Highly scrutinized SEC conflict mineral regs. include new audit requirement


The SEC on Wednesday approved disclosure rules designed to increase transparency around companies’ use of so-called “conflict minerals” and payments to governments for access to natural resources.

The rules, advocated by certain human rights groups, will implement two sections of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, P.L. 111-203.

But they contain disclosure provisions that divided the SEC commissioners’ votes and have been criticized by some business groups as being unworkable, in the case of conflict minerals, and likely to put U.S. companies at a competitive disadvantage, in the case of the natural resource payment reporting requirements.

Section 1502 of the Dodd-Frank Act requires yearly reporting on whether U.S. public companies use conflict minerals originating in the Democratic Republic of the Congo (DRC) or neighboring countries. Section 1504 requires U.S. public companies that extract resources to disclose in an annual report how much they pay the U.S. and foreign governments around the world for access to oil, natural gas and minerals.

The conflict minerals statute was included in the Dodd-Frank Act with the intent of cutting off funding for warlords in the DRC. Armed groups there are accused of atrocities against local populations and funding their activities by using forced labor to mine for gold and other minerals used in products ranging from jewelry to cell phones.

By requiring companies that use conflict minerals to document their chain of custody, the statute aims to choke off the market for raw materials produced in mines using forced labor. The regulation intends to use transparency to prompt companies to shun conflict minerals.

Human rights groups had encouraged the regulation. In a comment letter, seven human rights groups said the rule has “enormous potential” to transform the conflict.

“While the DRC government must take up its responsibilities to protect civilians and establish governance and infrastructure, U.S.-based companies and consumers also have a crucial role,” the groups wrote. “We are all connected to the conflict through the minerals we use in so many everyday items.”

Business groups disappointed

But some business groups say requiring companies to audit their supply chains and monitor those of their vendors is unreasonable because of the complexity of the supply chains. In an opinion piece for The Hill, Tom Quaadman, vice president of the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce, said the rule will create an unworkable regulatory regime that will be exploited by bad actors and difficult for honest market participants to implement.

The rule passed on a 3–2 vote. Dissenting commissioners Troy Paredes and Daniel Gallagher said the implementation of the rule did not fit the SEC’s mission of protecting investors. Gallagher said it was unclear whether the rule would have the unintended consequence of harming the populations it aimed to protect because it could create what amounts to an economic embargo of the DRC and other nations as U.S. issuers pull their business from the region altogether in an abundance of caution.

Businesses will be required to determine if the products they manufacture or contract to manufacture contain conflict minerals. If they use such minerals, they will need to determine whether they financed armed groups in the DRC or its adjoining countries.

Due diligence requires an independent private-sector audit of a conflict minerals report companies will file with the SEC. The audit must be conducted in accordance with standards set by the Government Accountability Office (GAO), according to testimony SEC Special Counsel John Fieldsend gave at Wednesday’s open meeting.

Companies will file their first specialized disclosure report on May 31, 2014, for the 2013 calendar year. Companies will be required to file for a calendar year regardless of when their fiscal year ends.

Natural resources reporting requirement

Gallagher also was among those concerned about whether Section 1504 of the Dodd-Frank Act fits into the SEC’s mission. That regulation was structured to increase accountability of leaders in resource-rich countries with high poverty rates by requiring companies to disclose how much they are paying for access to resources. It is hoped that transparency would ensure that the money paid to governments is used to benefit the entire population rather than enriching government officials.

“The final rule we consider today is in the interest of investors and the public interest,” said Commissioner Luis Aguilar.

The regulations pursuant to Section 1504 passed by a 2–1 vote with two commissioners recusing themselves, despite the concerns of a trade group for the energy industry, the American Petroleum Institute (API). API Chief Economist John Felmy called the rule a “Draconian approach to disclosure that will unnecessarily harm U.S. competitiveness and jobs.”

Felmy said Tuesday that the rule will require publicly traded energy firms to release commercially sensitive, detailed payment information that state-owned foreign national businesses – such as China National Petroleum Corp. and Russia’s Gazprom – could use to determine strategies and resource levels to win contracts.

Companies that extract resources will be required to comply with the new rules for fiscal years ending after Sept. 30, 2013. The form must be filed with the SEC no later than 150 days after the end of a company’s fiscal year.

Increased disclosure, opportunity

For the required audit of conflict mineral reporting, Fieldsend, the SEC special counsel, said the GAO staff has indicated that it plans to refer issuers to its existing government auditing standards (commonly referred to as the “Yellow Book”) so that the auditor can perform either an attestation engagement or a performance audit.

The audit’s objective will be to express an opinion or conclusion as to whether the design of the company’s due-diligence measures conforms with the criteria set forth in the nationally or internationally recognized due-diligence framework, and whether the company’s description of the due diligence performed is consistent with the process it undertook.

According to Fieldsend, the only due-diligence framework currently available for conflict minerals reporting is provided by the Organisation for Economic Co-operation and Development (OECD).

Fieldsend acknowledged that the auditing objective is not as comprehensive as an objective that would require the auditor to express a conclusion or opinion on whether the due-diligence measures are effective or the company’s materials are conflict-free. But the SEC said an independent opinion on whether the due-diligence framework is appropriately designed and whether the due diligence was performed gives investors some meaningful assurance.

Ken Tysiac ( ktysiac@aicpa.org ) is a JofA senior editor.

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