Latest conflict minerals filings show improved due diligence

Despite legal uncertainty and logistical difficulties, the show must go on for conflict minerals disclosures demanded by the Securities and Exchange Commission. In fact, experts say, many companies, voluntarily, took the reporting much more seriously this year.

The disclosures—pertaining to supply chain evidence of tin, tantalum, tungsten, and gold mined in the war-torn Congo—were due on May 31. By an initial breakdown, more than 1,201 Form SDs were submitted, along with more than 970 Conflict Mineral Reports, a deeper dive into supply chain investigations filed online and as an exhibit to Form SD.

CMRs as envisioned by the SEC, were a demand for companies determining that they were not conflict-free to detail due diligence efforts on the source and chain of custody of their conflict minerals and illustrate adherence to a “a nationally or internationally recognized due diligence framework,” such as the one approved by the Organisation for Economic Co-operation and Development.

According to Source Intelligence, a technology firm focused on supply chain issues, there was an increase in the number of CMRs filed this year: 80 percent of total filers submitted a Conflict Minerals Report for reporting year 2015, compared to 65 percent for 2014.

The increases may be a bit surprising, as the rule lingers in legal limbo. A coalition of trade associations partially prevailed in its legal challenge, striking down rule requirements for companies to declare their products as “DRC Conflict Free,” “DRC conflict undeterminable,” or “not found to be DRC Conflict Free.” The government has declined to appeal the matter to the Supreme Court, and the D.C. Circuit Court could, eventually, rule on whether the entire rule is, or is not, constitutional. The SEC, which could rewrite the rule, still requires annual Form SD disclosures, albeit without status declarations.

Few companies filed an independent private sector audit, which the SEC only requires if a company voluntarily declares itself “conflict free.”

This reporting year, there were 19 IPSA’s from a mix of companies large (Halliburton, Intel, Cannon, Signet Jewelers, and Texas Instruments) and small (Kemet Corporation, Arrow Electronics, and Skyworks Solutions).

“While companies may not be legally bound to provide full disclosure when it comes to conflict minerals, there is growing pressure from consumers, advocacy organizations, stockholders, and others that are prompting businesses to be more transparent,” said Jess Kraus, CEO of Source Intelligence. “The need for comprehensive supply chain reporting is only growing stronger.”

There were both success stories and struggles. Apple drew praise from even the hard-to-please activists of the Enough Project for its efforts. Its report highlighted that 100 percent of the smelters in the company’s supply chain were participating in third-party independent audits on conflict minerals issues, an industry first.

“Apple's new supplier report [separate from its SEC filings] is a model for how companies should be addressing conflict minerals,” says Sasha Lezhnev, associate director of policy for the Enough Project. “Apple’s tough love with its suppliers is critical to solving the problem of deadly conflict minerals. It offered assistance to suppliers, but then took the difficult step of cutting out those who were unwilling to undergo an audit. Firm but fair follow-through by tech and other companies with their suppliers is a key step that's needed to cut off global markets for conflict minerals.” Intel, Signet Jewelers, and Ford were also praised for providing “transparent, detailed reports on due diligence” in SEC filings.

“While companies may not be legally bound to provide full disclosure when it comes to conflict minerals, there is growing pressure from consumers, advocacy organizations, stockholders, and others that are prompting businesses to be more transparent.”
Jess Kraus, CEO, Source Intelligence

The fact that nearly 80 percent of companies filed CMRs and “the next level of transparency down about their supply chains,” is important progress, Source Intelligence’s Kraus says. “That is a key piece of information. They are not only doing the bare minimum of filing their Form SD, they are reporting out on their smelters their supply chains and undergoing a much deeper dive.”

He sees the increased transparency as “a growing trend across companies, especially companies that have brand names.”

“If they don’t do a fairly decent job of looking at their supply chains, somebody else is going to,” he adds. “No one wants to be associated with sourcing black market minerals.”

More companies are also listing smelters by name. “We find that interesting because, ultimately, that’s the choke point,” Kraus says. “You can’t take raw minerals and do much with them until they have been smelted and refined.”

His firm has, over the course of five years, developed a database of more than 20,000 aliases related to a much smaller number of smelters, roughly 600, but that operate under different names. Similar, widely accessible work is the mission of the Conflict Free Sourcing Initiative. It is working to identify smelters and refiners, determine aliases, and develop standardized smelter ID codes.

Michael Littenberg, a partner at law firm Ropes & Gray, noted more divergence in the quality of filings. “There are now clear leaders and laggards, which I don’t think is any different than any other SEC filing, whether it’s a 10-K or a proxy statement,” he says. “What you tend to see is that the pack divides. There are the companies that do a good or very good job, and then there are the ones that tend to engage in a mechanical compliance exercise, where not as much thought goes into it.”

Trends among companies that do a more admirable job, Littenberg says, include compartmentalizing their disclosures. “There are a lot of sections and sub-sections in their reports, so it is easy for the reader to find the information.” For example, there may be an introduction section, A Reasonable Country of Origin Inquiry section, a discussion of the due diligence, a discussion of smelters and refiners, and then a discussion of future action items. “There are a lot of bullet points and short paragraphs that make the disclosure easy to digest and very reader-friendly,” he says.

Another trend this year, discussions of future risk mitigation efforts are more tailored to the efforts by individual companies and less boilerplate. “That is to be expected as companies get further along with their compliance around conflict minerals,” Littenberg says. “Many of them have addressed all the low-hanging fruit and the obvious items. Now, the disclosure is a little more granular, specific, and tailored to the particular company.”

EU MOVES FORWARD ON CONFLICT MINERALS RULE

On June 16, European Union officials agreed on a regulatory framework regarding “conflict minerals” and the responsible sourcing of source tin, tantalum, tungsten and gold. Global efforts have sought to reduce the financing of armed militias that trade in those minerals.
The EU approach will build upon the OECD Due Diligence Guidance for responsible mineral sourcing and includes obligations for the "upstream" part of the conflict minerals supply chain, including smelters and refiners. The vast majority of metals and minerals imported to the EU will be covered, while exempting small volume importers from these obligations, a statement issued by EU institutions says.
The European Commission will also carry out a number of other measures, including the development of reporting tools, to further improve supply chain due diligence by companies that use these metals and minerals as components in goods. The preliminary agreement will now require months of technical work before it can be implemented as EU law. Two years after it is completed, there will be an effectiveness review that could broaden the reach of the regulations.
While the framework requires smelters and refiners to confirm the geographical source of raw minerals, imports of “downstream”-finished products are exempt. Small-volume importers are also excluded.
The EU rules cover conflict minerals that are sourced from anywhere in the world, a broader scope than the United State’s Dodd-Frank Act and a rule that focuses exclusively on the Democratic Republic of the Congo.
Activists, notably Amnesty International and Global Witness, are critical of the plan, in particular the focus on upstream entities and exclusion for smaller importers.
Jess Kraus, co-founder and CEO of Source Intelligence, a technology provider that specializes in supply chain management, is more optimistic. “The EU is the biggest block of commodity purchasers in the world and the rule to require importers to report out on their supply chains is huge,” he says. “The EU’s message is that black market materials are not going to be tolerated in their supply chains."
“I think the next thing we are going to hear is that it is not just going to be 3TG, there are going to be other minerals and products,” he adds. “It started with blood diamonds 20 years ago, goes to 3TG, and now anywhere there is human trafficking or black market activity is going to [governments] will start requiring companies to dig further into their supply chains.”
—Joe Mont

What’s next? Some of Littenberg’s clients are already looking ahead to 2017 filings, the fourth year disclosures are mandated. “There are a few things that many companies are doing, and I think should be doing,” he says. “One is, like any other compliance program, it is important to periodically evaluate the effectiveness and efficiency of the program.”

That includes focusing on whether “there is a better, more efficient way to do this and still get to the same, or perhaps a better, result.” That’s not about the disclosure so much as the process leading up to the report—starting with product scoping, supplier outreach, and supplier review and validation.

Companies should be, and many are, ensuring that their programs are audit-ready. “Even if an audit requirement doesn’t come back and they don’t go that full step of having an audit or a mock audit done, they should be looking at the program to ensure that not only does it meet the requirements of the OECD guidance framework, but that they have documented it sufficiently,” Littenberg says. “Is the documentation clear, concise, and relevant?”

Documentation is even more important because compliance leadership and staffing may change over time. “Many of the people who were involved with this in the beginning have either cycled-off the program or will soon do so,” Littenberg says. “They go on to do other things at their company or go somewhere else. A lot of companies have been burned, because their programs were not well documented; and when that program manager left, they lost continuity. People aren’t sure what to do, how to do it, or when to do it. Critical decisions were, effectively, in the program manager’s head and not well documented.”

“Like any other compliance procedure, there does need to be some level of documentation around this to provide for continuity,” he adds. “The ones who were doing it from Day One learned the rule ahead of time because they needed to. They really were in the trenches on a lot of this. For the people who need to pick up midstream, it is always much harder.”

There is a silver lining in that some companies are showing an increased proficiency when it comes to connecting their various supply chain obligations.

“For many companies, conflict minerals is still kind of in its own silo,” Littenberg says. “But companies are increasingly trying to put it together with anti-human trafficking efforts from European union regulations like REACH [Registration, Evaluation, Authorisation and Restriction of Chemicals] and RoHS [the Restriction of Hazardous Substances directive], and with other supply chain compliance measures to increase efficiency and reduce risk. For many companies, that is still a work in progress and will continue to be.”

CORRECTION: An earlier version of this story mentioned Nike among the companies that filed Form SD reports with the Securities and Exchange Commission. Although the company’s disclosure noted that it did not have sufficient information on the country of origin “of at least a portion of the Covered 3TG in each of [its] in-scope products,” there should not have been any suggestion, intentional or unintentional, of a substantial issue. Although smelters were not directly referenced with the company mention, it should be noted, in the interest of greater clarity, that the three smelters identified as sourcing in the covered countries were all compliant with the Conflict-Free Sourcing Initiative’s Conflict-Free Smelter Program. Separately, a speculative mention regarding stock price should not have been included. We regret any negative inferences drawn from the article.