29 September, 2012
Legal News & Analysis – Asia Pacific – Japan – Regulatory & Compliance
On August 22, 2012, the Securities and Exchange Commission (SEC) adopted a much-anticipated rule requiring U.S.-listed issuers to disclose their use of certain minerals that originate from the Democratic Republic of Congo or neighboring countries ("DRC countries"). The "conflict minerals rule,"( 17 CFR 240.13p-1. An SEC report detailing the final rule is available at http://www.sec.gov/rules/final/2012/34-67716.pdf – A flow chart summary of the final rule is available on page 33 of the report.) which was mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, ( Pub. L. 111-203, 124 Stat. 1376 (July 21, 2010).) aims to curtail funding sources for armed groups in the DRC countries by imposing public disclosure and reporting requirements on issuers that rely on one of four "conflict minerals" – gold, tantalum, tin, and tungsten – to manufacture goods. These minerals are key components of cell phones, computers, and many other consumer electronics products.
The rule as adopted on August 22 requires U.S.-listed issuers that use conflict minerals in their manufacturing processes to (1) determine whether those minerals originate from the DRC countries; (2) conduct due diligence to determine whether those minerals finance armed groups in the DRC countries; (3) publish a Conflict Minerals Report delineating the due diligence findings; and (4) obtain and publish an independent, private sector audit of the Conflict Minerals Report. The rule provides guidance regarding who must comply as well as specific reporting requirements for those who must comply.
The conflict minerals rule is far-reaching and will require affected companies to devote substantial resources to compliance programs. The SEC estimates that it may affect more than 6000 issuers, and initial compliance costs are expected to total more than $3 billion.
Issuers must comply with the conflict minerals rule starting on January 1, 2013, and they must meet their first annual reporting obligations by May 31, 2014. Non-compliance with the rule could leave issuers open to liability under Section 18 of the Exchange Act.
The conflict minerals rule could have a notable impact on the regulatory compliance practices of Japanese companies, particularly those in the consumer electronics sector. Japanese issuers should be aware of how the conflict minerals rule applies to them and take steps to develop robust compliance programs. In addition, Japanese non-issuers that use conflict minerals should be familiar with the rule and be prepared to respond to conflict minerals inquiries from issuers with whom they transact.
TO WHOM DOES THE CONFLICT MINERALS RULE APPLY?
The conflict minerals rule applies to a company that uses tantalum, tin, gold, or tungsten in its manufacturing processes if (1) the company files reports with the SEC, and (2) the minerals are "necessary to the functionality or production" of a product manufactured or contracted to be manufactured by the company.
Although determining whether a product is "necessary" or "contracted to be manufactured" ultimately depends on factual circumstances particular to each issuer, the conflict minerals rule contains guidelines that help clarify the meaning of each of these two terms.
To determine whether a conflict mineral is "necessary to the functionality" of a product, an issuer should consider, among other things, whether the conflict mineral is intentionally added to the product and whether the conflict mineral is necessary for the product's function.
Whether an issuer "contracts to manufacture" a product that contains conflict minerals depends on the degree of influence that it exercises over the inclusion of materials in that product. The SEC has not elaborated concretely on what degree of influence constitutes "contracts to manufacture." It has, however, stated that an issuer is not deemed to "contract to manufacture" if, for example, it affixes its logo to a generic product manufactured by a third party or repairs a product manufactured by a third party.
DISCLOSURE AND REPORTING OBLIGATIONS: A TWO-STEP PROCESS
Disclosure and reporting obligations under the conflict minerals rule consist of two steps. First, the issuer must determine whether its conflict minerals originated in the DRC countries. Second, it must file a Conflict Minerals Report, if required. The issuer then must disclose its findings on Form SD to be filed with the SEC.
Step 1: Reasonable Country of Origin Inquiry.
First, the issuer must undertake a "reasonable country of origin inquiry" to determine whether its conflict minerals originated in the DRC countries. If the issuer finds that its conflict minerals did not originate in the DRC countries, it must disclose this fact and provide a brief description of its inquiry on Form SD. The issuer need not take any further action.
Step 2: Conflict Minerals Report.
If, however, the issuer determines that its conflict minerals may have originated in the DRC countries, then it must undertake due diligence on the source and chain of custody of those minerals and file a Conflict Minerals Report as an exhibit to Form SD. Due diligence measures must conform to internationally recognized standards such as those drafted by the OECD. (See Organisation for Economic Cooperation and Development ("OECD"), Draft Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas (2010), available at http://www.oecd.org/dataoecd/62/30/46740847.pdf)
If the issuer determines through its diligence procedure that its conflict minerals may have originated from the DRC countries but do not finance armed groups (in other words, the issuer finds that its products are "DRC conflict free"), then it must obtain and publish an independent, private sector audit of its Conflict Minerals Report.
If the issuer determines that its products are not DRC conflict free, then it must identify those products, the facilities where the conflict minerals were processed, the country of origin of those minerals, and any efforts the issuer has taken to determine their origin.
Notably, the conflict minerals rule allows all issuers to label their products "DRC conflict undeterminable" until 2015, and smaller issuers until 2017, if they cannot determine the origin of the minerals or whether those minerals finance armed groups. Issuers need not obtain an independent private sector audit of any sections of its Conflict Minerals Report relating to products that are DRC conflict undeterminable.
CONCLUSION
Although the first Conflict Minerals Reports are not due until May 2014, many technology companies already are developing conflict-free sourcing practices and compliance regimes in anticipation of the complex issues that the conflict minerals rule raises. Given the scope and complexity of the rule, U.S.-listed Japanese manufacturers as well as unlisted Japanese manufacturers that do business with U.S.-listed companies may expect new regulatory and sourcing challenges in the months and years ahead.
For further information, please contact:
Peter J. Stern, Partner, Morrison Foerster
Malcolm K. Dort, Morrison Foerster