At the recent ASIC summer school, the chairman spoke of the dramatic changes to the regulatory environment resulting from the global financial crisis and the subsequent expansion of the regulatory perimeter outside the comfort zone of regulators. In no place has that regulatory perimeter been extended as far as in the US.

The Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 (“Act”) was enacted to reform the US financial system with a view to preventing financial meltdowns of the scale in late 2008.  Section 1502 of the Act is unrelated to this mandate and instead requires publicly trading companies to report to the Securities and Exchange Commission (“SEC”) and on their websites whether they source ‘conflict minerals’ from the Democratic Republic of Congo (“Congo”) or its neighbors. It requires further stringent reporting and auditing from companies that use Congo or neighboring country conflict minerals, and requires the SEC to create specific regulations as to how companies will satisfy the legislation’s requirements. The SEC released a proposed rule on 15 December 2010  and while the final rule was expected to be released on 15 April 2011, it is still delayed.

Section 1502 is one of a number of ‘exotic’ provisions contained in Dodd-Frank  that seems to have had its genesis through various lobbying groups, such as the Enough Project, and several failed attempts to legislate conflict minerals. In 2009 Rep. James McDermott submitted The Conflict of Minerals Trade Act to the House of Representatives, however it never moved out of the committees to which it was referred.  Also in 2009, Senators Sam Brownback (R-KS), Dick Durbin (D-IL) and Russ Feingold (D-WI) introduced the Congo Conflict of Minerals Act 2009, however it too received little support. When Dodd-Frank was tabled, Senator Brownback pushed for wording similar to his failed Bill to be included in Section 1502 and it was added with little controversy. 

The SEC is being pulled in competing directions with regard to implementation of the rules. On the one hand, activist groups and Capitol Hill are urging the SEC to “issue strong regulations with no phase-ins or delays as intended under Section 1502” . On the other hand, industry groups believe that the regulations impose too stiff of a burden on commerce without demonstrating market based reasons for doing so. In particular, the US Chamber of Commerce and its member companies are arguing that the legislation is impossible to implement as written, as noted in its submissions to the SEC on 28 February 2011 and 18 July 2011. The SEC takes the US Chamber of Commerce seriously after it had the SEC’s proxy access rule vacated in July 2011.  The proxy access rule was vacated in large part because the SEC failed to conduct a cost-benefit analysis of the impact of the regulations on industry prior to finalizing them. In the case of conflicts minerals, one of the biggest obstacles that the SEC faces is that it is not possible to conduct a cost-benefit analysis of the regulations because it cannot accurately pinpoint the costs to industry. This red-flag suggests that any legal challenge by the US Chamber of Commerce with respect to Section 1502 is likely to be successful. In an unprecedented move, the SEC held a roundtable on conflict minerals on 18 October 2011 in which corporations and advocacy groups  were invited to participate. The majority of the participants requested the SEC to delay implementation of the rules for reasons of complexity and cost.

There is global support for due diligence guidelines for supply-chains of minerals from conflict zones. In May 2011, the OECD released a report on “OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas”  and more recently published detailed guidance on supply chain due diligence for gold from conflict affected and high risk areas on 3 February 2012. On 27 January 2012, the EU  released a Trade and Development Communication which included a commitment to improving supply chain transparency across the EU, a move that will help prevent natural resource-fuelled conflict. The Communication also stated that the EU will advocate greater use of the due diligence standards published by the OECD.  The problem with Section 1502 is the extent of disclosure, the consequent regulatory burden and the associated costs.

The regulatory burden arises not from the fact that disclosure is required, but from the extent of the disclosure required. The SEC has recently issued guidance on disclosure obligations with regard to climate change, however the disclosure obligations centre on the costs of compliance and costs of potential litigation associated with applicable rules and regulations other than those issued by the SEC. Conversely, Section 1502 calls for a detailed supply-chain analysis in the region and requires issuers to assess the source of its products, when that may not be possible. The purpose of the section is therefore not disclosure of financial information which may affect the issuers' balance sheet, but rather a social agenda aimed at preventing issuers from dealing in the conflict minerals covered by the section.    

There is also no consensus on the costs of implementation, and it seems to depend on which side of the table you are sitting. A Tulane University economic analysis assesses cost of implementing Dodd-Frank conflict minerals regulation to be $7.93 billion, exceeding an estimate prepared by SEC of $71.2 million. Conversely, a Green Research report, sponsored by Global Witness, estimates that while costs will vary depending on the size and complexity of supply chains, they will represent approximately 0.00004 percent of annual revenues for large companies in their first year of reporting. Smaller companies should be able to meet their reporting obligations for less than the cost of a full-time employee in their first reporting year, with costs declining over time.

Unfortunately, it appears from a recent Working Paper from the Center For Global Development that Congo is already suffering the consequences:  “…Section 1502 has created a de facto ban on Congolese mineral exports, put anywhere from tens of thousands up to 2 million Congolese miners out of work in the eastern Congo, and, despite ending most of the trade in Congolese conflict minerals, done little to improve the security situation or the daily lives of most Congolese.” These findings are consistent with reports published in the New York Times and Reuters.

For a seemingly innocent provision that snuck into the back of a regulatory reform Act, it is creating a media frenzy. On a daily basis there is commentary from global organizations like the UN to local papers like the Detroit News debating the costs and benefits to the market. While those costs are indeterminate, what is certain is that if enacted in its current form the SEC will have a significant challenge in ensuring compliance.