Understanding compliance challenges
Conflict minerals are defined as those minerals and derivatives (as designated from time to time by the U.S. Secretary of State) that fund illegal armed troops in the DRC and adjoining countries. Over 5.4 million people have died within the countries that make up the conflict mineral zone since 1996. The U.S. Congress signed the Dodd Frank Wall Street Reform and Consumer Protection Act into law on July 21, 2010. Section 1502 of the Act aims at deterring — through increased transparency of companies’ sourcing practices — the extreme violence and human rights violations in the Democratic Republic of Congo and neighboring countries, which are funded by the exploitation and trade of certain minerals. Companies should evaluate their own internal capabilities to fully understand the course of action to take in terms of implementing new regulations.
These metals are widely used in several industries, including electronics and communications, aerospace, automotive, jewelry, healthcare devices, and diversified industrial manufacturing, among others.
The conflict mineral zone
The DRC and adjoining countries provide:
- 17% of the global production of tantalum
- 4% of the global production of tin
- 3% of the global production of tungsten
2% of the global production of gold
Source: The EICC-GeSI Extractives Work Group report on Conflict Minerals released May 30, 2011
The SEC rule has a number of areas subject to significant judgment for which additional guidance has not been published.
|"Product"||"Contract to manufacture"||“Necessary to the functionality” and “necessary to production”|
|This term is undefined, and is generating a number of questions about how to interpret it. For example, if a company is selling canned meat, is the product the meat, the can, or both? What about a company that sells products that require some sort of a protective covering to keep the product fresh. Is the product covering relevant to the discussion or just the product inside the protective covering? These examples illustrate the issue faced by companies in determining “products” in scope.
||Issuers that “contract to manufacture” may be subject to the rule depending on the “degree of influence” over the manufacturing process of a product. It is unclear at what point a company’s degree of influence is significant enough to fall within the rule’s coverage. The rule does highlight that an issuer is not subject to the rule when it solely:
1. Specifies or negotiates contractual terms with a supplier that do not directly relate to the manufacturing of the product (e.g., training, technical support, price, intellectual property rights)
2. Affixes its brand, marks, logo, or label to a generic product
3. Services, maintains, or repairs a product manufactured by a third party
|According to the rule, “conflict minerals must be intentionally added to or present in the product (not an accidental by-product), necessary for the product’s intended purpose or to produce it, and if added to the product for purposes of decoration, the primary purpose of the product must be decorative or ornamental.” The rule provides a few examples but no clear definition to assist in the determination of what constitutes something being necessary to a products intended purpose.|
|“Reasonable country of origin inquiry”||
“Reasonably reliable representations,” “reason to believe,” “may have originated,” “may not have come from”
|"Conflict mineral report and independent private sector audit"|
|According to the rule, companies that learn that their products contain conflict minerals must conduct a “reasonable country of origin” inquiry. There is no model provided as to what a reasonable country of origin inquiry may be; only that it must be performed in good faith. The lack of guidance is creating difficulties for companies to understand if their attempts at determining whether their conflict minerals were sourced from a covered country, scrap/recycled sources, or both is “reasonable.”||Within the provisions on the reasonable country of inquiry and due diligence process, key terms and phrases are not clearly defined, thus causing companies to interpret the terms differently. Interpreting terms that contains the words” reasonably,” “reason to believe,” and “may have” causes confusion and may lead to
|The SEC final rule defers to the Government Accountability Office (GAO) to indicate which audit standards to apply to the audit of the Conflict Minerals Report. The
GAO stated that it does not intend to develop new standards for the independent private sector audit of the Conflict Minerals Report and that existing Generally Accepted Government Auditing Standards (GAGAS), such as the standards for attestation engagements or the standards for performance audits can be applied. This presents a challenge in terms of comparability among IPSA that will be conducted and the benefits that one may derive from such reports.
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In our experience helping clients implement multiple new regulations over the years, we have identified one very important truth: companies should first evaluate their own internal capabilities to fully understand the course of action to take in terms of implementing new regulations.
Factors that should be considered by corporations as they analyze their internal capabilities are:
- Do we have the required knowledge to implement and manage the process ourselves?
- How capable are we at mapping the supply chain of our suppliers?
- How will we onboard new suppliers and embed compliance?
As companies prepare for compliance, considerations should be given to the following:
Beyond the regulation requirement, consider the implication of the approach taken from a corporate brand and reputation standpoint.