The Securities and Exchange Commission (SEC) Division of Corporate Finance issued a new statement adding some uncertainty to company obligations and enforcement exposure under the SEC conflict minerals rule ahead of the May 31, 2017 filing deadline. The statement is one of several moving pieces in an unprecedented wave of activity on conflict minerals in recent weeks. Companies should review these developments and their approach to meeting legal obligations imposed by the SEC’s implementation of Section 1502 of Dodd Frank, alongside the broader expectations of customers, activists and investors.
Summary of Recent Developments
Highlights of the recent developments are listed below, followed by more detailed discussions on several of these key points.
On April 3, 2017 the U.S. District Court for the District of Columbia entered a final judgment in the conflict minerals litigation. The judgment put an end to the litigation and remanded the SEC rule to the agency for further action consistent with a 2014 decision from the U.S. Court of Appeals for the District of Columbia Circuit (D.C. Circuit) striking down a narrow portion of the SEC rule.
SEC Acting Chairman Michael Piwowar released a statement on April 7, 2017 questioning whether the SEC could reconcile the D.C. Circuit’s decision with Congress’s intent in Section 1502. The Acting Chairman concluded that in light of the “regulatory uncertainties” outlined in his statement, it is “difficult to conceive of a circumstance that would counsel in favor of enforcing” paragraph (c) of Item 1.01 of Form SD (i.e., the rule’s requirements to conduct due diligence and file a Conflict Minerals Report).
On the same day, the SEC’s Division of Corporate Finance released a separate statement reporting that the Acting Chairman had requested the Division’s consideration of the regulatory uncertainties facing the Commission. In response, the Division declared that it “will not recommend enforcement action” to the Commission for companies that only file disclosures related to their scoping and reasonable country of origin inquiry under the provisions of paragraphs (a) and (b) of Item 1.01 of Form SD, even if they are required to conduct due diligence and file a Conflict Minerals Report pursuant to paragraph (c). The Division also declared that the statement is “subject to any further action that may be taken by the Commission, expresses the Division’s position on enforcement action only, and does not express any legal conclusion on the rule.”
Earlier this year, the SEC had announced plans to reconsider the SEC rule and requested public comments on all aspects of the rule. In the April 7, 2017 statement, the Acting Chairman reported that he had instructed SEC staff to begin work on a recommendation for future Commission action to consider, among other things, the public comments received in response to the January 31, 2017 request for comment.
Democratic lawmakers on the Senate Banking Committee have called on the SEC’s Inspector General to investigate whether the Acting Chairman exceeded his authority in asking staff to assess whether “additional relief” from the SEC rules is appropriate.
Other developments suggest changes to the conflict minerals requirements in the SEC rule or in Section 1502 are likely in the future.
On March 27, 2017 the State Department issued a broad request for stakeholder input to inform “recommendations” signaling a broader inter-agency effort to consider new approaches to addressing the responsible sourcing of minerals in the region. Comments are due to the Department of State by April 28, 2017.
President Donald Trump may still be considering the Presidential Memorandum that was circulated in February, which would seek to waive the SEC conflict minerals rule for up to two years based on national security interests.
In Congress, the Senate Subcommittee on Africa and Global Health Policy held a hearing on April 5, 2017 on the effects of Section 1502 on the Democratic Republic of the Congo (DRC) and the region, increasing speculation that legislation may soon be introduced to fully or partially repeal the conflict mineral provisions of Dodd-Frank.
Beyond Dodd Frank and the SEC rule, requirements for conflict minerals due diligence and disclosure are expanding in other contexts.
EPEAT, a leading environmental rating system for the procurement of electronic products used by the U.S. government and other institutional purchasers, announced a new standard for mobile phones (and in the future servers) that includes mandatory criteria for due diligence and public disclosure related to conflict minerals.
The European Council adopted a new conflict minerals regulation on April 3, 2017 focused on EU importers of covered minerals, metals, and their ores from “high risk” and “conflict affected” areas.
SEC Rule Litigation Wraps Up
On April 3, 2017 the U.S. District Court for the District of Columbia entered a final judgment remanding the SEC rule to the agency for further action consistent with the 2014 D.C. Circuit decision, as the parties to the legal challenge of the SEC’s conflict minerals rule requested. In the 2014 decision, the D.C. Circuit had held that the portion of the rule requiring issuers to describe their products as “not found to be DRC conflict free” was compelled speech in violation of the First Amendment to the U.S. Constitution. The SEC issued a partial stay of the rule in April 2014, providing that no company is required to describe its products using the SEC descriptors “DRC conflict free,” “not found to be ‘DRC conflict free,’” or “DRC conflict undeterminable” and staying the requirement to obtain an independent private sector audit as long as companies did not describe products as “DRC conflict free” in their disclosures. After requests for rehearing were denied and the D.C. Circuit reaffirmed its decision, the case was eventually remanded to the District Court and assigned to Judge Ketanji Brown Jackson, who entered the final judgment. The practical effect of the District Court’s final judgment is that any further changes to the conflict minerals requirements stemming from the case will be left to the discretion of the SEC (unless Congress or the Administration take action first) rather than handled in the courts.
SEC Statements Following Final Judgment
In his April 7 statement following the District Court’s final judgment, the Acting Chairman questioned whether the SEC could reconcile the D.C. Circuit’s decision with Congress’s intent in Section 1502. He noted that the Commission will now be called upon to determine how to address the D.C. Circuit’s decision – including whether Congress’s intent in Section 1502 can be achieved through a descriptor that avoids the constitutional defect identified by the court – and how that determination affects overall implementation of the SEC rule. According to the Acting Chairman, because “the primary function of the extensive and costly requirements for due diligence on the source and chain of custody of conflict minerals set forth in paragraph (c) of Item 1.01 of Form SD is to enable companies to make the disclosure found to be unconstitutional,” along with other “regulatory uncertainties,” it is “difficult to conceive of a circumstance that would counsel in favor of enforcing” paragraph (c). On the same day, the SEC Division of Corporate Finance released a statement echoing the Acting Chairman’s concerns and announcing that “it will not recommend enforcement action” to the Commission for companies that conduct and report on a reasonable country of origin inquiry pursuant to paragraphs (a) and (b) of Item 1.01 of Form SD but do not go on to conduct heightened due diligence and file a Conflict Minerals Report pursuant to paragraph (c).
The legal effect of these two SEC statements is unclear. The Division’s position on enforcement is not binding on the Commission, and even though it appears that the Division and the Acting Chairman coordinated with respect to their recent statements, it is not clear that the SEC is of “one mind” with respect to conflict minerals implementation. For example, it is reported that SEC Commissioner Kara Stein commented in response to the Acting Chairman’s statement that the action “engages in de facto rulemaking” and “represents a troubling attack not only on the Commission process, but also on the restraints of government power.” Moreover, the SEC has not modified the rule or explicitly changed its 2014 partial stay of the rule. Therefore the rule remains in effect, including, if necessary based on the results of a company’s reasonable country of origin inquiry, the requirement to conduct due diligence and file a Conflict Minerals Report as an exhibit to Form SD by May 31, 2017 pursuant to paragraph (c) of Item 1.01 of From SD. A decision by a reporting company to disregard any applicable requirements to conduct due diligence or file a Conflict Minerals Report should be very carefully considered.
In the meantime, companies should continue to monitor for potential activity in response to the SEC’s statements, which could include potential legal action by interested social justice organizations or renewed Congressional requests that the SEC Inspector General conduct an internal inquiry.
SEC Request for Comment
In January the Acting Chairman issued several statements regarding reconsideration of the conflict minerals rule. The statements, available here and here, direct staff to consider whether the 2014 guidance (i.e., the statements issued in conjunction with the partial stay of the rule’s requirements following the 2014 D.C. Circuit decision) is still appropriate and whether any additional relief is appropriate. The statement titled “Reconsideration of Conflict Minerals Rule Implementation” suggests that the current rule and general withdrawal from the region “may undermine U.S. national security interests by creating a vacuum filled by those with less benign interests.” The statements requested comments on “all aspects of the rule and guidance.” Comments were requested within 45 days of the statements (by March 17, 2017). According to the Acting Chairman, the SEC staff has been instructed to begin work on a recommendation for future Commission action to consider, among other items, the comments received as part of the SEC’s consideration of potential changes to the rule or guidance.
State Department Seeks Recommendations
The Department of State on March 27, 2017 published a request for comments from stakeholders to inform “recommendations of how best to support responsible sourcing of tin, tantalum, tungsten and gold.” In the brief notice, the Department provides a high level overview of U.S. efforts to break the link between armed groups and minerals in the Africa Great Lakes Region. The State Department may be seeking stakeholder input on further actions that could be taken to further responsible sourcing to inform ongoing discussions within the Administration (and in Congress) on alternative approaches to the current Dodd Frank due diligence and disclosure framework. Comments are due to the Department of State by April 28, 2017.
Potential Presidential Action
A draft Presidential Memorandum circulated in early February 2017 indicates that the White House may seek to temporarily waive the requirements of the conflict minerals rule. Under the Dodd-Frank Act the SEC “shall revise or temporarily waive” the requirements of the conflict minerals rule if the President transmits to the SEC a determination that such revision or waiver is “in the national security interest of the United States and the President includes the reasons therefor;” and establishes a date within two years that the exemption expires. The draft Presidential Memorandum states that the conflict minerals rule has caused harm to some parties in the region, thereby contributing to instability in the region and threatening the national security interest of the United States. The draft Memorandum directs the SEC to temporarily waive the requirements of the conflict minerals rule for two years and directs the Secretaries of State and Treasury to propose a plan for addressing human rights violations and funding of armed groups in the Democratic Republic of the Congo or an adjoining country within 180 days of the Memorandum.
The draft Presidential Memorandum raises a number of questions without clear answers. For example, it is unclear whether or when the SEC would be required to act as directed by the Memorandum, and whether an SEC action would be subject to notice and comment rulemaking or judicial review. Also unclear is how a temporary suspension of the SEC rule would affect efforts to incorporate conflict minerals reporting obligations into public and private procurement requirements or independent certifications such as EPEAT. The Administration has not indicated whether or when it might move forward with a final memorandum.
New EPEAT Procurement Criteria
Conflict minerals due diligence is also being integrated into institutional procurement criteria for certain electronic products. EPEAT is a leading environmental rating system for electronics that a wide variety of institutional purchasers (including federal, state and some foreign governments) have incorporated into procurement requirements. The Federal Acquisition Regulation (FAR) currently requires federal agencies to procure EPEAT-registered electronic products and prescribes language that must be used in procurement contracts for goods and services. EPEAT is in the process of expanding its registry to cover two new product categories and both are expected to include new mandatory criteria on conflict minerals.
On March 24, 2017, EPEAT and Underwriters Laboratory published an EPEAT standard for mobile phones. The mobile phone standard lays out three criteria (one required, two optional) related to conflict minerals. The new standard requires manufacturers to “provide a public disclosure relevant to due diligence performed in accordance with an internationally recognized standard to determine whether the supply chain for the product contains conflict minerals necessary to the functionality or production of their products.” If a manufacturer finds that the supply chain does contain conflict minerals necessary to the functionality or production of its product, the manufacturer must prepare the “relevant disclosures related to SEC requirements under Dodd-Frank and the SEC rule or related to the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas.”
Significantly, these requirements apply to all manufacturers registering mobile phone products under the standard, regardless of whether they are SEC registrants. There are two optional conflict minerals criteria, both relating to conflict minerals sourcing. An EPEAT server standard is also under development and, if adopted, is expected to include conflict minerals provisions.
New EU Conflict Minerals Regulation
In early April, the European Union took the final steps to adopt a new conflict minerals regulation aimed at stopping the financing of armed groups in “high risk” and “conflict affected” areas. The Council adopted the regulation on April 3, 2017, following approval by the European Parliament in early March.
The regulation, the first version of which was introduced in March 2014, establishes an approach that is fundamentally different than that under the Dodd-Frank Act and the SEC rule. Unlike the U.S. scheme, supply chain due diligence requirements under the EU regulation do not extend to downstream users of the metals, including importers of products containing those metals, and instead focus entirely on mandatory due diligence requirements for importers of the minerals, metals, and their ores. The geographic scope of the regulation also extends to conflict-affected and high-risk areas globally, extending beyond the DRC and adjoining countries covered by Dodd-Frank and the SEC rule.
Importers will be covered by the new due diligence requirements as of January 1, 2021. The new EU requirements are likely to enhance due diligence on the sourcing of conflict minerals from the DRC and other regions. Although downstream users or importers of products containing tin, tantalum, tungsten or gold would not be subject to mandatory due diligence requirements, the Commission is expected to address conflict minerals in non-binding guidance under the EU Non-Financial Reporting Directive that will set forth the methodology and topics for disclosures by companies covered by the Directive.