New Breed of Regulations Won't End With Conflict Minerals

When Congress included a demand for the disclosure of the use of “conflict minerals” throughout the supply chain in the Dodd-Frank Act—legislation primarily focused on banking reform—it took many companies by surprise.

Maybe it shouldn't have. For several years leading up to passage of the reform bill activist groups and shareholders continuously advocated for  legislation to combat the problem of militant groups in the Congo region of Africa using the proceeds from the mining of tin, tungsten, tantalum, and gold to fund violence, and they targeted U.S. companies that used the minerals in their products.

“We all knew this was coming, I just wasn't expecting it to be a part of Dodd-Frank to be honest," says Sonal Sinha, associate vice president of Industry Solutions for MetricStream, a provider of governance, risk, and compliance solutions. Now, however, “there is a lot more transparency and greater expectations shareholders are placing on operations.”

“Today we are talking about conflict minerals. Tomorrow it could be wood, or other materials,” she says. “The list can just go on and on.”

Companies, often prodded by activist shareholders as much as regulation, are being forced to be more transparent about their sustainability efforts. We set out to identify some of the issues that are on activist and shareholder agendas that could become the next conflict minerals if Congress or state legislators decide to pick up the cause and require companies to disclose more about how they use certain controversial components or if they engage in questionable practices.

Problem Materials

‘Blood Diamonds': The trend isn't a new one. Consider so-called “blood diamonds” that finance violent rebel groups throughout Africa and Latin America. It served as a precursor to U.S. legislation echoed years later by the conflict minerals rule. A voluntary protocol in place by the World Diamond Council, as well as the multi-national “Kimberly Process,” offer conflict-free certifications intended to eliminate the use of blood diamonds in jewelry and manufacturing supply chains. The Clean Diamond Trade Act, signed into law by President George W. Bush in 2003, demanded U.S. participation in the Kimberley Process. With growing complaints by activists, notably Global Witness (also a forceful proponent of conflict minerals regulations), that the Kimberly Process is failing in its effort, additional regulations might lurk in the future.

‘Death Metal': A geographic hot spot that could lead to new law or regulations is Indonesia, particularly the Bangka Island region. Military violence, often tied to a crackdown on even peaceful demonstrations, the persecution of journalists, and the excessive use of force by police, have long been concerns for human rights groups. As many as 2 million people were massacred in 1965-1966 during a violent purge of the Communist Party, now considered as genocide.

Tin produced in the region is controversial, not just because of ongoing human rights concerns, but for environmental reasons as well. Recent protests have targeted Apple, Samsung, Sony, LG, and others about the damage done to tropical rainforests from tin mining in the country. Members of the environmental group Friends of the Earth berated Apple with more than 24,000 e-mails and letters this summer to demand more information on its use of the tin mined in Indonesia, a request they complain has thus far been ignored.

Palm Oil Problems: Palm oil, also produced in Indonesia and in other countries, is another product that has drawn close attention from activists and could end up on the radar screens of regulators. Groups like the Roundtable on Sustainable Palm Oil have championed sustainably produced palm oil and global standards, citing “environmental destruction and the abuse of human rights.” Palm oil and its derivatives are used in thousands of products, including cooking oil, soap, lipstick, and fuel.

Child labor is also alleged to be widespread in Indonesia's palm oil industry. An investigative report by Bloomberg Business Week, published in July, documented evidence of human trafficking, violence against workers, and slavery.

“Today we are talking about conflict minerals. Tomorrow it could be wood, or other materials. The list can just go on and on.”

—Sonal Sinha,

Associate VP of Industry Solutions,

MetricStream

The Knock on Wood: Certain wood, produced domestically and abroad, could end up on the list of materials that regulators want more information from companies on whether and how they are used.

Where companies get their wood, and how they ensure that proper reforestation programs are in place, is a growing concern. Swedish furniture maker Ikea, for example, uses nearly 1 percent of the total wood used commercially around the world, making it one of the largest users of wood in the retail sector. As such, it has been under pressure from activists to treat that use more responsibly. The company, in its most recent sustainability report, insists that it has done so.

Ikea has bolstered its use of FSC certified timber to nearly 23 percent and has 19 foresters devoted to ensuring that all wood is sourced in compliance with company standards intended to “protect biodiversity, prevent deforestation, and support the livelihoods of communities in forest regions.”  Company standards are also intended to avoid illegal logging.

Cobalt: It wasn't included in the list of four conflict minerals cited by the Dodd-Frank Act, but many speculate that cobalt could be added to the list eventually. The Democratic Republic of Congo, targeted by the rule, is also the largest producer of the world's cobalt supply. Cobalt is used as a blue pigment in many paints and is widely used as a component of lithium ion batteries. Its strength and durability has also made it a preferred metal in tool construction, notably drill bits, and for artificial joints and limbs.

The Enough Project estimates that 60 percent of that production comes from illegal mines. Unsafe working conditions and child labor have been cited by the human rights watchdog.

Dirty Water: A wide range of other physical commodities could also, rather easily, fall under the regulatory umbrella, including the sourcing of cotton, leather, food items, and even water.

“A lot of people are talking about water footprints; it is not only about carbon footprints anymore,” says Mikko Valtonen, business development director for BWise, a global enterprise governance, risk management and compliance software company owned by NASDAQ OMX. “Water is the reason for several wars around the world. There isn't a lot of public reporting about that yet because companies really need to think about it before they announce all the problems they are causing with their water use.”

Poor Sourcing Practices

Factory Conditions: Reports of harsh working conditions and employee suicides at China-based manufacturer Foxconn has been an ongoing PR nightmare for Apple and other tech companies that rely on the cheap labor it provides.

Worker safety also came to light, in dramatic fashion, earlier this year when a garment factory collapse in Bangladesh killed 1,129 workers. Following the disaster, many retailers agreed to sign onto a legally binding European accord that requires retailers fund fire safety and building improvements at the Bangladesh factories they employ. A non-legally-binding effort spearheaded in the U.S. for its companies has been less successful, with companies like Walmart and GAP citing legal liabilities for their refusal to sign on. Although federal legislation to force an EU type of agreement is unlikely, expect to see shareholder activists push a similar agenda.  

SHAREHOLDERS AND SUSTAINABILITY

The following charts from the EY report “Six Growing Trends in Corporate Sustainability” reveals investor concerns about sustainability-related issues.

Survey takers were asked: “Has your company seen an increase in inquiries from investors/shareholders about sustainability-related issues in the past 12 months?”

And … “If yes, which topics are you being asked about?”

Sources: EY; GreenBizGroup.

Human Trafficking and Slavery: Many U.S. regulations can trace their origin to similar efforts that initiated either overseas or on the local level. Potential rules for public companies regarding human trafficking and slavery would be an example of both.

The California Transparency in Supply Chains Act requires many companies doing business in California to disclose efforts they have taken to eliminate human trafficking and slavery from their supply chains. The law applies to retail sellers and manufacturers with annual worldwide gross receipts exceeding $100 million that have either sales or operations in the state.

Leveraging Conflict Minerals Compliance

Given the lengthy list of supply chain issues that could eventually spur new regulations, companies may want to leverage their ongoing conflict minerals efforts to gear up for what is to come.

"For smart businesses to stay ahead of the regulators, they need to look past specific regulations on a micro level and look at the solution holistically,” says Matt Whitteker of Assent Compliance, a business consultancy. “Regulators regulate what's fashionable and what will get those mandating the regulation's votes. It's naïve to try and predict the future, but with a program that gives companies insight into products' material composition, they can rapidly adjust to any new regulation that is passed.”

“We are seeing a lot of customers dealing with conflict minerals and having to look deeper into their supply chains than they ever had to before,” says Matt Thorn, ?co-founder and chief operating officer at Source Intelligence, a software provider that offers a conflict minerals platform.

Companies may have been aware of potential product or labor issues before. “But they didn't have the tools, understanding, or budget to start investigating those things,” he says.

Traditional audits may not be adequate for assessing global supply risks. “When you are talking about human rights and factory conditions, an audit may not catch issues,” he says. “It is just not feasible. You can't audit every factory and supplier if you have thousands of them.”

His firm supplements that traditional effort with social media to expose potential risks, by tracking government information and the concerns of activist groups and NGOs.

The benefit for companies as they slog through conflict minerals due diligence is that they can adapt their work to other potential causes, Valtonen says.

“Are you going to buy a new technology solution for all upcoming legislation?” he asks. “I don't think that makes any sense.” Instead, especially larger companies, should look to maintain a broader compliance perspective, and conflict minerals demands “should be seen as part of the bigger change in the regulatory environment.”

Doing just what is necessary to meet regulatory demands and deadlines isn't enough.  “It's a pretty simple task to send your suppliers a questionnaire,” Thorn says. “But consequences can go unseen if you are only looking at a point of supply or treating this as a pure supply chain tool. Think about solutions that can integrate into other parts of your business. Start small, but think big.”