Conflict Minerals Compliance – Another Cost Challenge for Electronics Print E-mail

A little more than two years ago, “conflict minerals” were certainly well-known in humanitarian circles but had not yet caught on handily as a “cause” within the public capital markets, not to mention the electronics industry and supply chain. Enter the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, and “conflict minerals” has become a household word, often holding far less favor than the intended humanitarian purpose to minimize financing of militant groups in the Congo and adjoining countries (DRC).

US Securities and Exchange Commission issuers are forming high-level internal compliance teams with representatives from legal to finance and internal audit to purchasing involved in assessing to what extent, if any, the company’s products contain conflict minerals within the ambit of Rule 13p-1 under the Securities Exchange Act of 1934, adopted last August under Section 1502 of the Dodd-Frank Act.  Diligence efforts are not confined to SEC issuers, however, with supply chain participants deeply involved in determining and certifying the original source of supplies of tantalum, tin, tungsten and gold (3TGs), and their numerous derivatives, sold to their customers.

The SEC has stated that approximately 6,000 companies may be subject to the reporting requirement, and the National Association of Manufacturers (NAM) estimates that the compliance costs industry-wide are likely to range from $9 billion to $16 billion. These figures do not include suppliers whose customers may request product information as part of their compliance due diligence. Central to the application of the Rule is whether a conflict mineral contained or used in a public company’s product and “necessary to the functionality or production of a product manufactured or contracted by that registrant to be manufactured” originated in the DRC. For companies covered by the Rule, the diligence process required for compliance with the Rule will be long, expensive and arduous. Failure to comply may result in loss of S-3 eligibility, SEC enforcement proceedings and/or shareholder litigation, not to mention adverse publicity from shareholder activists or humanitarian groups. 

Impact on electronics manufacturers and components suppliers. Industry and trade associations representing general manufacturers, retailers, jewelers, the automotive sector, electronics sector and others engaged early on by developing compliance templates and tools, as well as sample policies and procedures, for their members in anticipation of the inevitable compliance frenzy. Certainly, within the electronics industry, EICC combined forces early on with the Global e-Sustainability Initiative (GeSI) to take the lead in establishing tools and resources for compliance. A quick search of the internet shows that savvy consultants have joined-in offering additional resources from online reporting tools to full-scale on-site compliance programs. Business appears to be booming, at least for some segments of the economy.

May 31, 2014 is the current SEC-mandated compliance date for companies to file their initial conflict minerals disclosure on Form SD for the calendar year 2013 and, if necessary, an independently audited Conflict Minerals Report.  Electronics companies are wise to take advantage of the available compliance tools and begin the process now, despite the legal challenge to the SEC Rule launched in the D.C. Court of Appeals by the National Association of Manufacturers, the US Chamber of Commerce and The Business Roundtable.  Pundits do not expect a judicial decision for at least 12-18 months.  It is widely expected that the key components of the Rule will be allowed to stand, given the Congressional mandate under which the Rule was adopted. Whether the SEC will be required to rethink the availability of limited exemptions – there is currently no class of issuer exempted and no de minimus exemption for trace amounts of minerals contained in a product – remains to be seen.  If the legal challenge fails, renewed lobbying efforts may be initiated to secure some relief from the Rule’s stringent requirements.

As electronic companies undertake the diligence exercise for compliance with Rule 13p-1, common issues are arising with interpretation of key terms used by the SEC, but with respect to which the SEC has declined to date to provide guidance (apart from the limited discussion in the Rule’s adopting release). Basic questions have arisen as to what, in fact, constitutes a “product” for purposes of the Rule.  Which is the product: the circuit board itself or, for example, the ATM into which the circuit board is installed? Is an ATM itself a “product” or does it provide a service?  What about credit cards issued by banks or other entities? Similarly there has been much discussion around the issue of “assembly” versus “manufacturing,” keeping in mind there is no “loophole” as some have reported. Is PCBA "assembly" or “manufacturing”?  Where is the line appropriately drawn?  Such determinations can be highly complex and fact-specific, but inevitably ad hoc. It is easy to see why the SEC declined to provide guidance, leaving it to industry and their advisors to establish “best practices” over time…but at what risk?

In addition to deploying human and financial resources to the diligence undertaking in preparation for the 2014 filing date, many companies are sharpening their pens in 2013 as they prepare to include conflict minerals-related disclosures in their registration statements and their Annual Reports on Form 10-K or Form 20-F (or Form 10-Qs for companies with a year-end other than December 31).  Key sections subject to a fresh review include the business description, MD&A, risk factors, disclosure controls, corporate governance, and the notes to the financial statements.   Corporate websites are also being updated to include corporate policies on conflict mineral sourcing and other issues of social responsibility.

From a practical perspective, the greatest risk of non-compliance is perhaps that an issuer may lose its eligibility to use Form S-3 if it fails to file the Form SD on a timely basis or its disclosure is non-compliant with the Rule.  Given that a company can, after reasonable good faith diligence, declare itself “DRC conflict undeterminable” for the initial two calendar years of reporting (the first four years for a smaller reporting company) and thereby avoid submitting an independent audit report of its Conflict Minerals Report, this “grace period” eases the burden on cash-stretched companies or those that have hundreds of products that must be accounted for or uncooperative suppliers along the chain.  Inevitably as the efforts to identify “conflict-free smelters” are expanded and certifications from suppliers become more customary, as well as reliable, compliance procedures and associated costs will be reduced over time, much as the industry experienced after the initial years of Sarbanes-Oxley compliance.

Unfortunate consequences. An interesting consequence of the mandated diligence and reporting is emerging: some companies are seeking to impose requirements in their supply contracts to ensure 3TGs are not sourced from the DRC at all or are considering alternatives to these minerals in the manufacture of their products.  Motorola and other companies, in an effort to stem the flow of business away from the DRC, initiated the “Solutions for Hope Project,” forming a relationship with a conflict-free tantalum mine in the Katanga Province.  However, for many companies this is not strictly a matter of humanitarian concerns; rather, it is a cost-benefit analysis designed to ultimately avoid the rigorous diligence requirements of Rule 13p-1, particularly given the current economic climate.  Management’s concern is with an increasingly challenging bottom line; further administrative costs and the diversion of management time from the core business provide significant incentive to pursue alternative measures and sources of supply.

Although these efforts will not always be successful, the intentional decrease of business with any DRC source of 3TGs runs completely counter to the original humanitarian purpose of the lobbying efforts that ultimately led to the inclusion of the conflict minerals provisions in the Dodd-Frank Act. Many US and non-US companies along the supply chain, whether public or private, remain at risk of losing business if they are unable to provide the requisite certifications to their customers. In addition, some companies are using this exercise to streamline their operations by reducing the number of suppliers they engage and by reorganizing internal operations to minimize functional overlap and rethink product specifications.

SEC issuers face additional scrutiny, including reputational challenges, from shareholder activists and humanitarian groups if they are unable to satisfactorily determine – and disclose -- their supply source or, pertinently, disclose that they in fact are not conflict-free and do source from the DRC. The resulting costs to industry are potentially far greater than the aggregate numbers initially put forth by the SEC in connection with industry-wide compliance with the Rule or even the much higher estimates set out by NAM. And, let’s not forgot the consumers of electronics who are likely to see increases in the prices of some of their favorite products as companies try to recoup a portion of their compliance costs. 

Ultimately, the Rule (notwithstanding its admirable underlying humanitarian purpose) may add to the view that the US public markets are losing competitive power with the likes of Hong Kong and London, for example, as existing registrants assess the continuing burden of being a public reporting company in challenging economic times and potential new registrants question whether an entry into the US public markets will yield the intended benefits without significant cost or burden. Certainly the bar continues to creep ever higher. In fact, even today the substantial majority of 3TGs are reported by the US Geological Survey to be sourced outside of the DRC, as the mineral reserves in the DRC represent only a small percentage of the worldwide supply. Certain of the minerals are expected to be fully mined worldwide in the next 40-50 years. 

Adopted by a 3-2 vote of the SEC, the Rule was clearly as controversial within the confines of the Commission as more broadly throughout industry. While the controversy will no doubt continue in the courts, as well as in the halls of Congress and the SEC, electronics companies must push forward with their diligence and compliance efforts, using this as an opportunity to rethink certain aspects of their operations and derive efficiencies where possible.  Ironically, in this case, it is likely that any humanitarian benefit will be merely a footnote.

Barbara Jones is a shareholder in Greenberg Traurig’s ( Corporate and Securities practice group and a member of the Global practice group and the Emerging Technologies Team, and co-coordinator of the firm’s cross-disciplinary Conflict Minerals Compliance Initiative; This e-mail address is being protected from spambots. You need JavaScript enabled to view it .




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