It’s that time of year again. Form SD filings are due June 1st (May 31st falls on a Sunday). For those who have been diligently working on your company’s annual report and proxy statement, it is time to turn your attention to conflict minerals and Form SD.
A Review of Last Year’s Form SD Filings
As everyone knows, last year was the first year that Form SDs were required to be filed by reporting companies that manufacture or contract to manufacture products if conflict minerals are necessary to those products’ functionality or production (see the most recent Doug’s Notes on this topic here, here and here). Though the 1,300 Form SDs filed last year were far fewer than the estimated 6,000, they nevertheless provide useful precedential guidance for this year.
Now is a good time to review the Form SD filings of your peers. If you filed a Form SD, this allows you to compare your conclusions and disclosures with companies in your industry. Even if you didn’t file a Form SD last year, it is a good exercise to review what your peers had to say about the products they manufacture and their assessment of their supply chain.
The SEC and other stakeholders do not expect perfection in the first couple of years, and they understand that disclosure will evolve and compliance processes will improve over time. However, they do expect companies to communicate a plan for improvement and implement that plan over time. Stakeholders will want to see improvement in this year’s filing, which may require more effort than dusting off last year’s Form SD and changing the dates.
Aside from reviewing your peers’ filings, here are some takeaways from last year’s filings to consider when preparing this year’s Form SD or determining whether your company should file for the first time.
Update the Layout of the Conflict Minerals Report
Over three-quarters of Form SDs included a Conflict Minerals Report (“CMR”) as an exhibit. This comes as no surprise because a CMR is required if the company either determines that its covered minerals came from one of the covered countries or is unable to determine that its covered minerals did not come from the covered countries. Most companies were unable to determine the origin of their covered minerals and filed a CMR. One of the biggest areas of criticism last year was that these CMRs were difficult to follow. Because the SEC provided no guidance on the layout of the CMRs and there was no precedent to go by, layouts varied widely.
The clearest reports were those that were compartmentalized into separate disclosure sections for such things as
- program design,
- due diligence,
- processing facilities, and
- future action items.
One area that Keith Higgins, Director of the SEC’s Division of Corporation Finance, noted created confusion among filers last year was the conflation of the reasonable country of origin inquiry (“RCOI”) and the due diligence requirements. While he acknowledged there is some overlap between the RCOI and supply chain due diligence, he urged companies to be more precise in their disclosure and draw clear distinctions between due diligence and the RCOI. The due diligence section should essentially track the five-step due diligence framework released by the Organisation for Economic Co-operation and Development (“OECD”). The OECD framework is the only framework that has been approved and, in preparing the due diligence disclosure, companies should identify and describe the procedures they have in place in order to comply with the framework. Tracking the OECD framework in drafting your disclosure will help draw the distinction between the RCOI and supply chain due diligence.
In addition to making the CMRs easier to follow, compartmentalizing due diligence measures into one section of the report will be helpful once, and if, audits are required. Under the rules, each company that files a CMR must also obtain an independent private sector audit (“IPSA”). However, according to SEC Staff guidance, “[p]ending further action, an IPSA will not be required unless a company voluntarily elects to describe a product as ‘DRC conflict free’. . .” Additionally, filers are currently able to rely on an exception available during the two year grace period that allows them to forego an IPSA if they find their products are “DRC conflict undeterminable.” Depending on future guidance from the SEC, the due diligence section of the CMR may be audited to ensure it complies with the OECD framework. It will be helpful, therefore, to have all due diligence information in one section of the report and in a structure that tracks the OECD framework.
Improve Smelter and Refiner Disclosure
As more companies gain visibility into their supply chain, smelter and refiner disclosure will become increasingly important. In fact, this is an area where Mr. Higgins expressed concern that companies did not disclose the processing facility when required and when these facilities were known. Given Mr. Higgins’ comments, this is likely to be an area that will be scrutinized by the SEC.
Some of the companies that did include smelter and refiner data last year could have improved their disclosure. For instance, some filers didn’t clearly state the basis for including this disclosure. This left investors asking whether the processing facilities that were listed are actually in the company’s supply chain or whether it was just a list of the processing facilities that the company identified in its due diligence.
Additionally, the Department of Commerce published a new list of smelters and refiners that contains a list of all the processing facilities known by the U.S. government. While this list provides more processing facilities than the Conflict Free Sourcing Initiative Lists, it does not determine which facilities are compliant. For now, companies may want to review the Department of Commerce list to help identify processing facilities in their supply chain, while the Conflict-Free Sourcing Initiative List will continue to help companies identify whether the facilities are conflict-free.
What’s On the Horizon?
As companies continue to integrate conflict minerals into their internal controls and compliance processes, it is helpful to identify issues that may arise in the future and evaluate how your company can begin preparing for such changes today.
Ongoing Legal Challenges
In April 2014, the Court of Appeals for the D.C. Circuit in National Association of Manufacturers v. SEC held that the requirement under the conflict minerals rules requiring companies to state on their website that their products have not been found to be “DRC conflict free” violated the First Amendment. Subsequently, the SEC Staff released guidance relieving issuers of the obligation to put those labels in their reports.
Since then, the Court of Appeals for the D.C. Circuit in American Meat Institute v. USDA held that mandatory country-of-origin labeling of meat products did not violate the First Amendment. So how does a meat labeling case affect conflict minerals? It impacts the standard of review applied in First Amendment cases. In National Association of Manufacturers, the court applied intermediate scrutiny in concluding that part of the conflict minerals rules and regulations violated the First Amendment. In American Meat Institute, the court applied a lower standard of review where a mandated disclosure was allowed so long as it was limited to purely factual and uncontroversial information and related to consumer deception.
Whether this lower standard of review could apply to conflict mineral disclosure has yet to be determined, but the Court of Appeals for the D.C. Circuit has agreed to rehear the National Association of Manufacturers case. For now, it is uncertain when this issue will be resolved and once it is, what, if any, practical effect this discrete issue might have on the conflict minerals rules.
Independent Private Sector Audits
An IPSA may be required as soon as the 2015 compliance period. At least some companies have started preparing for an IPSA by conducting a mock audit or something less formal like a pre-audit readiness assessment. While some companies may not have the documentation in place to support a mock audit, they should consider conducting some type of “gap analysis” to help identify the gaps that exist between the company’s compliance program and the requirements of the conflict minerals rule and the OECD framework. Performing some type of evaluation now will help prepare companies for when the grace period ends and audits may be required.
Pressure from Stakeholders
Many stakeholders other than the SEC, including customers, consumer groups and research firms, employees, non-governmental organizations and socially responsible investors, will be closely scrutinizing conflict minerals disclosure. And as conflict minerals disclosure evolves, pressure from these groups will likely increase. For example, in 2012, the Enough Project, a non-governmental organization, released the Conflict Minerals Company Rankings that ranked electronics companies based on their efforts to use conflict-free minerals in their products. In implementing compliance procedures and crafting disclosure, companies should consider who their stakeholders are and what message they are trying to send.
Additional Supply Chain and CSR Compliance Initiatives
As companies continue to integrate and improve their conflict minerals compliance programs, they should aim to design and structure the programs with flexibility to accommodate additional supply chain compliance initiatives. Conflict minerals legislation has been proposed in both the European Union and Canada, and legislative interest in socially responsible sourcing of other commodities is likely to increase. A well-designed, flexible program may prove to be the most efficient and effective way to prepare for future regulations and ensure ongoing disclosure compliance.