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Mixed Results on Conflict Mineral Disclosures as Court Affirms Unconstitutionality Decision

Thursday, August 27, 2015
Sandler, Travis & Rosenberg Trade Report

The Government Accountability Office recently reported that conflict mineral disclosures filed with the Securities and Exchange Commission for the first time in 2014 indicated that most companies were unable to determine the source of their conflict minerals. The news came the same day that a federal court upheld its previous ruling against one of the disclosure requirements in the SEC conflict mineral regulations.

Under the 2010 Dodd-Frank Act and the SEC’s implementing regulations, companies that file reports with the SEC under the Securities and Exchange Act of 1934, whether foreign or domestic, must file a specialized disclosure report (form SD) disclosing their use of tantalum, tin, gold or tungsten originating in the Democratic Republic of the Congo or an adjoining country if those minerals are necessary to the functionality or production of a product they manufacture or contract to manufacture. The minerals at issue are used to make a wide range of goods such as cell phones, computers and video game systems, medical equipment, high-speed tools, machine parts, glass and lamps. The first reports were due June 2, 2014, and are due May 31 of every year thereafter.

Among other things, SEC regulations require companies that use any of these conflict minerals to conduct a reasonable inquiry to determine whether they originated in the covered countries. If the inquiry determines that the company knows or has reason to believe that the minerals may have originated in those countries, the company must undertake due diligence on the source and chain of custody of its conflict minerals, file a conflict minerals report with the SEC and make that report publicly available on its Web site. In light of ongoing litigation (see below), the SEC has stayed a requirement for companies to list in these reports any products they manufacture or contract to manufacture that are not found to be “DRC conflict free” (i.e., they contain minerals that may have directly or indirectly financed or benefitted armed groups in the covered countries).

Disclosures. The GAO notes that the number of companies that filed form SD in 2014 – 1,321 – was substantially lower than SEC’s estimate of 6,000 companies that could possibly be affected, but an SEC official said that estimate was intentionally overly inclusive and was not an expectation.

According to the GAO, 99 percent of the companies that filed disclosures reported performing country-of-origin inquiries for the conflict minerals they used. Most (96 percent) said they had done so by conducting a survey of their suppliers, but only about 47 percent received responses to these surveys and some said the information they received was incomplete.

Two-thirds (67 percent) of the filing companies were unable to determine whether their conflict minerals came from the covered countries, consistent with the SEC’s expectation that most companies would claim this status in the first year of filing. Nearly a quarter (24 percent) concluded that their conflict minerals did not originate in these countries.

Four percent of companies said their conflict minerals did come from the covered countries. All of these companies said they conducted due diligence on the source and chain of custody of the conflict minerals they used, but none were able to determine whether such minerals financed or benefitted armed groups in the covered countries. However, they also indicated that they are or will be taking action to address the risks associated with the use and source of conflict minerals in their supply chains. For example, one company indicated that it would notify suppliers that it intends to cease doing business with suppliers who continue to source conflict minerals from smelters that are not certified as conflict-free.

Court Ruling. In April 2014 a three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit ruled that the requirement to publicly disclose that a company’s products use conflict minerals that have not been found to be conflict-free violates First Amendment protections of free speech by essentially requiring companies to criticize their own products. The SEC subsequently advised companies that they would not be required to make such disclosures, but two SEC commissioners called on the agency to suspend all conflict minerals reporting requirements until there is a final outcome in this case. The court upheld all other disclosure and reporting requirements in the SEC regulations, which continue to apply.

After rehearing this case in light of a separate ruling that appeared to strengthen the federal government’s ability to require a wide range of information disclosures, the D.C. court has affirmed its prior decision. Press sources indicate that one practical effect of this decision is that companies will not have to obtain an independent audit of any conflict mineral disclosures in 2015 unless they claim conflict-free status.

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