How to Limit Your Supply Chain's Exposure to Conflict Minerals

In August 2012, public company reporting obligations increased as a result of the SEC’s final rule to implement the new conflict mineral disclosure requirements stemming from the Dodd–Frank Act. Rigorous and in many cases operationally transformative, these requirements affect all public companies. The ruling requires public companies to examine and possibly amend operations, suppliers and supply chains based on conflict minerals’ presence. But this change doesn’t stop with public companies.

Running contrary to the rigorous reporting requirements for public companies, private companies aren’t required to report, let alone held to any reporting standard. It follows then that a private company that seeks to go public has much to do. In terms of conflict mineral reporting, going from zero to quite a lot can cause operational whiplash.

Therefore, fully understanding reporting requirements and their timing, navigating the legislation and ensuring compliance demands private companies’ focus. While private companies do not have a reporting obligation per se, many of their customers do, and the burden of conducting due diligence on the supply chain will fall to the many private companies that do business with public companies.

Some companies—both public and going-public private companies—erroneously see conflict minerals reporting as solely a compliance issue. In the bright light of reality, it involves overall supply chain risk strategy, oftentimes reaching throughout the entire organization. Although not required to report, private companies may consider beginning the process of figuring out just how exposed they are to conflict minerals in their products and supply chain.

A Cellular Connection to Human Rights

For some, it’s hard to digest the fact that items as ubiquitous as cellphones fuel a central African conflict that’s claimed 5 million lives, displaced 2 million people and spurred tremendous human rights abuses. Materials used to create electronics and other products across industries are abundant in the Democratic Republic of the Congo (DRC) and adjoining countries. Known collectively as Covered Countries, this region is rich in conflict minerals: tin, tantalum, tungsten and gold. Commonly referenced as “3TG,” these minerals are traded by armed groups, which force Congolese people to mine them.

More than a problem, this epidemic affects the DRC and is driven by global consumer demand. Recently, the global community has become increasingly aware of conflict minerals and is beginning to demand conflict-free consumer goods. As is often the course, this heightened social awareness has evolved into legislation, legislation that drives business decisions and operations.

R&D = Requirements and Disclosures

That evolution into law similarly has taken time. A year and a half after issuance of its proposed rule, the SEC issued a final rule, implementing new disclosure requirements required by Dodd–Frank. With the intent of making transparent the financial interests that support armed groups in central Africa, Section 1502 of the Dodd–Frank Act requires public companies to disclose their sources for conflict minerals. The ultimate goal is to promote conflict-free trade.

Section 1502 is applicable to all SEC issuers—including foreign entities—that create or contract to create goods where “conflict minerals are necessary to the functionality or production” of the product. Per the SEC final rule, all issuers must determine whether their manufactured products contain conflict minerals and whether those conflict minerals originated in the covered countries. Issuers with necessary conflict minerals from covered countries that are not from recycled or scrap sources need to conduct due diligence and file a Conflict Minerals Report (CMR).

The reach of the SEC’s final rule is broad, its requirements exacting. Beyond the electronics and communications industries, conflict minerals affect the aerospace, jewelry, industrial products and automotive industries, with automotive surprisingly using all four conflict minerals in its four-wheeled final products.

Of 6,000 SEC issuers, approximately 4,500 are directly impacted. But beyond that are many private companies throughout these public companies’ supply chains. Accordingly, such private companies will feel an indirect, yet very real, impact from the disclosures required of public companies. Understanding the disclosure process can only inform private companies’ actions.

Step by Step by Step

In its simplest form, the disclosure process distills into three steps: assess applicability, conduct inquiry and perform due diligence.

1. Issuers first need to determine if manufactured products contain conflict minerals, then ascertain – for each – whether these minerals are necessary to either the product’s functionality or its production process. If the conflict minerals are not present in their products, or if the issuer is only contracting to manufacture an otherwise commodity product or providing a service, the issuer’s job is done: disclosures or reports are not required. If, however, conflict minerals are contained in the product, necessary to its functionality and in the supply chain after January 31, 2013, the issuer must take step two: conduct inquiry.
2. In the form of a reasonable country of origin inquiry (RCOI), issuers must determine whether its necessary conflict minerals originated in Covered Countries. Based on each company’s “facts and circumstances,” the RCOI requirement is not delineated into steps. Rather, it functions on good faith, reasonable inquiry design, and attention on red flags or obvious warning signs to determine if any conflict minerals (not from recycled or scrap sources) originated in the Covered Countries. If not, then issuers must provide a yearly special disclosure report (Form SD) and briefly describe its RCOI. If, however, the issuer knows – or has reason to believe – that Covered Country non-recycled or scrap minerals are in its products, it must complete step three.
3. The third step entails performing due diligence to determine if issuer materials are “DRC conflict-free.” The issuer must base the due diligence on a recognized framework, e.g., the Organization for Economic Co-operation and Development (OECD), for the specific conflict mineral. If the issuer determines that their conflict minerals are not from the Covered Countries, or are from recycled or scrap sources, it files Form SD, but it is not required to file a CMR. However, if minerals came from Covered Countries, as specifically as possible issuers must trace the chain and source of custody of those minerals back to the processing facility, i.e., the smelter, that processed them and even their original mine. A daunting task to be sure. Private companies play a central role in helping their public company customers determine the origination point of the 3TG contained in products they supply to SEC registrants.

While there are no penalties for using conflict minerals themselves, companies that falsify their efforts or willfully misrepresent their efforts face fines and potentially even jail time.

Whether Public or Private, Plan

Private companies – like public companies – aren’t penalized for using conflict minerals since it’s a “name and shame” law. While private companies aren’t bridled with requirements to fill out surveys, there’s merit in aligning with public company requirements. Many public companies are making progress toward being DRC conflict-free. This process necessarily entails suppliers, i.e., private companies, who operate accordingly.

Public companies may request certifications for product sourcing for their own due diligence. But just how far down the supply chain public companies will go is anyone’s guess since there’s no de minimus threshold.

For some brand-name electronics firms, conflict minerals may enter their supply chain seven to nine layers deep. Companies are putting clauses in contracts, specifying that suppliers only buy from conflict-free sources. So regardless of whether alignment stems from a “being helpful” or a “have-to” mentality, private companies’ moving to DRC conflict-free operations makes good business sense.

Private companies that seek to go public must consider reporting as part of their transformation, but don’t have to report immediately. They can delay reporting until the end of the first reporting calendar year that begins no sooner than eight months after going public. Accordingly, here’s some advice to consider: Don’t go public before May 1 to benefit from the eight-month grace period.

Particularly for private companies that supply public companies, there are steps to improve standing in terms of conflict minerals. In a word, plan. Start your own track-and-trace program, and use technology to help vet supplier survey responses. Make the foreign familiar: educate yourself on the Electronic Industry Citizenship Coalition (EICC) and the Global eSustainability Initiative (GeSI) conflict minerals templates and surveys. On the consumer front, develop a “dear customer” letter, conveying your efforts despite not being subject to public company rules. Finally, include sourcing restrictions in your contracts, ensuring conflict-free sources.

Considering Costs, Preparing Accordingly

As with most any operational transformation, changes can’t occur without cost. The SEC estimates the initial cost of compliance to be $3-4 billion, with annual costs thereafter between $207-609 million – and that’s just for public companies. These costs stem from planning, mapping the supply chain, conducting due diligence and third-party audits. Though expense is a certainty, smaller companies with fewer suppliers and better ERP systems will incur fewer costs.

Adjusting public company operations to fit a DRC conflict-free model is more than a trend; it’s an increasingly stark reality. It’s solidified with each public company’s compliance and each private company’s following suit.

Proper planning is key: conduct due diligence, establish a conflict minerals policy, determine which products are affected and which suppliers you need to query, and conduct auditing at the end to evaluate adherence to OECD due diligence guidelines.

Rich Goode is senior manager, Climate Change and Sustainability Services practice, with Ernst & Young LLP.