Some Had a Head Start on Conflict Minerals Compliance

The Dodd-Frank Act has often been referred to as Wall Street reform, but the law includes several provisions that affect companies in many industries. The recently finalized “conflict minerals” rule is among the most onerous of those not germane to the financial services sector.

Companies from golf club manufacturers to circuit board makers must now comply with the rule and prepare for reporting requirements that begin next year, and many of them say it comes with a huge compliance burden. Some companies have been working on the conflict minerals problem for years, however, spurred by activists who have pushed for more transparency in the area long before the Dodd-Frank Act required it. How some of the world's largest companies are already working to comply with these new obligations may provide a game plan for their peers of all sizes.

The new rules, finalized by the Securities and Exchange Commission in August, require companies to disclose information each calendar year on the source of “conflict minerals”—including tantalum, tin, gold, and tungsten—found in their products, using a newly created Form SD. Congress included the provision in the Dodd-Frank Act to address concerns over the role of these minerals in funding armed militias in the Democratic Republic of the Congo and adjoining countries.

Companies must conduct a “reasonable” country of origin inquiry to determine if the minerals originated from the covered countries; track and document the source and chain of custody; and include findings in a Conflict Minerals Report that is independently audited and posted online for at least one year.

After a long battle by many industries to push for a less onerous version of the conflict minerals rules, however, many companies now appear to be shifting to planning for compliance with it. While no one is disputing the challenges posed by the new rules, some of the initial consternation may be fading. “Many companies are a lot more comfortable with what the rules are now and are hopeful that they can handle it,” says Jonathan Hughes, director of Assent Compliance, a consultant with a conflict minerals practice.

Follow the Leaders

They may find more comfort in the example of companies that have been working on conflict mineral-free manufacturing processes for the last few years, in order to avoid the ire of activists. Each year, for example, the Enough Project of the Center for American Progress issues a report that assesses how well consumer electronics companies have progressed toward conflict-free supply chains. This year's report found that four leading electronics companies—Intel, HP, Motorola Solutions, and Apple—have established conflict minerals programs that “pave the way for the rest of the industry.”

Chipmaker AMD—five on the Enough Project's list—has been working on conflict minerals since well before the final rules were adopted. While Tim Mohin, director of corporate responsibility, sees ranking as validation of his company's efforts, he still thinks AMD can do better. The key to its initial success, he says, was perseverance.

“When the regulation was passed, we were in the same boat that a lot of other folks are now, which is throwing up our hands and saying, ‘This is impossible, it can't be done,'” he says. “There was such fear and loathing over the rule. We had to zoom out of that, look at what this rule is about and what we are trying to accomplish here. Yes, we can complain about how this is going to stress our systems, but it is important to keep the final goal in mind.”

It also helped that the company wasn't starting from zero. Mohin says his industry first encountered the issue long before the law was passed. Electronics makers have been targeted as users of tantalum for over a decade, frequently through celebrity-fronted campaigns calling attention to its role supporting violence in the Congo. That longstanding awareness allowed many of these companies to be proactive ahead of the rule's passage or, at the very least, prepared for its inevitability.

Reaching Out to Suppliers

“The biggest challenge was to work with suppliers and get them to understand what we were asking for and why we were asking for it,” Mohin says. “The only way this law works is if you have your full supply base completely aware and cooperating.”

“Many companies are a lot more comfortable with what the rules are now and hopeful they can handle it.”

—Jonathan Hughes,

Director,

Assent Compliance

Hughes says suppliers and vendors should reach out to the companies they do business with as soon as possible, since they may find much-needed assistance on conflict minerals compliance. “They aren't necessarily going to conduct any of the steps for you,” he says. “They aren't going to do your country of origin inquiry or due diligence, but they will definitely help put you on the right path.”

AMD has been able to track the materials it uses back to about 100 individual smelters that can be analyzed to ensure that they are not sourcing materials from the conflict-ridden zone in Central Africa. Thus far, AMP has been able to certify 13 of those smelters as compliant. “The crown jewel of our entire compliance strategy is the conflict-free smelter program,” Mohin says. “Without that program we don't have a system at all.”

AMD relied heavily on its internal audit function to get the certification process started. “We were able to take a core competence in our industry, which was auditing, and apply that to a very different problem set, the smelter issue,” he says. “Once we identified the smelters as that choke point and we developed a protocol and process, we certified auditors and we went to these places to build relationships. Now we have a growing list of smelters who aren't supporting the conflict.”

PUTTING THE LEGAL TEAM ON ALERT

A drawback of the new rule is that activist shareholders and others will be watching closely. If compliance efforts don't meet their ideal they may sue.

“Those shareholders who are very aggressive in this kind of issue are going to be looking at your competitors to see what they reported,” says Jane Luxton, a partner at law firm Pepper Hamilton. “You not only have to do your own best job, you have to imagine how your competitors will be reporting because you will be looked at side by side.”

Companies will also have to work to ensure that their suppliers are in compliance with the rules. “Some corporations require their suppliers to show proof that they've done audits and due diligence,” says Robert Weiner, managing director and regional counsel for IPSA International, an investigative consulting and risk advisory firm. "They may represent that they conducted due diligence, but what did they really do? To what extent can you reasonably rely on the information that you are being provided? You are going to start seeing watchdog groups and activist shareholders and others saying, ‘Well, that wasn't good enough, you have to do more.'”

Still, if activists shareholders bring lawsuits on the issue, they might have trouble getting support from a larger class action. Amy Goodman, a partner with the law firm Gibson, Dunn & Crutcher, in a recent webcast sponsored by the firm, said shareholder suits are generally brought when people expect large recoveries and “it is hard to imagine that would happen in this case.”

Nevertheless, “we may very well be surprised by some of the reputational damage that comes from some of these disclosures,” she says, adding that companies should be prepared for whistleblowers to report them if they are non-compliant.

—Joe Mont

Tracing minerals to the smelter, rather than the mine itself, still conforms to standards set by the Organization for Economic Co-operation and Development. The final SEC rules mandate that conflict minerals supply chain due diligence be performed in accordance with “a nationally or internationally recognized due diligence framework.” For now, the OECD Guidance, adopted by 41 countries, is the only established framework available.

The effort to avoid conflict minerals is also not a new concept to Motorola Solutions. It launched its Solutions for Hope Project last July, which is an initiative to source conflict-free tantalum, a mineral used in capacitors for electronic products. Its partner in the effort is AVX Corporation, a leading tantalum capacitor manufacturer.

At the time, the company was concerned that efforts to secure conflict-free supply chains would lead to a de facto embargo of minerals from the region, actually hurting those whose livelihoods depend on artisanal mining. “Taking away their economic stability will only exacerbate the problem and not solve it,” says Michael Loch, director of supply chain sustainability at Motorola Solutions.

In response, Solutions for Hope developed its own network of vetted suppliers. It supports, and is supported, by other initiatives such as the conflict-free smelter program by the Global e-Sustainability Initiative (GeSI) and efforts of the Electronics Industry Citizenship Coalition (EICC).

SHOULD YOU REPORT?

The following selection from a guide published by IPC – Association Connecting Electronics Industries explains which companies are subject to conflict minerals reporting requirements.

The final rule applies to a company that uses conflict minerals or their derivatives if:

(1) The company files reports with the SEC under the Exchange Act, and

(2) The minerals are “necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company.

The SEC did not to provide a definition for several key terms used throughout the final rule. Instead, the SEC has provided guidance to help issuers determine the applicability of the requirements under the final rule. The SEC states that the flexibility provided will allow issuers to tailor their due diligence to their individual needs, thereby reducing the cost of the regulation.

“Manufacture” was not defined; however the SEC states that the term does not describe an issuer that only services, maintains, or repairs a product containing conflict minerals. “Manufacture” also does not include mining or contracting to mine.

“Contract to manufacture” applies to companies that have “actual influence” over the manufacturing of a product. A company that contracts the manufacturing of components for their products and has influence over the materials, parts, ingredients or components to be included in any final product that contains necessary conflict minerals is subject to disclosure requirements. A company is not considered to have actual influence over the manufacturing of a product if it:

Affixes its brand, marks, logo, or label to a generic product manufactured by a third party

Services, maintains, or repairs a product manufactured by a third party

Specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product.

“Necessary to the functionality” applies to conflict minerals that are:

Contained in the product or any component of the product

Intentionally added to the product or any component of the product

Necessary to the product's generally accepted function, use, or purpose

If a conflict mineral is incorporated into a final product for purposes of ornamentation, decoration or embellishment, that conflict mineral would be considered necessary to the functionality of the product.

The SEC provides the following supplemental information to help companies determine if they must comply with the conflict minerals regulation:

Conflict minerals information is required for the calendar year in which the manufacturing of the product that contains necessary conflict minerals is completed.

Only a conflict mineral contained in the product is considered “necessary to the functionality or production” of that product. The final rule does “not consider a conflict mineral used as a catalyst or in another manner in the production process of a product to be ‘necessary to the production' of the product if that conflict mineral is not contained in the product.”

A conflict mineral in a physical tool or machine used to make a product is not considered “necessary to the production” of the product and not subject to disclosure requirements.

The final rule does not provide a de minimis exception. If a trace amount of the conflict mineral is found in the product, then the conflict mineral is considered to be “necessary to the production” of the product and therefore subject to disclosure requirements.

Source: SEC.

“Part of Solutions for Hope was to get material flowing through the ‘closed pipe” system so that the verification and traceability programs could be evaluated, utilized, and tested,” Loch says. “Once the independent auditor verified the systems were in place and we visited the mine site, trade route, and export depot, the shipments began.”

The use of an independent auditor also helped open the project to other companies, necessary to keep the project sustainable. Monthly shipments are now on track. Like other initiatives, it will need to be “continuously monitored to establish credibility” and provide the necessary mine and processor information required by the SEC rules, Loch says.

Industry Groups Step Up

Companies are also increasingly relying on industry groups and trade associations to help then navigate the rules and share data. “The scope of some of the work that needs to be done is really beyond an individual company's capabilities and that's why working together is so important,” says Fern Abrams, director of government relations and environmental policy for IPC - Association Connecting Electronics Industries, the association for printed circuit board and electronics manufacturing service companies.

“Although this is not an environmental issue, many companies have assigned leadership on this issue to their environmental department,” she adds. This makes sense because they have systems in place to satisfy other regulations that ban the use of certain hazardous materials and track, for example, lead content. These protocols can be adapted to meet the new requirements.

Tanya Bolden, manager of corporate responsibility for the Automotive Industry Action Group, says her group has worked closely with the electronics industry, in particular the Electronic Industry Citizenship Coalition, which has developed a conflict-free smelter list and drafted industry protocols for tantalum, tin, tungsten, and gold.

Earlier this month, AIAG and iPoint, a provider of environmental compliance products, announced that a working group with representatives from two dozen member companies — including automotive industry OEMs and suppliers like Chrysler Group, Ford, and Honda — collaborated on the development of a Web-based data management tool that will help supply chain participants identify whether their products contain conflict minerals.

“Tools that benefit the automotive supply chain can also benefit other industries,” Bolden says, explaining the need for scalable systems that can go from data collection to reporting to auditing.