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Thursday, January 1, 2015

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As Conflict Minerals Rules Tighten, Vendor Audits Are Critical


The two-year “grace period” for SEC conflict minerals disclosure ended December 31. As a result, many public companies and their suppliers must now gather more detailed information about the source of the raw materials in their goods.

Conflict minerals are used in a vast range of high-tech products, from semiconductors and electronic components to consumer electronics, so the stricter rules mean high-tech companies need to have an effective vendor audit system in place in 2015. This applies equally to companies that outsource their manufacturing, because they are held accountable for their suppliers’ actions.

Background
The Conflict Minerals Rule was issued by the SEC in August 2012, as required by the Dodd-Frank Act, and took effect at the beginning of 2013. The rule requires public companies to determine annually whether their products contain so-called conflict minerals―gold, tin, tungsten or tantalum―mined in the mineral-rich Democratic Republic of Congo (DRC) or adjoining countries, and if so, to disclose certain information (there’s an ongoing legal battle over what they have to disclose).

Money from illicit mining in and around the DRC is used to fund violent military groups that have killed millions of people in the past two decades. The legislation is meant to target the illegal mining to help stop the ongoing conflict and human rights, labor and environmental abuses in the region.

Public companies are legally required to comply with the disclosure and due diligence rules.  Although they aren’t required to become conflict-free, they face market pressure to do so from consumers, investors, NGOs, watchdog groups, etc. This impacts vendors on down the supply chain, because filing companies must rely on their suppliers for sourcing information―and are likely to get rid of any that can’t provide it.

Filing requirements
The annual SEC filing deadline is May 31. To comply, public companies that use conflict minerals must first conduct a reasonable country of origin inquiry (RCOI) to determine whether the minerals came from the DRC region. If the minerals did not or are scrap/recycled, companies must report how they determined this by filing a specialized disclosure, Form SD.

 If the minerals came from the DRC or their source is unknown, filers have to track the minerals down the supply chain to determine whether they’re conflict-free. To do so, they must use a detailed due diligence process like that created by the Organisation for Economic Cooperation and Development (OECD).  These companies must file a Form SD, a conflict minerals report that shows their due diligence process, and an independent audit opinion.

To help companies get up to speed, the SEC gave filers a grace period in 2013 and 2014 (the grace period is 2013 through 2016 for companies with less than $75 million of public equity float or revenues of less than $50 million, if the equity float can’t be counted). During this time, filers were allowed to list products as “DRC conflict undeterminable” in their conflict minerals report, and they could also skip the independent audit for these products.  

Now that the two-year transition period is over, larger filing companies must dig deeper to determine whether or not a product is conflict-free. They will also expect their suppliers to provide supporting data well before the May 2016 deadline. 

Create a vendor audit system
Wherever you are in the supply chain, you need to set up a reliable system to audit your vendors’ business practices―for sourcing raw materials or for vetting their own suppliers. Although conflict minerals compliance is more about processes and policies than it is about technology, and you can use anything from Excel to ERP, the right system can make the due diligence process much easier.

An ERP system that supports a formal supplier qualification process is ideal and will significantly streamline the whole compliance process. A well-structured ERP database enables simple reporting on sourcing activities and can be configured to enforce sourcing rules around approved suppliers.

These are the basic steps to follow to set up a vendor audit system:

  1. Review your compliance requirements and educate your suppliers about the information you will need from them. Establish a system (using ERP, etc.) to formalize your supplier qualification plan, identifying your top suppliers, and investigate their compliance status. Remember that your suppliers’ suppliers are also risk areas that need adequate review.
  2. Establish best practices, ensuring formal vendor qualification processes with expiration dates and review periods to revisit vendors’ compliance status on an ongoing basis.
  3. As you gather information, begin the RCOI analysis and due diligence process, as needed. Documenting how you got your results is crucial.
  4. Determine your areas of probable compliance and non-compliance, so you can begin developing a product-oriented strategy for how to report to maximize the percentage of compliant products.
  5. Have an independent third-party audit performed (if required).
  6. File with the SEC or provide the information to your customers downstream.

Leverage Your Audit System  
Setting up a conflict minerals process can take considerable effort, but it can pay dividends in other ways. For example, you may be able to leverage your vendor audit system for other supply chain-related regulations, such as federal trade sanctions or the Foreign Corrupt Practices Act, which addresses bribery of foreign officials.

By improving your supply chain transparency, you’ll also be in a better position to handle other social responsibility issues. Areas such as child labor and sustainability are getting increasing attention from activists, consumers and legislators.

You’ll also have a system in place in the event that more minerals are added to the conflict minerals list. One likely candidate for the list is cobalt, which is used in lithium batteries and artificial limbs, among many other things.

In any case, the message for public companies and suppliers is clear: To be compliant in time for the May 2016 filing deadline, you need to set up an effective audit system now.

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