Conflict Minerals Compliance Program Implementation

Conflict Minerals Compliance Program
Implementation: An Analysis of 4 Prevailing
Approaches
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January 2014
Conflict Minerals
Compliance Program
Implementation:
An Analysis of 4
Prevailing Approaches
©Source Intelligence 2014
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Introduction
On May 31, 2014 under Section 1502 of the SEC’s Conflict Minerals Rule, U.S. publicly
traded companies will have to file a special disclosure for the 12-month reporting period
ending on December 31, 2013. The aim of the rule, mandated by the Dodd-Frank Wall
Street Reform and Consumer Protection Act, is to provide transparency into corporate
practices and specifically to reduce funding for armed groups involved in human rights
violations in the Democratic Republic of the Congo and surrounding countries. Section
1502 compels public disclosure for any issuer whose products are identified as containing
Jennifer Kraus, MPH, PhD
one or more of the four conflict minerals (tantalum, tin, tungsten and gold also known as
Jordan Groves, Director
“3TG”) suspected to have originated in the DRC or surrounding countries. Said minerals
are found in thousands of products ranging from electronics such as phones, televisions,
Kelsey Flynn-Granquist
and computers to jewelry, toothpaste, PVC pipe, and even anti-microbial fabrics. Minerals
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contained in products that are found to be sourced from the covered countries will trigger
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a “not found to be conflict free” disclosure, while minerals that are not found to be
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sourced from the covered countries will trigger a “conflict free” disclosure. Where an
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Issuer is unable to determine the source of 3TG minerals, an “Undeterminable”
Carlsbad, CA 92011
classification may be filed along with a Conflict Minerals Report detailing the reasonable
and good faith effort to try to determine their origin.
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O: 877. 916. 6337
Industry Impact
F: 858. 876. 1728
According to the rule, an estimated 5,994 public companies that file with the SEC will
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have to provide new disclosures. Moreover, approximately 275,000 private companies
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that are part of issuers’ supply chains will also be expected to provide conflict minerals
due diligence to their public customers. Furthermore, a 2011 study1 by Tulane University,
assessed the costs of implementing the Dodd-Frank conflict minerals regulation to be
$7.93 billion — more than one hundred times greater than the initial estimate prepared by
the U.S. Securities and Exchange Commission (SEC) of $71.2 million2 that was later
revised to $3 billion to $4 billion3.
Companies are now discovering first hand that complying with the rule is not as
straightforward as expected. Factor in the depth and complexity of global supply chains,
language barriers, political obstacles, confidentiality concerns, supplier resistance plus the
sensitive nature of the materials being traced and it is not surprising that over 75% of
companies surveyed by PricewaterhouseCooper’s July 20134 report: “How Companies Are
Preparing” are either inactive - waiting or unsure if the rule applies - or in the very early
stages - beginning to identify products and suppliers of interest - of implementing their
conflict minerals program.
Approaches to Compliance
In July 2013, PwC published a report based on a survey of nearly nine hundred individual
Issuers across 16 different industries. The report concluded that “almost half of the
companies [surveyed] are still in the initial stages of their compliance efforts: 16% haven’t
started gathering information, while 32% are still in the process of determining the
applicability of the rule to their products.” With the reporting period ending on December
31, 2013 and the first filing deadline approaching, time is running out for companies who
have still not decided on the best approach for their company.
There are four prevailing approaches that companies are utilizing to address Dodd-Frank
1502 compliance requirements. In some cases organizations have adopted an approach
combining two or more of the following methods:
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!Tulane University “A Critical Analysis of the SEC and NAM Economic Impact Models and the Proposal of a Third
Model in View of the Implementation of Section 1502 of the 2010 Dodd-Frank Wall Street Reform and Consumer
Protection Act”
2
SEC Final Rule page 247
3
SEC Final Rule page 346
4
PwC “How Companies Are Preparing”
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In-House
An internal team consisting of experts from IT, procurement, legal, finance, and/or
environmental health and safety (EHS) implement the compliance program
Hourly Consultant
Boutique and Big 4 firms offering conflict mineral consulting services.
File-Based Management Software
Assists companies in organizing supplier data and outreach via automated email
system
Full Service Providers
Turnkey solutions that combine technology with managed services to address all
of the key components of DF-1502: Filtering, RCOI, Assessment, Due Diligence
and Reporting
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Key considerations for issuers weighing the benefits of each approach above comes
down to the cost, quality and efficiency with which the following compliance requirements
can be performed:
1. Applicability
Determining which products and respective suppliers are in-scope
2. Reasonable Country of Origin Inquiry (RCOI)
Engaging direct suppliers to determine whether the 3TG minerals they supply
originated in the DRC or covered countries, or are from recycled or scrap sources
3. Assessment & Data Validation
Analysis of RCOI responses to assess risk and identify red-flags that may warrant
further due diligence
4. Due Diligence
Conduct further due diligence if, based on the assessment of responses, it is
determined that conflict minerals originated or may have originated in a covered
country and were not from recycled or scrap sources.
5. Report
Completing the required Form SD and, as required, appended Conflict Minerals
Report (CMR) describing the measures taken to perform due diligence on the
source and chain of custody of 3TG minerals.
Whether leveraging in-house resources, retaining a consultant, using 3rd party software or
working with a full-service provider, there are five key elements to consider when
evaluating the costs, efficiency and quality of your conflict minerals program:
1.
2.
3.
4.
Available Service - is performing the requirement an offered service?
Core Capability - is the service being performed a core capability?
Technology Platform - is data stored on a proprietary technology platform?
Issuer Resources Dependent- what is the level of dependence on Issuer resources to
perform the requirement?
5. Cost - what is the relative cost when compared against utilizing internal resources?
January 2014
Optimization these 5 variables will drive a successful conflict minerals compliance
program. Even more critical, however, is to assess these variables for the different
approaches for EACH stage of the conflict minerals compliance program. This includes
the initial applicability phase as well as subsequent RCOI, assessment and data
validation, due diligence, and reporting stages.
Conflict Minerals
Compliance Program
Implementation:
An Analysis of 4
Prevailing Approaches
©Source Intelligence 2014
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Applicability
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Key considerations for identifying which products may be in scope center around
efficiency, cost and expertise. Weighing the costs of managing these tasks internally
should factor the ease with which product data can be gathered and consolidated. In
many cases companies will need to scrutinize products down to the BOM level in order
to identify the potential for 3TG minerals. Consultants may be engaged to provide
granular level analysis to hone in on suspect products while a Full Service Provider may
leverage known databases of products, product categories and keyword lists to more
efficiently analyze product information in order to flag products to be included in the
Reasonable Country of Origin Inquiry.
In summary, the more granular your approach to filtering, the more costly it will be.
When considering the fact that RCOI is essentially designed to filter by asking suppliers
to verify whether 3TG minerals are contained within their products, Issuers can focus on
suspect products versus coming up with a black & white determination prior to
performing RCOI. Working with a Full Service Provider that leverages an existing
database to match your products with known lists of products that may contain 3TG
may be a more cost effective and efficient way to move forward.
Reasonable Country of Origin Inquiry
January 2014
There are multiple options for companies to consider when exploring the optimal way to
perform Reasonable Country of Origin Inquiries. Arguably the most important
consideration when evaluating the best approach to perform RCOI is to go beyond simply
engaging suppliers about the source of conflict minerals suspected to be contained in the
products they supply to you. It is important to take a long view and factor in what you will
do with the data once you have engaged suppliers and begin collecting responses. RCOI
is linked with the data assessment piece of the puzzle which is related to performing
further due diligence. Managing the data associated with performing RCOI must rank
high when considering the optimal approach.
Conflict Minerals
Compliance Program
Implementation:
An Analysis of 4
Prevailing Approaches
Technology will play a key role in performing RCOI as companies will need a way to
engage suppliers and maintain a central repository to store individual responses.
Organizations can send an email directly to their suppliers asking them to complete a
©Source Intelligence 2014
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questionnaire5 using in-house tools and resources, and be left to sort through responses
to classify Conflict Free status and assess where further due diligence is required
themselves. Without an efficient way to manage the data collected during RCOI, this can
be a very expensive and resource intensive undertaking for organizations to tackle on their
own.
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Software comes in two distinctions: database or file-based management systems. Filebased systems may include an email-blast engine for supplier engagement on the front
end combined with a file repository for storing and organizing the individual files
associated with supplier responses and any supporting documentation included with
those responses. This is where taking that long view approach comes into play as there
are potentially significant cost-savings and efficiencies to be gained when weighing the
benefits of a database driven technology platform against a file-based system. Databases
provide maximum flexibility when it comes to performing the next important step in this
process of assessing the data collected for accuracy and completeness in order to
determine if further due diligence is required.
Lastly and potentially one of the most underestimated challenges related to meeting
Dodd-Frank 1502 compliance requirements is tied directly to the time and resources
required to follow up with non-responsive suppliers. There are many reasons for nonresponsive suppliers: bad contact information, wrong contact, RCOI request ended up in
a junk mailbox, person receiving the request forwarded to another party and the list goes
on. Engaging suppliers for data collection typically involves multiple telephone and/or
email contacts. Direct communication in a supplier’s native language increases the
chances data being requested will be provided. Assuming you are taking reasonable and
good faith efforts to ensure suppliers respond to your requests, following up on these
non-responsive suppliers can be a very time consuming and costly endeavor.
Assessment and Data Validation
Because the solutions developed to tackle conflict minerals compliance are survey driven,
it is important to address survey limitations before any form of analysis takes place.
Suppliers may be cautious when it comes to sensitive issues that may be linked to
controversial human rights abuses. This may lead to conservative survey responses or
response bias. Indeed, the term “conflict” carries a negative connotation that may cause
some suppliers to become protective or wary.
January 2014
Conflict Minerals
Compliance Program
Implementation:
An Analysis of 4
Prevailing Approaches
©Source Intelligence 2014
!
The relatively short timeline between the approval of the final ruling and the first reporting
deadline may also lead to response bias. With an average of 90 minutes spent on each
supplier for data collection in a chain with hundreds or thousands of suppliers, the time
commitment can add up very quickly, often overwhelming issuers and suppliers to the
point where quality is degraded. Lastly, due to pressures from the court of public opinion,
issuers and other suppliers may impel responders to provide conservative information to
avoid risk of public shame and cut costs.
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The EICC-GeSI template has been adopted across industries as the generally accepted standard for collecting
3TG related information.
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The importance of gathering comprehensive data is critical for identifying supply chain
risks and preparing for an audit. Factor in the global nature of supply chains, language
barriers, political obstacles, confidentiality concerns plus the sensitive nature of the
materials being traced and the complexities involved in this kind of work become clear.
The types of important information that will be collected include: the location of the
facilities that are used in the production or storage of the products being traced, as well
as a list of materials that are included in the products and telephone contacts to follow-up
on missing data and resources will need to be allocated appropriately based on region
and global time zones.
After successfully engaging suppliers and obtaining required data, you will also need
procedures for data quality assessment. Completed templates and surveys need to be
reviewed for reasonableness and missing data. Verifying responses and obtaining
additional information may require several iterations of follow-up just within the first tier of
your supply chain.
There is a direct correlation between the accuracy and efficiency with which data is
analyzed and the method used to collect data. Databases have a clear advantage in this
area compared to a file-based system. So much so that during this data assessment
stage, the first step an Issuer must take if collecting data at the file level is consolidate all
of their supplier responses into a single file. It is not difficult to envision the complexity of
that step alone when considering inconsistencies in the way responses are provided,
incomplete responses and the variety of ways supporting documentation may be
provided.
Due Diligence
As with performing RCOI, conducting further due diligence to understand the source of
3TG minerals is both a time and resource intensive process. Going beyond an Issuer’s
tier-1 suppliers is, in many cases, venturing into unknown territory and as such, not
something Issuers have developed in-house expertise to address. Once again, being able
to leverage a technology platform to keep track of supplier outreach and communication
logs, responses and related supported documentation in order to maintain a complete
and accurate audit trail, is paramount to program success.
Conflict Minerals
Compliance Program
Implementation:
An Analysis of 4
Prevailing Approaches
Cost-benefit analyses should take into consideration the expertise required to engage
suppliers further upstream within your supply chain. Often 3TG minerals enter the supply
chain many tiers upstream from an Issuer with the processors of those minerals even
further upstream. Depending on the cooperation of suppliers within your supply chain
and quality of the data being provided, understanding the source of 3TG minerals may
involve engaging anywhere from one or two actors within that chain to, in some cases, 10
or more actors. Having a proficient and cost effective way to keep track of who has been
contacted, how he or she relates to you and the other players within your supply chain,
while at the same time capturing any relevant data and supporting documentation will
allow Issuers to not only meet first year reporting requirements, but create a foundation
for more efficient supplier engagement and accurate data verification for meeting
©Source Intelligence 2014
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January 2014
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regulatory requirements in subsequent years.
Reporting
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Last but not least, at a pre-determined point following each reporting period, Issuers will
report on the methodologies, process and procedures used to perform the regulatory
requirements and the specific outcomes tied to the data collection. The work required to
complete the SEC required Form SD and appended Conflict Minerals Report (as required)
will be directly tied to the approach employed by each Issuer. In the event multiple
approaches are combined, Issuers will need to consolidate and compile a final report that
reflects the details associated with each component of the process. A Full Service
Provider will create these final reports by documenting standard operating procedures
associated all of the steps performed to meet compliance requirements. Report drafts are
given to Issuers for review before filing with the SEC. The same content used for the SEC
disclosures may then be used by Issuers to provide public disclosures as required.
Conclusion
Dodd-Frank 1502 compliance is complex. Period. Issuers should carefully weigh the
benefits and trade-offs between the various approaches reviewed in this paper. As
Issuers move through the steps to meet compliance requirements the multi-dimensionality
and complexity of supply chains, is revealed. Comparing the costs of leveraging internal
resources and developing in-house expertise to outsourcing the steps required to meet
compliance requirements should factor in the human resources, data management and
proficiency with which the selected approach addresses both immediate and long term
program objectives.
Although the specifics of conflict mineral disclosure requirements are expected to
continue to evolve, conducting applicability analysis, RCOI, data assessment and
validation, and due diligence must be implemented to meet the intent of Section 1502. A
long view may also factor in new regulations associated with ethical sourcing and an
Issuers ability to leverage existing data and management systems to expand programs as
needed.
January 2014
Weighing pros and cons tied to each of the approaches we have been analyzing will vary.
Issuers are faced with interpreting the law, defining their policy and strategy for
compliance then implementing a plan once the optimal course of action has been
identified. With performance standards directly tied to interpreting what the SEC will view
as “reasonable” and “good faith”, the lengths to which Issuers will perform the required
steps will vary from those focused on the bare minimum to those more averse to risk and
committed to ensuring the highest degree of ethical sourcing. None want to be an outlier
and most simply wish to meet compliance requirements in the most cost-effective and
ethically responsible way.
Conflict Minerals
Compliance Program
Implementation:
An Analysis of 4
Prevailing Approaches
As we analyze each approach for strengths and weaknesses we quickly identify the
challenges organizations will face when attempting meet requirements using in-house
resources. Issuers will have to invest in expert staff to oversee managing their
compliance efforts internally while still being faced with identifying an efficient way to
©Source Intelligence 2014
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engage suppliers to collect and manage data. Turning to expert consulting resources
may be the right approach understanding that this is typically the most expensive option
and can be complicated where services are not tightly integrated with the technology
used to manage data. Likewise, software can be purchased or licensed to assist with
RCOI and file management leaving the more challenging work of following up with nonresponsive suppliers and analyzing collected data to other means. Whereas working with
a Full Service Provider may be the obvious choice for organizations with hundreds of inscope tier-1 suppliers. A strong case can be made for an Issuer realizing immediate and
long term value by leveraging the same managed services and proprietary technology
platform designed to map their global supplier network and manage all supply chain
facing regulatory data whether they have ten suppliers or ten thousand suppliers.
January 2014
Conflict Minerals
Compliance Program
Implementation:
An Analysis of 4
Prevailing Approaches
©Source Intelligence 2014
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*Generally speaking, consultants specializing in Conflict Minerals compliance typically rely on
software partners to provide the technology needed to manage data though there are firms
that utilize proprietary software to address various aspects of DF-1502 compliance.
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Summary of Implementation Analysis by Approach
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Source Intelligence delivers supply chain intelligence and supplier data collection and analysis services that support
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January 2014
®
Conflict Minerals
Compliance Program
Implementation:
An Analysis of 4
Prevailing Approaches
©Source Intelligence 2014
!
Source Intelligence combines the best of cloud-based technology with a 24/7 Supplier Engagement Team to provide
clients with the scalability, flexibility and expertise needed to turn supply chain data into something both meaningful and
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