Corporate Social Responsibility and the Law : Foley Hoag LLP

This post, authored by Sarah A. Altschuller and Gwendolyn W. Jaramillo, was originally published, in excerpted form, by The Elm Consulting Group.

The U.S. Securities and Exchange Commission (“SEC”) failed to issue a final rule on conflict minerals regulations before the end of 2011, and companies still await clear guidance on the scope of Section 1502 and the nature of the relevant reporting requirements. In an announcement regarding "upcoming activity" related to the implementation of Dodd-Frank, the SEC has now indicated that the final rule for Section 1502 will be adopted between January and June 2012. Notably, the SEC’s announcement indicates that “this is an estimated timeline and may be subject to change.” The final rule was originally scheduled to be issued no later than April 15, 2011.

The Conflict Minerals Report Requirement

Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires companies that utilize tin, tungsten, tantalum, and gold to conduct and disclose due diligence on their supply chains in order to identify whether the those minerals originated in the Democratic Republic of Congo (“DRC”) or adjoining countries. If an issuer either determines that its conflict minerals originated in the DRC countries, or cannot conclude that the conflict minerals did not originate in the DRC countries, the issuer will be required to disclose this information in its annual report. The issuer must then furnish a Conflict Minerals Report (“CMR”) as an exhibit to the annual report, and must disclose the Internet address at which this exhibit is available.

The CMR must describe the due diligence that the issuer conducted on the source and chain of custody of its conflict minerals. Issuers will be required to describe: products that are not "DRC conflict free"; the country of origin of those conflict minerals; the facilities used to process those minerals; and efforts taken to locate the mine or source of the minerals with the greatest possible specificity.

The Reporting Timeframe

Section 1502 requires impacted issuers to submit their first disclosures regarding their first full fiscal year which begins after the promulgation of the final rule. With a final rule now delayed again, issuers currently subject to the legislation must evaluate how to prepare for the future disclosure requirements.

Looking ahead, and based on previous experience, it is most likely that the SEC will introduce a phased approach for disclosures, whereby certain initial disclosures will be required in the first reporting year that will need to be augmented in subsequent years. Many stakeholders have urged the SEC to adopt a phased approach in comments to the proposed regulations issued in December 2010.

Groups calling for a phased approach include the U.S. Chamber of Commerce, the National Association of Manufacturers, and the House Financial Services Committee. This could logically take the form of requiring larger issuers to fully comply in the first year following the issuance of the final rule, while giving smaller issuers the benefit of more time to comply. This approach has been used in several prior instances, including: the requirement for the inclusion of XBRL (eXtensible Business Reporting Language) data files in corporate filings; and the requirement, pursuant to Section 404 of the Sarbanes-Oxley Act, for an independent auditor’s report on the effectiveness of internal controls over financial reporting (although the requirement for smaller companies was eliminated by Dodd-Frank).

If the rule is issued in the next few months, issuers with fiscal years beginning in March/April or June/July would be required to issue their first reports in early to mid-2013. Issuers may fear being required to report on due diligence efforts undertaken during a time period unguided by final regulations, but that appears unlikely based on the language of Section 1502. That said, however, issuers with fiscal years beginning soon should be prepared to hit the ground running and ideally will have identified appropriate internal groups or departments who would be charged with collecting the required information in order to facilitate full compliance.

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The Securities and Exchange Commission ("SEC") has delayed the release of final rules applicable to companies that source "conflict minerals" from the Democratic Republic of Congo ("DRC") and adjoining countries. Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires companies that utilize tin, tungsten, tantalum, and gold to conduct and disclose due diligence on their supply chains in order to identify whether the sourcing of these minerals is supporting the ongoing conflict in the Democratic Republic of Congo.

In an announcement regarding "upcoming activity" related to the implementation of Dodd-Frank, the SEC has indicated that final rules for Section 1502 will be adopted between August and December 2011. Final rules were originally scheduled to be issued no later than April 15.

Even as the federal rules on conflict minerals have been delayed, companies impacted by Section 1502 should pay attention to recent legislative activity in California. On April 12, the California State Senate passed a bill that would prohibit the state government from doing business with companies that fail to comply with federal regulations on conflict minerals. The California legislation, even if passed, is unlikely to impact many companies: it would apply only to companies against which the SEC has filed a civil or administrative enforcement action. That said, California's legislative activity reflects significant stakeholder concern, as well as advocacy activity, regarding the ways in which the sourcing of specific minerals may be contributing to the ongoing conflict in the DRC.

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Last week, Sarah Altschuller was interviewed on Capital Thinking, an internet radio program on VoiceAmerica Business Network. During the interview, she addressed several recent legal developments in the field of corporate social responsibility, including the Dodd-Frank provisions on conflict minerals and disclosure of payments to governments, as well as the California Transparency in Supply Chains Act. She also discussed the Draft Guiding Principles recently released by the U.N. Special Representative on Business and Human Rights. A podcast of the interview is available here (.mp3).

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The Securities and Exchange Commission ("SEC") has extended the time period for comments on proposed rules issued pursuant to Section 1502 (conflict minerals) and Section 1504 (disclosure of payments to governments) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The proposed rules are now open for comment until March 2, 2011.

The extension applies to rules proposed pursuant to:

• Section 1502 of the Dodd-Frank Act, which requires companies that utilize certain conflict minerals to conduct and disclose due diligence on their supply chains in order to identify whether the sourcing of these minerals is supporting the ongoing conflict in the Democratic Republic of Congo; and
• Section 1504, which lays out transparency provisions requiring oil, gas, mining, and other extractive industry companies to report their payments to governments to the SEC.

As stated by the SEC in the notices of extension (.pdf),

The nature of the proposed disclosure requirements differs from the disclosure traditionally required by the Exchange Act…The Commission believes that providing the public additional time to consider thoroughly the matters addressed by the release and to submit comprehensive responses to the release would benefit the Commission in its consideration of final rules. 

Many companies and industry groups had requested an extension of the comment period because of the new and complex issues raised by the proposed disclosure provisions.

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In previous posts, we have discussed the requirements and implications of Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (.pdf), which requires companies that utilize certain conflict minerals to conduct and disclose due diligence on their supply chains in order to identify whether the sourcing of these minerals is supporting the conflict in the Democratic Republic of Congo.  The Security and Exchange Commission released its proposed rule on conflict minerals in on December 15, 2010.  The rule is open for comment until January 31, 2011.

Recently, Sarah Altschuller, one of the attorneys in our CSR practice, recorded a podcast on the SEC's proposed conflict minerals rule for Compliance Week.  The podcast is available here.  Conflict minerals consist of columbite-tantalite (tantalum precursor), wolframite (tungsten precursor), cassiterite (tin precursor), and gold.  As noted in the podcast, these minerals are used in the production of automobiles, jet engines, computers, cell phones, jewelry, medical equipment and many other products, and the rule will thus affect a broad range of industries. 

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Looking back at 2010, there have been a number of significant legal developments in the field of corporate social responsibility.  New federal and state statutes have imposed due diligence requirements on companies with the specific intent of addressing human rights concerns, ranging from forced labor to the ongoing conflict in the Democratic Republic of Congo.  Courts continue to grapple with the potential scope of corporate liability under the Alien Tort Statute (“ATS”).  At the international level, the concept of the corporate “responsibility to respect” human rights continues to gain credence, at the same time as access to water was recognized as a human right by the United Nations.

As lawyers, we advise clients on developments in both “hard law” requirements and “soft law” expectations for companies in the area of human rights and social responsibility.  The intersection of what is required and what is expected of companies can present both challenges and opportunities.  In no specific order, here are five “big developments” that we think will impact corporations, and the expectations of corporate stakeholders, in 2011 and beyond.

• The SEC, Conflict Minerals, and Disclosure of Payments.  Buried in the Dodd-Frank financial reform legislation are two provisions that impose significant new disclosure requirements on companies.  Section 1502 requires companies that utilize certain conflict minerals to conduct and disclose due diligence on their supply chains in order to identify whether the sourcing of these minerals is supporting the conflict in the Democratic Republic of Congo.  Section 1504 requires companies in the extractive sector to report on taxes, royalties, fees, and other material benefits paid to foreign governments and the United States.  Compliance with these provisions will be a significant challenge for many companies.  In mid-December, the SEC released proposed rules pursuant to these two provisions, and final rules are expected to be in place by April 2011, although under the new Congress implementation of these rules may be delayed.

• Ruggie's Draft Guiding Principles.  The U.N. Special Representative on Business and Human Rights, John Ruggie, released his Draft Guiding Principles for the implementation of the three-part “Protect, Respect, and Remedy” framework first set forth in his 2008 report to the U.N. Human Rights Council.  Institutions ranging from the European Parliament to the OECD have already cited certain provisions of the framework, especially with regard to the corporate responsibility to respect human rights -- that is, not to infringe on rights -- and its central component of human rights due diligence.

• Water is a Human Right.  In July, the U.N. General Assembly declared access to safe water to be a human right.  In September, the U.N. Human Rights Council adopted a resolution recognizing access to clean water and sanitation as a fundamental human right, “equal to all other human rights” and capable of legal enforcement.  These developments came at the same time as increasing water scarcity is impacting communities, and companies, around the world.  Companies will likely find that stakeholders increasingly expect due diligence efforts, especially with regard to human rights impacts, to include assessments of corporate impacts on community water resources.

• The Second Circuit Declares that Companies are Not Proper Defendants Under the ATS.  In a controversial opinion, the Second Circuit Court of Appeals held in Kiobel v. Royal Dutch Petroleum that corporations cannot be properly sued under the ATS for violations of customary international law.  Already cited by other courts, and by many defendant briefs, this opinion, whether or not it is upheld, stands as one of the most significant ATS decisions to date.

• California Transparency in Supply Chains Act.  Retailers and manufacturers operating in California with global receipts in excess of $100 million will now be required to disclose what efforts they are taking, if any, to “evaluate and address” the risks of slavery and human trafficking in their supply chains.  This requirement applies to a wide range of companies, ranging from apparel companies that have grappled with concerns about their supply chains for many years, to companies in other sectors for which these due diligence requirements represent a new challenge.

As the New Year begins, we will continue to monitor these developments, and others, in the dynamic field of corporate social responsibility and the law.

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Yesterday, the Securities and Exchange Commission (“SEC”) posted proposed rules pursuant to Section 1502 (conflict minerals) and Section 1504 (disclosure of payments to governments) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

The proposed rules are open for comment until January 31, 2011.  Final rules will be issued no later than April 15, 2011.

We will be providing further analysis of both of these proposed rules.  Based on an initial review, key points include:

Section 1502 (Conflict Minerals)

• The proposed reporting requirements apply to all SEC issuers who file reports with the Commission, including foreign private issuers and smaller reporting companies, for which conflict minerals are "necessary to the functionality or production of a product manufactured" or contracted to be manufactured by such an issuer.  Conflict minerals consist of columbite-tantalite (tantalum), wolframite (tungsten), cassiterite (tin), and gold.  The rules apply even if only small amounts of such minerals are utilized. 
• If an issuer determines through a "reasonable country of origin inquiry" process that the conflict minerals it uses did not originate in the Democratic Republic of the Congo or adjoining countries ("DRC countries"), it will be required to disclose this determination in its annual 10-K report.  The annual report must also state what "reasonable country of origin inquiry" process the issuer undertook.  The issuer would be required to maintain records demonstrating that its conflict minerals did not originate in the DRC countries.
• If an issuer either determines that its conflict minerals originated in the DRC countries, or cannot conclude that they did not originate in the DRC countries, the issuer will be required to disclose this information in its annual report. The issuer must then furnish a Conflict Minerals Report as an exhibit to the annual report, and must disclose the Internet address at which this exhibit is available.
• The Conflict Minerals Report must describe the due diligence that the issuer conducted on the source and chain of custody of its conflict minerals.  Issuers will be required to describe: products that are not "DRC conflict free"; the country of origin of those conflict minerals; the facilities used to process those minerals; and efforts taken to locate the mine or source of the minerals with the greatest possible specificity.
• The Conflict Minerals Report must be audited by an independent private sector auditor. Issuers must identify the auditor and certify the audit. 
• Issuers will be required to provide their first disclosures after their first full fiscal year following the promulgation of the final rules.

Section 1504 (Disclosure of Payments by Resource Extraction Issuers)

• All U.S. and foreign companies engaged in the commercial development of oil, natural gas, or minerals that are required to file annual reports with the SEC are subject to the rule, regardless of size. Commercial development encompasses exploration, processing, export, and other “significant actions,” but does not include ancillary activities such as producing equipment utilized in commercial development or providing transport.
• Covered companies must report on taxes, royalties, fees, production entitlements, bonuses, and other material benefits paid to foreign government and the Federal Government that are not de miminis. The SEC does not plan to define "de minimis." These benefits can be in cash or in kind.
• Covered companies must report the type and total amount of payments made to a government for each project. The SEC does not propose to define the term "project."
• Covered companies must report on such payments made by subsidiaries or entities under their control, where the definition of control is taken from existing securities law.
• Covered companies must disclose a brief statement of this information in their annual 10-K reports, which refers investors to detailed information provided in two exhibits that would be furnished to the SEC as part of the 10-K. One of the two exhibits would include information in XBRL format, an interactive data format.
• Disclosure will be required in annual reports relating to fiscal years ending on or after April 15, 2012.

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The Dodd-Frank Wall Street Reform and Consumer Protection Act (.pdf), signed into law by President Obama on July 21, contains provisions requiring publicly traded companies that utilize certain "conflict minerals" to report regarding whether their products are “conflict free” – meaning that they should report on any due diligence steps taken to demonstrate that their products are not fueling conflict in the Democratic Republic of Congo ("DRC"). The legislation does not prohibit companies from using minerals from conflict areas. Rather, it relies on the reputational effects of public reporting to push companies to rely on conflict free sources. Human rights organizations believe that the sale of conflict minerals -- tantalum (coltan), cassiterite (tin), wolframite (tungsten), and gold – helps armed groups fund the purchase of weapons and the continuation of hostilities in the DRC.

For over a year, civil society has pushed the U.S. Congress to implement these provisions (.pdf) as an attempt to address the ongoing conflict in the eastern DRC, and have used a variety of means, including viral videos, to focus the public's attention on this issue. 

The minerals in question are commonly utilized in a variety of commercial products, such as automobiles, cellular phones, and airplane engines. The legislation therefore affects a large spectrum of industries, including mining, automotive, aerospace, and jewelry. The aim of the legislation is not to ban the use of these minerals if they originate from the DRC, but rather to ensure that the minerals do not come from conflict areas of the DRC or otherwise help fund the conflict. Given the due diligence that may be necessary to decisively demonstrate that products are conflict free, some have argued that the legislation will unintentionally create a de facto ban on minerals from the DRC and neighboring countries. On the other hand, if the SEC provides appropriate guidance, the legislation is likely to offer a clearer path for companies to demonstrate that they are not supporting conflict in the DRC.

Requirements imposed by the legislation include:

• A company that uses conflict minerals must produce an annual disclosure to the Securities and Exchange Commission ("SEC") if the minerals are "necessary to the functionality or production of a product" manufactured by the company. The company must also report on its public website.
• The annual disclosure must state whether the conflict minerals originated in the DRC or an adjoining country (including Angola, Burundi, Central African Republic, Republic of Congo, Rwanda, Sudan, Tanzania, Uganda, and Zambia).
• If the minerals used by a company originate in the DRC or an adjoining country, the company must report on the due diligence measures that it took regarding the source and chain of custody of those minerals. These measures are expected to include an audit by an independent professional audit company.
• Companies must also submit a description of any products manufactured by the company that are not "DRC conflict free." Products are conflict free if they do not contain minerals that directly or indirectly finance or benefit armed groups in the DRC or an adjoining country. Products are considered to benefit such groups if they come from areas where armed groups physically control mines or force civilians to mine, transport, or sell conflict minerals; tax, extort, or control any part of trade routes for the minerals up to the point of export; or tax, extort, or control trading facilities, in whole or in part.

Unfortunately, many key aspects of the legislation remain uncertain at this time. It is not clear exactly which companies will be required to produce reports.   In addition, it is not clear whether the information must be in companies’ 10-Ks or can be contained in other reports, although it is likely that penalties associated with fraud or deceit in SEC reporting will apply. Finally, it is not certain what it means for a mineral to be "necessary to the functionality or production of a product.” The SEC's 270-day rulemaking process should provide greater clarity for many companies.

The legislation is likely to affect all levels of the supply chain for these minerals. At this time, companies that utilize the named minerals should consider how they will demonstrate that they conducted due diligence to ensure that the mines from which their minerals come, as well as the routes and trading depots through which the minerals came, are conflict free. For end-user companies, this will mean ensuring, at a minimum, that smelters have robust due diligence processes on the ground and providing for an independent audit of those due diligence processes.

The legislation allows the U.S. State Department to expand the list of minerals that fuel conflict in the DRC, which would potentially affect a larger number of companies. The legislation currently covers the minerals that human rights organizations believe are primarily funding the conflict, so the expansion of the list seems unlikely unless a new mineral begins to be sourced from the eastern DRC in significant quantities.  

Under the legislation, the Department of Commerce can designate specific independent private sector auditors and due diligence processes as “unreliable.” If, in its reporting, a company relies on a determination of an independent audit or other due diligence process that is deemed unreliable, the report does not satisfy the SEC reporting requirement. Therefore, it is particularly important that due diligence processes are robust.

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