Corporate Social Responsibility and the Law : Foley Hoag LLP

A coalition of 80 institutional investors sent a letter to Congress last week in support of the Business Transparency on Trafficking and Slavery Act (HR 2759).  As discussed previously, the proposed legislation would require companies to disclose efforts to identify and address the risks of human trafficking, forced labor, slavery, and the worst forms of child labor in their supply chains.

Modeled after the California Transparency in Supply Chains Act, which went into effect on January 1, 2012, the proposed federal legislation, unlike the California statute, is not limited to retailers and manufacturers. If enacted, the legislation would be applicable to any publicly-traded or private company currently required to submit annual reports to the Securities and Exchange Commission ("SEC"), as long as the company meets an established annual gross receipts threshold. Companies would be required to include the required disclosures in their annual reports to the SEC.

In a letter sent to Speaker of the House John Boehner and House Majority Leader Eric Cantor, members of the Interfaith Center on Corporate Responsibility and U.S. SIF: The Forum for Sustainable and Responsible Investment called for HR 2759 to be placed at the top of the legislative agenda in order to move "this important legislation forward in an expeditious manner.”  In urging Congressional leaders to prioritize the bill, the investors stated that the proposed legislation

reflects the realities of the marketplace, which increasingly requires that companies be sensitive to social and ethical issues, including human rights, in their operations and global supply chains, and create human rights policies, as well as due diligence processes to evaluate, monitor, and strengthen these policies.

Notably, the investors’ statement also argued that the U.N Human Rights Council’s unanimous endorsement of the Guiding Principles on Business and Human Rights in June 2011 established “a global norm for the ‘corporate responsibility to respect’ human rights and underscores the importance of public reporting by companies.”

When it was introduced in August 2011, HR 2759 was referred to the House Committee on Financial Services and currently sits with the Subcommittee on Capital Markets and Government Sponsored Enterprises. Given the contentious climate on Capitol Hill, and the upcoming presidential election, it is unlikely that the bill will move in 2012, but its introduction is reflective of shifting expectations regarding the responsibilities of companies to identify and account for the adverse human rights impacts of their operations.

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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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In less than two months, on January 1, 2012, the California Transparency in Supply Chains Act will go into effect. Companies impacted by the legislation will be required to disclose their efforts, if any, to ensure that their direct supply chains are free from slavery and human trafficking.

As discussed in previous posts, the legislation applies to retail sellers and manufacturers doing business in California that have annual worldwide gross receipts exceeding one hundred million dollars.

Today, a group of investors released a best practices guide for companies seeking to comply with the California legislation. The guide, Effective Supply Chain Accountability: Investor Guidance on Implementation of The California Transparency in Supply Chains Act and Beyond, was released by the Interfaith Center on Corporate Responsibility, Christian Brothers Investment Services, and Calvert Investments. 

Beyond making the minimum disclosures required by the legislation, the guide urges companies to implement a comprehensive approach to the management of human rights risks in their supply chains. Specifically, the authors call on companies to develop a comprehensive management approach to human rights-related risks that includes the following elements:

• A human rights policy;
• Human rights due diligence;
• Human rights risk assessments;
• Verification and traceability mechanisms;
• Training/capacity building;
• Collaboration; and
• Disclosure/transparency. 

This guidance is responsive to the expectations of key corporate stakeholders, including shareholders, legislators, and consumers, who are increasingly demanding that companies identify and manage the human rights impacts of their operations, including human trafficking.  As the guide states,   

[g]iven the enactment and proposal of similar laws protecting human rights, including Section 1502 of the Dodd-Frank Act and HR 2759, the Business Transparency on Trafficking & Slavery Act, it has become clear that human rights risks within business value chains are becoming more widely acknowledged. As such, it is imperative that companies take active steps to combat human trafficking within their direct operations as well as supply chains to ensure that they are not complicit in human rights abuses.

In a press release accompanying the guide, David Schilling, Program Director for Human Rights at the Interfaith Center on Corporate Responsibility, observed that

We believe that additional legislation, at both the state and the federal levels, addressing these egregious human rights violations in company supply chains is inevitable.  The California Supply Chain Act may be the first law of its kind in the nation, but it will most certainly not be the last.

We believe that stakeholder expectations regarding the corporate responsibility to respect human rights will be increasingly embedded in state, national, and international legislative and regulatory frameworks. This "convergence of expectations" is a trend reflected by the California legislation and the advice provided in the new guide is intended to assist companies in meeting both current and future compliance requirements.

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On August 1, Rep. Carolyn Maloney (D-NY) introduced H.R. 2759, the Business Transparency on Trafficking and Slavery Act (.pdf), a bill modeled after the California Transparency in Supply Chains Act.  The bill would require companies to disclose efforts to identify and address the risks of human trafficking, forced labor, slavery, and the worst forms of child labor in their supply chains. 

The requirements of the California statute, which goes into effect on January 1, 2012, have been described in several previous posts.  Similar to the California legislation, the proposed federal legislation would only apply to companies with annual worldwide gross receipts exceeding one hundred million dollars.  Notably, however, the federal legislation is not limited to retailers and manufacturers.  If enacted, the legislation would be applicable to any publicly-traded or private company currently required to submit annual reports to the Securities and Exchange Commission ("SEC"), as long as the company meets the annual gross receipts threshold. 

Specifically, H.R. 2759 would require companies to include, in their annual reports to the SEC, disclosures describing to what extent, if any, they:

• Maintain policies to identify and eliminate risks of forced labor, slavery, human trafficking, and the worst forms of child labor within their supply chains;
• Maintain policies prohibiting the use of company products, facilities, or services to obtain or maintain conditions of forced labor, slavery, human trafficking, and the worst forms of child labor;
• Engage in verification of product supply chains to evaluate and address risks of forced labor, slavery, human trafficking, and the worst forms of child labor;
• Ensure that audits of suppliers are conducted, including specifications as to whether audits are independent and unannounced;
• Assess the supply chain management and procurement systems of suppliers to verify whether suppliers have appropriate systems in place to address risks of forced labor, slavery, human trafficking, and the worst forms of child labor within their own supply chains;
• Require suppliers to certify that materials incorporated into products comply with the laws regarding forced labor, slavery, human trafficking, and the worst forms of child labor in the country or countries in which they are doing business;
• Maintain internal accountability standards, supply chain management and procurement systems, and procedures for employees or contractors that fail to meet company standards regarding forced labor, slavery, human trafficking, and the worst forms of child labor;
• Provide training to employees and management on forced labor, slavery, human trafficking, and the worst forms of child labor;
• Ensure that recruitment practices of all suppliers comply with company standards for eliminating exploitive labor practices that contribute to forced labor, slavery, human trafficking, and the worst forms of child labor; and
• Ensure that remediation is provided to those who have been identified as victims of forced labor, slavery, human trafficking, and the worst forms of child labor.

The bill is co-sponsored by Rep. Christopher Smith (R-NJ), Rep. Jackie Speier (D-CA), and Rep. Jim McGovern (D-MA).  Rep. Maloney and Rep. Smith are co-chairs of the Congressional Human Trafficking Caucus.

While the ultimate passage of this proposed legislation is uncertain at best, given the current Congressional climate, the introduction of the bill reflects increased attention to the issue of human trafficking by public policy leaders.  Looking ahead, it is likely that legislative and regulatory efforts to eradicate human trafficking and other human rights abuses will involve provisions seeking to engage companies in addressing these concerns.  As noted in a recent article in Ethical Corporation magazine,

[n]ew efforts to combat human trafficking and slave labour have placed growing pressure on larger companies throughout the world to work towards eradicating trafficked and forced labour from their supply chains....Companies worldwide are being increasingly presed to become more transparent about their efforts to eliminate all formes of forced labour.

H.R. 2759 has been referred to the House Committee on Financial Services for further consideration.  We will be tracking the progress of this legislation closely.

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Retailers and manufacturers seeking to evaluate the potential applicability of The California Transparency in Supply Chains Act to their businesses should make certain that they are aware of recent changes in the California Revenue and Tax Code.  Specifically, Section 23101 of the Revenue and Tax Code was amended in a way that creates a more expansive definition of "doing business" in the state for taxable years beginning on or after January 1, 2011. 

As discussed in previous posts, the transparency legislation will go into effect on January 1, 2012 and applies to retail sellers and manufacturers doing business in California that have annual worldwide gross receipts exceeding one hundred million dollars.  These companies will be required to disclose their efforts, if any, to ensure that their product supply chains are free from slavery and human trafficking.  The transparency legislation states that "doing business in this state" shall have the same meaning as set forth in Section 23101.

As revised, Section 23101 states that a retailer and manufacturer may be found to be "doing business" in California if its sales in California exceed the lesser of $500,000 or 25 percent of its total sales. The manufacturer or retailer need not have a physical presence in California for sales to count as California sales. Retailers and manufacturers located outside California should evaluate the effects of these changes and the extent to which their businesses may now be subject to the transparency legislation's disclosure requirements.

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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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Gare Smith and I recently co-authored an article on corporate social responsibility ("CSR") and risk management for Executive Counsel magazine. In the article, "Making Corporate Social Responsibility Systemic," one issue we discuss is the potential risk to companies that "claim to have embraced CSR and then simply point to glossy reports reflecting anecdotal philanthropic initiatives to demonstrate the degree of their commitment." We believe that

such companies fail to develop the internal policies and mechanisms necessary to ensure that the correct people, in the right functional areas, are held accountable for following specific environmental and social standards. References to good deeds do not mitigate against the risks associated with lack of internal commitment and oversight.

We observe that a lack of executive-level oversight with regard to a company's approach to CSR may leave companies with little capacity to develop strategic and comprehensive responses to stakeholder concerns about the social and environmental impacts of the company's operations. 

A copy of the full article is available here (.pdf).

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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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Today is National Human Trafficking Awareness Day.  In less than one year, on January 1, 2012, The California Transparency in Supply Chains Act will go into effect.  As discussed in previous posts, many large retailers and manufacturers doing business in California will be required to disclose their efforts, if any, to ensure that their product supply chains are free from slavery and human trafficking.

Companies that will be impacted by the legislation include both brand name retailers that have already faced considerable scrutiny with regard to human rights issues in their supply chains, as well as companies that have not historically received much attention with regard to these issues.  All impacted companies must make the required disclosures on their corporate websites.

What should companies doing business in California be doing to prepare for this legislation?

• Identify whether the legislation applies to your company.  If your company does business in California and is identified on its tax returns with a "principal business activity code" that falls within the category of “manufacturing” or “retail trade”, the legislation applies if your company’s annual gross receipts exceed one hundred million dollars.  This will impact a range of companies, including clothing retailers, grocery stores, and metal manufacturers.

• Review any human rights policies and standards applicable to your product supply chain.  If the legislation applies, it is time to closely review your corporate policies and supplier standards that address issues of human rights.
  • Does your company have policies in place that address forced labor and human trafficking?
  • How does your company inform its suppliers of these policies?
  • Does your company have procedures to evaluate the risk of forced labor or human trafficking associated with the manufacture of its products?
  • Do your supplier standards require certification that the raw materials used in the manufacture of products were sourced in compliance with applicable laws on slavery and human trafficking?

These are all important questions to consider when evaluating your company’s capacity to produce the required disclosures.

• Review, or implement, auditing and verification mechanisms.  Policies and procedures must be implemented and verified.  It is important to evaluate the capacity of existing verification procedures: 
  • How does your company verify compliance with its human rights policies? 
  • Does your company have systems in place to audit suppliers for compliance with corporate human rights policies? 
  • Are existing, or planned, auditing procedures sufficient to evaluate the specific risks of forced labor and human trafficking associated with your product supply chain? 
  • Does your company use independent auditors? 

Note that the legislation will require companies to specify whether verification of supplier compliance is done through independent, unannounced audits.

• Review internal accountability mechanisms and training procedures.  Your supplier policies and standards provide little assurance unless they are effectively integrated into the management of your supply chain.
  • Are corporate human rights policies integrated into supplier guidelines and standards?
  • What functional areas within your company are best-positioned to implement policies on forced labor and human trafficking?
  • Are the correct people within the functional areas noted above held accountable for implementing corporate policies on forced labor and human trafficking?
  • Is your company providing sufficient training to the right personnel to ensure that corporate policies are carried out effectively?  

Note that the legislation specifically calls for disclosures regarding internal accountability mechanisms and training programs for employees and management.

• Start thinking about the content of disclosures.  When planning public disclosures, one year can go by very quickly.  It is important to begin internal discussions about the content of the required disclosures within your company.  The California statute requires disclosure of corporate efforts "if any" -- and this allows for a range of potential approaches.  It may be appropriate to engage in discussions with external, as well as internal, stakeholders when determining what information should be provided. 

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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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Raise the topic of due diligence in a room of corporate lawyers and you might expect the conversation to turn to a discussion of mergers and acquisitions or environmental site assessments.   Increasingly, however, corporate counsel are being asked to help clients develop due diligence strategies and systems to identify the human rights concerns that may be associated with their existing, or potential, operations. 

Corporate stakeholders, including both legislators and shareholders, are requesting that companies demonstrate that they have due diligence mechanisms in place to assess, and respond to, human rights concerns in their supply chains and operating areas.

Recent legislative developments in this area include:

• Section 1502 of the new Dodd-Frank financial reform legislation requires companies using minerals originating in the Democratic Republic of Congo (“DRC”), or adjoining countries, to report on their “due diligence measures” regarding the source and chain of custody of those minerals. This provision, meant to address concerns that the purchase of “conflict minerals” is fueling conflict in the DRC, could impact companies in a wide range of industries depending on the final language of implementing regulations. 
• The new California Transparency in Supply Chains Act of 2010 asks retailers and manufacturers operating in California to disclose their efforts to “evaluate and address" the  risks of human trafficking and slavery in their product supply chains. 

Compliance with these requirements will not be straight-forward.  It is frequently hard to identify consistently reliable sources of information regarding, for example, the source of specific minerals or the veracity of supplier assurances regarding the status of certain workers.  What is clear is that these new requirements reflect a desire on the part of corporate stakeholders to ensure that corporate commitments to human rights go beyond short policy statements.  Stakeholders increasingly expect companies to demonstrate that they have systems in place to assess, avoid, and mitigate the adverse impacts of their activities on human rights. 

In the 2010 proxy season, socially responsible investors filed resolutions with a number of companies, including Caterpillar, Hewlett-Packard, Motorola, and KBR, asking for the adoption of comprehensive human rights policies and assessment mechanisms.  The resolutions filed with Motorola and Hewlett-Packard urged these companies to develop policies sufficient to provide assurance that their “products and services are not used in human rights violations.”  The resolution filed with KBR asked the company to report on the extent to which the company’s “contractors and suppliers are implementing human rights policies in their operations, including monitoring, training, [and] addressing issues of non-compliance[.]”

The legislative provisions and shareholder resolutions cited above are consistent with the recommendation put forward by the U.N. Special Representative for Business and Human Rights that companies carry out “human rights due diligence” in order to discharge their responsibility to respect human rights.  As framed by the Special Representative (.pdf), human rights due diligence involves the implementation of policies, assessment mechanisms, and internal oversight and control systems to identify, prevent, and address the actual and potential adverse human rights impacts associated with a company's operations. 

With the recent emergence of human rights due diligence as a mechanism to ensure accountability for the adverse human rights impacts associated with corporate activity, companies, and their counsel, should evaluate the extent to which they have developed policies and oversight mechanisms sufficient to address stakeholder concerns and expectations.

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On September 30, California Governor Arnold Schwarzenegger signed The California Transparency in Supply Chains Act of 2010 into law.  The legislation will require companies to disclose their efforts to ensure that their supply chains are free from slavery and human trafficking. 

The legislation will go into effect on January 1, 2012 and applies to retail sellers and manufacturers doing business in California that have annual gross receipts exceeding one hundred million dollars.

Once the legislation goes into effect, companies will be required to disclose what actions they are taking, if any, to:

• Evaluate and address the risks of human trafficking and slavery in their product supply chains. These disclosures must state if companies are not using third parties to verify the risks in their supply chains.
• Require their direct suppliers to certify that the materials incorporated into company products comply with laws regarding slavery and human trafficking in the countries in which they are doing business.
• Conduct audits of their suppliers to evaluate compliance with company standards on trafficking and slavery.  These disclosures must state whether independent, unannounced audits are conducted.
• Maintain accountability standards and procedures for employees or contractors that fail to meet corporate standards regarding slavery and human trafficking.
• Provide employees and managers, who have direct responsibility with supply chain management, with training on the mitigation of human trafficking and slavery risks.

Companies are required to make these disclosures on their websites.  If a company does not have a website, the information must be made available in writing within 30 days of a consumer request for the disclosure.  The exclusive remedy for failure to comply with the law is an action brought by the Attorney General of California for injunctive relief.

A coalition of institutional investors, faith-based investors, and research firms had urged Governor Schwarzenegger to sign the legislation, which was passed by California's Senate and Assembly in July.  Rev. David M. Schilling, program director for human rights at the Interfaith Center on Corporate Responsibility, recently observed that the legislation's requirements are in line with the recommendations of the U.N. Special Representative for Business and Human Rights, specifically with regard to corporate implementation of human rights due diligence processes (.pdf). 

Initial estimates suggest that the legislation will impact approximately 3,200 companies.  That said, as was noted by the legislation's supporters, many companies are already disclosing detailed information about the human rights risks associated with their supply chains.  The intent of the legislation is to provide consumers with the information they need to make purchasing decisions with the elimination of slavery and human trafficking in mind.  The language of the bill specifically cites a September 2009 report by the U.S. Department of Labor (.pdf) that lists 122 goods from 58 countries that the Department of Labor has reason to believe were produced with either forced labor or child labor, and states that "[a]bsent publicly available disclosures, consumers are at a disadvantage in being able to distinguish companies on the merits of their efforts to supply products free from the taint of slavery and trafficking."   

The legislation does not require companies to take specific actions other than the disclosure of what, if any, efforts are being made to address the risks of slavery and human trafficking in their direct supply chains.  Ultimately, the impact of the legislation will depend on both consumer behavior and the extent to which advocates, including investors, are able to use the required disclosures to pressure companies to monitor, and mitigate, the human rights risks in their supply chains. 

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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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The Dodd-Frank Wall Street Reform and Consumer Protection Act (.pdf), signed into law by President Obama on July 21, contains broad-reaching transparency provisions requiring oil, gas, mining, and other extractive industry companies to report their payments to governments to the Securities Exchange Commission (“SEC”).

The premise of the bill is that transparency, in the long run, supports human rights, and helps limit corruption in countries where few benefits from mineral wealth typically reach the general population.

Key elements of the legislation include:

• Companies that are securities issuers under U.S. law must report annually to the SEC on their payments, as well as those of their subsidiaries and entities under their control, to the U.S. and foreign governments. The law does not exempt foreign issuers, and it is likely that the legislation will cover many issuers of ADRs, as well. The legislation does not specify whether the annual report must be the company’s 10K or another form of reporting, leaving this decision to the SEC rule-making process. It is likely that the penalties related to fraudulent or deceptive reporting to the SEC will apply. 
• Companies must report on the type and total amount of payments made on a project basis to both the U.S. and foreign governments. It is unclear whether companies must report on projects for which they do not serve as the operator, nor hold a majority interest in the project. 
• The payments that companies must report include taxes, royalties, fees, production entitlements, bonuses, and other material benefits, to the extent that the SEC determines that these are part of the commonly recognized revenue stream for extractive projects. Payments do not include de minimis payments. The SEC rulemaking process should help clarify the extent to which this information must be disaggregated. 

The legislation covers most, but not all, major multinational companies, but likely does not encompass a number of state-owned companies that are primarily active in their own jurisdictions and have no presence in the United States. The SEC rule-making process will help determine whether contractors and service providers must comply with the legislation.

The legislation is intended to reinforce the Extractive Industries Transparency Initiative, which is a multi-stakeholder initiative consisting of oil, gas, and mining companies; civil society; and governments. Under the Extractive Industries Transparency Initiative, many U.S. companies already report their payments to some, although not all, governments around the world. The bill may require the reporting of more detailed payment information than the Extractive Industries Transparency Initiative demands, depending on the SEC’s interpretation of the legislation. 

The SEC’s rulemaking process will help define more clearly how companies will need to change their accounting practices. For instance, the SEC will presumably define a de minimis payment. Companies are advised to monitor the SEC’s rulemaking process closely.

 

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