• Supply Chain Regulation Drifts Downstream
  • August 16, 2013
  • Law Firm: Holland Hart LLP - Denver Office
  • In recent days, the decision by a federal district court to uphold Securities and Exchange Commission (SEC) regulations on conflict minerals and the White House's issuance of an Executive order regarding Burmese gems have reinforced the growing trend in regulation of supply chains. In the past, when governments sought to increase oversight over the conditions of extraction of natural resources to prevent their contribution to conflict or human rights abuse, the controls tended to affect miners or processors of those resources. As discussed below, newer efforts focus on downstream and end users, from original equipment manufacturers across industry sectors to component manufacturers and traders, who now must be able to report on the entirety of their supply chains in very new ways.

    Dodd-Frank Section 1502 Regulation of Conflict Minerals

    Although the 2010 Dodd-Frank Act focused principally on financial sector reform, section 1502 of that legislation1 and subsequent regulations2 adopted in August 2012 by the SEC establish a rigorous three-step process concerning "conflict minerals" that will require reporting from all annual filers with the SEC, with the first reports due in May 2014.

    In sum, section 1502 and its regulations require companies to determine whether gold, tin, tantalum, or tungsten are necessary, in any amount, to a product they manufacture or contract to manufacture. If so, a company must work with its suppliers to make a reasonable country-of-origin inquiry, specifically to identify whether the minerals originated in the Democratic Republic of the Congo (DRC) or any of its nine neighbors. If a company identifies any products containing minerals from these countries, or is unable to determine the country of origin, then it must report on the due diligence process undertaken to ensure that mineral purchases did not directly or indirectly benefit armed groups. The company must then file a newly created Form SD with the SEC, identifying whether products are "DRC Conflict Free" or "Not DRC Conflict Free" (or, during a phase-in period, "DRC Conflict Undeterminable") and have an independent private-sector audit performed on the information presented to the SEC. Given the ubiquitous use of these minerals (such as tin in solder), these new rules impact thousands of companies; public companies must report, and non-public companies will be asked by their customers or suppliers for information they need to make those reports.

    Given the broad impact and enormous projected compliance costs, the U.S. Chamber of Commerce and other industry groups sued the SEC in October 2012 to overturn the rule, arguing among other things that the SEC regulations underestimated compliance costs, improperly failed to include a de minimis amount of these minerals, and failed to consider fully whether the rules would actually benefit the DRC.

    In late July 2013, U.S. District Court Judge Robert Wilkins granted summary judgment in favor of the SEC.3 Although Judge Wilkins acknowledged that the many of the Plaintiffs' arguments were reasonable-for example, there may well have been a de minimis threshold that the SEC could have implemented- he found that the SEC's decision to act otherwise was not "arbitrary and capricious." Finally, and perhaps most importantly, Judge Wilkins held that the SEC was not required to demonstrate conclusively that the rule would meet its stated humanitarian objectives, but rather could rest on Congress' determination.

    In another significant part of the opinion, Judge Wilkins raised but then left unanswered the question whether the SEC is required to evaluate the impact of any new rule on "efficiency, competition, and capital formation," which the SEC is required by Section 3(f) of the 1934 Exchange Act to promote in U.S. markets. Plaintiffs argued this was an on-going responsibility for the SEC, and although the SEC had actually addressed the issue in its issuance of the rule, Judge Wilkins questioned whether such analysis was necessary. His dictum on the subject may have opened the door to further such efforts at placing supply chain monitoring and reporting within the purview of the SEC.

    Although the Plaintiffs have appealed the ruling,4 unless the SEC regulations are stayed or subsequently overturned, companies affected by these regulations must develop their compliance programs to prepare for reporting by May 2014. The European Union is also actively reviewing options for a similar approach, through a recently completed "public consultation process,"5 and an analogous bill is under consideration in Canada.6

    Burmese Rubies and Jadeite: Last Import Sanctions Standing

    As discussed in a recent Holland & Hart Legal Update,7 the Obama Administration has taken a number of steps to ease long-standing sanctions in place against the military junta in Burma following the regime's move toward more open and democratic processes. However, the softening of sanctions has not been universal. In addition to requiring broad reporting by companies undertaking new investment in Burma, an Executive order issued by President Obama on August 78 confirmed the termination of the previous ban on imports of Burmese-origin goods - with the notable exception of rubies and jadeite. Importation of these products remains prohibited, whether in rough form or if incorporated into finished articles of jewelry, requiring the jewelry sector to maintain significant levels of due diligence to ensure that these valuable gems remain outside their supply chain. Although this particular step primarily impacts on one industry, this is another example of downstream end users bearing the brunt of regulation and compliance in the hope of changing lives upstream.


    115 U.S.C. § 78m(p).
    2The SEC Commissioners voted to adopted the Regulations in a public hearing on August 22, 2012. The Regulations were subsequently published at 77 F.R. 56,273, available at http://www.gpo.gov/fdsys/pkg/FR-2012-09-12/pdf/2012-21153.pdf.
    3Opinion available at https://ecf.dcd.uscourts.gov/cgi-bin/show-public-doc?2013cv0635-37.
    4See, e.g., http://stream.wsj.com/story/latest-headlines/SS-2-63399/SS-2-300632/.
    5See http://trade.ec.europa.eu/consultations/?consul-id=174.
    6Bill C-486 is available at http://www.parl.gc.ca/HousePublications/Publication.aspx?Language=E&Mode=1&DocId=6062040&File=4.
    7See http://www.hollandhart.com/under-appreciated-importance-of-the-burma-responsible-investment-reporting-guidelines/.
    8Executive Order 13651 (August 6, 2013), available at https://www.federalregister.gov/articles/2013/08/09/2013-19520/prohibiting-certain-imports-of-burmese-jadeite-and-rubies.