A Conflict Minerals Checklist for Public and Private Companies

by Schulte Roth & Zabel LLP

on September 11, 2014

Conflict Minerals compliance is one of the most complex compliance projects ever undertaken by many public companies and requires significant cooperation across locations, divisions and departments.

In a nutshell, the rule requires public companies to conduct supply chain diligence and make disclosures concerning specified minerals and their derivatives contained in their products. The rule is intended to reduce a significant source of funding for armed groups that are committing human rights abuses in the eastern Democratic Republic of the Congo (DRC).

The Conflict Minerals Rule imposes substantial compliance obligations on a significant portion of the public company universe across a wide range of industries. The SEC estimates that approximately 6,000 registrants are impacted by the rule and that 75 percent of these registrants will be required to file a Conflict Minerals Report thereunder. Although private companies are not directly subject to the Conflict Minerals Rule, they are indirectly affected by the rule to the extent that they are part of a public company’s supply chain. Some estimates place the number of affected private companies in the hundreds of thousands, ranging from small businesses to large companies and both domestic and foreign.

Most companies are familiar, at least in broad strokes, with the diligence and reporting requirements under the rule. However, in many cases, companies are having difficulty at a more basic level with the initial steps that need to be taken to efficiently establish and administer an effective Conflict Minerals Rule compliance program. At many companies, developing the compliance program has been daunting due to the complexity of the rule and the limited guidance thereunder, as well as the scope of the project.

 

A Near-Term Conflict Minerals Checklist

 

Companies in the earlier stages of Conflict Minerals Rule compliance — which includes most companies — should consider the following near-term action items to the extent not already taken or in process. The items in this conflict minerals checklist come from our extensive practical experience advising on the Conflict Minerals Rule.

 

Assembling the Team

 

  • Create an internal Conflict Minerals Rule compliance team. For most companies, the internal team should consist, at a minimum, of representatives from manufacturing, engineering, procurement, IT, finance, internal audit and legal. Corporate social responsibility and investor relations should be represented as well to the extent those functions reside in-house.

  • Empower the team leader. Conflict Minerals Rule compliance is one of the most complex compliance projects ever undertaken by many public companies and requires significant cooperation across locations, divisions and departments. At many companies, it has been a slow, difficult process to achieve the requisite level of internal cooperation to move Conflict Minerals Rule compliance forward effectively. Senior management should empower the project leader with the authority to develop and implement the compliance program and create the appropriate incentives to ensure cooperation.

  • Establish a point person to address questions on the Conflict Minerals Rule. This may be the team leader or, in a larger organization, perhaps one of his or her reports. Designating a point person for inquiries will make it more likely that important questions concerning the Conflict Minerals Rule get asked and will help ensure that the rule is applied consistently throughout the organization, especially with respect to Step One diligence. Furthermore, as certification requests, questionnaires and contract amendment requests are received, these also will need to be dealt with consistently throughout the organization.

  • Consider whether one or more additional internal hires are needed to manage the Conflict Minerals Rule compliance program.

  • Consider whether the internal team needs to be supplemented by specialist outside counsel. Outside counsel can assist in (1) developing the compliance program, (2) educating personnel on the requirements of the Conflict Minerals Rule, (3) advising on interpretive questions and gray areas under the rule (there are many), (4) preparing compliance policies, supplier communications, questionnaires, certifications and contract modifications, (5) reviewing and advising on incoming materials from suppliers and customers and (6) preparing Conflict Minerals Rule disclosure.

  • Consider the need for other outside consultants. Other consultants can, among other things, assist in analyzing the supply chain and supply chain risk, developing and assessing the effectiveness of diligence procedures and advising on and implementing enhancements to IT systems.

 

Getting Up to Speed

 

  • Conduct internal training sessions on the Conflict Minerals Rule for relevant personnel. Given the complexity of the rule, at most companies, it is unrealistic to expect personnel to have a good understanding of the rule based solely on a written summary.

  • Become familiar with the OECD conflict minerals due diligence framework, since it is currently the only recognized framework for Step Three due diligence.

  • Become familiar with other relevant NGO recommendations and industry initiatives. In many cases, companies will want to piggyback on industry-wide diligence initiatives to reduce compliance costs.

 

Scoping Out the Compliance Project

 

  • Determine the products that may be implicated by the Conflict Minerals Rule. At companies without a centralized product database, this often is a cumbersome task. Some companies circulate questionnaires internally to elicit this information.

  • Catalogue current procurement policies and practices, supplier diligence practices and internal reporting and data gathering practices and capabilities relevant to Conflict Minerals Rule compliance in order to determine areas that may require enhancement.

  • Construct a work plan, timeline and budget for Conflict Minerals Rule compliance.

  • Consider conducting a pilot compliance program. This is especially important for companies with a complex supply chain to identify weaknesses and areas for improvement before the Conflict Minerals Rule compliance program is rolled out more broadly.

  • Prior to conducting a pilot compliance program, consider whether to send a preliminary questionnaire to suppliers or a sample group to gather information concerning their existing procurement practices, compliance policies and procedures and data-gathering capabilities. The insight gained from the responses to the preliminary questionnaire can be used to construct a more effective pilot compliance program or hard launch.

  • Demo third-party Conflict Minerals Rule compliance software solutions.

  • Many companies will need to look to third-party software solutions to assist with data collection, and there are several solutions competing for IT spend.

  • Meet with supply chain consultants if some of the heavy lifting will need to be outsourced. Because this is a developing expertise with consultants at a wide range of price points, many companies will want to meet with several supply chain consultants before deciding which firm to hire.

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Communicating the Rule and the Compliance Program

 

  • Update compliance manuals and policies to reflect the Conflict Minerals Rule and the company’s compliance policy. Some companies have separate supply chain policies, while others include the principles in their social responsibility or equivalent policy.

  • Send a written communication to relevant employees sensitizing them to the Conflict Minerals Rule, the company’s compliance obligations under the rule and the company’s compliance policy.

  • Implement procedures to ensure that all certification and contract amendment requests relating to Conflict Minerals Rule compliance are sent to a knowledgeable employee for vetting. Many of the certifications and amendments that companies have been requested to sign thus far are overly broad and, as a practical matter, impossible to comply with. Because of technical language used in the certifications and amendments, this often will not be evident to employees that are not familiar with the Conflict Minerals Rule.

Managing Suppliers

 

  • Assemble a database of supplier personnel that should receive Conflict Minerals Rule compliance materials. Supplier compliance personnel will in many cases be different from regular supplier contacts, who typically are on the sales side of the organization.

  • Send an initial written communication to suppliers sensitizing them to the final Conflict Minerals Rule and your company’s compliance obligations thereunder.

  • Consider whether to conduct sessions on the Conflict Minerals Rule for suppliers.

  • Communicate your supply chain policy to suppliers.

  • Develop supplier questionnaires and certifications and determine additional supplier documentation, diligence and compliance requirements. The supplier certification process should take into account industry recommendations and diligence initiatives to map common supply chains. Questionnaires and certifications also should capture information relevant to Step Three of the due diligence inquiry to the extent applicable. In addition, consider whether to build into these materials forced labor and child labor elements, given evolving disclosure and legislative developments in those areas.

  • As discussed above, consider sending a preliminary questionnaire to suppliers, or a sample group, to gather information concerning their existing procurement practices, compliance policies and procedures and data-gathering capabilities.

  • Incorporate relevant elements of Conflict Minerals Rule compliance into contracts and purchase orders with suppliers, such as adherence to your company’s supply chain policy, diligence and inspection rights, supplier disclosure, reporting and cooperation requirements and flow-down clauses.

  • Develop a risk management plan that includes procedures for suspending or terminating suppliers that do not comply with your sourcing policies, as well as alternative sources for products and/or conflict minerals.

  • Confirm that contract manufacturers have the systems in place to track the date of manufacture of products, since this will determine the calendar year in respect of which products are required to be reported.

  • Consider participating in the continuing development of industry supply chain initiatives.

Near-Term Disclosure Considerations

 

  • Many public companies already have included a conflict minerals risk factor in their public disclosure. However, if your company has not already done so, consider whether the risks relating to the Conflict Minerals Rule are significant enough to your particular business to merit a risk factor. The risk factor should reflect the uncertainty surrounding the final rule.

  • If not already publicly available, consider whether to post your sourcing policy proactively on your website. Sites such as Rankabrand.org and Goodguide.com are already explicitly tracking conflict minerals policies.

 

A Few Other Items to Consider

 

  • Conflict minerals that are “outside the supply chain” prior to Jan. 31, 2013 are not required to be reported on under the Conflict Minerals Rule. Conflict minerals are outside the supply chain if they were smelted or refined or outside of the covered countries before that date. Conflict minerals and products already in-house should be inventoried prior to Jan. 31, 2013 so that they can be excluded from diligence and reporting. In addition, supplier certifications should be requested in respect of grandfathered conflict minerals and products that are delivered or manufactured on or after Jan. 31, 2013.

  • Benchmark your supply chain policy and practices against your competitors to the extent their policies and practices are publicly disclosed.

  • Participate in industry working groups. These groups are a good source of information as to how peer companies are addressing interpretive questions under the Conflict Minerals Rule.

  • Consider the investor relations and shareholder implications of Conflict Minerals Rule compliance and conflict free sourcing generally. At a minimum, expect to receive questions from some institutional investors on conflict minerals usage and sourcing and the anticipated effect of the Conflict Minerals Rule on your company. Some investors may more actively seek to drive conflict free sourcing through shareholder proposals and voting policies. In any case, expect conflict free sourcing to become an increased focus of some institutional investors. Underscoring the increased emphasis on human rights generally by some institutions, the Louisiana Municipal Police Employees’ Retirement System recently sued The Hershey Co. for access to its internal records, alleging that Hershey was complicit in child labor violations by African cocoa suppliers.

  • When pursuing acquisitions, the Conflict Minerals Rule needs to be taken into account in due diligence and assessing risk.

 

Implications of the Court Challenge 

 

In October 2012, a lawsuit challenging the Conflict Minerals Rule was filed with the Court of Appeal for the D.C. Circuit by the National Association of Manufacturers, the U.S. Chamber of Commerce and the Business Roundtable.

The challenge to the Conflict Minerals Rule was not unexpected. The petitioners had previously indicated that they might challenge the rule. In addition, the successful challenges of mandatory proxy access and the CFTC’s position limits rule, the dissents of Commissioners Gallagher and Paredes in connection with the adoption of the Conflict Minerals Rule and the challenge of the SEC’s resource extraction disclosure rule all contributed to the likelihood that the Conflict Minerals Rule would be challenged.

Although the challenge is being handled by the court on an expedited basis, the case is still in its early stages. Final briefs currently are due on March 28, 2013 and a decision by the court is not expected until fairly late in the year.

In the meantime, public companies and their suppliers are in the difficult position of having to determine how much effort and expense to incur in connection with their Conflict Minerals Rule compliance in light of the uncertainty surrounding the rule. The right answer for the vast majority of public companies and private suppliers is to stay the course for the time being and continue to implement their compliance programs.

If companies wait until the court case is resolved to begin their compliance, they are unlikely to complete all of the work that must be done in 2013. However, the good news (or, depending upon one’s perspective, bad news) for most companies is that they still are in the early stages of developing their Conflict Minerals Rule compliance programs and have significant ground to cover before they get to the heavy lifting under the rule, in particular the expensive and time-consuming exercise of supply chain-wide diligence and enhancements to IT systems. Therefore, in most cases, company compliance personnel are not yet in the position of having to advocate internally for immediate approval of significant budget items needed to comply with a rule that ultimately may be struck down.

In addition, in most cases, suppliers do not have the luxury of deferring the implementation of their compliance programs. Many companies that are taking a more gradual approach to their own Conflict Minerals Rule compliance while the challenge to the rule is pending, are nevertheless continuing to aggressively push Conflict Minerals Rule compliance down the supply chain because they can do so at relatively little cost to themselves.

Furthermore, even if the Conflict Minerals Rule ultimately is struck down, the usage of conflict minerals that are not “DRC conflict free” will remain a focus of the NGO community, socially responsible investors and consumer groups. Larger companies that already have expended significant effort to establish conflict free supply chains also are expected to continue these initiatives irrespective of the outcome of the challenge to the Conflict Minerals Rule. Other companies are expected to remain focused on creating a conflict free supply chain as part of their broader corporate social responsibility program, either to obtain a competitive advantage in the marketplace or to avoid adverse publicity.

Whatever the reason, in each case the result is the same — companies up and down the supply chain will need to stay focused on Conflict Minerals Rule compliance and the creation of a conflict free supply chain generally.

 

A Schulte Roth & Zabel White Paper authored by Michael R. Littenberg and Farzad F. Damania


This information has been prepared by Schulte Roth & Zabel LLP (“SRZ”) for general informational purposes only. It does not constitute legal advice, and is presented without any representation or warranty as to its accuracy, completeness or timeliness. Transmission or receipt of this information does not create an attorney-client relationship with SRZ. Electronic mail or other communications with SRZ cannot be guaranteed to be confidential and will not (without SRZ agreement) create an attorney-client relationship with SRZ. Parties seeking advice should consult with legal counsel familiar with their particular circumstances. The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions.

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