At first blush, the Securities and Exchange Commission's proposed “conflict minerals” rule seemed fairly esoteric. After all, it applied to companies that use such rare metals as cassiterite, columbite-tantalite, and wolframite. But as they take a closer look, many companies in various industries are finding that the rule could place a hefty compliance burden on them.
Consider Kraft Foods, hardly the type of manufacturing company that Congress likely had in mind when it put the rule into the Dodd-Frank Act last year. Kraft recently discovered that some of its packaging, promotional materials, and factory equipment contain trace amounts of the four metals named in the rule. As the rule is currently proposed, Kraft says it will be obligated to track as many as 100,000 suppliers for thousands of products to comply with the law. “We had no idea this legislation was going to be covering companies like us,” said Kraft's Irma Villarreal, chief securities counsel and assistant corporate secretary, during an SEC forum on the proposed rule. “Respectfully this is not something we can turn on a dime and start doing in 2012. It is going to take us some time. We don't have the ability to talk to 100,000 suppliers to ensure what and who has conflict minerals," she said.
Kraft is not alone. Many companies say they were blindsided by the scope of the proposed rule, and many more may not even yet realize that the presence of the minerals in their supply chain, however minute, could create a huge compliance requirement.
“This is a sleeper issue with a huge segment of manufacturing and retail companies not aware of it. They think that the rule only applies to mining and metal,” says Jane Luxton, a partner at law firm Pepper Hamilton. Not so. Luxton says many of the companies she advises are finding it difficult to believe that they will be subjected to the rule.
The conflict minerals rule will require companies to report whether they or their suppliers obtain any of four metals— gold, wolframite (a source of tungsten), cassiterite (the main source of tin), and columbite-tantalite, which is also known as coltan and is used in consumer electronics and computer chips—from the Democratic Republic of Congo or neighboring countries. The objective of the provision is to add transparency to the market, which is alleged to fuel violence and human rights abuses in the war torn area.
“This part of the world has been one of the most deadly on earth,” U.S. Senator Dick Durbin (D-Ill.) said at a recent SEC roundtable. “Our demand for products that contain these minerals could inadvertently be fueling this war.” Durbin was one of the provision's authors.
Tom Quaadman, vice president capital markets at the U.S. Chamber of Commerce, says most businesses are busy with their operations and they are not necessarily closely following the developments of the rule. “I think that more members are now becoming aware of the potential issues that the conflict minerals provision may pose to them,” he says.
To comply with the due diligence process under the conflict minerals rule can be difficult, especially for large companies like Kraft. The rule contains a three-step process that companies must follow to determine if they are covered by the rule. The initial step involves conducting due diligence to determine if they use any of the minerals in their production.
“Respectfully this is not something we can turn on a dime and start doing in 2012 … We don't have the ability to talk to 100,000 suppliers to ensure what and who has conflict minerals.”
—Irma Villarreal,
Chief Securities Counsel,
Kraft Foods
Next, companies must make substantial inquiry from their suppliers on the origin of minerals used in their supply chain. If they can conclude decisively that the metals used are not sourced from the DRC, companies can then disclose the information in the body of their annual report and submit the methodologies they have used to confirm the origination of the minerals.
Any companies that cannot conclude decisively the origin of such minerals must include their findings in their annual reports. In addition, they have to furnish a separate conflict minerals report as part of their 10-K filings and have the report reviewed by independent auditors annually.
No Exceptions
The main issue with the proposed rule and the source of most of the frustration voiced by companies at the roundtable is that as it is proposed the rule does not provide for exemptions for companies that use minute amounts of the minerals in question, known as a de minimis exception. The de minimis provision would exempt companies with final goods containing less than five percent traces of those minerals from the reporting requirement. “De minimis is a must. Without it, there will be a high number of companies pulled into this [Conflict Minerals Rule],” says Kevin Petrasic, a partner at law firm Paul Hastings. Without the exception, he says there will be many instances where companies performed their due diligence in good faith but missed an aspect of its production which contained traces of those minerals.
SBA LETTER
In the excerpt below from the SBA Office of Advocacy letter to the Securities and Exchange Commission, the SBA explains why it believes the IFRS underestimates the cost and the number of small businesses affected by the proposed conflict minerals rule:
Under the Regulatory Flexibility Act, an initial regulatory flexibility analysis (IRFA) must contain: (1) a description of the reasons why the regulatory action is being taken; (2) the objectives and legal basis for the proposed regulation; (3) a description and estimated number of regulated small entities; (4) a description and estimate of compliance requirements, including any differential for different categories of small entities; (5) identification of duplication, overlap, and conflict with other rules and regulations; and (6) a description of significant alternatives to the rule.
In the proposed rule's IRFA, the SEC estimated that approximately 793 small entities would be subject to the proposal. The IRFA provided that the proposed rule would add to the annual disclosure requirements of companies with necessary conflict minerals, including small entities, by requiring them to comply with the disclosure and reporting obligations. The proposed rule stated that the costs of compliance are “difficult to assess but are likely insignificant.”
Small business stakeholders have been in contact with Advocacy to express concern with the proposed rule. Small businesses contend that the SEC underestimates both the costs that the proposed rule will impose and the number of small businesses that will be impacted by the proposal.
As an example, one small business representative who met with Advocacy commented that the SEC proposed rule would impose a median due diligence burden in excess of $65,000 per company in the electronics industry supply chain to comply with the rule during the first year alone. This same small business representative stated that the proposed rule would impose additional estimated costs for tracking software, additional staff, training, legal expenses, and third party audits with a median total of $170,000 per company in the electronics industry supply chain. These high compliance costs stem from the fact that supply chains in the electronics industry are an extremely complex, multi-layered network of global trading companies and suppliers.
Similar to the electronics industry, small businesses in most industries that would be subject to the proposed rule participate in a complex supply chain that is comprised of numerous other businesses. The proposed rule would affect most manufacturers of electronics, aerospace, automotive, jewelry, health care devices, and industrial machinery. Even businesses that don't necessarily file with the SEC may be impacted if they are part of the supply chain for these metals to SEC filing companies. Because the SEC does not take into account the complexity of supply chains and the number of small businesses that are part of those supply chains, the SEC has underestimated the number of small businesses that would be impacted by the proposed rule.
Advocacy recommends that the SEC publish in the Federal Register an amended IRFA for the proposed rule. The amended IRFA should more accurately describe the costs and burdens of the proposed rule, and should also more accurately detail the number of small entities that would be impacted by the proposed rule. Amending the IRFA will help the SEC gain valuable insight into the effects of the proposed rule on small entities, and will require that the SEC consider less burdensome alternatives to the proposed rule.
Source: SBA letter to the SEC on Conflict Minerals.
Schneider Electric, a global energy solutions upstream supplier for many of the Fortune 1000 companies says there will be instances where they cannot supply the required information to their clients.
Jeff Masson, senior vice president purchasing North America at Schneider says he is concerned with the expected level of detail the SEC plans to require. “We are looking at our supply chain to determine the best way of obtaining the information necessary for our customers. Many of our large global suppliers are aware and prepared for the rule. However, most of our small to medium size suppliers are just starting to look at the regulation. In many cases, they don't have the internal competencies to understand the requirements and will likely struggle to comply,” he says.
Masson adds some of the minerals used in the production are so minuscule that attempting to verify their origin is a significant undertaking as the minerals may come from numerous suppliers.
Quaadman says businesses are concerned about the potential inability to trace the source of minerals that may have been smelted or used in trace amounts. The process is likely to increase costs of compliance and raw materials. There are concerns that the due diligence process will affect companies' long-term raw materials acquisitions. “Obviously, this rule has harmful economic and job creation consequences that were not initially contemplated by regulators,” he says.
Cost to Comply
The SEC projected the rule to affect 6,000 companies at the cost of $71 million. The U.S. Chamber of Commerce puts the scope and cost of the rule much higher. It says it estimates that the rule will affect tens of thousands of businesses and the cost will topple $16 billion. A recent study by Tulane University Law School put the aggregate cost to comply at $7.9 billion.
Meanwhile, the U.S. Small Business Administration (SBA) proposed a re-evaluation of the Commission's initial study on the impact of the rule to small businesses. In its comment letter to the SEC, the SBA said the SEC's initial analysis dismissed the costs of compliance to small businesses, defining it as “difficult to assess but are likely insignificant.”
“Because the SEC does not take into account the complexity of supply chains and the number of small businesses that are part of those supply chains,” the SBA said in the letter, “the SEC has underestimated the number of small businesses that would be impacted by the proposed rule.”
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