By: Kelly Richardson, Buck Endemann and Achraf Farraj
On August 22, 2012, the Securities and Exchange Commission (the SEC) adopted a final rule implementing the conflict minerals provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act).[1] The final rule and its adopting release clarify several issues raised by the SEC’s proposed rule, published in the Federal Register on December 23, 2010. Significantly, the final rule differs from the proposed rule in one key respect: how to determine whether a conflict mineral is “necessary to the functionality or production” of a product.
The Dodd-Frank Act, enacted in 2010, focuses primarily on financial regulatory reform.[2] One relatively little-noticed provision, however, requires SEC-reporting companies to make certain annual disclosures if “conflict minerals” are “necessary to the functionality or production of a product manufactured” by such SEC-reporting companies.[3] The definition of “conflict minerals” includes gold, cassiterite and its derivative tin, columbite-tantalite and its derivate tantalum, and wolframite and its derivative tungsten.[4] Among other places, these minerals are found in the Democratic Republic of Congo (DRC), which has suffered years of armed conflict.[5] Evidence suggests that the mining and trade of conflict minerals helps finance paramilitary groups that perpetuate the conflict.[6] Whether the minerals originate from the DRC or an adjoining country, however, does not matter: the final rule classifies all such materials as “conflict minerals.”[7]
Conflict minerals are used extensively for a variety of applications, particularly in the aerospace, automotive, construction, electronics, industrial equipment, and jewelry industries.[8] In the release accompanying the proposed rule, the SEC estimated that approximately 5,994 registered companies would be required to disclose the use of conflict minerals in their products.[9]
Neither the final rule nor the proposed rule define when a conflict mineral “is ‘necessary to the functionality or production’ of a product,” however.[10] According to guidance contained in the adopting release, any of the following factors, either individually or in the aggregate, may be determinative:
(a) whether a conflict mineral is contained in and intentionally added to the product or any component of the product and is not a naturally-occurring by-product; (b) whether a conflict mineral is necessary to the product’s generally expected function, use, or purpose; or (c) if a conflict mineral is incorporated for purposes of ornamentation, decoration or embellishment, whether the primary purpose of the product is ornamentation or decoration.[11]
The first consideration reflects a departure from the proposed rule, as the SEC has determined that a conflict mineral must be contained in a product to be necessary to the functionality or production of that product.[12] This construction could favor the exclusion of SEC-reporting companies that only use conflict minerals as catalysts, provided that all traces of the conflict minerals are completely washed away before the product is considered “final.”[13] The SEC cautioned that even trace levels of conflict minerals would trigger the application of the final rule.[14]
The SEC also decided against including a de minimis threshold for determining the necessity of conflict minerals to the functionality or production of a product, finding that such a threshold would be inconsistent with the Congressional intent of the Dodd-Frank Act, noting that “there are instances in which only a minute amount of conflict minerals is necessary for the functionality or production of a product.”[15] However, the SEC has determined that whether a conflict mineral was “intentionally added” to a product is a “significant factor” in determining whether such conflict mineral is necessary to the functionality or production of a product.[16] This interpretation could be used to exclude products that contain a conflict mineral as a contaminant or as a result of naturally-occurring processes.
The second consideration is also a departure from the proposed rule. Whether a conflict mineral is necessary to the product’s generally expected function, use, or purpose is a straightforward but expansive alternative to the proposed rule’s “basic function” and “economic utility” tests referenced in the release accompanying the proposed rule. At the urging of commentators, the SEC determined that the line-drawing required by the proposed tests would be unworkable.[17] The adopting release recognizes that a product may have multiple generally expected functions, uses, and purposes (e.g., a smart phone that can place and receive calls, take photographs, and play stored music), but a conflict mineral need only be necessary for any one purpose in order to trigger the rule’s reporting obligation.[18]
The last consideration could favor the exclusion of a product in which a conflict mineral is incorporated for the purposes of ornamentation, decoration, or embellishment (rather than functionality), unless such purpose is the primary purpose of the product.[19] Although this test may seem straightforward, the “primary purpose” standard could create line-drawing issues For example, whether the primary purpose of a gold-accented picture frame is decoration or the display of art could be subject to debate. While a trophy may be decorative in a sense, trophies are generally not appreciated for their aesthetic qualities so much as they stand as markers for accomplishment. Conversely, a set of glassware with gold accents is primarily used to serve drinks, but such glassware is probably only used because of its aesthetic quality. How the SEC will interpret and apply this consideration remains to be seen.
In sum, the adoption of the final rule and accompanying release implementing the Dodd-Frank Act’s conflict minerals provision provides some measure of clarity to SEC-reporting companies that use conflict minerals in their products. Disclosure must be made by May 31 after the end of a subject company’s most recent fiscal year end, beginning January 1, 2013.[20] As the deadline for complying with the SEC’s reporting requirements approaches, SEC-reporting companies must think hard about how to address the remaining ambiguities.
[1] See Conflict Minerals, Exchange Act Release No. 67,716 (Aug. 22, 2012), available at http://www.sec.gov/rules/final/2012/34-67716.pdf.
[2] See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203 (2010).
[3] Id. § 1502(b).
[4] See Exchange Act Release No. 67,716, supra note 1, at 352 (to be codified at 17 C.F.R. § 249b.400).
[5] See Simon Robinson, The Deadliest War in the World, Time Magazine (May 28, 2006), available at http://www.time.com/time/magazine/article/0,9171,1198921,00.html.
[6] See U.S. Dep’t of State, Country Condition Reports on Human Rights Practices for 2011: Democratic Republic of the Congo 15 (2011), available at http://www.state.gov/j/drl/rls/hrrpt/humanrightsreport/index.htm?dlid=186183 (“Clandestine trade in minerals and other natural resources facilitated the purchase of small arms to commit abuses and reduced government revenues needed for increasing security and rebuilding the country.”).
[7] See Exchange Act Release No. 67,716, supra note 1, at 40.
[8] Id. at 34.
[9] See Conflict Minerals, 75 Fed. Reg. 80948, 80966 (Dec. 23, 2010).
[10] See Exchange Act Release No. 67,716, supra note 1, at 81.
[11] Id. at 82.
[12] Id. at 83.
[13] Id. at 85.
[14] Id.
[15] Id. at 93.
[16] Id. at 86.
[17] Id. at 87.
[18] Id. at 88.
[19] Id.
[20] Form SD, General Instruction B.