Conflict minerals compliance was supposed to get easier this year.
The Securities and Exchange Commission had a clear strategy: The first two years of filings allowed companies to declare “undeterminable” status when assessing whether certain materials in their products were mined in the Democratic Republic of the Congo. After that ramp-up, the 2015 filings, due by spring of next year, were intended to be higher-quality and auditable.
Well, so much for that idea. A court ruling on Aug. 18 means the SEC’s plan is now kaput, just as companies, academics, and consultants were digging into this year’s crop of filings to understand what work lies ahead for next year.
That decision, made in the U.S. Court of Appeals for the District of Columbia, upheld a 2014 ruling that barred the SEC from requiring companies to report whether their products are “not found to be DRC-conflict free” on the grounds that forcing them to do so violates companies’ free speech rights. (As usual with litigation against the SEC, the plaintiffs were the U.S. Chamber of Commerce, the Business Roundtable, and the National Association of Manufacturers.)
Judge Raymond Randolph, writing for a 2-1 majority, disputed the SEC claims that conflict minerals disclosures escape free speech scrutiny because they are “purely factual and uncontroversial.” Such labels, he wrote, tell consumers that a company’s products “are ethically tainted” and amount to having a company “publicly condemn itself.”
The crucial point for compliance officers, however, is that the appellate court only said the SEC cannot force companies to declare whether they are conflict-free. The annual exercise of inspecting your supply chain for conflict minerals, and of filing a Form SD to the Securities and Exchange Commission—both of those remain in place. So does the legal uncertainty about conflict minerals compliance overall. In fact, that confusion could last for years.
First, the SEC still has an opportunity to ask for a rehearing of the case before the full D.C. appeals court, a process that could take upwards of a year and certainly go beyond the 2016 filing deadline. There is also the distinct possibility this debate will wind its way to the Supreme Court, a process that could take years and have implications that go far beyond the conflict minerals rule itself.
The free speech issues behind the U.S. Chamber’s lawsuit, and the constitutional protection against compelled speech at the core of its success, raise fundamental questions about the nation’s regulatory regime. That is, if the government cannot order companies to disclose information against their wishes or contrary to their best interests, how can the SEC (or other agencies) continue to place filing demands on public companies? Nobody believes the Supreme Court would take the opportunity to overturn decades of securities regulation, but such a case would still strike up the band for a parade of rule challenges.
Here and Now
As for regulatory demands in the interim, some assumptions can be made. When the SEC suffered its first legal setback in 2014, the Division of Corporation Finance quickly issued fresh guidance informing companies that they still had to file the required Form SD and, if needed, a related Conflict Minerals Report detailing how a “country of origin” investigation was conducted.
“The only item that is really in question is whether you need to conduct an IPSA regardless of your disclosure, or based on your disclosure if you said you were not conflict free or the status was undeterminable. It is going to create confusion.”
Jon Hughes, Director, Assent Compliance
Thanks to that original court ruling last year, no company had to declare that it was “DRC conflict free,” or undetermined, or any other status. You could do so if you liked, but you had to get an independent private sector audit (IPSA) of the process that led you to reach that conclusion. The Aug. 18 decision affirms that 2014 decision, so most expect that this guidance will be reiterated, either through formal guidance or SEC staff commentary.
“When one reads the past guidance, it still hangs together properly,” says Michael Littenberg, a partner at law firm Schulte Roth & Zabel who heads its conflict minerals practice.
“With respect to conducting a reasonable country of origin requirement, engaging with suppliers, validating data, creating a conflict minerals report—nothing changes,” says Jon Hughes, director of the consulting firm Assent Compliance’s conflict minerals practice. “The only item that is really in question is whether you need to conduct an IPSA regardless of your disclosure, or based on your disclosure if you said you were not conflict free or the status was undeterminable. It is going to create confusion.”
Life (and Compliance) Goes On
Legal wrangling aside, companies now have two years of filings behind them, lessons can be drawn from those first conflict minerals filings.
The assessment is a mixed one. A report by the Government Accountability Office found that in the first year of filings, 67 percent of filers were unable to determine whether their products had minerals from the DRC; none could determine if they financed the armed groups that exist there and use mining as a lucrative source of revenue.
The following, a statement by Keith Higgins, director of the SEC’s Division of Corporation Finance in April 2014, responded to the first appellate court decision and could reflect the Commission’s approach given the recent ruling.
On April 14, 2014, the United States Court of Appeals for the District of Columbia Circuit issued a decision in National Association of Manufacturers, et al. v. SEC. That case involved a challenge to Exchange Act Rule 13p-1 and Form SD. Rule 13p-1 and Form SD were adopted pursuant to Exchange Act Section 13(p), which was added by Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Court of Appeals rejected all of the challenges to the rule based on the Administrative Procedure Act and the Securities Exchange Act of 1934. The Court, however, concluded that Section 13(p)(1) and Rule 13p-1 “violate the First Amendment to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have ‘not been found to be “DRC conflict free.”
In so concluding, the Court specifically noted that there was no “First Amendment objection to any other aspect of the conflict minerals report or required disclosures.” In an order issued concurrently with the decision, the Court of Appeals withheld the issuance of its mandate until seven days after disposition of any timely petition for rehearing or petition for rehearing en banc. As a result, the earliest date on which the Court’s mandate is likely to issue is June 5, 2014. Under Rule 13p-1, the first reports are due to be filed on June 2, 2014.
Subject to the guidance below and any further action that may be taken either by the Commission or a court, the Division expects companies to file any reports required under Rule 13p-1 on or before the due date. The Form SD, and any related Conflict Minerals Report, should comply with and address those portions of Rule 13p-1 and Form SD that the Court upheld. Thus, companies that do not need to file a Conflict Minerals Report should disclose their reasonable country of origin inquiry and briefly describe the inquiry they undertook. For those companies that are required to file a Conflict Minerals Report, the report should include a description of the due diligence that the company undertook. If the company has products that fall within the scope of Form SD, it would not have to identify the products as “DRC conflict undeterminable” or “not found to be ‘DRC conflict free,’” but should disclose, for those products, the facilities used to produce the conflict minerals, the country of origin of the minerals and the efforts to determine the mine or location of origin.
No company is required to describe its products as “DRC conflict free,” having “not been found to be ‘DRC conflict free,’” or “DRC conflict undeterminable.” If a company voluntarily elects to describe any of its products as “DRC conflict free” in its Conflict Minerals Report, it would be permitted to do so provided it had obtained an independent private sector audit (IPSA) as required by the rule. Pending further action, an IPSA will not be required unless a company voluntarily elects to describe a product as “DRC conflict free” in its Conflict Minerals Report.
A review of the most recent filings was conducted by Chris Bayer of Tulane University’s Payson Center for International Development. The study was commissioned by Assent Compliance and advised by a panel of conflict minerals experts.
It found that as of July 2015, 1,267 issuers filed conflict minerals disclosures for reporting year 2014. One fifth of the filers filed a Form SD only. An estimated 6 million man hours were devoted to conflict minerals reporting, at a collective cost of $709 million. Companies spent a combined total of $149 million on non-IT related external resources (such as consultants and lawyers), almost $41 million on performing a gap analysis on their respective IT systems, and $97.5 million on the actual IT project.
The Bayer report also ranked companies according to both objective compliance with the rule, and a more subjective assessment of best practices and adherence to the Organisation for Economic Co-operation and Development’s framework. No surprise: large companies, especially in the tech sector, topped the list. Apple, IBM, Nokia, Blackberry, Ford, Goodyear, and Microsoft were praised for their efforts.
A buzzword underlying the study is “transparency,” Hughes says. It applies to both visibility into the supply chain and effectively communicating efforts to create it. “Once you start solving the problems of supplier engagement and validating supplier data, everything else is just signing and filing on time,” he says. Companies serve themselves well by providing a window into these efforts for consumers and business partners.
Littenberg, who sat on the Tulane advisory panel, has also been scouring the latest filings and sees marked improvement. “We saw more companies implement the OECD framework and incorporate more steps of the framework,” he says. “We saw a higher quality of disclosures with more detail around processes and procedures and results. Certainly there is room for improvement from the NGO perspective, but they view the rule as the starting point, not the end point. From a compliance perspective, there was certainly a lot of positive momentum.”
The filings do, however, reveal a need for companies to go beyond step-by-step compliance and think big picture, says Jared Connors of iPoint, a consultant and software provider for environmental compliance. “People are so focused on the process of surveying suppliers that they are not focused on building a program framework,” he says.
Without that larger a blueprint for how a conflict minerals program blends with other supply chain sustainability efforts, auditors will have little to work with when IPSAs are ultimately required.
“Surveying suppliers is only a means to and end,” Connors says. “Successful companies are not just collecting surveys; they are evaluating responses and making a concerted effort to increase their supply chain transparency.” The filings, thus far, show that plenty of work remains, he says.