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New SEC Guidance Provides Answers on Conflict Minerals Disclosures

April 9, 2014Articles

As the deadline approaches for publicly traded U.S. companies to file new conflict minerals reports, the Securities and Exchange Commission (SEC) has issued new guidance designed to help companies prepare the mandatory reports. Many companies have had questions about what the new conflict minerals rules mean to them, and the first of the reports required by the rules are due May 31, 2014. The new SEC guidance in the form of FAQs (available here) helps resolve several interpretive issues companies have been grappling with.

The Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to promulgate rules regarding the use of conflict minerals by public companies. Conflict minerals are defined as four minerals – gold, cassiterite (tin), columbite-tantalite (tantalum), and wolframite (tungsten) – that are commonly mined in parts of central Africa and the mining of which has been used to fund armed conflict and human rights abuses. Publicly traded companies whose products include those four minerals must make a reasonable inquiry to determine whether the conflict minerals they used came from that region and, in some cases, file a report with the SEC.

If the minerals originated in the Democratic Republic of Congo or any adjoining countries or the source cannot be determined, companies must conduct additional due diligence and conduct an independent private sector audit of their supply chain. Many companies are far removed from the source of the conflict minerals used in their products and often use multiple minerals in some products, making the analysis complex and time consuming. Perhaps in recognition of the increased attention public companies are giving to these new disclosures as the reporting deadline approaches, the SEC has provided some new guidance.

The guidance provides answers in two key areas:

  • First, the SEC clarified how a company must handle multiple products or one product containing minerals from different sources, some of which cannot be determined. An audit is not required during the first two or four reporting years (depending on a company’s size) if a company cannot determine whether one of its products contain conflict minerals. However, without an audit of its process, a company that could not determine whether its products contain conflict minerals cannot describe any of its other products as conflict-mineral free.
  • Second, the SEC clarified who can perform the independent private sector audits (IPSA) required by the rules and what those audits must contain. The auditor does not need to be a certified public accountant but must perform the audit in accordance with Government Accountability Office standards. The audit does not need to assess the quality of the due diligence actually performed by a company but rather determine whether the due diligence described in the resulting report conforms to the nationally or internationally recognized due diligence framework the company was following and whether the reporting company actually followed the steps described in the report.

Below are the questions and answers the SEC released, grouped by topic:

Multiple Products or Products Containing Multiple Minerals

Question 14: If, after exercising due diligence on the source and chain of custody of its conflict minerals, an issuer determines that at least one of its products may be described as “DRC conflict undeterminable,” is the issuer required to obtain an IPSA of its Conflict Minerals Report during the temporary transition period (four years for smaller reporting companies and two years for all other issuers)? 

Answer: No.  The Commission stated in the adopting release that, during the transition period, issuers with products that may be described as “DRC conflict undeterminable” are not required to obtain an IPSA of their “Conflict Minerals Report.”  If any of an issuer’s products are “DRC conflict undeterminable” during this period, the issuer is not required to obtain an IPSA of its Conflict Minerals Report. 

Question 15: If an issuer does not obtain an IPSA of its Conflict Minerals Report because one of its products is “DRC conflict undeterminable,” may it describe any of its other products as “DRC conflict free” in its Conflict Minerals Report?

Answer: No.  An issuer is not required, under the rule, to describe any qualifying products as “DRC conflict free” in its Conflict Minerals Report.  The Commission stated in the adopting release, however, that an issuer may choose in its Conflict Minerals Report to describe its products with conflict minerals sourced from the DRC or its adjoining countries as “DRC conflict free” if the issuer is able to determine that the conflict minerals in those products did not finance or benefit armed groups in that region based on its due diligence.  The rule defines due diligence as including an IPSA of the Conflict Minerals Report.  Therefore, to be able to describe qualifying products in its Conflict Minerals Report as “DRC conflict free,” an issuer must have obtained an IPSA.

Question 16: During the temporary transition period, an issuer has products that it manufactured or contracted to have manufactured with conflict minerals that are necessary to the functionality or production of those products.  Each product is composed of a number of conflict minerals from different sources.  In its Conflict Minerals Report, how should the issuer describe any particular product based upon the various combinations of conflict minerals in the product? 

Answer: During the temporary transition period, if an issuer has a product that would qualify as “DRC conflict free” except that the product contains a conflict mineral that the issuer is unable to determine did not originate in the DRC or an adjoining country, or is unable to determine did not directly or indirectly finance or benefit armed groups in those countries, the issuer may not describe that product as “DRC conflict free.”   Both during and after the temporary transition period, however, if an issuer determines that a product contains a conflict mineral that did finance or benefit armed groups in the DRC or an adjoining country, it must describe that product as “having not been found to be ‘DRC conflict free.’”

Question 19: A product manufactured by an issuer or contracted by an issuer to be manufactured includes some conflict minerals from recycled or scrap sources, which would not require the issuer to file a Conflict Minerals Report.  It also includes conflict minerals not from recycled or scrap sources, which would require the issuer to file a Conflict Minerals Report.  Must the issuer provide the required disclosures about the conflict minerals from recycled or scrap sources in the Conflict Minerals Report?  Would the IPSA of the Conflict Minerals Report include the conflict minerals from recycled or scrap sources?

Answer: If the issuer determines that any conflict minerals in its product came from recycled or scrap sources, the issuer must include in the body of its specialized disclosure report on Form SD the required disclosures for those conflict minerals.  The issuer must also file a Conflict Minerals Report as an exhibit to the Form SD that includes a description of the due diligence it performed and any other required disclosures about its conflict minerals that are not from recycled or scrap sources.  The Conflict Minerals Report would not need to include the disclosures for the conflict minerals from recycled or scrap sources.  An issuer is only required to obtain an IPSA of its Conflict Minerals Report and not of the disclosures contained in the body of its Form SD.

Independent Private Sector Audits

Question 13: May an auditor that is not a certified public accountant perform the independent private sector audit (“IPSA”) of an issuer’s Conflict Minerals Report pursuant to the Performance Audit provisions in the U.S. Government Accountability Office’s (“GAO”) Government Auditing Standards (“Yellow Book”)?

Answer: Yes, if the applicable requirements are met.  Section 1502 of the Dodd-Frank Act requires the IPSA of an issuer’s Conflict Minerals Report to be conducted in accordance with standards established by the GAO.  The GAO staff has informed the Commission staff that the Yellow Book is applicable to the IPSA of the Conflict Minerals Report, and that, in addition to the general provisions of the Yellow Book, auditors are permitted to use either the provisions for Attestation Engagements or Performance Audits.  According to the Yellow Book, although Attestation Engagements require that auditors be licensed certified public accountants, Performance Audits allow auditors, including auditors other than certified public accountants, to perform audits if they meet the applicable requirements under the Yellow Book, which can be found at www.gao.gov/yellowbook.  Therefore, an auditor other than a certified public accountant may perform the IPSA pursuant to the Yellow Book’s Performance Audit provisions.

Question 17: Does the scope of the IPSA include the completeness or reasonableness of the issuer’s due diligence, including with respect to which products the issuer described as “DRC conflict free” or “having not been found to be ‘DRC conflict free,’” or which suppliers are covered by the due diligence measures?   

Answer: No.  The IPSA scope is limited to the IPSA objective provided in the rule.  The IPSA objective is to express an opinion or conclusion as to whether the design of the issuer’s due diligence measures as set forth in, and with respect to the period covered by, the issuer’s Conflict Minerals Report is in conformity, in all material respects, with the criteria set forth in the nationally or internationally recognized due diligence framework used by the issuer, and whether the issuer’s description of the due diligence measures it performed as set forth in the Conflict Minerals Report, with respect to the period covered by the report, is consistent with the due diligence process that the issuer undertook.  The IPSA is not required to cover any matter beyond that objective, including the completeness or reasonableness of the due diligence measures actually performed.  The following diagram demonstrates the two distinct parts of the IPSA objective.

As shown, the objective is to compare A to B and C to D.  Any other comparison would be outside the IPSA scope.
 
Question 18: The nationally or internationally recognized due diligence framework used by an issuer may include procedures for obtaining information about a conflict mineral’s country of origin.  If so, this aspect of the nationally or internationally recognized due diligence framework would encompass the reasonable country of origin inquiry requirement under the rule.  In that situation, would the IPSA also include the issuer’s reasonable country of origin inquiry?

Answer: No.  The IPSA does not need to include the reasonable country of origin inquiry because, under the rule, that inquiry is a distinct step separate from the due diligence process.    As a result, the independent private sector auditor need only opine on whether the design of the issuer’s due diligence framework is in accordance with the portion of the nationally or internationally recognized due diligence framework beginning after the country of origin determination.  With regard to the second part of the IPSA objective, the issuer’s conflict minerals report is required to describe the due diligence measures it undertook.  As such, the independent private sector auditor need only opine on whether the issuer actually performed the due diligence measures described in the report after the issuer determined it had reason to believe its conflict minerals may have originated in the DRC or an adjoining country.

Question 20: The second part of the IPSA objective is to express an opinion or conclusion as to whether the issuer’s description of the due diligence measures it performed, as set forth in the Conflict Minerals Report, with respect to the period covered by the report, is consistent with the due diligence process that the issuer undertook.  The “period covered by the report” is the calendar year.  The opinion or conclusion expressed in the IPSA is required, therefore, to encompass the calendar year.  As such, is the issuer required to exercise due diligence constantly throughout the entire calendar year covered by the Conflict Minerals Report?  Could the issuer’s due diligence measures described in the Conflict Minerals Report extend beyond the calendar year?

Answer: An issuer’s due diligence measures must apply to the conflict minerals in products manufactured during the calendar year.  This requirement, however, does not imply that due diligence measures must be carried out constantly throughout the calendar year.  It is also possible that the issuer’s due diligence measures may begin before or extend beyond the calendar year.

Question 21: The IPSA objective is to express an opinion or conclusion as to whether the design of the issuer’s due diligence measures as set forth in, and with respect to the period covered by, the issuer’s Conflict Minerals Report is in conformity, in all material respects, with the criteria set forth in the nationally or internationally recognized due diligence framework used by the issuer, and whether the issuer’s description in the Conflict Minerals Report of the due diligence measures it performed with respect to the period covered by the report is consistent with the due diligence process that the issuer undertook.  Although the rule requires that the issuer include in its Conflict Minerals Report a description of the due diligence it exercised, it does not require a separate description of the design of its due diligence framework.  The rule indicates, however, that the auditor must express an opinion or conclusion as to the design of the issuer’s due diligence measures “as set forth in” the Conflict Minerals Report.  Does the rule require that an issuer provide a full description of the design of its due diligence in its Conflict Minerals Report?

Answer: No.  The rule does not require an issuer to include a full description of the design of its due diligence in the Conflict Minerals Report.  Under the rule, however, the due diligence measures undertaken that are the subject of the second part of the IPSA must be described in the Conflict Minerals Report, and the description must be in sufficient detail for the auditor to be able to form an opinion or conclusion about whether the description in the Conflict Minerals Report is consistent with the process the issuer actually performed.

Questions regarding the Conflict Minerals Disclosures may be directed to David Lavan at [email protected] or (202) 372-9122.