backAs the deadline for submission of a companys Form SD draws closer, we continue to field questions from clients hitting on important concepts underlying threshold issues regarding the scope and content of their required disclosures. [1]
We also note that the SEC recently released additional FAQs covering conflict minerals disclosures. [2] Frankly, there wasnt much content in the FAQs that was surprising and the great majority mirrored what many practitioners have been saying for months.
Barring receipt of responses from suppliers indicating otherwise, a company should be in a position to conclude that it has no reason to believe that conflict minerals contained in its products may have originated from the covered countries if the company conducted, in good faith, a reasonable inquiry into the country of origin of any necessary conflict minerals contained in its products. We believe that the most significant benefit from this conclusion would be the companys ability to simply file a Form SD (and provide appropriate website disclosure) that describes this determination, the companys Step Two reasonable country of origin inquiry (RCOI) undertaken, and the results of that inquiry without the need to conduct further due diligence or to file a Conflict Minerals Report.
Take, for instance, a company that commenced its inquiry early in 2013, assembled a group of professionals (both internal and external that have helped guide the companys interpretation of the Rule and its application to the companys circumstances), implemented a considered procedure, received reliable responses from suppliers, analyzed survey responses, and verified that procedures were followed. Such a company has surely conducted a reasonable inquiry and is entitled to rely on the results of such inquiry.
Other factors that would support the reasonableness of a companys inquiry include:*Began inquiry early and retained focus;
*Obtained responses from over 65% of suppliers surveyed (including responses from some suppliers noting that they were still completing their conflict minerals work) none of which indicated that a supplier had reason to believe that it supplied the company with products containing conflict minerals that originated from the DRC;
*Engaged outside experts to provide interpretative guidance and counsel;
*Assembled a diligent and knowledgeable internal team or contracted with reputable vendors to provide insight into a companys supply chain and/or outsourced the supplier survey and response process; and
*Maintains membership in groups formed to address compliance with the Rule (such as industry trade associations, EICC-GeSi, or other organizations). When viewed in the context of reliable figures documenting that less than 1 percent of gold, 2-4 percent of tungsten, and 6-8 percent of tin originate from the DRC, [3] the reasonableness of a companys belief that they have no reason to believe conflict minerals present in their products originated in the DRC when they have conducted a thoughtful inquiry, and evinced no reasons to believe otherwise, is hard to deny. [4]
On the flipside, there are clearly situations when it would not be reasonable for a company to conclude at Step Two that it has no reason to believe that conflict minerals in its products originate from the DRC countries.
Examples might include companies that:
*Possess little internal expertise surrounding conflict minerals and didnt assemble an internal team or hire a third-party to assist in structuring or conducting a reasonable inquiry;
*Resisted undertaking any inquiry until the first quarter of 2014;
*Experienced low response rates from suppliers (15% - 25%); and
*Conducted little or no follow-up with suppliers. Take, for instance, a company that did not commence its inquiry until January 2014. The companys inquiry did not take the form of an organized inquiry but rather was conducted in an unorganized and undocumented fashion. The companys inquiries were not tightly written to reflect the requirements of the Rule. No suppliers checked the box indicating that any conflict minerals could have come from DRC, as the RCOI requirements were poorly paraphrased in the companys survey. Twenty-five percent of suppliers replied to the company in some fashion. Responses were not tracked closely nor were they followed-up on.
We dont think that under this set of facts, a company can be confident that just because they have not heard from any suppliers that relevant conflict minerals may originate in the DRC countries (and they themselves have not uncovered information to the contrary), that the company has no reason to believe and could therefore end its inquiry at Step Two. We believe the reasonableness overlay to the RCOI implies a more substantial level of inquiry akin to the factset outlined in question 1 before a company can conclude that it has no reason to believe that any of its products contain conflict minerals that originated in the DRC.
We dont believe the Rule was elegantly drafted to address this undesirous situation. However, if this is where a company finds itself there at least seems an intent by the SEC to direct companies down a path (during the first two years) toward filing Undeterminable.
According to the Rule, Undeterminable is not a disclosure status that a company may disclose after conducting only an RCOI. In order to reach an Undeterminable disclosure status, a company must conduct an RCOI, conclude that it does have a reason to believe conflict minerals came from the covered countries, conduct due diligence on the source and chain of custody of those conflict minerals following the OECD framework, and only then, if a company cannot conclude that its conflict minerals did or did not originate from the covered countries, may a company file an Undeterminable Form SD.
While we dont consider it to be an ideal approach, the reality is that some companies are in this position. If a company ends up in a spot where they dont believe theyve conducted a reliable RCOI, we think the better approach is not to say weve got a conflict mineral problem, , filing a conflict minerals report and conducting an audit reaching this point would require true due diligence on a companys behalf. In the alternative, we would encourage these companies to be forthcoming in their disclosures, assume there are reasons to believe conflict minerals came from covered countries for RCOI and due diligence purposes, and be transparent about the fact that the companys response to the required disclosures has been less than optimal but explain why the company is Undeterminable at the present time.
Since the Rule does not contain a exception, all responses indicating the presence of conflict minerals in a product that are believed to be from a covered country should be taken seriously. Luckily for companies that receive late notices from suppliers, the Rule does not require a company to conduct due diligence across its entire supply chain due to an indication that a conflict mineral contained in a limited class of products from a specific supplier may derive from the covered countries.
If such an indication from a supplier seems valid and does not fall under any of the other exceptions available under the Rule, then the company should prepare to conduct due diligence on the source and chain of custody of only those conflict minerals present in the affected product(s). If, at the end of this due diligence, the company still has reason to believe that its minerals originated in a covered country, then the company should provide a conflict minerals report that includes a description of the measures the company has taken to exercise due diligence on the source and chain of custody of only those minerals present in the affected product(s) from the specific supplier.
We expect companies to adopt an approach that utilizes a companys existing disclosure committee and sub-certification processes to provide senior officers with a level of comfort similar to other financial reporting disclosures. These processes are likely to include:
(1) a detailed report on the conflict mineral process undertaken by the company, including:
*a description of the companys policies (including any major company-specific policy positions that may not be addressed by, or that interpret, the Rule) and process design and implementation;
*response rates on supplier surveys consisting of percentage breakdowns of responses received overall, by dollar value and by product; and
*the process taken, if any, to identify or investigate red flag responses; (2) sub-certifications (consistent with other financial reporting items) from the relevant officers charged with the conflict minerals inquiry; and
(3) at least one presentation to the companys audit committee regarding the companys compliance process and proposed disclosure.
We have heard that some companies may consider obtaining a review or report from the companys internal audit team (or other third-parties) specifically as to certain aspects of the companys conflict minerals process and procedures (unrelated to the audit required by the Rule); however, this would likely make sense only for companies with mature processes and a history of conducting supply-chain due diligence.
We believe companies will take a less is more approach to completion of their Form SD. In a recently published article, Lawrence Heim, a respected expert on conflict minerals disclosures, agrees. [5] Heim believes that many issuers plan to fulfill the requirements in a concise manner and leave additional narrative to their corporate social responsibility or sustainability reports (CSR). Moreover, he observes that concise reports provide more freedom and flexibility for companies to tell their story through the CSR report without concern of misinterpretation[.] [6]
We expect to see four variants of conflict minerals disclosures. They are:
*Form SD describing RCOI and determination that the company has no reason to believe that conflict minerals present in its products may have originated in the covered countries;
*Form SD disclosing determination that the company has reason to believe, describing due diligence measures, and coming to conclusion (after due diligence) that conflict minerals did not originate in the covered countries;
*Form SD describing RCOI and determination that the company is Undeterminable; and
*Form SD and conflict minerals report determining that the company is or is not conflict-free along with an audit. We continue to work with clients to develop their conflict minerals disclosures and are available to advise on various formats.
[1] The SECs rule concerning the use of conflict minerals in products that a company manufactures or contracts to manufacture (the Rule) outlines three distinct steps. Step One is an initial inquiry into the presence of conflict minerals in a companys products. Step Two concerns an inquiry into the country of origin of those conflict minerals. Step Three involves the exercise of due diligence on any conflict minerals that a company has reason to believe may have originated in the DRC or a surrounding country.
[2]
http://www.sec.gov/divisions/corpfin/guidance/conflictminerals-faq.htm#q13.
[3]
, A Comprehensive Approach to Congos Conflict Minerals, App. 1, The Enough Project
available at
http://www.enoughproject.org/files/Comprehensive-Approach.pdf.
[4] Tantalum, for which the DRC accounts for roughly 15 to 20 percent of world supply, is less conducive to this approach.
[5]
Form SD and Conflict Minerals Reports: Short Story or Novel?, Elm Consulting Group (March 18, 2014)
http://www.elmgroup.com/blog/2014/03/18/form-sd-conflict-minerals-reports-short-story-novel/.
[6]
.