Behind the SEC Rules On Conflict Minerals

English: DRC, orthographic projection.

(Photo credit: Wikipedia)

Update: For more information about the SEC’s new conflict minerals rules, you can view this webcast where my colleague Laura Finn, from Corporate Board Member, and Mary Ann Cloyd, Leader of PwC’s Center for Board Governance, discuss these new rules and what directors should be asking management so they can get a clear understanding of how conflict minerals may impact the business. Click here.

On Wednesday, August 22nd, the SEC released a new rule regarding the use of conflict minerals - tin, tantalum, tungsten or gold - mined from the Democratic Republic of the Congo.

Francis Byrd, Senior Vice President - Corporate Governance & Risk Practice Leader, Laurel Hill Advisory Group, spoke with me about the new rule and how important it is for companies and boards.

McLevey/NYSE Euronext: What are the new rules?  What countries are covered?  What kinds of minerals are included and is there a transition period?

F.H. Byrd: Here is where we are on Conflict Minerals, and it is not all bad news. The new rule will require that companies publicly report on their “reasonable country of origin inquiry” to determine whether tin, tantalum, tungsten and/or gold from the DRC or adjoining nations/regions in Africa (Angola, Burundi, Central African Republic, Republic of Congo, Rwanda, South Sudan, Tanzania, Uganda, Zambia) were used in the manufacture of products they make or sell.

These reports would be issued as a specialized disclosure report by May 31 of each year, reporting on activity in the preceding calendar year. The good news is that these specialized disclosure reports would not be due at the same time as a company’s annual report is due so as not to interfere with a company’s preparation of its annual report.

The rule will heavily impact the electronics industry and others (automotive, jewelry, mining, and industrial machinery) but will spare retailers from reporting on store-branded items manufactured by outside contractors. The other good news from the rule is that the effective date for disclosure has been pushed back to May, 2014. The additional phase in period of two or four years (depending on size) to identify and confirm where all of their “indeterminate” minerals come from will allow companies who do not have what I call Conflict Mineral Compliance Teams (CMCTs) and processes in place to develop them.

McLevey/NYSE Euronext: What should companies/boards be doing now? Are these new disclosure requirements a challenge for companies/boards? Are all companies/industries impacted?

F.H. Byrd: Those companies/boards that have not been on the cutting edge of these developments need to formulate plans on how they are going to strengthen their supply chains, establish CMCTs and determine how and who should audit the progress and effectiveness of their efforts. Also, not all companies are affected in the same manner. Following minerals from mine to smelter to supplier to manufacturer will be a difficult task as different industries take possession of products made with, or composed of conflict minerals at various stages of product development.

McLevey/NYSE Euronext: Do the new rules require an executive sign-off? What do you think the implications may be?

F.H. Byrd:  They do not call for a CEO or CFO certification, in part due to a decision by the SEC to allow reporting on this issue to take place in a separate form. The logistics of corporate reporting would make combining the specialized reporting on conflict mineral and fiscal year-end quite difficult for companies. However, institutional investors viewing this as a glaring weakness in the reporting and auditing are quite concerned with accountability.

McLevey/NYSE Euronext:  Do you expect to see companies transitioning away from these materials?  Are they already doing so?

F.H. Byrd:  The transition effort has already started. Several companies are already making an effort to source away from the war-torn central African region. Intel, Motorola Solutions, HP, and Apple have initiated programs designed to limit the use of conflict minerals in their products and been cited by advocates for their work according to Taking the Conflict out of Consumer Gadets, a report by the Center for American Progress.

At the same time, as I mentioned earlier, the rule was softened in some key areas so that the business community can walk away from this with some victories. That said, boards and companies should be wary of the potential for shareholder proposals in 2013 and 2014, from governance and human rights advocates seeking to plug what they are likely to perceive as laxity in the rules. Some 82 investor organizations have been following this issue closely and many have histories of filing shareholder resolutions. For example, retailers such as Best Buy, Target and WalMart could come under harsh shareholder scrutiny given the exemption from the rule granted by the SEC to retailers.

McLevey/NYSE Euronext:   I’m seeing estimates in the $10-$15 billion for companies to comply with this new rule, versus the $71 million SEC estimate.  There has been some speculation about the Chamber of Commerce suing to stop this new rule from being put in place.  What are your thoughts?

F.H. Byrd: Since the SEC’s defeat last year on proxy access, the Commission has been vulnerable to legal challenges on the basis of the quality of the cost-benefit analysis put forward by SEC staff in the rule-making process. In fact, Thomas P. Quaadman, vice president of the Center for Capital Markets Competitiveness, U.S. Chamber of Commerce, hints at those very grounds for a potential challenge in a blog post on The Hill. Quaadman also attacks the expected cost of compliance as understated by SEC staff based on their lack of expertise in building or managing supply chains. The final release places the potential initial cost of executing a reporting regime in the range of $2 - $4 billion and subsequent annual cost in the range of $200 to $400 million annually.  While that is a far cry from critics’ contention of an annual cost of $16 billion, it is far more than the original SEC estimate of $73 million.

The bottom-line is that we will have to live through a couple of reporting cycles to learn what the real cost of compliance will be.

McLevey/NYSE Euronext:   In addition to the new rules on conflict minerals, the SEC also imposed new disclosure rules on domestic and foreign resource extraction issuers.  Disclosure of payments made to the U.S. government or foreign governments for the commercial development of oil, natural gas or minerals will be required if payments exceed $100k during the most recent fiscal year (new SEC Form SD must be used and the information must be tagged using eXtensible Business Reporting Language (XBRL) format). Compliance with the new rule is required for issuers with a fiscal year end of 9/30/13, although issuers have 150 days after their fiscal year end to submit the Form to the SEC.