Companies Struggle to Comply With Rules on Conflict Minerals

Gold, seen here, along with tantalum, tungsten and tin extracted from countries like the Democratic Republic of Congo, are considered conflict minerals.

A pink My Little Pony balloon does not usually evoke images of rifle-toting warlords in the Democratic Republic of Congo. Still, Party City Holdings, the decorations and costumes retailer, recently disclosed a possible link to securities regulators, helping to put it near the bottom of a list ranking companies on their compliance with laws against using minerals mined in war-torn regions across Africa.

Party City is just one of 1,262 companies that filed the required disclosures on their use of so-called conflict minerals. Ninety percent of those companies, including Microsoft, Apple, General Electric and Ford Motor, said they also might be using tainted supplies. Yet Party City landed near the bottom of a list compiled by Tulane University researchers that ranked the companies’ compliance records in this area, while giants like Microsoft achieved perfect scores.

“Anybody with a relative interest in ethical sourcing would be interested in this list,” said Matthew Whitteker, the marketing director for Assent Compliance, a software and services firm in Ottawa that commissioned the Tulane study. “For any company that manages this well, both Wall Street and Main Street will look at their brand favorably.”

The Tulane study is just one example of a growing business opportunity for consultants, auditors, lawyers and software firms looking to cash in on a complex provision in the Dodd-Frank financial reform law that requires companies to disclose their use of conflict minerals “necessary to the functionality or production” of products they make or contract out for manufacturing.

Conflict minerals are tantalum, tungsten, tin or gold mined from ore, and extracted in Congo or nine surrounding countries, including Angola, Rwanda and Sudan. Minerals from the countries, long mired in civil war, violence, acts of rape and the use of child soldiers, appear in a variety of products.

Tantalum, for example, allows Apple’s iPhone to maintain an electrical charge. Tungsten permits the filaments in General Electric light bulbs to get hot enough to emit a bright light without melting, and tin gives Party City’s My Little Pony balloons a special sheen. And gold, of course, is a staple of fine jewelry.

The 356-page disclosure rule is tied to State Department efforts to stamp out militias that are financed by minerals; such militias helped lead to 5.4 million deaths from 1998 to 2006 in Congo alone. The rule requires companies to conduct a “reasonable country of origin inquiry” in “good faith” to ferret out conflict minerals in a company’s final products. But the rule doesn’t define those subjective terms, leaving room for interpretation. At the end of May, companies filed their annual disclosures for the second consecutive year.

The rule calls for civil penalties against any company knowingly making a false or misleading statement. PricewaterhouseCoopers noted that “outside of the legal implications of not complying, issuers may also face pressure from human rights activists, nongovernmental organizations, consumer or other market forces to prove they are conflict-free.”

It is a challenging task for companies, not least because it involves collecting data from smelters and processing centers halfway around the world. The rule gives companies wiggle room to rely on a “reasonably reliable representation” from players in its supply chains, yet those supply chains are notoriously long and disjointed, including miners digging ore with their hands and vendors of recycled or scrap metal. Smelters buy ore from a variety of sources and process it for multiple suppliers that in turn sell various finished parts to companies.

The upshot, said Dynda A. Thomas, a lawyer who leads the conflict-minerals practice at the law firm Squire Patton Boggs, is that companies have difficulty tracking the original sources of minerals they use even though they spend heavily on compliance services aimed at getting a handle on their supply chains. Many big technology companies, including Apple, Microsoft and Intel, have devoted substantial resources to this task, even sending representatives to Africa-based mines and smelters in other regions.

Those difficulties can lead to problems for companies that make public statements vowing not to use conflict minerals. If their disclosures suggest otherwise or an independent study has a finding that could be seen as negative, companies could find themselves with legal problems. Companies, Ms. Thomas said, “have to balance the risk of being a good corporate citizen with” that of “getting sued by activist investors, consumers or nonprofits who unearth discrepancies.”

Adding to the complications surrounding the rule, a Federal Appeals Court in Washington ruled in August, for the second time, that the requirement that companies flag in disclosures and on their public websites which products “could not be found to be ‘D.R.C. conflict free’ ” was a violation of a company’s First Amendment right to free speech and forced a company to “confess blood on its hands.” Companies still must file disclosures, but the appeals court panel said they cannot be forced to incriminate themselves with that phrase.

Companies that assert they do not use minerals from Congo but do not undergo an independent audit to prove it, as the disclosure rule requires, could open themselves to challenge. Zoom Telephonics, based in Boston, a maker of modems, keyboards and other connecting devices, was the only company to make that claim without an audit, the Tulane study said.

The Tulane list is the most comprehensive of its kind, but it is not the first. Over the last 15 months, smaller studies by the Responsible Sourcing Network, a nonprofit group; Amnesty International and Global Witness; and PricewaterhouseCoopers, the accounting and auditing firm, have also looked at disclosures.

Researchers at Tulane, led by an adjunct faculty member, Chris Bayer, dissected the complex disclosures according to two equally weighted categories, each with more than a dozen indicators: how well a company complied with the literal requirements of the rule and how well a company followed “good practice” in figuring out its exposure.

Microsoft received a perfect compliance score because its disclosures met all of the Tulane study’s compliance indicators, themselves tied to the legal requirements of the disclosure rule, while Party City fell short on seven of those indicators, including the need to use the Organization for Economic Cooperation’s due diligence guidelines and the need to name smelters and refiners, unless they were determined to be free of minerals from Congo and had undergone an independent audit to prove it.

Party City also lost points because it did not, among other things, thoroughly describe which products used which minerals and did not “take leadership” in engaging smelters, refiners and region-based vetting efforts, the study said. How much of a black mark that constitutes is open to interpretation, because such “good practice” indicators, created for the study by the Responsible Sourcing Network, a nonprofit, and Sustainalytics, a research and software compliance firm, are not requirements of the disclosure rule. Asked to comment, Ressa Tomkiewicz, a spokeswoman for Party City, said the company could not share details not already provided in its disclosure.

Such scrutiny, experts say, is likely to extend to other goods, like shrimp, rubber and cotton, produced in regions known to use child or forced labor. “Over the past couple of years, the corporate focus on responsible sourcing, across a range of commodities, geographies and subject areas, has increased,” said Michael Littenberg, a conflict-minerals lawyer at the firm Schulte Roth & Zabel who served as an independent adviser to the Tulane study.

In October, Britain’s Modern Slavery Act will require companies doing at least £36 million, or $50 million, of business in the country, regardless of where they are incorporated, to begin disclosing the steps they are taking to determine whether any of their products or services involve forced labor or trafficked workers.

In what experts say is the first lawsuit of its kind, and a potential harbinger, Costco Wholesale was sued on Aug. 19 by a California resident who claimed that the retailer had violated the state’s slave labor and anti-trafficking laws by selling frozen shrimp farmed in Thailand, where abuses are widespread.

Companies, Ms. Thomas of Squire Patton Boggs said, “are spending a fortune” buying compliance services aimed at getting a grip on supply chains. But the drive for transparency “puts companies between a rock and a hard place. They are being asked to be accountable for every bit of information they put out there.”

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