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FISCHER: The case for corporate civil disobedience
‘Conflict minerals’ reporting rules are unworkable
Question of the Day
''An Act to promote the financial stability of the United States," commonly known as the Dodd-Frank Act, contains, anomalously, a provision captioned, "Conflict minerals." Stuffed into the back of the 848-page law, at the 11th hour, the provision is intended to reduce violence in the Democratic Republic of the Congo, which Congress understands is partially financed by conflict minerals. This goal is to be achieved by requiring public companies to disclose, in reports to the Securities and Exchange Commission, whether gold, tantalum, tin or tungsten contained in any product that a company manufactures or contracts for manufacture benefited "armed groups" in the Congo or any of the nine surrounding countries.
As a statistical matter, chances that a product contains conflict minerals originating in the covered countries range from slight (as they have accounted for less than 2 percent, respectively, of world production of gold and tin and approximately 3 percent of tungsten) to less-than-likely (as up to 30 percent of world production of tantalum is sourced there). Adoption of the law nonetheless had swift, devastating impact.
Well before the SEC adopted implementing rules, sourcing of these minerals from the area stopped, hundreds of thousands of artisanal miners and their millions of dependents lost their means of livelihood and remote mining towns were cut off as airplanes that serviced them stopped landing there. Consistent with its humanitarian record, China began purchasing minerals from the area at huge discounts to global market prices. However, longstanding ethnic and land-rights conflicts, unrestrained by an ineffectual government, not minerals, fuel the violence in the Congo, so this de facto embargo on minerals from the area has not reduced it. New opportunities for thugs, such as providing protection for smugglers have been created. Observers on the ground in the country consider the law illustrates the malign effects of ill-informed do-goodism.
One might ask whether Congress' goal was less to help the people of the African nation than to punish big business for being in the business of making money. Imposed solely on companies that report to the SEC, the requirement burdens public companies and puts them at a disadvantage to competing private and foreign companies for no reason logically connected to the stated congressional intent. The law also requires disclosure, unnecessary to further its purpose, of detailed information difficult or impossible to obtain. Congress would advance its stated aims far more effectively by directly investing in the Congo the stupendous sums that will be required for compliance — estimated in the billions of dollars for initial implementation and hundreds of millions of dollars annually.
Under SEC rules, a manufacturing company initially must determine the chemical composition of its products, including from raw materials or components obtained from third parties. If the products contain even a trace of a conflict mineral necessary to their production or function, the company must conduct a "reasonable country-of-origin inquiry" to determine whether the conflict mineral originated in a covered country.
As the commission recognizes, the reporting regime relies upon supply-chain tracing mechanisms that will require cooperation from numerous companies and organizations not subject to the conflict minerals rule. Some company's supply chains may be 10 or more tiers deep, and the tiers may have their own supply chains. Except for limited reporting relief during phase-in periods, however, the commission makes no allowance for the time required for, or any failure of, the mechanisms to develop.
Further inquiry, referred to as "due diligence," is required, if, based on the reasonable country-of-origin inquiry, the company "has reason to believe that its conflict minerals may have originated" in the covered countries. What is the significance of "may have," if the covered countries account for only small proportions of the global market for three of the four conflict minerals? The starting proposition for almost any company ought to be, with respect to those three minerals, that they almost certainly did not originate in the offending area. The rule requires enormous resources to preclude a tiny possibility — essentially to prove a negative — and, absent such proof, due diligence is required.
A company required to perform due diligence must establish either that the conflict minerals in its products did not "directly or indirectly finance or benefit armed groups" or provide a description of the "products, the facilities used to process the ... conflict minerals in those products, and the efforts to determine the mine or location of origin with the greatest possible specificity." So a company already unable to determine whether a mineral came from any of nine countries is supposed to identify the originating mine and who had custody of or otherwise made profits on the mineral from the point it was extracted until it reached international markets.
Conflict minerals pundits contemplate "multidisciplinary teams" made up of legal, financial, accounting, procurement, engineering and internal audit personnel, as well as others, to tackle the reporting challenge. Some of the international giants having the wherewithal to deploy such assets are combining forces to meet the May 31, 2014, first reporting deadline. However, according to SEC rules data, around 60 percent of reporting companies have a public float of less than $75 million, and, doubtless, such "smaller reporting companies" are among the large percentages of companies that surveys find haven't even begun to implement compliance.
The SEC rules leave unclear the relevance of another rule to a company's conflict minerals reporting obligations. Rule 12b-21 requires that information be provided "only insofar as it is known or reasonably available" to the reporting company. Information unduly difficult or costly to obtain may be omitted. The conflict minerals rule is yet another law adopted, because "good intentions" displaced careful consideration of feasibility and effect.
The correct response might be to attempt to comply with the rule, but, perhaps, the right thing would be for companies en masse to answer, "The information cannot be obtained without unreasonable effort or expense."
David C. Fischer practices corporate and securities law in New York City.
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