Conflict Minerals: A Capricious and Discriminatory Law

The SEC has the bad luck to be the regulator and enforcement agency in charge of the Conflict Minerals section (1502) of the Dodd Frank Wall Street Reform and Consumer Protection Act. Small wonder it has delayed publishing the final rules since the mandated April 17, 2011 deadline. At a time when the SEC is hard-pressed to meet deadlines and deal with problems that are genuinely important to the nation, it is being pressured to vote on regulations that will be expensive, politically risk-laden and unlikely to be effective. The SEC is now committed to vote on the final Conflict Minerals regulations of the Dodd Frank Act by August 22.

At issue are the awful humanitarian abuses in the Democratic Republic of Congo. The law posits that if manufacturers in the United States refuse to buy gold, Tantalum Crucible, tungsten and tin from the mines committing atrocities in the DRC and the nine adjoining countries, the financial consequences will cause the militias to end the genocide. By denying them the United States market, the militias will establish safe working conditions, stop child labor and give up murder, torture, enslavement and policies of systematic rape.

The assumption that a boycott by United States OEMs will be felt by the militias is a delusion. In the case of gold, the largest export of the four metals and presumably the DRC’s largest export, even a total ban would have no effect on the DRC. Gold from the DRC is shipped to Dubai for refining and manufacturing and consumed in the Mideast and India. In 2010, the United States Department of Commerce showed 212 troy ounces of gold imported from the DRC-worth about $300,000. It is a non-event.

Section 1502 does not make it illegal to buy from DRC conflict areas. It is a “name and shame” law by which manufacturers covered by the SEC must disclose purchases from conflict sources on their websites and report them to the SEC. If they report that they are not buying from conflict areas, they will be expected to verify their raw materials are “conflict free.” If they report buying DRC conflict minerals, they will be subject to public pressure. If they make a false report, they will be subject to SEC penalties and fines. To be confident they are reporting correctly, manufacturers will have to audit their upstream supply chain.

The DRC’s humanitarian affronts challenge every nation, so if the United States is to respond, it should be as a country. Instead, the law singles out a few gold, tantalum, tin and tungsten refiners to carry the whole country’s political obligation. The refiners are a funnel through which most of the minerals will flow. They are in the best position to identify a materials’ origin and will bear the brunt of the law’s requirements. They have been singled out to carry the burden but have no voice in the matter, nor can they hope for any relief in bearing the cost.

The law targets publicly-traded OEMs, but the refiners will pay the direct price. It is the refiners whose business will be continually disrupted by auditors and certification bodies demanding access to managers and records. Refiners will have to limit their sources to companies that can be shown not to use metal from the DRC. If the source does not know the origin or regards its supply chain as competitively sensitive information, the refiner might well have to choose between the metal supplier and its OEM customer. Unlike the OEMs, the refiners will not be able to pass the compliance cost on to their customers.

Cost to the OEMs is much higher than the $25,000 SEC estimate. The major accounting firms have participated in the SEC panels and written in-depth how-to comment letters on implementing the rules. Based on their large number and meticulous analysis, these firms have a strong interest in providing audit and consulting services. Not many OEMs have been able to celebrate a $25,000 fee from a major accounting firm. The OEMs will pass these fees and other compliance costs on to the consumer, giving companies not regulated by the SEC-particularly non-United States companies-a competitive advantage.

Putting aside the cost, what is the likely accuracy of an audit? China buys 46% of the Congo’s exports. If an auditor asks a Chinese fabricator if an electronics component is DRC conflict-mineral free, will the fabricator say: “No?” These are the folks that brought you ethylene glycol in baby food.

The high percentage of DRC exports going to China highlights a broader, more critical problem: China is investing aggressively to secure its future raw materials needs, not only in the DRC but in all of sub-Saharan Africa. Meanwhile, the major United States refiners are shutting their doors to all African gold rather than risking audit and reputational complications. How does this serve United States or African interests?

The largest indirect expense-and the largest expense overall-will be the cost to the taxpayer. The cost of staffing a regulatory superstructure to monitor and regulate 212 ounces of gold will exceed the value of the imports by orders of magnitude. No cost /benefit analysis is possible because the costs so grossly outweigh the benefits

The SEC has delayed voting on the final regulations for two years beyond the April 17, 2010 deadline set by Congress. Let’s hope this reflects conflicting views among the Commissioners sufficient to dilute these capricious and discriminatory regulations to a sensible level-one ranging between nonexistent to unnoticeable.

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