Conflict Minerals Rule in Limbo, as Legal Challenge Awaits

Companies waited for more than two years for the Securities and Exchange Commission to provide specifics on the Dodd-Frank Act's rule requiring disclosure of conflict minerals in a company's supply chain. Now, as a legal challenge to the rule awaits, they will have to wait some more.

The manufacturing industry and the U.S. Chamber of Commerce last week launched their long-awaited legal challenge against the SEC on the rule. But even if the lawsuit was easy to predict—business groups have hinted at launching a legal challenge of the rule for months—it only brings more uncertainty to businesses trying to decide how best to satisfy their current and future compliance obligations.

A full brief, outlining the plaintiffs' strategy, remains forthcoming. The plaintiffs' petition with U.S. Court of Appeals for the District of Columbia requests “that the rule be modified or set aside in whole or in part.”

The rule, mandated by Section 1502 of Dodd-Frank, applies to the mining of tin, tungsten, tantalum, and gold in war-torn Central Africa, that is considered a source of funding for militant groups. The value of the Congo's mineral wealth is estimated as high as $24 trillion and the SEC rule is estimated to directly apply to 5,994 companies and hundreds of thousands of their suppliers. Even before the SEC's final rule was approved in August, critics have lamented that purging their supply chains of these substances, or even just tracking their origin, would be a costly challenge.

“The $64,000 question is: ‘What do we do now?'” says Michael Littenberg, a partner at law firm Schulte Roth & Zabel. “What does this mean for compliance?”

Not only does the petition not yet clarify the basis of the challenge, nearly a week after it was filed, no official press release has been released by either the Chamber or NAM. “They have been relatively vocal in that they might challenge the rule, so there was no surprise that they did,” Littenberg says. “But it was a very quiet filing.”

The lawsuit is likely to buy companies more time on compliance. Although details on the legal challenge are still pending, Littenberg expects the court to stay the effective date of the rule, which would likely delay its implementation until at least 2014. “Until this gets resolved it doesn't make a lot of sense to have a rule that people have to spend a lot of time and money complying with it when it might get overturned,” he says.

Jonathan Hughes, director of Assent Compliance, a consultant with a conflict minerals practice, stresses that the challenge is more likely to modify the rule, rather than strike it down. “If it was a good idea for you to comply before, it is still a good idea, because only one of those eventualities leads to having to do nothing,” he says.

Advisers say it's unwise to put conflict minerals rule compliance completely on hold. “If you are a compliance officer you are really gambling with your credibility and your job if you want to put all your eggs in the NAM lawsuit basket,” says Hughes. “If you delay your company's internal actions based on this filing and the rules aren't completely set aside, your company will be behind the eight ball because of your actions.”

Robert Weiner, managing director and regional counsel for IPSA International, an investigative consulting and risk advisory firm, agrees that companies cannot use the challenge as an excuse to derail ongoing compliance efforts. “At the end of the day, you have to prove that you took reasonable measures to get the answers that you need,” he says. The shared resources and cooperative approach offered by industry associations and mineral-specific initiatives mean that the cost may not be “as overly burdensome as NAM has proposed it would be.”

Reputational Risk

“You are really gambling with your credibility and your job if you want to put all your eggs in the NAM lawsuit basket.”

—Jonathan Hughes,

Director,

Assent Compliance

Aside from the threat of being ill prepared to eventually satisfy SEC regulations, companies must also weigh reputational risk. Advocacy groups say that companies with a leadership role on the issue have been thus far been reluctant to jump into the fray on the legal challenge to the rule. But some have made overtures of individual and joint statements of supporting the rule, as good policy in the fight against militant groups in Africa.

Activists have long been pushing companies to break rank with the Chamber over the issue. Electronics industry associations, the Electronics Industry Citizenship Coalition and the Global e-Sustainability Initiative, as well as other leading companies, have publicly supported measures to deal with conflict minerals.

In May, the U.K.-based Business and Human Rights Resource Centre wrote to prominent electronics and automotive companies and asked them to clarify their positions on the conflict minerals rule, the Chamber, and NAM. Microsoft, General Electric, and Motorola Solutions were among the few companies that responded.

“Microsoft has expressed support for the SEC's prompt action on this rulemaking, and we do not support or fund the Chamber's lobbying against the proposed rules,” wrote Dan Bross, senior director of corporate citizenship at Microsoft. “[On] climate change and conflict minerals, we are opposed to the Chamber's positions and do not fund or support their work.”

U.S. CHAMBER COMMENTS

The following is a selection from a July 11, 2012, comment letter to the Securities and Exchange Commission from the U.S. Chamber of Commerce, prior to a Final Rule pertaining to conflict minerals.

1. Impact upon Small Businesses and Other Private Companies

The SEC estimated that the proposed Conflict Minerals Rule would impact between 1,199 and 5,551 companies. However, as the Chamber has noted this estimate is limited to those public companies directly subject to the proposed Conflict Minerals Rule. However the impact and cost of this rule extends far beyond reporting companies. As proposed this rule will impose significant costs on vendors and suppliers to public companies. An individual manufacturing company may have as many as 60,000 or 100,000 separate vendors, including small private businesses.

The SEC's estimate only reflects the tip of the iceberg and is therefore fundamentally deficient.

2. Cost-Benefit Analysis

In releasing the proposed Conflict Minerals Rule, the SEC estimated the compliance costs at $71,243,000.

Because of the supply chain complexities, as well as the scientific and metallurgical issues involved, the Chamber stated that this analysis was not realistic and that the SEC should disclose its rationale for this estimate, provide a new cost-benefit analysis and withdraw the proposed rule. The Chamber also requested that the SEC voluntarily submitted the proposed Conflict Minerals Rule to the Office of Information and Regulatory Affairs (OIRA) for an enhanced regulatory review.

The failure of the SEC to consider the true impact of the proposed rule on all businesses materially undermines its analysis and resulting estimate of the actual cost of the proposed rule.

3. Safe Harbor and de minimis Standard

The reporting burden could be improved by including safe harbor and de minimis standards. Safe harbor standards could enable companies distant in the supply chain that have little or no view of, or control over the acquisition of conflict minerals to comply by adopting defined contractual procurement practices, without also being subject to undue and impractical audit or reporting requirements. Additionally, the failure to provide a de minimis standard would trigger meaningless disclosure requirements even if only trace amounts of a mineral or its derivative are used in a product.

Shareholders may also be harmed when some companies are forced to make difficult judgments concerning how to report inconclusive data. Because of the inherent problems many companies will face in tracking their supply chain, they may not be able to reach a definitive conclusion as to whether their minerals were derived from a tainted source. Unable to provide unequivocal proof of the negative, many companies would have to report potentially unjustifiably negative information that may not be accurate to the detriment of investors.

Source: SEC.

Companies that support the legal challenge to the rule may find themselves the targets of activists. The international non-governmental organization Global Witness issued a statement calling any company that supports the action, or remains silent, “gutless.” “The companies financing this action that the Chamber and NAM are fronting should have the courage to say who they are,” says Global Witness Director Patrick Alley. “If they really thought this was a case of unwarranted regulation that costs jobs, why wouldn't they publicly identify themselves with such a noble cause? Why the need to hide behind corporate lobby groups?”

 “We think businesses got almost everything they wanted in the legislation, so I don't think that it's an accident that these particular business groups didn't specify what their basis for suing was,” says Sasha Lezhnev, senior policy analyst for the Enough Project. “Frankly, they have very shaky ground to stand on.”

Lezhnev expects many leading companies to step up and support the rule. In the meantime, the “first hurdle” is to make sure the court doesn't stay implementation of the rule. “This case could go on for years,” he says.

Buying Time

Some companies, however, even if they agree with the cause, may not regret any extra time they get.

The electronics industry “appears to be unprepared” and “90 percent of firms so far have not produced the data, declarations, or documentation” that will help detail the presence of conflict minerals in their supply chains, says information and analytics provider IHS.

According to its research, as of August, the percentage of electronics component manufacturers with available conflict minerals information amounted to only 11.3 percent of the peer group. These companies account for 17.1 percent of active electronic components on the market.

“Large electronic original equipment manufacturers use tens of thousands of parts that must be examined to determine their conflict mineral content,” says Rory King, director, supply chain product marketing at IHS. “The next 19 months really is not very much time to communicate, collect, analyze, and prepare information on mineral sources across a globally diverse, multi-tier [supply chain].”