conflict minerals rule as adopted by the SEC requires each conflict minerals report to include certain disclosures about the company s products containing conflict minerals from the covered countries and the origin of those minerals. To account for the 2014 ruling in National Association of Manufacturers v. SEC, the SEC staff statement modifies these requirements (see Disclosure About Company s Products and Conflict Minerals Origin). As adopted, the conflict minerals rule also requires each conflict minerals report to include, subject to limited exceptions, an IPSA report and certain statements about the IPSA. Again, to account for the 2014 ruling in National Association of Manufacturers v. SEC, the SEC staff statement modifies this requirement (see Audit Report Disclosure). Diligence Description The conflict minerals report must describe the measures the company took to exercise due diligence on the source and chain of custody of the company s conflict minerals. As discussed, under the rule, the company is required to conduct due diligence in conformance with a nationally or internationally recognized due diligence framework, if available (see Purpose and Design of the Diligence). The SEC staff statement indicates that the staff expects companies to comply with this disclosure requirement despite the 2014 ruling in National Association of Manufacturers v. SEC. SEC guidance states that the company s due diligence measures must be described in sufficient detail to allow an auditor conducting an IPSA on the conflict minerals report to form an opinion or conclusion about whether the description is consistent with the diligence process that the company actually performed (Question 21, conflict minerals FAQs). According to the SEC staff statement, however, no company is required to obtain an IPSA pending further SEC guidance, unless it voluntarily elects to describe a product as DRC conflict free in its conflict minerals report (see Conflict Minerals Audit). 7

8 Disclosure About Company s Products and Conflict Minerals Origin Under the conflict minerals rule as adopted by the SEC, companies have differing disclosure obligations depending on the results of their Step 3 due diligence. Under the rule as adopted, companies must describe their products containing conflict minerals as either: DRC conflict free. Having not been found to be DRC conflict free. During a temporary transition period only, DRC conflict undeterminable. For a full discussion of the disclosure required under the rule as adopted, see Box, Disclosure Requirements under Conflict Minerals Rule as Adopted. National Association of Manufacturers v. SEC (as reaffirmed) held that the requirement that companies describe their products as having not been found to be DRC conflict free is unconstitutional (see Legal Challenge to the Conflict Minerals Rule). In response to the 2014 ruling in that case, the SEC staff statement lays out modified disclosure requirements. The staff statement remains in effect. Under the SEC staff statement, companies must make the following disclosure, depending on the results of their Step 3 due diligence: Optional disclosure for companies that determine their conflict minerals did not finance armed groups. If a company affirmatively determines that the conflict minerals in its products did not directly or indirectly finance or benefit an armed group (as defined in Form SD) in a covered country it may, but is not required to, describe its products as DRC conflict free. However, a company may make this disclosure only if it has voluntarily obtained an IPSA on the applicable portions of its conflict minerals report (SEC staff statement and Question 15, conflict minerals FAQs). An IPSA is not otherwise required for any company pending further SEC guidance. Companies that describe their products as DRC conflict free are not required to specifically identify which products contain conflict minerals (Question 10, conflict minerals FAQs). In remarks made at a September 12, 2014 address to members of the bar concerning observations from conflict minerals reporting in 2014, the director of the SEC s Division of Corporation Finance expressed concern about disclosure that subtly implies that products containing covered minerals meet the definition of DRC conflict free without actually using these words or obtaining an IPSA. Mandatory disclosure for all other companies. If a company does not affirmatively determine that the conflict minerals in its products did not directly or indirectly finance or benefit an armed group in a covered country, the company must make additional disclosure. The company must describe the facilities used to produce the conflict minerals in its products, the country of origin of the minerals and the efforts to determine the mine or location of origin. The company is not required to describe its products as having not been found to be DRC conflict free or DRC conflict undeterminable. The company is also not required to obtain an IPSA of its conflict minerals report or make any disclosure concerning an IPSA (SEC staff statement). Audit Report Disclosure Under the conflict minerals rule as adopted, portions of each conflict minerals report generally must be audited (for detailed information about the IPSA, see Conflict Minerals Audit). The conflict minerals report must state that the company has obtained the IPSA, identify the auditor if the auditor is not identified in the audit report and provide the audit report prepared by the auditor. Under the SEC staff statement, no company is required to obtain an IPSA pending further SEC guidance. However, a company that voluntarily chooses to describe its products as DRC conflict free must obtain an IPSA and, presumably, include this disclosure. Disclosure Requirements under the Conflict Minerals Rule as Adopted The conflict minerals rule as adopted by the SEC required companies to include one or more of the following disclosures about the company s products containing conflict minerals for which Step 3 due diligence was required. These requirements have been modified by the SEC staff statement (see Disclosure About Company s Products and Conflict Minerals Origin). DRC conflict free products. If a company affirmatively determines that the conflict minerals in a product did not directly or indirectly finance or benefit an armed group (as defined in Form SD) in a covered country, it may, but is not required to, describe the product as DRC conflict free. Note that a company that has not obtained an IPSA on its conflict minerals report because it is relying on the temporary DRC conflict undeterminable designation may not describe its products as DRC conflict free in the conflict minerals report (Question 15, conflict minerals FAQs). Companies that describe their products as DRC conflict free are not required to specifically identify which of its products contain conflict minerals (Question 10, conflict minerals FAQs). DRC conflict undeterminable products. This is a temporary designation that any company may take advantage of in its conflict minerals report for calendar years 2013 and 2014, and SRCs can take advantage of in their conflict minerals reports for calendar years A company can categorize products as DRC conflict undeterminable if, after conducting Step 3 due diligence, the company is unable to determine whether or not the products are DRC conflict free. With respect to these products, the company must describe: zthe products containing the relevant minerals. The rule gives companies flexibility on how to identify the products. zthe steps it has taken or will take since the end of the period covered by its last conflict minerals report to mitigate the risk that its conflict minerals benefit armed groups, including any steps to improve the company s due diligence. zif known, the smelters or refiners used to process the conflict minerals in those products, the country of origin of the minerals and the efforts to determine the mine or location of origin with the greatest possible specificity. 8

9 Products that have not been found to be DRC conflict free. Both during and after the time the temporary DRC conflict undeterminable designation is available to a company, if the company determines that the conflict minerals in its products did directly or indirectly finance or benefit an armed group in a covered country, it must describe its products containing the minerals as having not been found to be DRC conflict free (Question 16, conflict minerals FAQs). If, after the DRC conflict undeterminable designation is no longer available to a company, that company cannot determine whether its products are DRC conflict free, the conflict minerals rule as adopted requires the company to describe its products containing the minerals as having not been found to be DRC conflict free. The rule permits a company to include explanatory disclosure explaining what DRC conflict free means, and why the company is unable to say that its products meet the definition of DRC conflict free. The adopting release includes sample disclosure for this scenario. In either case, the company must go on to describe the smelter or refiner used to process the conflict minerals in those products, the country of origin of the minerals and the efforts to determine the mine or location of origin with the greatest possible specificity. The staff has given guidance on how a company is required to identify products that are DRC conflict undeterminable or have not been found to be DRC conflict free. It has clarified, among other things, that the company is not required to provide model numbers of these products. A company may describe its products based on the company s own facts and circumstances and in terms commonly understood in its industry (Question 9, conflict minerals FAQs). As adopted, the conflict minerals rule also required a company to include certain disclosures about its IPSA report in the conflict minerals report. Conflict Minerals Audit Under the conflict minerals rule as adopted by the SEC, each company that is required to file a conflict minerals report must also obtain an IPSA, unless the company is taking advantage of the temporary DRC conflict undeterminable exception for one or more of its products (see Conflict Minerals Report). According to the SEC staff statement, no company is required to obtain an IPSA pending further SEC guidance. However, companies that voluntarily choose to describe their products containing conflict minerals as DRC conflict free must obtain an IPSA of their conflict minerals report (SEC staff statement and Question 15, conflict minerals FAQs). For a further discussion of the requirements for the IPSA under the conflict minerals rule as adopted, see Box, Requirements for IPSA under Conflict Minerals Rule as Adopted. Requirements for IPSA under Conflict Minerals Rule as Adopted Under the conflict minerals rule as adopted by the SEC, each company that is required to file a conflict minerals report must also obtain an IPSA, unless the company is taking advantage of the temporary DRC conflict undeterminable exception for one or more of its products. The objective of the IPSA is to express an opinion or conclusion on whether, for the covered period: The design of the company s due diligence process described in its conflict minerals report is in conformity in all material respects with the recognized due diligence framework used by the company. The company s description of the due diligence measures that it performed is consistent with the due diligence process that it undertook. The IPSA is limited in scope. Notably, the rule does not require the auditor to express an opinion on the company s conclusions in the conflict minerals report as to the conflict status of its products, or on the completeness or reasonableness of the due diligence measures the company performed. For further guidance on the scope of the IPSA, see Question 17, conflict minerals FAQs. The IPSA must only cover the design of, and description of, the company s Step 3 due diligence. This is the case even if the recognized due diligence framework the issuer relies on for its Step 3 due diligence also includes procedures for obtaining information about a conflict mineral s country of origin for its reasonable country of origin inquiry (Question 18, conflict minerals FAQs). The IPSA must be performed in accordance with existing Government Auditing Standards established by the Government Accountability Office (GAO). The GAO has indicated that the Yellow Book is applicable to the IPSA, and that the standards for either attestation engagements or performance audits may be used. According to the Yellow Book, while an attestation engagement must be performed by licensed certified public accountants, auditors other than certified public accountants may perform a performance audit if they meet the applicable requirements of the Yellow Book (Question 13, conflict minerals FAQs). The adopting release notes that the GAO will be responsible for responding to questions or concerns about the application of its standards to the IPSA. According to the adopting release, it is not inconsistent with the auditor independence requirements in Rule 2-01 of Regulation S-X for the company s independent public accountant to also perform the IPSA. The release notes, however, that the IPSA would be considered a non-audit service and therefore subject to the pre-approval requirements for non-audit services. 9

10 Diligence Flow Chart The following SEC flow chart from the adopting release depicts the steps of diligence required by the conflict minerals rule. 10