In Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), Congress expressed its sense that the exploitation and trade of conflict minerals originating in the Democratic Republic of the Congo (the “DRC”) is helping to finance conflict characterized by extreme levels of violence in the eastern DRC, particularly sexual- and gender-based violence, and contributing to an emergency situation. Section 1502 requires disclosure relating to conflict minerals originating in the DRC or adjoining countries and directs the Securities and Exchange Commission (the “SEC”) to promulgate regulations in connection therewith. The SEC proposed rules on December 15, 2010, and, after a lengthy comment period in which widely divergent views were expressed, adopted final rules on August 22, 2012 (the “Final Rules” or “conflict mineral rules”).¹

The SEC estimates that the Final Rules will directly affect approximately 6,000 public companies at an initial cost of compliance of approximately $3 billion to $4 billion, with ongoing annual compliance costs of between $207 million and $609 million. As part of the Final Rules, which require disclosure by public companies that have conflict minerals necessary to the functionality or production of products manufactured or contracted to be manufactured by such companies, the SEC adopted Form SD (Specialized Disclosure Report), the initial filing of which is due on Monday, June 2, 2014² for conflict mineral activity during calendar year 2013.

What are Conflict Minerals?

The “conflict minerals” are cassiterite, columbite-tantalite (coltan) and wolframite, all of which are mineral ores, and tin, tantalum and tungsten, which are the respective metals derived from the ores through a smelting process. Gold is also a conflict mineral. In common parlance, the conflict minerals are often referred to as “Three T’s and a G.” Given that a mineral ore can have numerous derivative metals within the ore, the SEC clarified that tin, tantalum and tungsten are currently the only derivative metals that are deemed to be conflict minerals. However, under the Dodd-Frank Act and the Final Rules, the Secretary of State can add additional minerals or derivatives to the list of conflict minerals if he or she determines that such minerals or derivatives are helping to finance conflict in the DRC or adjoining countries. “Conflict minerals” is a defined term for the applicable minerals and derivatives, regardless of any conflict or the source of the minerals, and is used throughout the Final Rules. For example, if a public company knows with absolute certainty that the tin in its products comes from Wyoming, the company is still subject to the conflict mineral rules.

Step One — Who’s Covered by the Conflict Mineral Rules?

The conflict mineral rules apply to every company that (1) files reports with the SEC under Sections 13(a) or 15(d) of the Securities Exchange Act of 1934 and (2) has conflict minerals that are necessary to the functionality or production of a product manufactured by the company or contracted by the company to be manufactured.

Public Companies

The conflict mineral rules apply to all public companies, including domestic companies, foreign private issuers and smaller reporting companies. Private companies should take note, however. As public companies subject to the rule start to inquire about conflict minerals necessary to the functionality or production of their products, they will be asking various suppliers, contract manufacturers and other intermediaries (public and private) for representations, warranties and other assurances with respect to conflict minerals.

“Manufacture” and “Contract to Manufacture”

The Final Rules do not define “manufacture” or “contract to manufacture” as the SEC believes the terms are generally understood. However, the SEC notes in the Final Release that it does not consider a company that only services, maintains or repairs a product containing conflict minerals to be “manufacturing” a product. “Mining” conflict minerals is also excluded from the definition of manufacturing.

Determining whether a company has contracted to manufacture a product is a facts and circumstances test and will depend on the degree of influence that a company exercises over the materials, parts, ingredients and other components to be included in a product. In the Final Release, the SEC expresses its view that the following activities alone would not be deemed to be “contracting to manufacture”:

• specifying or negotiating contractual terms with a manufacturer that do not directly relate to the manufacturing of the product, such as training or technical support, price, insurance, indemnity, intellectual property rights, dispute resolution, or other like terms or conditions concerning the product, unless the issuer specifies or negotiates taking these actions so as to exercise a degree of influence over the manufacturing of the product that is practically equivalent to contracting on terms that directly relate to the manufacturing of the product; or
• affixing its brand, marks, logo, or label to a generic product manufactured by a third party; or
• servicing, maintaining, or repairing a product manufactured by a third party.³

By way of example, the SEC notes in the Final Release that a cell phone service provider that requires a manufacturer to produce a cell phone that works on a particular network would not be “contracting to manufacture” the phone. According to the Final Release, a company that simply adds its brand name to a product manufactured by a third party should not be deemed to contract for the manufacture of the product unless its involvement goes beyond mere labeling, in which case a facts and circumstances test would need to be conducted.

Necessary to the Functionality or Production of a Product

The Final Rules do not define “necessary to the functionality” or “necessary to the production” of a product, and the SEC notes in the Final Release that the answer is dependent upon a company’s particular facts and circumstances. In the SEC’s opinion, though, a conflict mineral must actually be contained in the product for the mineral to be “necessary to the functionality or production” of a product. Thus, a company would not be subject to the conflict mineral rules if conflict minerals used in the manufacturing process, including conflict minerals contained in tools or machines used in the production process, never actually end up in the product itself. The SEC also noted the importance of having the conflict mineral be intentionally added to the product, whether by the company or a third party.

In determining whether conflict minerals contained within a product are necessary to the functionality of a product, companies should assess the product’s generally expected function, use or purpose. According to the SEC, if a product (such as a smart phone) has multiple functions, uses or purposes and a conflict mineral is necessary for one of those functions, uses or purposes, the conflict mineral would be necessary to the functionality of the product as a whole. In fact, the SEC stresses in the Final Release that there is no de minimis exception to the conflict mineral rules and even trace amounts of conflict minerals contained in a product would implicate the rules, assuming such minerals are otherwise necessary to the functionality or production of a product.

If a conflict mineral is incorporated into a product for purposes of ornamentation, decoration or embellishment, the SEC urges companies to consider whether ornamentation or decoration is a primary purpose of the product. Although the facts and circumstances assessment still applies, if (1) the primary purpose of a product (e.g., a necklace) is ornamentation and (2) a conflict mineral (e.g., gold) is added for ornamentation purposes, it is more likely that such mineral is necessary to the functionality of the product. If ornamentation is not a primary purpose, the conflict mineral is less likely to be necessary to the functionality of such product.

Step Two – Determine whether Conflict Minerals Originated in the DRC or Adjoining Countries

If conflict minerals are necessary to the functionality or production of a product that is manufactured or contracted to be manufactured by a public company, the public company is subject to the conflict mineral rules and will have a disclosure obligation on Form SD, as further described below. A public company subject to the rule must conduct in good faith a reasonable country of origin inquiry (“RCOI”) that is reasonably designed to determine whether any conflict minerals originated in the DRC or adjoining countries (collectively, the “Covered Countries”)⁴ or are from recycled or scrap sources.

Reasonable Country of Origin Inquiry

The SEC does not define the parameters of an RCOI in the Final Rules but does offer some guidance. In the Final Release, the SEC stresses that the RCOI can differ among companies based on a company’s size, products, relationships and other factors and that the RCOI may vary over time with changes to the infrastructure for assessing the source of conflict minerals. What is reasonable today may not be reasonable tomorrow.

In the Final Release, the SEC provide insights into procedures that would constitute an RCOI. For instance, if a company seeks and obtains reasonably reliable representations and warranties indicating the facility at which conflict minerals were processed and demonstrating that such conflict minerals did not originate from a Covered Country or came from recycled or scrap sources, the SEC would consider the company to have satisfied its RCOI. According to the SEC, the representations and warranties could come directly from the processing facility or indirectly through the company’s immediate suppliers, but the company must have a reason to believe that such representations and warranties are true under the facts and circumstances. A “conflict-free” designation from a recognized industry group that requires an independent audit of a processing facility would be an example of a “reason to believe” that the representations and warranties of the facility are true. As long as a company does not otherwise have warning signs regarding representations and warranties, it need not obtain representations and warranties from all suppliers in the supply chain to satisfy an RCOI.

What if Conflict Minerals Did NOT Originate in a Covered Country?

If (1) a company determines, based on its RCOI, that its conflict minerals did not originate in a Covered Country or did come from recycled or scrap sources or (2) based on its RCOI, a company has no reason to believe that its conflict minerals may have originated in a Covered Country or reasonably believes that its conflict minerals are from recycled or scrap sources, the company will nonetheless have a disclosure obligation on Form SD. In the body of Form SD under a heading entitled “Conflict Minerals Disclosure,” the company must disclose its determination and briefly describe the RCOI it undertook and the results of such inquiry. The Company must also disclose the foregoing information on its website and provide a link to the website on Form SD. A Conflict Minerals Report (discussed below) is not required.

What if Conflict Minerals DID Originate in a Covered Country?

If, based on its RCOI, a company (1) knows that its conflict minerals originated in a Covered Country and are not from recycled or scrap sources or (2) has reason to believe that its conflict minerals may have originated in a Covered Country and has reason to believe that they may not be from recycled or scrap sources, the company must exercise due diligence on the source and chain of custody of its conflict minerals.⁵ In addition, except in certain limited circumstances,⁶ a company must file a Conflict Minerals Report as an exhibit to Form SD and make the report available on its website. In the body of Form SD under a heading entitled “Conflict Minerals Disclosure,” the company must disclose that it has filed a Conflict Minerals Report as an exhibit to Form SD and provide a link to its website where the report is available.

Step Three – The Conflict Minerals Report, Supply Chain Due Diligence, and Independent Private Sector Audit

Content of the Conflict Minerals Report

The content of the Conflict Minerals Report will vary slightly depending on the circumstances, but the Report must generally include the following:

•  a description of the measures the company has taken to exercise due diligence on the source and chain of custody of the conflict minerals;
•  except in certain limited circumstances,⁷ an independent private sector audit report, including identification of the independent private sector auditor;
•  if applicable, a statement that the company has obtained an independent private sector audit of the Conflict Minerals Report; and
•  for products that have not been found to be “DRC conflict free,”⁸ a description of such products, the facilities used to process the conflict minerals in such products, the country of origin of the conflict minerals, and the efforts to determine the mine or location of origin with the greatest possible specificity.

The Conflict Minerals Report is neither signed by a member of management nor issued over the names of any members of management.

Supply Chain Due Diligence

The Final Rules provide that a company’s due diligence on the source and chain of custody of its conflict minerals must conform to a nationally or internationally recognized due diligence framework,⁹ if such a framework is available for the conflict mineral. The SEC has confirmed in the Final Release that the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas (the “OECD Due Diligence Guidance”) ¹⁰ satisfies the requirements of the rule and even states that the OECD Due Diligence Guidance appears to be the only nationally or internationally recognized due diligence framework available. Absent the adoption of additional guidelines as well as the SEC’s approval of such guidelines, the OECD Due Diligence Guidance will be the applicable framework for due diligence inquiries.

Independent Private Sector Audit

The independent private sector audit must be conducted in accordance with standards established by the Government Accountability Office (GAO) and will constitute a critical component of the due diligence in establishing the source and chain of custody of the conflict minerals. According to the Final Release, the GAO staff does not intend to issue any additional auditing standards and that existing Generally Accepted Government Auditing Standards (GAGAS) are applicable. The existing GAGAS standards, which are contained in what is commonly known as the “yellow book,”¹¹ provide for both “attestation engagements” and “performance audits,” and the GAO staff has indicated that either form of audit is acceptable. However, an attestation engagement must be performed by a licensed accountant¹², whereas a performance audit does not require a licensed accountant. Those conducting a performance audit, however, are subject to continuing professional education requirements, peer review and the like. It is probable that companies conducting supply chain due diligence will turn initially to certified public accountants unless and until further guidance is issued on performance audits of conflict minerals and the necessary requirements for auditors of such performance audits.¹³

In response to concerns about the nature and scope of the audit, the SEC articulates the audit objective in the Final Rules. The objective of the audit is to express an opinion or conclusion as to whether (1) the design of the company’s due diligence measures, as set forth in the Conflict Minerals 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 company, and (2) the company’s description of the due diligence measures it performed as set forth in the Conflict Minerals Report is consistent with the due diligence process the company undertook. The independent private sector audit will not be an audit of the entire Conflict Minerals Report (and is actually part of the Conflict Minerals Report) but just the part of the report relating to the due diligence procedures.

Recycled or Scrap Sources

The Final Rules treat conflict minerals derived from recycled or scrap sources differently than minerals derived directly or indirectly from a supply chain. Conflict minerals are considered to be from “recycled or scrap sources” if they are from recycled metals, which are reclaimed end-user or post-consumer products, or scrap process metals created during product manufacturing.

Under the Final Rules, a company will have to exercise due diligence if it has reason to believe, following its RCOI, that the conflict minerals it thought were from scrap or recycled sources may not be from such sources. The due diligence must conform to a nationally or internationally recognized framework (if available) for determining whether conflict minerals are from recycled or scrap sources. According to the SEC, there are internationally recognized due diligence standards for determining whether gold has come from recycled or scrap sources,¹⁴ but there are no standards for the other conflict minerals. Thus, companies will have to exercise due diligence without the benefit of a framework for other conflict minerals thought to have derived from scrap or recycled sources. If there is no due diligence framework for a conflict mineral from a recycled or scrap source, there is no requirement for an independent private sector audit of the due diligence procedures on such mineral.¹⁵

Transition Period – “DRC Conflict Undeterminable”

The SEC has provided for somewhat more flexible, less costly disclosure requirements during the initial implementation of the conflict mineral rules. For smaller reporting companies, the “transition period” applies to conflict mineral activity during calendar years 2013 through 2016. For all other public companies, the “transition period” applies to conflict mineral activity during calendar years 2013 and 2014. If, during the applicable transition period, a company is conducting due diligence on its supply chain and is unable to determine whether or not a product qualifies as “DRC conflict free,” the company may conclude that the product is “DRC conflict undeterminable.” If a company has a product that is DRC conflict undeterminable, it must disclose in the Conflict Minerals Report the steps it has taken or will take, if any, since the end of the period covered by its most recent prior Conflict Minerals Report to mitigate the risk that its conflict minerals benefit armed groups, including any steps to improve its due diligence. In addition, the company is not required to get an independent private sector audit of its Conflict Minerals Report with respect to such conflict minerals.

Timing Matters; Liability Issues

Form SD is due by May 31 with respect to conflict mineral activity from the prior calendar year.¹⁶ The first calendar year in which conflict mineral activity will be measured is calendar year 2013, and thus the first Forms SD are due by June 2, 2014 (May 31 is a Saturday). A company is subject to the conflict mineral rules with respect to a calendar year in which the manufacture of a product that contains any conflict minerals necessary to the functionality or production of a product is completed, regardless of whether the company manufactures the product or contracts for its manufacture. Thus, if a third-party manufacturer completes a product in December 2013, but the public company that contracted for the manufacture does not receive shipment until February 2014, the public company must still file a Form SD with respect to 2013.

As an initial matter, a company is not required to provide information regarding conflict minerals if such minerals, prior to January 31, 2013, are located outside the supply chain. A conflict mineral is deemed to be outside the supply chain after (1) any columbite-tantalite, cassiterite or wolframite, or their derivatives, have been smelted; (2) any gold has been refined; or (3) any conflict mineral or its derivatives that have not been smelted or fully refined are located outside of a Covered Country. For instance, if tantalum mined in the DRC is sitting at a loading dock in New Jersey on January 25, 2013, and the public company does not otherwise use conflict minerals in the manufacture of its products, the company has no disclosure requirement under the conflict mineral rules.

In a change from the proposed rule, Form SD is deemed to be filed with the SEC and not furnished. As a result, companies filing Form SD will be subject to not only the antifraud provisions of the securities laws but potential liability under Section 18 of the Securities Exchange Act of 1934. However, by having the Conflict Minerals Report filed with a Form SD rather than an Annual Report on Form 10-K, the chief executive officer and chief financial officer of the public company will not be certifying to the conflict minerals disclosure under Sections 302 or 906 of the Sarbanes-Oxley Act of 2002. In addition, the information on Form SD is not incorporated by reference into a public company’s outstanding registration statements.¹⁷

Next Steps for Public Companies

Public companies that manufacture products or contract for the manufacture of products should start to take initial steps to address the conflict mineral rules, including the following:

Educate the Vice President of Manufacturing (or equivalent) on the conflict mineral rules

• Consider adding the VP of Manufacturing to any Disclosure Committee
• Do an initial assessment of whether any conflict minerals are added to products or included in the manufacturing process

Develop internal controls to determine whether any conflict minerals are included in products or used in the manufacturing process

• No de minimis exceptions; any amount counts
• Internal controls should address State Department updates of the list of conflict minerals
• Consider assigning one or more persons in the legal/manufacturing area to oversee manufacturing/sourcing requirements and conflict mineral disclosure obligations

Contact suppliers and contract manufacturers to determine whether any conflict minerals are being used in company products or the manufacturing process

• Send letters to suppliers and third-party manufacturers regarding conflict mineral rules¹⁸
• Add representations and warranties to manufacturing/supply agreements or, at a minimum, obtain certifications from the suppliers/contract manufacturers regarding conflict minerals
• Consider adopting a supply chain policy¹⁹
• Outreach will take time; unilateral revisions to supply/manufacturing agreements will not work

If conflict minerals appear to be included in products, convene a Disclosure Committee meeting to determine if such conflict minerals are necessary to the functionality or production of a product

If conflict minerals are necessary to the functionality or production of a product, start to conduct an RCOI

• Maintain records of inquiry and update document destruction policies²⁰
• Obtain certifications from suppliers and manufacturers

If a company engages in merger and acquisition activity, update due diligence request lists and add representations, warranties and indemnities on conflict minerals to standard acquisition agreements.²¹

If an independent private sector audit appears to be a possibility, reach out to certified public accountants to discuss their thoughts on an audit and consult with outside legal counsel.

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¹See SEC Release No. 34-67716 (August 22, 2012) (the “Final Release”). The Final Rules are embodied within the new Form SD (Specialized Disclosure Report), principally Section 1 (Conflict Minerals Disclosure).

²The annual deadline for Form SD is May 31, but May 31, 2014 is a Saturday.

³Final Release at p. 65.

⁴The countries that share an internationally recognized border with the DRC are Angola, Burundi, the Central African Republic, the Republic of the Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia.

⁵Due diligence procedures are distinct from, and more extensive than, the procedures undertaken in a reasonable country of origin inquiry and are discussed under “Supply Chain Due Diligence.”

⁶A Conflict Minerals Report is not required if an RCOI initially leads a company to believe that it has or may have conflict minerals from a Covered Country, but the subsequent due diligence on the supply chain leads to the company’s ultimate conclusion that its conflict minerals did not originate from a Covered Country. However, disclosure in the body of Form SD is still required.

⁷See “Recycled or Scrap Sources” and “Transition Period – ‘DRC Conflict Undeterminable'” below.

⁸According to the Final Rules, the term “DRC conflict free” means that a product does not contain conflict minerals necessary to the functionality or production of the product that directly or indirectly finance or benefit “armed groups” in a Covered Country. An “armed group” is an armed group that is identified as a perpetrator of serious human rights abuses in annual Country Reports on Human Rights Practices under Sections 116(d) and 502B(b) of the Foreign Assistance Act of 1961 relating to a Covered Country.

Conflict minerals obtained from recycled or scrap sources are deemed “DRC conflict free” under the Final Rules.

⁹A nationally or internationally recognized due diligence framework is a framework established following due-process procedures, including the broad distribution of the framework for public comment, and is consistent with the criteria standards established by the Government Accountability Office.

¹⁰The OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas (2011) is available at http://www.oecd.org/daf/internationalinvestment/guidelinesformultinationalenterprises/46740847.pdf. The OECD (Organization for Economic Cooperation and Development) has also issued supplemental material relating to gold. See OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas, Supplement on Gold (2012) (the “Gold Supplement”), which is available at http://www.oecd.org/corporate/guidelinesformultinationalenterprises/FINAL%20Supplement%20on%20Gold.pdf

¹¹See U.S. Government Accountability Office, GAO-12-331G, Government Auditing Standards, 2011 Revision (Dec. 2011), which is available at http://www.gao.gov/assets/590/587281.pdf.

¹²Chapter 3.75 of the yellow book provides that auditors of attestation engagements “should be licensed certified public accountants, persons working for a licensed certified public accounting firm or for a government auditing organization, or licensed accountants in states that have multi-class licensing systems that recognize licensed accountants other than certified public accountants.”

¹³The SEC has emphasized in the Final Release that the GAO is responsible for establishing auditing standards with respect to the independent private sector audit. The SEC did confirm, however, that it would not be inconsistent with the independence requirements of Rule 2-01 of Regulation S-X if the company’s registered public accounting firm also performs the independent private sector audit of the Conflict Minerals Report. The Final Release also notes that the audit of the Conflict Minerals Report would be considered “non-audit services” subject to the pre-approval requirements of Rule 2-01(c)(7) of Regulation S-X and that any fees for such services would be categorized as “All Other Fees” in the proxy statement.

¹⁴See the Gold Supplement, which is available at http://www.oecd.org/corporate/guidelinesformultinationalenterprises/FINAL%20Supplement%20on%20Gold.pdf.

¹⁵As there is an internationally recognized framework for due diligence on gold derived from recycled or scrap sources, an independent private sector audit would be required in connection with gold due diligence.

¹⁶The conflict mineral rules relate to calendar years, regardless of a public company’s fiscal year.

¹⁷As such, auditors will not have “expert” liability under Section 11 of the Securities Act of 1933, and an auditor’s consent will not be required in connection with the filing of a conflict minerals audit report.

¹⁸Sample letters to suppliers and other useful information can be found in Downstream Implementation of the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas, Cycle 2 Interim Progress Report on the Supplement on Tin, Tantalum, and Tungsten, Final Draft (June 2012), which is available at http://www.oecd.org/investment/guidelinesformultinationalenterprises/Downstream%20cycle%202%20report%20-%20Edited%20Final%20-%201%20June.pdf.

¹⁹See the OECD Due Diligence Guidance for sample language.

²⁰Although the SEC eliminated a record retention requirement in the Final Rules, good practice suggests that records are essential to supporting an RCOI or any additional due diligence.

²¹According to the Final Rules, if a public company acquires or otherwise obtains control of a manufacturer that was not subject to Form SD, the public company can delay reporting on products manufactured by the acquired company until the end of the first reporting calendar year that begins no sooner than eight months after the effective date of an acquisition. Thus, if a public company acquires a target company in June 2013, the public company must assess the target products for calendar year 2015 and report on them in Form SD due on May 31, 2016.