Implications of the OECD Report on Conflict Minerals Due Diligence Guidance for Issuers Subject to Dodd-Frank Reporting Requirements
While we wait for a decision in the suit filed by the National Association of Manufacturers challenging the SEC’s final rule implementing Section 1502 of Dodd-Frank (the “conflict minerals provision), it is worth reviewing the findings of the Final Downstream Report on One-Year Pilot Implementation of the Supplement on Tin, Tantalum, and Tungsten issued by the OECD (the “Report”).
The Report discusses the pilot program implementation of the OECD’s Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas (“Guidance”). The Guidance has particular relevance for issuers subject to SEC reporting requirements because it is intended to help companies put in place a due diligence process to help them meet disclosure requirements under Section 1502. The Securities Exchange Commission has stated that the Guidance “satisfies our criteria and may be used as a framework for purposes of satisfying the final rule’s requirement that an issuer exercise due diligence in determining the source and chain of custody of its conflict minerals.” Currently, the Guidance is the only internationally recognized due diligence framework which issuers can use to develop the due diligence process for satisfying the reporting requirements under Dodd-Frank.
Participants in the pilot program include large multi-billion multinationals from the information and communications technology sector and also aerospace and defense, automotive, medical devices and consumer products among others. The majority of participants are subject to US disclosure requirements and are under pressure to adopt systems and processes that will comply with the US law.
The Report highlights the difficulties issuers have in determining the source of minerals used, a piece of information critical to the disclosure regime established under Dodd-Frank. While the Guidance provides tools to better enable companies to trace minerals through their supply chains it remains impossible to be fully informed of where each mineral used is sourced from. Therefore, at present, the SEC final rule implementing Section 1502 “creates a disincentive to source materials from the DRC and its nine neighboring countries, because [companies then] must conduct due diligence, write a conflict minerals report and get an independent audit,” stipulating the precise sourcing of all covered minerals. None of these steps are if minerals come from other “conflict-free” regions. This observation supports the finding that production of minerals in certain regions of the DRC was down by 80% in 2011 as compared to production in 2008 and that only five provincial mineral trading houses remain in operation in 2011, as compared to 29 in 2010. http://digital.olivesoftware.com./ODE/FTUS.
Over the course of the pilot program, more companies have implemented policies, undertaken efforts to gain a better understanding of their supply chain and engaged with their suppliers, but challenges persist in obtaining information about upstream and smelter due diligence. Participants’ attempts to obtain information from their suppliers provided new insights into the depth and complexity of their supply chains. As companies attempted to implement the various steps of the Guidance the process revealed a lack of control and insight beyond their immediate suppliers. This suggests that it will be extremely difficult for issuers to state with certainty whether their products contain "conflict minerals" that are "necessary to the functionality or production of a product"—the key disclosure item required under Section 1502 of Dodd-Frank.
The Report also noted that companies subject to the Dodd-Frank requirements face a compliance cost deterrent. For companies in the upstream part of the supply chain, the cost of implementing in-region due diligence programs that can provide assurance of the conflict-free nature of minerals used in production may be problematic. Costs associated with conducting the requisite diligence will have to be absorbed elsewhere in the supply chain or other mineral sources (where diligence is not required) will always be less expensive.
There are certainly many positive findings in the Report, including, among others, that more participants have defined and established clear policies on sourcing materials from conflict regions and are increasingly willing to participate in industry programs (including the Conflict Free Smelter program). It is clear from the Report however, that the process will take time and that the additional burdens imposed by Dodd-Frank may hinder progress in the very areas it was intended to help. The U.S. District Court for the District of Columbia which is hearing the challenge to the SEC final rule may likely ignore the Report’s findings, but the Report does lend some credence to the challengers’ claim that the final rule is inappropriate in that it imposes “extraordinary costs upon them given the difficulty of determining country of origin and other matters relevant to compliance."