The comment letters continue to pile up over the Securities and Exchange Commission's proposal to require disclosure of a company's use of “conflict minerals” from Central Africa, as companies beg for clarity and flexibility.
The SEC's proposal, mandated by the Dodd-Frank Act, specifies that companies must determine whether the minerals—several rare compounds commonly used in electronics—appear in their supply chains. If so, the company must also prepare a “Conflict Minerals Report” as part of its annual report and have it audited. According to the proposal, the report should include a description of the company's “due diligence on the source and chain of custody of the conflict minerals” or its “due diligence in determining that the conflict minerals came from recycled or scrap sources.”
Issuers were so worked up about the proposal that the SEC extended the comment period—along with two other SEC proposals related to mining and natural resources—for an additional month to March 2.
The SEC has received 165 comment letters on the proposal on both sides of the issue. “There's a great divide between two groups of commenters,” says David Martin, partner at the law firm Covington & Burling, and former director of the SEC's Division of Corporation Finance. “This isn't about everybody agreeing that something needs to be done, and it's just on a continuum. You've got a whole group that says, ‘I wish we didn't have to do it, and please make it workable,' and you've got a whole other group that wants it done.”
Congress originally included the legislation in the Dodd-Frank Act to discourage companies from using conflict minerals, which warlords in the Congo use to finance their operations. The minerals in question are gold, wolframite (a source of tungsten), and cassiterite (the main source of tin). Electronics, jewelry, construction tools, weapons systems, and aerospace products all use those minerals in critical components.
The comment letters are mostly divisible into the industry voices and institutional investors that push for socially responsible investing.
Commenters generally said that compliance with such a broad rule, with so many undefined terms, will be a challenge. “We believe that without additional clarity in the areas of objective, criteria, and evidence, there will be significant inconsistency and lack of comparability of information in issuers' Conflict Minerals Reports,” Deloitte & Touche wrote in a letter to the SEC. In particular, Deloitte warned, if a company can't determine the origin of the minerals, an independent private-sector outside auditor might not be able to gather enough evidence to form an opinion.
“Compliance officers should figure out a way to establish a due diligence process and determine the source or the custody of any of these conflict minerals.”
—Brian Breheny,
Partner,
Skadden, Arps, Slate, Meagher & Flom
Companies were hoping that the SEC would narrow the language of the rule in the proposal, but open questions still abound, says Brian Breheny, partner at the law firm Skadden, Arps, Slate, Meagher & Flom. For example, the current language doesn't clarify whether a retailer of electronic goods has any obligation to study conflict minerals in the items it sells. Companies must also determine whether the mineral is “necessary” to the production or to the functionality of the product. What exactly does “necessary” mean? The proposal doesn't specify.
“The SEC needs to figure out how to accomplish the purpose of the legislation, while ensuring that it provides companies with guidance regarding what constitutes reasonable and sufficient due diligence,” says Amy Lehr, an associate in Foley Hoag's corporate social responsibility practice.
While some compliance questions could be answered in the final version of the rule, attorneys are not advising companies to wait around. “Compliance officers should figure out a way to establish a due diligence process and determine the source or the custody of any of these conflict minerals,” Breheny says. “I would also start to do some research as to which third-party auditors people are going to use, what's going to be involved in that process, and how much it is going to cost.”
ACCOUNTING FIRMS COMMENT
What follows are comments from Big 4 accounting firms KPMG, Deloitte, and Ernst & Young on the conflict mineral proposal:
Applicable GAO Standards:
We are concerned that the lack of specificity as to the relevant GAO standards to be followed by the auditor could result in significant variability in the type of engagements performed by auditors, which would affect the nature and extent of procedures performed. In addition, we note that the reporting standards related to Attestation Engagements differ significantly from the standards related to Performance Audits. Therefore, to the extent an issuer may engage an independent private sector auditor to perform the conflict minerals audit under either set of GAO standards, investors would be provided with different types of auditors' reports. This could be confusing to investors and might result in them making inappropriate inferences about the nature and extent of due diligence performed by the issuer or the extent of assurance provided by the audit.
Independence
The Commission should clarify the particular independence standards to which the independent private sector auditor would be subject. For instance, we note that GAGAS includes independence standards that generally extend beyond those required by the AICPA, but that are not identical to the SEC's independence requirements. Clarifying the relevant independence standards applicable in these engagements would avoid confusion regarding the level of independence of the third party performing the conflict minerals audit as compared to the independence of the issuer's registered independent public accounting firm.
—Ernst & Young
We believe that without additional clarity in the areas of objective, criteria, and evidence, there will be significant inconsistency and lack of comparability of information in issuers' Conflict Minerals Reports. In turn, we believe this will lead to inconsistency in the procedures that independent private sector auditors may perform and in the content of IPSA reports. We note an additional potential consequence that may result from a lack of suitable criteria or guidance around sufficiency of evidence, namely, that an independent private sector auditor may not be able to form an opinion on an issuer's Conflict Minerals Report. We therefore recommend that the final rule provide the criteria needed for issuers to prepare their Conflict Minerals Report and for independent private sector auditors to perform the IPSAs.
—Deloitte
Attestation standards have a standardized reporting structure which would allow for greater comparability among audit reports. However, as the SEC highlighted in footnote 101, an attestation engagement requires suitable evaluation criteria. The GAGAS standards for attestation incorporate the AICPA general standard for criteria: "the practitioner [auditor] must have reason to believe that the subject matter is capable of evaluation against criteria that are suitable and available to users."
If we assume that the adequacy of the due diligence is the subject being evaluated, reference might be made to the due diligence guidance referred to in footnote 145 as drafted by the OECD which has since been finalized. This appears to be the most standardized criteria. However, that guidance also indicates that due diligence in conflict-affected and high risk areas presents practical challenges and that flexibility is needed in the application of due diligence. This flexibility may not permit consistent assessment of the subject matter. If the Commission intends that issuers should have flexibility in applying due diligence procedures, we recommend that this be clearly indicated in any final rule.
—KPMG
Source: SEC Comment Letters.
A coalition of 13 industry groups submitted a letter imploring the SEC to make clear a legal standard for compliance, adopt transition rules that recognize current infrastructure limitations (which, in Central Africa, can be severe), and only apply the regulation to issuers that control production and supplier sourcing. The group also urged that issuers be allowed to give the SEC a separate report, instead of adding conflict mineral disclosures to their Form 10-K filing.
Other critics of the proposal, such as law firm Davis, Polk & Wardwell, also argued in comment letters that there should be minimum threshold in use of conflict minerals to trigger the new disclosures.
Indeed, this question of whether the disclosure requirement would put companies at a competitive disadvantage, or otherwise cause headaches with other regulatory environments in which the companies operate, also weighed on commenters' minds. “U.S. rules are generally more prescriptive than European approaches, which will tend to be more principled-based, but it's hard to say whether this rule would create a direct conflict,” says Mark Bergman, co-head of the capital markets practice at the law firm Paul, Weiss, Rifkind, Wharton & Garrison.
The SEC is required to pass its final conflict-mineral disclosure rule by April 15. Worse, the rule has no room for a delayed effective date—meaning companies need to be in compliance for their fiscal year as of the day the final rule is issued, says Elizabeth Petersen, associate at the law firm Jones Day. Though companies won't have to make their first Form 10-K filing until the following year, as long as their year-end date is before April 15, they do already need to have the processes in place prior to beginning that fiscal year, she says.
Plenty of letter writers took issue with the rule's taking immediate effect. Companies should not be required to do the new reporting for at least one year after the rule's adoption and the mineral report should be due at a different time than the annual report, to avoid burdensome deadlines, wrote the law firm Davis, Polk, & Wardwell.
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