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Saturday, October 10, 2015

Conflict Minerals: How Much Should SEC Companies Disclose?


Public companies continue to struggle with the conflict minerals disclosures required under the Dodd-Frank Act. Many questions remain unanswered, including: How much information do companies need to tell the public about the use of conflict minerals? And how far must companies go to verify information they receive from vendors along their conflict minerals supply chains? So far, the guidance has been complex and controversial, forcing companies to provide limited—sometimes uncertain—answers.

Conflict minerals 101
You’ve probably heard the term “conflict minerals” in the news. But you may not know who uses them or why the Dodd-Frank Act addresses responsible sourcing of these raw materials. Here’s some background to help get you up to speed.

Gold, tantalum, tin and tungsten extracted from the Democratic Republic of Congo and its neighboring countries are considered conflict minerals. An estimated 5.4 million people have been brutally murdered in civil wars led by rebel groups in this region of Africa. Rebels have funded their activities, which include acts of rape and the use of child soldiers, with minerals mined (or recycled) there and sold on the black market to suppliers who provide these raw materials to companies throughout the world.

Most people associate conflict minerals with electronics manufacturers, but more than 1,200 public companies reported the use of conflict minerals to the Securities and Exchange Commission (SEC) by the June 1, 2015, deadline, including not just electronics manufacturers but also retailers, automakers, consumer products manufacturers and a variety of other types of businesses.

SEC rules
The complex and controversial conflict minerals reporting requirements are covered in SEC Release No. 34-67716, Conflict Minerals. Issued in 2012 as part of the financial reforms under the Dodd-Frank Act, this 356-page rule requires public companies that use gold, tantalum, tin or tungsten in their production process to disclose annually whether those minerals originated in the Democratic Republic of the Congo or an adjoining country.

If they did, the company must submit a report to the SEC describing the measures it took to “exercise due diligence on the conflict minerals’ source and chain of custody.” One such measure is an independent private sector audit of these disclosures.

Additionally, public companies must report the following information to the SEC:

  • Descriptions of the facilities used to process the conflict minerals,
  • Country of origin of the conflict minerals, and
  • Efforts to determine the mine or location of origin. 

The SEC release also calls for companies to declare products as “conflict free” or “not conflict free.” Together, these disclosure requirements are intended to apply pressure on public companies from human rights activists, investors and socially conscious consumers to discourage the use of minerals obtained from this violence-ridden region of central Africa. The ultimate objective is for such pressure to cut off cash flow to the rebels.

Recent legal battles
Legal challenges have prompted the SEC to scale back some of the required wording in the disclosure form that companies must file to comply with the conflict minerals rule. Specifically, companies won’t be required to declare products as “conflict free” or “not conflict free.” The U.S. Court of Appeals for the District of Columbia Circuit recently affirmed a previous decision, which determined that this requirement violated the First Amendment right to free speech.

The rest of the SEC conflict minerals rule remains intact, however. So the appellate court decision is expected to leave public companies in largely the same position they have been in for two years with regard to their annual conflict minerals disclosures.

It’s also possible that the SEC will appeal the ruling to the full appellate court, in what’s called an “en banc” ruling. The latest decision was rendered by a 2-1 ruling of a three-judge panel.

Additional guidance
Legal challenges to the conflict minerals rule led the SEC to issue additional interpretive guidance to help clarify matters. SEC Statement on the Effect of the Recent Court of Appeals Decision on the Conflict Minerals Rule says that, as long as a company avoids using statements referring to the conflict-free content of its products, the company won’t have to have its disclosures and related reports independently audited. If a company opts to use such language, audits of the disclosures must adhere to the generally accepted government auditing standards (GAGAS) issued by the Government Accountability Office.

A hot topic
Even without further legal action, the focus on conflict minerals is expected to grow. In May, the European Parliament approved a mandatory disclosure saying that any company doing business in the European Union (EU), including a U.S. business, has to file a conflict minerals disclosure that’s even more stringent than required by the SEC.

The EU rule covers minerals sourced anywhere in the world where there’s armed conflict, not just the region in central Africa covered by the SEC rule. The emphasis on responsible sourcing could even spill over to other products, such as shrimp, pet food, rubber or cotton that are produced using child or forced labor.

Companies continue to wrestle with conflict minerals rule
Unfortunately, many companies are unsure how to tackle the Securities and Exchange Commission’s (SEC’s) conflict minerals reporting requirements. In August, the Government Accountability Office (GAO), a congressional watchdog group, said that most companies that use one or more of the minerals covered by the SEC rule can’t trace the minerals’ sources, because suppliers provide incomplete information, limiting the ability to verify it.

To comply with due diligence requirements of the conflict minerals rule, these companies reportedly surveyed their first-tier suppliers, who then surveyed their sources of the minerals (and so on) until the inquiries reached up the supply chain to smelters who process the minerals into a more usable format. The smelters typically deal directly with the groups that mine conflict minerals in (or near) the Democratic Republic of the Congo. However, this approach left many companies uncertain about the minerals’ ultimate sources, in part because of the continued presence of the armed rebels in these regions.

“The minerals trade in [this region] cannot be effectively monitored, regulated or controlled as long as armed groups and some members of the Congolese national military continue to commit human rights violations and exploit the local population at will,” the GAO said.

Despite these challenges, several studies — including research conducted by Tulane University, the Responsible Sourcing Network (a nonprofit organization) and Amnesty International — have shown that companies’ conflict minerals disclosures have improved over the two years that the SEC rule has been in effect. For help with your conflict minerals disclosures, contact an accounting professional.

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