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Between a Rock and a Hard Place: Conflict Minerals Compliance

November 1, 2012 Dodd-Frank
conflict-materials

Does this sound familiar?

“The SEC recently adopted final rules relating to conflict minerals. Public companies should evaluate whether the rules apply to them, and if so, whether they are prepared to meet the deadline for compliance.”

If so, it probably means that you’ve already read a zillion white papers and client alerts in an effort to stay on top of the latest SEC disclosure requirement. The problem is that the rules are fraught with ambiguities that most public companies are finding problematic.

Instead of repeating the SEC rules in detail or regurgitating its decision making flow chart (which is available here), this article outlines some flashpoints that may not have occurred to you and that illustrate the types of issues you should consider when deciding whether and how the rules may apply to you. And we dutifully add our voice to the chorus that has been warning that the rules apply more broadly than you might suspect.

First, however, we offer a very, very brief summary of the rules so that we are all on the same page:

  • Public companies must make certain disclosures if conflict minerals are necessary to the functionality or production of products they manufacture or contract to manufacture.
  • Such disclosures will be made on a new Form SD and on the Company’s website.
  • Conflict minerals include gold, cassiterite, columbite-tantalite and wolframite, and their derivatives, which include tantalum, tin and tungsten, that originate in the Democratic Republic of the Congo (DRC) or any country adjoining the DRC (which, if you look at a map, includes much of Africa).

“What is in a name? That which we call a product by any other name would be a … product?”

The rules only apply to those public companies who manufacture or contract to manufacture products. For some public companies, this analysis is straightforward. For example, Johnson&Johnson manufactures items like dental floss and toothpaste and introduces them into commerce. Other public companies must be more thoughtful. As another example, consider a service provider like Amtrak. One would not be surprised to learn that a train contains at least some discernible amount of conflict minerals. However, is Amtrak manufacturing a product? Here, Amtrak likely has a strong argument that it is in the business of offering a service and not in the business of making any “product” at all.

“Would you make this for me?”

Another area of ambiguity lies in whether a public company has contracted to manufacture a product containing conflict minerals. The SEC indicated that it will be looking at the degree of influence the public company has over the manufacturing. The closer they are to the design and production, the more likely the rules will be implicated. The further apart they are, the less likely the rules will apply.

Consider, for example, a flashlight manufacturer that contracts with a bulb manufacturer to produce custom fit halogen bulbs that contain a unique long-lasting filament developed by the flashlight manufacturer. The answer is obvious in this case – not only did the flashlight manufacturer develop the technology, but it provided the specifications to the bulb manufacturer to make custom fit bulbs. The flashlight manufacturer clearly contracted to manufacture a product that contains a conflict mineral.

A closer case might involve a toy that has a built-in battery. The toy manufacturer may have only specified the voltage to the battery manufacturer in its order. It is unclear if the rules apply when a manufacturer specifies certain characteristics of the product it wishes to include, but does not specify that certain conflict minerals be used.

“Not necessary at all…”

The rules only apply if the conflict minerals are necessary to the functionality of a product. The SEC instructs that conflict minerals may be necessary to the functionality of a product if a conflict mineral is necessary to any of the product’s expected functions, uses or purposes. In contrast, if the conflict mineral exists for decorative or ornamental purposes, the conflict mineral is less likely to be necessary to the functionality of the product.

Even this requirement produces some strange results: a manufacturer of gold jewelry would likely be subject to the final rules, even though most people would view jewelry as being decorative and ornamental. Also, it is unclear if a product that uses a conflict mineral in its packaging would be subject to the rules – the wrapper may be necessary, but it does not relate to the functionality of the product. We don’t know at this point whether disclosure would be required.

What do I do now?

The three examples above demonstrate that a careful facts-and-circumstances analysis is necessary and that no bright-line tests currently exist. We highlight these ambiguities in hopes of sharpening your focus during the pre-compliance phase. The SEC is expected to offer additional guidance in the coming months, but it is hard to know when that might occur and how helpful it will be. In the interim, you should closely monitor other public companies in your industry sector. If the trend is towards compliance, you do not want to be left out in the cold.

A Plan for Moving Forward

While the first disclosure report is not due until May 31, 2014, the start of the first reporting period is only two months away.

If you suspect that the rules might apply to you, you should take the following steps now:

Look at your purchase orders, RFPs and other contracts with your vendors and suppliers. Begin incorporating language now that will obligate your business partners to assist you as you investigate your supply chain.

Assemble your compliance team.  Although most SEC disclosure initiatives are implemented by public company legal teams, this will require coordination of a public company’s lawyers, accounting and audit and purchasing departments, as well as operations personnel.

Consider whether it is worth the effort.  Some public companies use conflict minerals on a very limited basis, but unfortunately, there is no de minimis exception to the rules.  When compliance proves to be more costly than the benefit derived from manufacturing the product, some public companies are either redesigning the product or discontinuing the product line.

Document your thought process.  Because so much ambiguity exists around the applicability of the final rules, public companies should document everything, including the facts and circumstances that were considered with each threshold, the technical and design decisions made with respect to each product and the company’s analysis for why the rules might not apply.

Monitor the news.  Although the conflict mineral rules are final, continue to monitor the news.  The U.S. Chamber of Commerce and the National Association of Manufacturers recently petitioned a federal court seeking to modify the rules or have them set them aside entirely.

 

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