Conflict Minerals Rule Compliance Is Off to a Slow Start

“It's game time.”

That's the warning from Barbara Kipp, a partner in PwC's risk assurance services practice, on ramping up compliance with new disclosure requirements for the use of conflict minerals in the company supply chain.

Last August, the Securities and Exchange Commission issued a final rule outlining how companies must report the use of certain minerals—including tin, tantalum, tungsten, and gold—mined in the war-torn Congo region of Africa and often used to fund violent militia groups.

The rule, a mandate of the Dodd-Frank Act, requires companies to determine and disclose the source country of the four minerals used. A Reasonable County of Origin Inquiry (RCOI) is required to determine whether they were sourced from the Democratic Republic of Congo or an adjoining country. Disclosure of this assessment is required in the SEC's new Form SD. If designated minerals do, or might, come from covered countries, additional due diligence into the source and chain of custody of those minerals is required, along with an audit of that assessment.

As months have passed, businesses digging deep into their supply chains are now beginning to assess how difficult meeting those requirements will be. While many companies continue to bemoan what they consider to be vague language in the regulations and the high cost of compliance, strategies are emerging on how to deal with the most onerous aspects.

Lagging Behind

PwC is currently surveying hundreds of companies on how they are approaching compliance with the new rule. Although responses are still being collected, initial results indicate that many companies have intentionally delayed compliance efforts. Kipp is concerned that many companies are getting too late a start to adequately meet the May 2014 deadline to file the first Form SD. 

Others share those concerns. “There is very little time, only a few months, to survey your company, assess your products, be in contact with all of your suppliers and give them time to follow up with their suppliers,” says Dynda Thomas, a partner with the law firm Squire Sanders. “The cascading effect of this rule means there are many steps.”

“A company simply giving its suppliers a questionnaire isn't the end of the topic,” she says. “Depending on the complexity of the part or product involved, there may be 10 steps down to where you finally get to the actual source of the conflict mineral.”

According to the preliminary results of the PwC survey, nearly 33 percent of respondents said they are working on identifying products that may contain conflict minerals. Five percent have gathered most of the necessary data from suppliers and are assessing it as part of their RCOI obligation; only 2 percent have completed initial RCOI and started due diligence.

Some companies are playing the waiting game. Nearly 17 percent said they haven't done much or are waiting to see what happens with a legal challenge currently making its way through the courts. Last October the National Association of Manufacturers and the U.S. Chamber of Commerce filed a legal challenge to the regulation in the U.S. Court of Appeals for the District of Columbia. They are seeking that the rule be modified or set aside, due to what they see as unreasonable burden and insufficient cost-benefit analysis by the SEC. Briefs have been filed, with oral arguments scheduled for May 15. A judge's decision isn't expected until the third quarter of the year.

Waiting until the legal challenge is resolved to begin compliance efforts is a huge gamble and an unwise approach, says Kipp. It's unreasonable to tell regulators you waited until November or December to start compliance efforts with hope the law would get repealed, she says.

“You have to get started,” Kipp advises. “You need to put a team together and think about what your end game is and your ultimate disclosures. You need to start somewhere.”

Suppliers and Demands

A significant hurdle for companies is getting their potentially vast network of suppliers to cooperate. “A lot of entities in the supply chain aren't necessarily public companies, located in the United States, or even have much visibility into this issue,” says David Lynn, a partner with the law firm Morrison & Foerster. “So when they get these questionnaires from companies they are not inclined to always respond.”

Another problem is that since most contracts with suppliers were drafted long before the new disclosure requirements were anticipated, companies don't have a lot of leverage to compel their suppliers to provide information, says Lynn. “They don't really have a very good hook over their suppliers,” he says.

The final SEC conflict minerals rule states that to be in compliance, issuers must seek and obtain “reasonably reliable representations” from their suppliers regarding origin of the materials in question. Certainty is not required, but reasonableness is, although the definition of reasonable is left to discretion, says Kirsten Wallerstedt, senior regulatory analyst for 3E Company, a business consulting firm.

Even companies that have been diligently collecting information from suppliers are having a lot of trouble managing the volume of data, she says.

“Depending on the complexity of the part or product involved, there may be 10 steps down to where you finally get to the actual source of the conflict mineral.”

—Dynda Thomas,

Partner,

Squire Sanders

The SEC also expects companies to be aware of, and address, “red flags” that might signify a supplier is misrepresenting information. The intent is that companies must be on the lookout for inconsistencies, and perhaps even outright lies, offered by suppliers. They cannot just take supplier questionnaires at face value, Kipp says.

Contract to Manufacture

There also remains confusion about exactly what companies the regulations cover. Those that contract out the manufacturing process must comply, for example, but those with branded or private label products are having a difficult time determining whether they meet the definition of “contract to manufacturer.” The rule says that companies that have influence over the manufacturing process, as opposed to re-sellers or retailers, must file Form SD, although no clear-cut definitions were included in the regulation. 

“Many companies have found this definition murky, and determining whether they meet this tipping point can be a difficult decision,” Wallerstedt says. “There could be ramifications for making an incorrect determination.”

The expectation is that the SEC probably won't provide much public clarification on who is subject to the contract manufacturer rule, but will likely do so through a number of private letter rulings, as has been their approach in the past, she says, explaining that some of her clients have started collecting conflict minerals information for their private labels as a precaution.

Thomas says companies that engage in businesses deemed “maintenance and repair” might also need to worry about the rule, especially if they replace returned products with new ones. “Under those circumstances they could very easily be found to be a manufacturer, because they are introducing a product into the stream of commerce,” she says.

The Problem With Packaging

Thomas says product packaging must also be carefully considered. A footnote in an SEC brief filed for the lawsuit indicates that it never intended packaging to be covered by the rule. Although some are interpreting this as a break for companies, she warns that this likely only applies to boxes used to ship a product not, for example, the outer layer of a cell phone that wraps up the inner workings as some are arguing.

DODD-FRANK 1502 COMPLIANCE TIMELINE

Source: PwC.

Conflict minerals rule compliance could be further complicated by new rules from other countries. Canada and the European Union, for example, are considering new conflict mineral requirements of their own, and they could be broader than the ones the United States has adopted. “What's troubling to me is [the proposed Canadian rule] is inconsistent with the U.S. rule,” Thomas says. “Having inconsistent, yet overlapping rules, would create a lot of extra work for companies.”

The Canadian rule under consideration, she says, includes additional countries and minerals, extending back to the ore itself and not just processed material. It is also much broader, covering extraction, trading, and sourcing. Because it applies to all Canadian companies, a subsidiary of a U.S. reporting company would have to adhere to both regimes.

Not as Bad as It Seems?

The National Association of Manufacturers estimates a cost of $9.34 billion for compliance, a figure that includes $1 million per issuer to institute IT systems to collect and maintain auditable records, and $1.2 billion for all affected companies to strengthen internal management systems as they perform due diligence.

Companies are finding ways to cope and cut costs, however. “It could be argued that compliance, at this stage, is proving to be less onerous than expected,” Wallerstedt says.

Third-party solutions are rapidly emerging as cost effective-alternatives to in-house programs. And although there were initial fears over anti-trust laws and exposing proprietary information, industry-wide initiatives, such as ones launched by the electronics industry and auto part makers, are also proving popular and effective.

“My mantra is to work together and share information and standardize as much as possible, says  Patricia Jurewicz, director, Responsible Sourcing Network, a project of the non-profit organization As You Sow, which promotes responsible supply-chain coalitions. “The only way we can really build transparency and accountability in the entire supply chain, all the way down to the dirt, is to share information.”