HardAssetsInvestor

Written by Tom Butcher  |

July 31, 2012

‘Conflict Minerals’ Gold, Tin & Tungsten Face New Layer Of Regulation

Details

Dodd-Frank Act seeks to cut funding of armed groups engaged in conflict and human rights abuses through disclosure rule.

 

Question: What do columbite-tantalite (coltan), cassiterite, gold and wolframite have in common?

Answer: They, and their derivatives, are “conflict minerals” in the context of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in July 2010. (For those less geologically minded: Tantalum comes from coltan, tin comes from cassiterite and tungsten from wolframite.)

Whatever else Dodd-Frank may be, it is certainly long—849 pages. Only on the 839^th page do you encounter “SEC. 1502. CONFLICT MINERALS.,” with the entire section, and issue, wrapped up in just six pages.

But for the SEC, tasked with framing the relevant rules, the wording in those few pages appears to have echoed ominously the brevity of Fermat’s Last Theorem, and what the mathematician famously claimed: “I have discovered a truly marvelous proof of this, which this margin is too narrow to contain.”

That theorem took over 350 years to prove, and the proof by Andrew Wiles is longer than 100 pages. With a proposed rule of more than 100 pages back in mid-December 2010, after two years, the SEC has still not come up with the final rule. We have recently been informed however that a vote will be taken on Aug. 22. We wait—still.

Why “SEC. 1502. CONFLICT MINERALS”?

Tacked on to the end of Dodd-Frank, and described succinctly in LG Electronics’ Statement on Conflict Minerals, “The goal of the act [in this section anyway] is to cut direct and indirect funding of armed groups engaged in conflict and human rights abuses.”

The conflict and human rights abuses targeted are those currently occurring in the Democratic Republic of Congo (DRC)—formerly Zaire—particularly in the provinces of North and South Kivu and in the Ituri district of the Orientale province, and adjoining countries.

 

Source: GAO: CONFLICT MINERALS DISCLOSURE RULE

 

The funding targeted is that currently derived from the sale of gold, tantalum, tin and tungsten, and “any other mineral or its derivatives determined by the Secretary of State to be financing conflict in the Democratic Republic of the Congo or an adjoining country.”

 

 

How Will It Work?

Nobody yet knows precisely how this will work. The SEC, the regulatory body required by the act to codify the law, has yet to outline the process. The act essentially forces public companies to disclose their use of any conflict minerals that “are necessary to the functionality or production of a product manufactured” or “contracted to be manufactured” by that company.

If a product “does not contain conflict minerals that directly or indirectly finance or benefit armed groups in the Democratic Republic of Congo or an adjoining country” it can be labeled “‘DRC conflict free.’’’

While Dodd-Frank may not ban companies from using conflict minerals, it does  force them to identify, verify and audit the source; outline the chain of custody; and make a public disclosure, not least on their websites, of their use.

Under current SEC proposals, this disclosure would be on at least an annual basis and the act would affect an estimated 6,000 companies, both U.S. and foreign, that file reports with the SEC.

Some Mineral Context

The DRC has vast natural resources, but as a supplier to the global market of conflict minerals—based on figures for 2010 from the U.S. Geological Survey—it is a very small player, supplying just 1 percent of the global market for gold and tungsten. There are two exceptions: tantalum (21 percent of the global market); and tin (3 percent).

 

Tantalum – Global Production of Mineral Concentrates (2010)

Source: USGS

 

Tin – Global Mine Production (2010)

Source: USGS

 

 

Some Issues

One of the most basic issues is whether Section 1502 really has a place in Dodd-Frank. Since it is now law, the issue could be considered academic except that the opposite sides of the argument define where critics and supporters of the act, as well as their cases, stem from.

Intent vis-à-vis the conflict in the DRC aside, supporters of the legislation believe the section is well situated. Section 1502 helps protect investors against investment risk—in this instance, the potential legal liabilities and reputational risk to which a company may be exposed from its use, or sourcing, of conflict minerals.

On the other hand, critics believe not only that its intention falls outside the scope of Dodd-Frank as a reformative legislation, but that it places a large burden on a wide range of U.S. and foreign companies. Some also argue this is much more a foreign policy issue than a domestic, financial issue.

Apart from all this, there is the matter of the act’s use of the SEC, and its regulatory authority, in this context. That there is substance to this concern is evident from the fact that the SEC has still not promulgated any rules two years after the legislation’s enactment.

While there are a number of issues associated with this section, following are just three of the knotty ones.

 

The Conflict Minerals

Although the act names only gold and those minerals from which the metals tantalum, tin and tungsten can be derived and their derivatives, the secretary of state can, in certain circumstances, add “any other mineral or its derivatives.” The scope, therefore, of what constitute conflict minerals could widen considerably. Hypothetically, it could include oil in South Sudan or Angola, or cobalt and copper from Zambia.

In addition, would the secretary of state be obliged under Dodd-Frank to include diamonds across the region, since diamonds are being produced by mines under the control of a “qualifying” “armed group” in some new civil strife in, say, Angola, whether the conflict is anywhere near the DRC, or not? And does this apply to any mineral?

What about niobium, also produced from coltan? As a derivative, is it also a conflict mineral? Although not mentioned by name, strictly speaking, it would appear that it should be so considered.

 

Adjoining Countries

A quick look at the map above shows that the DRC “shares an internationally recognized border” with no fewer than nine other “adjoining” countries:

• South Sudan
• Uganda
• Rwanda
• Burundi
• Tanzania
• Zambia
• Angola
• Republic of Congo
• Central African Republic

 

Some deft use of a map shows that these countries together cover a huge tract of the African continent, stretching from the border of Tanzania and Mozambique on the Indian Ocean, to that of Angola with Namibia, and up to the border of Sudan and South Sudan.

One of the single most important issues, especially for these African countries, will be what the SEC decides (if it does) with regard to certification: Is it going to be on a national or regional level? That is, will a small, confined incident, in say, the southeast of Tanzania affect certification for the whole of the country in this respect?

 

 

‘Functionality’ And ‘Manufactured’

Neither of these terms is defined within the section, but how both of them are understood is critical to its interpretation. For example, what are the limits of “functionality”? As Edward Wyatt of the New York Times points out in his article Use of ‘Conflict Minerals’ Gets More Scrutiny From U.S., “Is a coffee can made with tin “necessary to the functionality” of the coffee being sold?” Are radios containing tantalum items affecting the “functionality” of an automobile as a way to get around? What about an item made using tungsten carbide high-speed rotary tools? What about ornamentation? And is a mine operator a manufacturer?

As Nicholas Cook of the Congressional Research Service states in his Conflict Minerals in Central Africa: U.S. and International Responses, published on July 20: “A large range of legal, technical, logistical and other types of issues are in play under the Section 1502 rule-making process, as are diverse human rights, transparency, political, corporate financial and reputational (e.g., public relations and consumer perceptions) interests.” These are quite apart from concerns over due diligence standards and how the rules are phased in.

Cook, in detailing further the “Key Issues Under Debate,” describes how “… key legal and technical questions focus on such issues as how final Section 1502 rules will define, operationalize, or treat.” In addition to those mentioned above the SEC has had (and will have) to address the following:

• Reporting thresholds, if any, in cases where a firm does not control all facets of production of its products (e.g., parts are manufactured by chains of discrete subcontractors contractually unrelated to the final buyer) or has a role limited to product branding and sale (e.g., of generics possibly sourced from multiple vendors)
• Various derivatives of the minerals and their recombination with other elements to create new substances.
• Ornamental and other “de minimis” uses of the minerals, or instances where a product unintentionally includes naturally occurring trace occurrences of a conflict mineral
• Recycled supplies with essentially untraceable origins
• “Reasonable” credibility standards for mineral country-of-origin inquiries.
• “Armed groups.” It is unclear how firms would differentiate between state military or police forces at large and those elements of these forces which—based on allegations of human rights abuses or other criminal acts, including illicit involvement in the conflict minerals trade—would be considered armed groups under the law.
• Indirect “finance or benefit” to armed groups arising from association with a conflict mineral. The threshold or definition for “indirectly finance or benefit” is not stated in Section 1502. The burden of proving an absence of indirect financing or benefit could potentially be large.
• Firms bound by long-term contracts that precede or may conflict with or otherwise not reflect the requirements of Section 1502 (such as rules potentially requiring immediate implementation and compliance)
• The status of stocks of materials already in processing and supply pipelines prior to the adoption of the rules
• Firms covered, as some interpretations of the definition of ‘‘person described” in the law, as written, could arguably be applied to “persons” who are not SEC issuers
• The standards and responsibilities accountants and auditors will need to comply with to provide required due diligence auditing to firms subject to Section 1502.
• The technical modalities of reporting language and standards, types of documentation and forms to be employed, and other technical and legal process questions.
• The basis for determining if compliance costs may be too great for small manufacturers to bear and for determining what costs will be for affected firms, persons and industries.

 

 

Further Comments

The SEC

Perhaps one of the greatest causes of concern in anything to do with Section 1502 is the action, or inaction, of the SEC. Its delay in framing any rules can only be described as egregious.

Delays have been multiple, with even an April 17, 2011, deadline laid down in the Dodd-Frank missed. In a table on the opening page of its report CONFLICT MINERALS DISCLOSURE RULE - SEC’s Actions and Stakeholder-Developed Initiatives, the GAO illustrates the course of these delays with information from the SEC itself.

 

 

As it looks now, decision-making by the SEC is set for Aug. 22, helped, no doubt, not only by the publication of the GAO report, but also by a letter to it on June 22 signed by no fewer than 58 members of Congress urging the SEC most diplomatically to begin taking action.

Since Dodd-Frank was enacted, there have been myriad excuses. The “various factors” described to the GAO by the SEC as having “caused delays in developing, modifying, and finalizing a rule” are:

• Significant learning curve
• Intense stakeholder interest and input
• Heavy rule-making workload
• Rigorous economic analysis in rule-making process

 

It would be very interesting to know the contribution of each of these factors to the overall delay and, not least, whether, in light of the successful use by the U.S. Chamber of Commerce of the cost argument in the proxy access case, attention to the last of these four has taken up an inordinate amount of time and attention. The estimate of around $71 million the SEC has approximated for the cost of compliance of all affected U.S. public companies will undoubtedly be the focus of considerable scrutiny.

The SEC: underfunded, overworked, incompetent, put upon …? The argument still rages. But regarding Section 1502, its inaction has had some unforeseen (?) consequences, not just for companies affected by the act, both in the U.S. and abroad (how can you design tools without rules?), but in the DRC itself.

Although there are reports, from the United Nations Group of Experts in October 2011, that despite the absence of an SEC rule, the situation on the ground in the DRC has improved because of Dodd-Frank.

Consider what Serge Tshamala, an official at the Embassy of the Democratic Republic of Congo, said as quoted by Wyatt in his New York Times article: “It is causing, I would say, a sort of embargo on traders and diggers in Eastern Congo… The longer it takes the SEC to come up with guidelines, the worse it is for our people.’” (By extension, one does wonder whether, even with “guidelines” in place, if compliance with the act is too onerous, will companies just throw in the towel and buy from ex-African and, therefore, “safe” sources, either leaving those in the affected parts of the DRC with no market, or leaving the market to others less concerned about the situation and able effectively to “launder” the minerals into the global market?)

Whether Section 1502, alone or in conjunction with other measures, will ever be effective in realizing its intention is another matter. It is, and always will be, open to debate. Similarly, for some, even predicated on the section’s possible success, there will always be a level at which either the prevention of human suffering, or the possibility of it, becomes too expensive an enterprise. As, once again, Cook describes it: “Many firms and trade groups, some Members of Congress, and others, however, question whether the potentially large costs associated with implementing Section 1502 are justifiable.”

 

 

Supply Chains

It is perhaps surprising to hear mention of the complexity of supply chains as one of the obstacles in tracing the source of conflict minerals, especially if they are used in vanishingly small amounts in the smallest of components.

Do companies now not try to ensure the transparency of their supply chains, not least to plan for situations in which certain materials—for example, rare earths, or components made using them—may become either unavailable or unacceptably expensive? Of course, it is often difficult to know what materials you are using.

Although we have little choice but to accept the likes of the Department of Defense (and can do little as individuals to change it), and opine “typical!” when it has so much difficulty reporting on the extent of its use of rare earths, let alone whence they come, surely we as shareholders can expect a little more from the companies in which we can choose to be shareholders.

Whatever the shortcomings of the DoD may in this respect be, it must be relatively competent at policing its own supply chains: the Berry Amendment has some quite stringent requirements that need policing. (The DoD did have a little trouble back in 2001 under the provision with the matter of some 5 million berets and a $23 million contract to produce them to companies in China, Sri Lanka and Romania instead of American small businesses.)

Therefore, maybe the DoD could be looked to for some direction when it comes to tracking conflict minerals. (Back in 2006, there must have been enough to and fro between the Bush administration and Senate on the one hand, and the House on the other, for a little to have been learned in this area.)

That said, insofar as, back then, the furor arose only after it was disclosed by some defense contractors that they were not in compliance with the provision because of actions by their suppliers, maybe the rules for contractors are actually less stringent than they will be for run-of-the-mill public companies and conflict minerals. Now, that would come as no surprise, would it?