New Corporate Social Responsibility Mandate Related to Conflict Materials in the New Financial Reform Bill Could Affect Many CompaniesJuly 20, 2010
On July 15, 2010, the US Senate passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Bill”). President Obama is expected to sign the bill into law in the coming days. Among many other things, the bill imposes new due diligence and disclosure requirements for publicly traded companies and, possibly, private companies, that manufacture or trade in products using certain “conflict minerals” originating in the Democratic Republic of Congo (“DRC”). When refined or extracted the conflict minerals become gold, tin, tantalum, or tungsten and are components used in a wide variety of consumer and industrial electronics and other goods, including cell phones, computers, and televisions.
The provision was added by Senator Sam Brownback (R–KS) with the intent of limiting sources of funding available to armed militias operating in and around the DRC. The amendment is also part of a larger corporate social responsibility movement that includes the Kimberly Process Certification Scheme which was adopted by the United Nations to assure consumers that purchases of diamonds and other minerals were not directly financing armed conflicts and human rights abuses.
The Brownback Amendment was approved by a voice vote. In a statement issued after the vote, Senator Russ Feingold (D–WI), who co-sponsored the amendment, explained that the amendment was intended to address reports issued by a U.N. Group of Experts in support of U.N. S.C. Res. 1857 (2008), which called upon Member States to take measures “to ensure that importers, processing industries and consumers of Congolese mineral products under their jurisdiction exercise due diligence on their suppliers and on the origin of the minerals they purchase.”
Scope of legislation. While the Conference Report[i] does not define which type of person is covered by the legislation, the Securities and Exchange Commission (“SEC”) may apply the provision to any company that files mandatory periodic reports under Section 13(a)(2) of the Securities Exchange Act of 1934 (“Exchange Act”).[ii] [iii] The legislation also calls for a study of the use of conflict minerals in the supply chain of private companies. A covered company will be required to make disclosures if “conflict minerals” are “necessary to the functionality or production of a product manufactured” by the company.[iv] The legislation defines “conflict minerals” to include “(A) columbite-tantalite (coltan), cassiterite, gold, wolframite, or their derivatives; or (B) any other mineral or its derivatives determined by the Secretary of State to be financial conflict in the Democratic Republic of the Congo or an adjoining country” (Angola, Burundi, Central African Republic, Republic of the Congo, Rwanda, Sudan, Tanzania, Uganda, Zambia).[v] The minerals listed in subparagraph (A), when refined or extracted, become gold, tin, tantalum, or tungsten, which are commonly used in a variety of consumer and industrial electronics goods.[vi]
Substance of disclosure requirement to be implemented by SEC rulemaking. Within 270 days of enactment, the SEC must issue rules requiring covered persons to annually disclose to the SEC and on their web site the following:
(1) whether conflict minerals that were “necessary to the functionality or production of a product manufactured by” the covered person “did originate in the Democratic Republic of Congo or an adjoining country”, defined as a country that “shares and internationally recognized border with the Democratic Republic of Congo” (Angola, Burundi, Central African Republic, Republic of the Congo, Rwanda, Sudan, Tanzania, Uganda, Zambia ).[vii] and
(2) (a) a report that includes a description of measures taken to exercise “due diligence on the source and chain of custody” of conflict minerals and that is subject to a certified independent private sector audit not deemed unreliable and conducted in accordance with standards to be established by the U.S. Comptroller General, (b) a description of any “products manufactured or contracted to be manufactured that are not DRC conflict free”, i.e., that are not certified as “not contain[ing] minerals that directly or indirectly finance or benefit armed groups in the [DRC] or an adjoining country”[viii], (c) “the facilities used to process” the conflict minerals, (d) their country of origin, and (e) “efforts to determine the mine or location of origin with the greatest possible specificity.” [ix] [x]
Types of companies affected. In light of the substance of these provisions, any companies in the supply chain for covered minerals, even if they do not originate from conflict zones, should prepare for this legislation. Publicly-traded manufacturers will be required to conduct such due diligence, and also may be required to respond to due diligence inquiries if their products are used in other manufacturing processes. In addition, companies at the base of the supply chain, such as extractive firms, will need to adopt internal procedures to prepare to respond to due diligence inquiries.
Unresolved issues. SEC rules may clarify several unresolved issues, such as:
- When is a conflict mineral “necessary to functionality or production”? The legislation does not include a test to determine when a conflict mineral is “necessary to the functionality or production” of a manufactured product (though, as noted above, consumer electronic goods containing such minerals are common examples). Therefore it is unclear whether a de minimis threshold will apply.
- What constitutes “manufacture” of a product. The Brownback Amendment does not define the term “manufacture”, though the legislative history suggests it is a significant term.[xi] The legislation also does not define what is a “derivative” or what is a “product”. Potentially significant to the interpretation of these terms, earlier proposals explicitly applied not only to companies using covered minerals in their manufacturing process, but also to persons engaged in “the commercial exploration, extraction, importation, exportation, or sale” of the covered minerals. Unlike these earlier proposals, the Brownback Amendment does not state that mining, processing, or export of conflict minerals trigger the disclosure duty.
- The extent to which manufacture by a subsidiary triggers disclosure duty by the parent company. The legislation does not state whether a product manufactured by a subsidiary of a “person” is deemed to be manufactured by the “person” for purposes of the disclosure requirement. In late 2009, after S.891 had been introduced, Sen. Brownback had introduced a similar proposal – S.A. 2707. Unlike the Brownback Amendment, both of these earlier proposals defined the term “person”. The definition covered both a person who engaged in covered activities and a person who “controls a person” engaged in such activities.[xii] The term “control” was defined as ownership of at least 50 percent of the voting stock.[xiii]
- How to address uncertainties in the supply chain due diligence. The legislation does not address what to do if the company is not able to ascertain with certainty the country and mine or origin of minerals. Consistent with the legislative history, the SEC rules (or standards on due diligence best practices to be adopted by the GAO) may offer clarifications that reduce uncertainty and avoid undue burden on companies.[xiv]
- Nature of penalties and applicable liability standards. The new provisions do not establish penalties for their violation, leaving it unclear whether all of the traditional SEC liability rules and regulations may apply to disclosures related to conflict minerals. The SEC rule could mandate disclosure in glossy annual reports that are only “furnished” to the SEC, as an integral part of Form 10-K filed with the SEC, or in some other form. The form of disclosure may affect the applicable liability and due diligence standards under the securities laws, which can be higher for documents that are “filed” as part of a periodic report. (Such information also could potentially fall within the scope of Sarbanes-Oxley requirements that executive officers certify periodic disclosures.) In any event, absent a provision to the contrary in the SEC rule, the anti-fraud provisions of Rule 10b-5 and other books and records rules still would apply. That may not make much sense, in light of the burden and uncertainties inherent in this new form of payment tracking and disclosure, and that decisions to invest are unlikely to be affected by the disclosure in the same manner as earnings and other financial results. Thus, companies affected may want to try to seek provisions during the rulemaking process that exempt the required disclosures from the scope of the anti-fraud provisions of the securities laws (as well as possibly other provisions of the securities laws relating to books and records, control person liability, or otherwise). That could be accomplished through differing approaches, such as a presumption against materiality of the required disclosures or a blanket exemption.
Conclusion. While the enforcement mechanism and penalties for non-compliance remain uncertain, the Brownback Amendment may have helped usher in a new era of corporate social responsibility mandates that will require companies to audit their supply chains as vigorously as they are required to audit their financials. Companies potentially affected by this legislation, both suppliers and purchasers, will want to pay close attention to the SEC’s rulemaking, as several significant issues in the legislation may be addressed there.
[i] H.Rep. 111-517 (the “Conf. Rept.”)
[ii] Section 1502(b) of the Conference Report omits reference to Section 13(a)(2) that had appeared in S.A. 3997, and instead adopts a circular definition of which type of reporting person is covered (Section 78m(p)(1)(A) disclosure obligation and Section 78m(p)(2)(A) definition of person cross-reference one another); for purposes of this analysis, we assume the legislation will be interpreted to apply to persons who file periodic reports under Section 13(a)(2).
[iii] 15 U.S.C. § 78m(a)(2)
[iv] Conf. Rept. § 1502(b) (adopting new Exchange Act § 13(p)(2)(A))
[v] Conf. Rept. § 1502(e)(4)
[vi] In the only floor statement identified on the amendment, co-sponsor Sen. Durbin of Illinois stated that the purpose of S.A. 3997 was to “encourage companies using [covered] minerals to source them responsibly.”[vi] Sen. Durbin said the amendment was designed to address the fact that “the products we use every day—from automobiles to cell phones –may use one of these minerals from this area of conflict …”[vi] Senator Brownback previously had indicated that similar proposals were focused on consumer electronic goods such as cell phones, PDAs, DVD players, computers, televisions, as well as advanced electronic goods with commercial and military applications, that were manufactured using conflict minerals.
[vii] Conf. Rept. §§ 1502(b) (adopting new Exchange Act §§ 13(p)(1)(A)), 1502(e)(1)
[viii] The term “armed group” is defined as “an armed group that is identified as perpetrators of serious human rights abuses in the annual Country Reports on Human Rights Practices under sections 116(d) and 502B(b) of the Foreign Assistance Act of 1961 (22 U.S.C. § 2151n(d) and 2304(b)) relating to the Democratic Republic of the Congo or an adjoining country.” Conf. Rept. § 1502(e)(3).
[ix] Conf. Rept. § 1502(b) (adopting new Exchange Act §§ 13(p)(1)(A)(i)-(ii), 13(p)(1)(B), 13(p)(1)(C))
[x] The required disclosures must be made for five years, plus in any additional years for which the President certifies to Congress that no armed groups continue to be directly involved and benefiting from commercial activity involving covered minerals from covered countries. Id. (§ 13(p)(4)). In addition, the SEC must issue waivers or revisions to the disclosure requirements to the extent the President deems them to be in the “national security interest”. Id. (§ 13(p)(3)) The Comptroller General must issue a study within two years of enactment, and annually thereafter, analyzing, inter alia, the effectiveness of the Brownback Amendment at promoting “peace and security in the Democratic Republic of the Congo and adjoining countries.” Conf. Rept. § 1502(d)(2).
[xi] On May 12, 2010, S.A. 3844 was superseded by S.A. 3997, which included the term “manufactured” to the scope provision – indicating that producers are covered by the disclosure requirement only to they extent their product is “manufactured”. The Conference Report adopted June 25, 2010, similarly elaborated the disclosure duty to clarify that disclosures must identify “products manufactured or contracted to be manufactured that are not DRC conflict free …” Conf. Rept. § 1502(b) (adding Exchange Act § 13(p)(1)(A)(ii)).
[xii] S.A. 891 § 5; S.A. 2707 § 604
[xiv] In an undated quote picked up by the press, Sen. Brownback elaborated that his amendment sought to “bring accountability and transparency to the supply chain of minerals used in the manufacturing of many electronic devices, without placing a disproportionate burden on publicly traded companies.” N.Y. Times (May 21, 2010). See also Nicholas D. Kristof, Death by Gadget, N.Y. Times (June 27, 2010) (discussing how the Brownback Amendment affects “[e]lectronics manufacturers” such as Intel, Motorola, and Apple.