- A Surprise Turn on the SEC’s Winding Road to the Dodd-Frank “Conflict Minerals” Rule
- February 23, 2012 | Authors: Curtis M. Dombek; Mark L. Jensen
- Law Firms: Sheppard, Mullin, Richter & Hampton LLP - Brussels Office ; Sheppard, Mullin, Richter & Hampton LLP - Washington Office
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), Pub. L. 111-203, signed into law on July 21, 2010, requires the U.S. Securities and Exchange Commission (SEC) to implement regulations under which issuers attest to aspects of the origin of certain “conflict minerals” used in their products, if those products derive from the Democratic Republic of Congo (DRC) or neighboring countries. Under the SEC’s Proposed Rule, “conflict minerals” would include cassiterite (a source for tin), columbite-tantalite (used to manufacture electronic capacitors), gold, wolframite (a main source of the metal tungsten), or their derivatives, or any other minerals or their derivatives determined by the U.S. Secretary of State to finance conflict in DRC countries. Proposed Rule on Conflict Minerals on December 23, 2010. 75 Fed. Reg. 80,948 (Dec. 23, 2010) at 80,950 (Proposed Rule). Thus, if the products you sell include these substances, at any level, the new regulations must be considered.
The law and proposed regulations were aimed at disrupting the financing of armed rebel groups contributing to violent conflict and human rights abuses in the DRC. After the SEC promulgated an initial Proposed Rule detailing measures that potentially would have had a broad effect on industry, a Final Rule was delayed throughout 2011 and has not yet been finalized. A recent U.N. report on the DRC suggests that the rule may have some unintended consequences. Among other factors, these consequences may further delay issuance or limit the scope of the final rule.
Background of Rule
Dodd-Frank includes a requirement that the SEC promulgate regulations within 270 days under which issuers make annual disclosures related to their use of DRC “conflict minerals.” The Proposed Rule issued pursuant to that authorization would require “any issuer for which conflict minerals are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by that issuer” to indicate in its annual report whether any conflict minerals used by the company originated in the DRC or an adjoining country. Id. at 80,949. Where any conflict minerals were of such origin, the proposed rule would require a separate report describing due diligence steps taken to ascertain the source and chain of custody of conflict minerals, including an independent private sector audit of the report. Id. The SEC expected the Proposed Rule would apply “to many companies and industries” due to the range of uses of the covered minerals. Id. In the Proposed Rule, the SEC requested comments related to several areas of the proposed regulations, including, for example, whether there should be exceptions for products using a de minimis level of conflict minerals. Id. at 80,951-64.
Events following the issuance of the Proposed Rule made it clear that the SEC faced difficulty in finalizing the regulations. First, noting in part the comments it had requested on the Proposed Rule, the SEC extended its comment period 30 days to March 2, 2011. See 76 Fed. Reg. 6110, 6111 (Feb. 3, 2011). The SEC then missed the 270-day statutory deadline for implementation of the regulations. In October, the SEC issued notice that it would hold a public roundtable on October 18, 2011, in which participants would be invited to discuss various issues related to the proposed conflict minerals rules. 76 Fed. Reg. 63,573 (Oct. 13, 2011). The SEC has not yet released a Final Rule, although the agency’s website indicates that the SEC plans to adopt a rule between January and June 2012.
As of the October 18 public roundtable, several aspects of the scope of any Final Rule appeared to have remained undetermined, including whether a de minimis exception will be included, and what will be covered by the “necessary to the functionality or production” definition of the rule. See David S. Hilzenrath, SEC Struggles to Write “Conflict Minerals” Regulations for Companies, Washington Post (Oct. 18, 2011).
Issues in Implementation
As might be expected, a rule requiring due diligence on the minerals used in a wide variety of products and passing through highly complex global supply chains has raised significant concern from industry. Companies ranging from aerospace manufacturers to food producers have suggested that compliance with the provision could be overwhelming due to the numbers of suppliers they use for materials and components, the shifting nature of their supply base, and the number of parts using the materials listed in the Proposed Rule. See Hilzenrath. Beyond those logistical challenges, industry has raised the question of whether any minerals could be traced all the way back to the mine of origin. See id.
Perhaps more unexpectedly, a new U.N. Report released in late December 2011 includes findings that question the efficacy of the Rule as a means to target armed groups in the DRC that raise funds from conflict minerals. See UN News Center, DR Congo: UN Experts Outline Sources of Funding for Armed Rebels (Dec. 30, 2011). That report indicates that few mineral trading companies in eastern DRC and neighboring countries are implementing due diligence requirements put in place by the DRC’s mines ministry in September 2011. Id. The report also states that mineral ore production has fallen in certain conflict areas of the DRC, but a greater proportion of the trade has become criminalized, leading to increased illegal export of minerals. Id.; see Jonny Hogg and Graham Holliday, Conflict Minerals Crackdown Backfiring in Congo: U.N., Reuters (Dec. 30, 2011). As further evidence of this trend, the report notes that production of conflict minerals in Rwanda has been pushed higher than industry analysts consider the real level of production for that country. See Hogg and Holliday.
Disputes over the scope and feasibility of the conflict minerals rule are in some respects typical of any new regulation imposing significant requirements on industry. However, they also pose at least two specific issues that we think are worth noting.
First, the conflict minerals rule represents a significant expansion in scope from prior due diligence requirements for products and materials that are related to an underlying social or security issue. For example, the United States has implemented similar origin-based controls for rough diamonds to limit the import of conflict diamonds through the Rough Diamonds Control Regulations, 31 C.F.R. Part 592. The United States has also imposed restrictions on the importation of jadeite and rubies originating in Myanmar, 50 U.S.C. 1701 note, to restrict a major source of income for the controlling regime of that country. The proposed conflict minerals regulations go further than these prior regulations, in part because the minerals covered by the Proposed Rule are used in a much broader range of products than rough diamonds, jadeite, or rubies. The due diligence requirement of an independent audit proposed for conflict minerals also would be stricter than existing materials regimes. Finally, the requirement to publish the conflict minerals statement in a company’s annual report could present new sources of liability. If this heightened focus on the origin of materials is effective in targeting DRC rebel groups, it seems possible that other source materials or goods that are key to the economies of specific conflict regions could be similarly targeted for security reasons.
Second, the delay in implementing the rule underscores just how difficult any rule focused on materials in the global supply chain would be to enforce. Even companies that may have sophisticated logistics policies and procedures in place to comply with requirements such as U.S. customs country of origin marking requirements would need to implement separate measures for a process attesting to the origin of minerals - the “substantial transformation” element of country of origin marking that acts as a terminus for most customs purposes may not apply for conflict minerals. Further, any such efforts focusing on the origin of minerals would likely have to operate in areas in significant turmoil that are targeted precisely because of the absence or weakness of rule of law. The smuggling identified at the local level in DRC brings into question whether pressure applied on U.S. companies will have the intended effect.
We expect that a Final Rule will be forthcoming from the SEC, although the timing and shape of the rule that is ultimately produced seems very much in question given the new U.N. findings, in addition to the hurdles the SEC already faced. Even after publication of any Final Rule, the chance of litigation against a rule posing significant reporting burdens on industry seems high. We will continue to monitor developments related to the rule and provide updates as warranted.