Conflict Minerals Disclosure Requirements and Corporate Social Responsibility

Background

In August 2012, the SEC issued a conflict minerals rule in fulfillment of section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, aimed at protecting human rights and curtailing funding available to armed groups in the DRC and neighboring countries. Under the rule, U.S. publicly traded companies and foreign issuers using conflict minerals (e.g., gold, tantalum, tin, tungsten) necessary to the functionality or production of a product manufactured or contracted to be manufactured must disclose related product and supply chain information to determine whether any of their products contain conflict minerals mined in the DRC or an adjoining country. To comply with the conflict minerals rule, a company must—

• determine whether it manufactures or contracts to manufacture products for which conflict minerals are necessary to the functionality or production;
• conduct a reasonable country of origin inquiry (RCOI) concerning the origin of conflict minerals used, if any, and file a Specialized Disclosure Report (Form SD); and
• exercise due diligence, if appropriate, to determine the source and chain of custody of conflict minerals used and file a conflict minerals report (CMR) as an exhibit to Form SD to document due diligence process, facilities used to produce conflict minerals, information about products using conflict minerals, and the country of origin of the minerals.

Due diligence is defined by the Organization for Economic Cooperation and Development (OECD) as an ongoing, proactive and reactive process through which companies ensure that they respect human rights and do not contribute to conflicts in high-risk areas (OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas Second Edition, OECD Publishing, 2013, http://bit.ly/2t9iQcD). Companies that voluntarily describe any of their products as “DRC conflict free” are required to include documentation of an independent private sector audit (IPSA) in their report.

The conflict minerals rule faced legal challenges, as manufacturing industry representatives and the U.S. Chamber of Commerce argued that it was inadequate on economic and company size grounds and that it infringed on companies’ rights under the First Amendment [Dynda Thomas, “Challenging the Conflict Minerals Rule: A Review of the Docket—Petitioners’ Brief and Amicus Briefs,” Squire Patton Boggs (firm website), February 2013, http://bit.ly/2JM7x16]. In 2014, the United States Court of Appeals for the District of Columbia Circuit held that conflict minerals provisions requiring covered companies to report to the SEC and state on their websites that their products have “not been found to be DRC conflict free” violated the First Amendment [National Association of Manufacturers v. SEC, No. 13-5252 (D.C. Cir. 2014)]. The SEC responded by confirming that companies must describe and disclose their RCOI on a Form SD, describe their due diligence process if they are required to file a CMR, and disclose product information and the countries of origin of the necessary conflict minerals.

Companies are only required to obtain an IPSA, however, if they voluntarily choose to describe any of their products as “DRC conflict free” in their CMR (Keith F. Higgins, “Statement on the Effect of the Recent Court of Appeals Decision on the Conflict Minerals Rule,” Apr. 29, 2014, http://bit.ly/2Mp1SQi). In 2015, the D.C. Circuit Court of Appeals confirmed its ruling, and the SEC decided to forego further appeal. In April 2017, the court entered final judgment in the case and remanded rulemaking back to the SEC, which responded that it will work on addressing reporting requirements. Until such requirements are established, it is difficult to conceive of an enforcement action being brought against a company that does not report on conflict minerals in its supply chain (Michael S. Piwowar, “Statement of Acting Chairman Piwowar on the Court of Appeals Decision on the Conflict Minerals Rule,” Apr. 7, 2017, http://bit.ly/2yi0X0S).

Conflict Minerals Reporting as Integrated Sustainable Practice

In contrast to human rights, environmental, and anti-corruption regulations that would outright prohibit trade in conflict areas of the world, the conflict minerals rule requires issuers to disclose information about their conflict minerals and their due diligence processes. The goal is to dissuade companies from engaging in trade that supports regional conflicts, to promote the exercise of due diligence in conflict minerals supply chains, and to bring greater public awareness of the sources of conflict minerals. It is hoped that mandatory conflict minerals disclosure requirements, coupled with the best practices demonstrated by industry leaders, will lead to the spread of integrated sustainability practices within and across industries. Indeed, companies such as Intel and Royal Philips practiced social responsibility and sustainability by seeking conflict-free supply chains well before the conflict minerals rule became law.

The conflict minerals rule refers to OECD due diligence as the most established due diligence process for compliance with conflict minerals reporting. Certification providers such as CFSI are designed to implement OECD’s guidelines and undergo external review to ensure alignment with those guidelines. Even with certification and standardized audits, the costs are prohibitively high, especially for smaller suppliers, and this discourages their participation. These challenges are also echoed by the Government Accountability Office (GAO) (“SEC Conflict Minerals Rule: Companies Face Continuing Challenges in Determining Whether Their Conflict Minerals Benefit Armed Groups,” August 2016, http://bit.ly/2JUow4A).

Another challenge in compliance with the conflict minerals rule is identifying the source and chain of custody of conflict minerals, especially when a company does not interact directly with second-level suppliers and several suppliers may be involved for each product. This increases the costs of collecting reliable information and may lead to “DRC conflict undeterminable” or “unable to reach a determination” status. One developing technology that helps with this is chemical fingerprinting, which allows minerals to be traced to their location of origin based on distinct chemical signatures. In addition, manufacturers and suppliers may use technology to centralize data collection, verify sources, and report effectively. To alleviate the risk of intentional misrepresentation and omission, policies can be set to communicate the tone at the top throughout the supply chain. This will also facilitate the maintenance of accurate disclosures on companies’ websites, as required by the rule.

Although compliance with the rule has proved costly, collecting and evaluating information about conflict minerals helps companies identify opportunities for improving supply chain transparency, practice better risk management, and improve overall operations and compliance (“IPSA Facto: Anticipating the Independent Private Sector Audit after the Year 2 Conflict Minerals Reporting Cycle,” Deloitte Heads Up, Aug. 25, 2015, http://bit.ly/2LSHK88; GAO 2016). Mitigating human rights risk in global supply chains will likely improve a company’s social responsibility ratings and attract consumers and investors, thus improving competiveness and profitability.

Reporting Trends

May 2017 marked the fourth year of the Form SD filing requirement for covered companies, affecting a wide spectrum of industries, including electronics and communications, aerospace, automotive, jewelry, medical instrumentation, and retail. According to the blog Audit Analytics (Olga Usvyatsky, “An Initial Look at Conflict Minerals & Dodd-Frank Section 1502,” June 23, 2014, http://bit.ly/2LVaIEz; Derryck Coleman, “Analyzing Conflict Minerals Reporting in Year 2,” July 23, 2015, http://bit.ly/2ldsLdG), the semiconductors and related devices industry alone accounts for roughly 9% of the total filings (1,330 and 1,279 in 2014 and 2015, respectively). The proportion of companies describing their products as “DRC conflict free” is approximately 20%, and the number of companies obtaining IPSA for their CMRs remained minimal due to the exemption of IPSA during the rule’s transition period. The transition period ended in May 2016 for most companies on calendar year 2015 reporting; based on the SEC rule as amended following the D.C. Court of Appeals’ decision, an IPSA is necessary only if a company voluntarily chooses to describe a product as “DRC conflict free” or “not DRC conflict free” following due diligence. Coleman and Usvyatsky (“Conflict Minerals Update: Year 3 Brings Better Reporting,” Audit Analytics, July 13, 2016, http://bit.ly/2HQAdEo) found that the total number of Form SD filings in 2016 has further decreased to 1,225, and only 7 of the 19 IPSAs filed reported a “DRC conflict free” designation for all of their products.

Examples of Conflict Minerals Reporting

Intel Corporation and Royal Philips are notable for their extensive efforts in attaining conflict-free supply chains long before the SEC rule was enacted (Ken Tysiac, “Conflict Minerals Rule Poses Compliance Challenge,” Journal of Accountancy, April 2013, http://bit.ly/2HR4W4m); they are two of the few companies that have obtained an IPSA for a CMR filed since 2015. An analysis of their conflict minerals reporting over the years informs sound practices in meeting and even exceeding the SEC’s conflict minerals disclosure requirements. Their annual Form SD filings (available at https://intel.ly/2tv9icQ and https://philips.to/2lzOgFK, respectively) present in great detail how their conflict minerals programs are set forth in conformity with the OECD’s due diligence guidance, as well as the due diligence measures undertaken during the reporting period. Intel further describes how it plans to integrate acquired companies’ conflict minerals program with its own in the next reporting period.

Intel and Philips both document their proactive relationship in assisting their priority suppliers with developing a conflict-free supply chain, such as by encouraging suppliers to participate in the Conflict-Free Smelter Program (CFSP) created by the Electronic Industry Citizenship Coalition (EICC) and the Global e-Sustainability Initiative’s (GeSI) Conflict-Free Sourcing Initiative (CFSI) or other independent third-party audit programs and by actively requesting complete and accurate sourcing information using the Conflict Minerals Reporting Template (CMRT). As members of the steering committee of CFSI, they also actively work with the initiative and broaden the list of certified smelters and refiners around the world. They mention the desire to continue business relationships with their suppliers that may have sourced conflict minerals or used such suppliers themselves and actively educate, train, and assist suppliers to be conflict-free certified by third-party audit programs. As a result, even as downstream purchasers, their extensive efforts toward attaining conflict-free supply chains can reach far and increase the number of compliant smelters used by their suppliers.

Both Intel and Philips provide the list of facilities and countries of origin of their necessary conflict minerals, leveraging suppliers’ information made available to CFSI members or the Good Delivery List (GDL) published by the London Bullion Market Association (LBMA), and determine some of their products as DRC conflict free after conducting due diligence over several years. Finally, both companies obtain IPSAs from their accounting firms for their Form SD filings. The language used in IPSAs is clear about the section of the filings that is examined and opined upon—that is, whether the company’s due diligence framework conforms with the OECD Due Diligence Guidance and whether the description of the due diligence measures performed is consistent with the due diligence process undertaken. The language is also clear about areas not evaluated for the purpose of the audit, which appears to be standard in an IPSA.

Reviews of Form SD filings of other companies, such as Hewlett-Packard, Apple, Western Digital, and Signet Jewelers, reveal a similar structure in filings because the OECD Due Diligence Guidance is the only due diligence framework accepted under the SEC rule. The filings do, however, vary in the disclosure details, and several filings report greater supplier due diligence compliance than in previous years. Another observation is that the language used in Hewlett-Packard’s, Western Digital’s, and Apple’s 2016 and 2017 filings avoids classifying products as “DRC conflict free” or “not DRC conflict free” following due diligence, and thus the requirement for an IPSA is not triggered. Signet Jewelers’s 2016 and 2017 filings, audited by a consulting firm, conclude that its product is DRC conflict free, while Apple, even with all its suppliers and smelters participating in a third-party audit program since 2015, does not believe that a third-party audit alone is sufficient to label products as conflict free and continues to enhance due diligence in its supply chain and improve local incident reporting and resolution.

Overall, conflict minerals reporting has become more established in the past few years, although the number of reports has diminished. Companies that report are bringing more transparency to their supply chains and achieving a higher standard of due diligence over time, despite the recent legal challenges.

Conflict Minerals Reporting in Other Countries

The European Union’s Nonfinancial Reporting Directive went into effect in December 2014, and the first reporting cycle begins this year. The directive requires companies with more than 500 employees to file sustainability reports in each EU member country and specifies that the reports must include information relating to “environmental matters, social and employee aspects, respect for human rights, anticorruption and bribery issues, and diversity in their board of directors” (http://bit.ly/2JRC1lx). Furthermore, in May 2016, several European Union stakeholders, including Intel and Philips, formed a new public-private partnership, the European Partnership for Responsible Minerals (EPRM), which supports and complements the forthcoming EU conflict minerals legislation (“Innovative European Partnership to Stimulate Responsible Mineral Trade,” EPRM press release, http://bit.ly/2LRcDd2).

In addition, some countries have adopted laws that aim directly at protecting human rights and managing global supply chain risks; for example, the China Chamber of Commerce of Metals, Minerals and Chemicals Importers and Exporters (CCCMC) adopted voluntary industry guidelines on responsible mineral supply chain in December 2015. The adopted rule is in cooperation with the OECD risk-based due diligence process and ensures that the CCCMC’s 6,200 member companies continue to support responsible practices throughout the global value chain (http://bit.ly/2t2lTnC). These efforts afford better supply chain risk management and better integration with sustainability reporting trends.

Opportunities for CPAs

CPAs can play an important compliance, assurance, and advisory role in conflict minerals reporting. CPA firms can provide an interdisciplinary approach to compliance, as they already have a competitive advantage in the human capital and technical knowledge to integrate the sustainability, assurance, data analytics, and technology services needed to provide a platform for compliance. Perhaps one of the critical issues is that the right tone—that sustainable practices and compliance are beneficial to the success of the organization and to its various stakeholders—is set and propagated throughout the organization. Individuals must understand how their daily tasks are integral to the company’s overall strategy on sustainability and conflict minerals rule compliance. Considerable opportunities arise for CPAs, whether inside or outside of a company, to help management and staff envision sustainability as a value-added practice that affects society as a whole and assist in developing a sustainability strategy, governance structure, and action plan. CPAs can help companies assess compliance costs, determine whether existing resources are sufficient or overextended given the increased demand on the same resources by multiple regulatory requirements, and provide a plan to acquire new resources, personnel, and technology. Firms can also assist in integrating conflict minerals due diligence and reporting with other sustainable practices in global supply chains and generate more efficient and effective reports across the board.

Specifically, CPAs can provide technical knowledge and training to a company’s compliance and governance team and other relevant personnel to better understand the conflict minerals due diligence process and disclosure requirements. It is common for public accounting firms to provide human resources services by defining required job qualifications and responsibilities for conflict mineral compliance officers and employees. Furthermore, CPAs can assist in planning and designing a strategy for developing processes, managing compliance, documentation, and reporting activities, and integrating due diligence with the existing practice. In addition, public accounting firms can also evaluate clients’ supply chain risks; the likelihood and magnitude of non-compliance; quantify such risks; and advise and implement remedial actions. CPAs can also provide technologies that encourage and facilitate suppliers’ engagement and cooperation in collecting the requisite supply chain data for reporting. They can establish suppliers’ channels for data collection at a global level and provide required, certified supplier reporting information on demand. Moreover, because conflict minerals reporting is an SEC mandate, public accounting firms can also provide legal and assurance services.

Navigating the Sustainability Future

At the moment, the language used in conflict minerals–related filings does not trigger an independent private sector audit requirement. Compliance with the SEC’s conflict minerals rule seems difficult due to complex and constantly changing international supply sources and lack of transparent sourcing information, especially for smaller and outof-reach suppliers. The rule provides opportunities for covered companies to pursue sustainable practices, integrate conflict minerals reporting with existing supply chain sustainability efforts, and mitigate human rights risk in global supply chains. It also provides CPAs working inside and outside of covered companies the opportunity to provide value-added services in this area. Sustainability and integrated reporting is becoming a business norm, so the benefits of conflict minerals reporting seem to outweigh the costs. It remains to be seen, however, whether the conflict minerals rule may change in the future.