September 11, 2012
Volume 19, Issue 21

by Joe DiLeo and Tim Kolber, Deloitte & Touche LLP

On August 22, 2012, the SEC narrowly approved (by a 3–2 vote) a final rule¹ implementing Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).² Section 1502 instructs the SEC to promulgate regulations that require issuers to annually disclose a description of the measures they took to “exercise due diligence on the source and chain of custody of . . . conflict minerals.”

The SEC originally expected to finalize its December 2010 proposed rule on conflict minerals in April 2011 but delayed issuance of the final rule to (1) consider feedback received in over 400 comment letters on the proposal; (2) assess input requested from key stakeholders at an October 2011 roundtable discussion; and (3) further evaluate the rule’s implementation costs, which the SEC estimates will be between $3 billion and $4 billion. See Deloitte’s November 29, 2011, Heads Up for a discussion of the proposed rule’s key provisions and constituents’ feedback.

Because the concepts underpinning the conflict minerals rule are rooted in the statutory language of the Dodd-Frank Act, the final rule’s provisions are generally consistent with those in the proposed rule. However, to address stakeholder input, the SEC changed several of the key “mechanisms.” For example, although the final rule retains the proposed rule’s three-step process for evaluating a registrant’s use of conflict minerals,³ the final rule requires registrants to file such information with the SEC in a newly created Form SD rather than in their annual report (e.g., Form 10-K, 20-F, or 40-F).⁴

In addition to summarizing the final rule’s provisions and the changes made to the proposed rule, this Heads Up includes the following appendixes containing additional information about the conflict minerals final rule and related initiatives that have been undertaken or are in process:

• Appendix A — Summary of Differences Between the Proposed Rule and the Final Rule.
• Appendix B — Final Rule Decision Tree.
• Appendix C — Leading Industry and Nongovernmental Organization Initiatives.
• Appendix D — Legislative and Other Initiatives.

Determining Whether a Registrant Is Within the Scope of the Final Rule

All SEC domestic registrants, foreign private issuers, and smaller reporting companies need to assess whether they use conflict minerals⁵ and whether such conflict minerals are “necessary to the functionality or production” of either (1) products they manufacture or (2) products that they have contracted to third parties for manufacture. Like the proposed rule, the final rule does not define certain key phrases such as “necessary to the functionality or production” or “contract to manufacture.” Moreover, the registrant’s evaluation of each of these concepts is not based on a de minimis threshold. However, the final rule outlines important factors for registrants to consider in performing this evaluation.

In determining whether a conflict mineral is necessary to the functionality or production of a product, registrants must assess whether the conflict mineral is necessary to the product and contained in the final product. Accordingly, registrants should consider whether a conflict mineral:

• Was added intentionally to the product or its components and is not a naturally occurring by-product.
• Was added intentionally to the production process (however, the final rule explicitly excludes tools, machinery, and equipment from such a determination).
• Is necessary to a product’s “generally expected function, use, or purpose.”
• Was added “for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration.”
• Was used only as a catalyst in the production process. If so, it is outside the scope of the final rule unless it remains in the final product.
• Was not merely mined. The final rule does not regard mining as a manufacturing process and thus explicitly excludes mining issuers unless they are also manufacturers.

The final rule specifies that in considering the use of conflict minerals in products that have been contracted for manufacture, registrants would need to evaluate whether they exerted influence over the third party’s manufacturing process. In reaching this conclusion, the SEC rejected constituent feedback suggesting that whether a product has been contracted for manufacture should depend on whether the registrant has exerted “substantial” influence. Instead, the SEC gave the following examples of activities that would not indicate a sufficient level of influence over a third party’s manufacturing process:

• The registrant’s logo, brand, or label was merely affixed to generic products.
• Involvement is limited to servicing or maintaining a third party’s manufactured product.
• Negotiations of contract terms are not directly related to the manufacturing of the product.

In addition, the final rule excludes from its scope conflict minerals that are “outside the supply chain” before January 31, 2013, and defines “outside the supply chain” as
(1) after smelting of columbite-tantalite, cassiterite, and wolframite minerals; (2) “after gold has been fully refined”; or (3) “after any conflict mineral, or its derivatives, that have not been smelted or fully refined are located outside of the Covered Countries.”

Reasonable Country-of-Origin Inquiry and Due Diligence Requirement

Upon concluding that it uses conflict minerals in its products and that they are necessary to the products’ functionality or manufacture, the registrant must conduct a reasonable country-of-origin inquiry to determine whether any of its minerals are from a covered country or originated from scrap or recycled materials. Like the proposed rule, the final rule does not define “reasonable” or prescribe an inquiry process; however, the final rule notes that such an inquiry should be performed in good faith. Consequently, a registrant may satisfy the reasonable country-of-origin standard by obtaining “reasonably reliable representations” indicating the origin of the conflict materials (i.e., that they are not from covered countries) or that they are recycled or scrap materials. The final rule notes that such representations can be obtained from the facility or the registrant’s immediate suppliers but that the registrant must have reason to believe them to be true (e.g., by considering the sources, the related facts and circumstances, and any relevant “warning signs”).

Under the final rule, if a registrant concludes that conflict minerals are not from the Democratic Republic of Congo (DRC) or are from scrap and recycled sources, the registrant must briefly describe its country-of-origin inquiry process in its Form SD and must post this description to its Internet Web site. Although the final rule does not require registrants to maintain records supporting their reasonable country-of-origin process, it suggests that keeping such records “may be useful in demonstrating compliance with the final rule, and may be required by any nationally or internationally recognized due diligence framework applied by an issuer.”

Conversely, if a registrant (1) has affirmatively concluded or “has reason to believe” that conflict minerals may have originated in a covered country or (2) has reason to believe that such minerals may not be from scrap or recycled materials, the registrant must perform due diligence on its supply chain to determine its sources and chain of custody. The final rule retains the requirement for a registrant to prepare a conflict minerals report and stipulates that a registrant’s due diligence process must be performed in accordance with a nationally or internationally recognized due diligence framework.⁶ The requirement to perform due diligence in accordance with such a framework, if one is available, was added to the final rule to promote comparability and provide independent private-sector auditors with a basis upon which to evaluate management’s assertions. Also unchanged from the proposed rule is the requirement for a registrant to post its conflict minerals report on its Internet Web site.

Audit Requirement and Conflict Minerals Report

Except for situations in which a registrant, after completing its reasonable due diligence measures, (1) confirms that its conflict minerals did not originate in covered countries or are from scrap or recycled sources or (2) cannot determine the origin of its conflict minerals (see “DRC Conflict Free” and “DRC Conflict Undeterminable” sections below), the final rule retains the audit requirement, which was mandated by the Dodd-Frank Act. In addition, like the proposed rule, the final rule requires that such an audit be an independent private-sector audit (IPSA) performed in accordance with the “Yellow Book.”⁷ In response to constituents’ concerns about the nature of the IPSA, the SEC summarized the audit objective in the final rule as follows:

The audit’s objective is to express an opinion or conclusion as to whether the design of the issuer’s due diligence measures as set forth in the Conflict Minerals Report, with respect to the period covered by the report, is in conformity with, in all material respects, the criteria set forth in the nationally or internationally recognized due diligence framework used by the issuer, and whether the issuer’s description of the due diligence measures it performed as set forth in the Conflict Minerals Report, with respect to the period covered by the report, is consistent with the due diligence process that the issuer undertook.

While the final rule generally does not change the requirements for what registrants must provide in their conflict minerals report, it indicates that this report should also discuss the nationally or internationally accepted framework that a registrant used to perform its due diligence on the source and chain of custody of its conflict minerals. As discussed below, a registrant must also classify its minerals as (1) “DRC conflict free,” (2) “not found to be DRC conflict free,” or (3) “DRC conflict undeterminable.”

DRC Conflict Free

This classification indicates that, while the registrant’s products might contain conflict minerals from a covered country, the registrant has performed due diligence and concluded that such minerals did not originate from the DRC, originated from scrap or recycled sources, or did not finance or benefit armed groups. When a registrant concludes that conflict minerals did not originate from covered countries or affirms that conflict minerals are from scrap or recycled sources, it does not need to prepare a conflict minerals report or obtain an IPSA but must submit Form SD and disclose its conclusion and a brief description of its inquiry and due diligence processes. However, when a registrant concludes that its products contain conflict minerals that originated in the covered countries but did not finance or benefit armed groups, the registrant would need to file a conflict minerals report and to:

• Obtain an IPSA report of its conflict minerals report.
• Certify that such an audit was performed.
• Include the audit report in its conflict minerals report.
• Identify the auditor conducting the audit.

Not Found to Be DRC Conflict Free

This conclusion results when a registrant’s products might have conflict minerals that originated from covered countries and the minerals may have helped finance or benefit armed groups. In addition to obtaining an IPSA report and complying with certification requirements, a registrant in this category must describe in its conflict minerals report:

• Any of its products in this category.
• The production facilities it used to process the minerals.
• The country from which the minerals originated.
• The efforts it made to identify the mine or location of origin for these minerals.

DRC Conflict Undeterminable

This temporary designation, which is limited to two years (four years for smaller reporting companies), applies when a registrant is unable to determine whether the conflict minerals in its products originated from a covered country or financed or benefited armed groups. When such a determination is made, an IPSA is not required and an IPSA report does not have to be filed. However, a registrant must file a conflict minerals report that discloses the same information as that in the “not found to be DRC conflict free” category and must further disclose the steps it took to improve due diligence since the end of the most recent period covered by the conflict minerals report.

Transition and Next Steps

Unlike the proposed rule, which would have required registrants to provide disclosures in an annual report filed with the SEC (and to furnish additional reports as exhibits to this annual report), the final rule requires all registrants that are subject to the rule’s provisions to file Form SD containing (1) their conflict minerals disclosures and (2) if applicable, their conflict minerals reports as exhibits. Form SD must be filed on a calendar-year basis (regardless of fiscal year-end) beginning with the first calendar year ending on December 31, 2013, with such reports due on May 31, 2014 (and on May 31 of each year thereafter).

For additional information, please contact Deloitte’s Conflict Minerals Advisory Team:

• Eric Hespenheide (ehespenheide@deloitte.com).
• Kristen Sullivan (ksullivan@deloitte.com).
• Elise Gautier (elgautier@deloitte.com).

Appendix B — Final Rule Decision Tree

Below is a flowchart, reproduced from the final rule, to help registrants determine the reporting and disclosure requirements related to conflict minerals.

Appendix C — Leading Industry and Nongovernmental Organization Initiatives

Below is a list of various organizations’ initiatives for identifying and tracking of conflict minerals that has been obtained from each organization’s Internet Web site. Click on the links below for additional information.

Appendix D — Legislative and Other Initiatives

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1 SEC Final Rule Release No. 34-67716, Conflict Minerals.

2 Section 1502 of the Dodd-Frank Act amends the Securities Exchange Act of 1934 by adding Section 13(p).

3 The three-step process involves (1) determining whether the conflict minerals rule applies to the registrant, (2) performing a reasonable country-of-origin inquiry for determining whether conflict minerals in a registrant’s process originated in the Democratic Republic of Congo and adjoining countries (“covered countries”), and (3) fulfilling requirements related to supply-chain due diligence and the independent private-sector audit.

4 In explaining the rationale for requiring a registrant to “file” the conflict minerals information rather than “furnish” it as originally proposed, the final rule notes that the requirement to file subjects the registrant to potential liability under Section 18 of the Securities Exchange Act of 1934. However, the final rule notes that Section 18 does not create strict liability; rather, it requires a plaintiff asserting a claim to meet the statute’s criteria for establishing a claim, including reliance and damages. Moreover, a registrant will not be liable for misleading statements under Section 18 if it can establish that it acted in good faith and did not knowingly provide false information. The change requiring registrants to file the information on a new form (outside of the registrant’s annual report to the SEC) also means that conflict mineral reports will not be subject to CEO and CFO annual certifications.

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