We once again call on The Bard to help us with our musings on conflict minerals. In this case, we look at supplier and product screening approaches, how they impact the RCOI effort and important considerations in relying on supplier 3TG content information.
In almost every discussion or engagement we have with companies, the question arises as to how to identify suppliers to include in the RCOI. As readers likely already know, two primary approaches have emerged:
- The “shotgun”. This tactic involves little more than sending conflict minerals information requests to all vendors in the company’s database. Typically, very little up front effort is required since no screening is conducted. Of course, this results in a large number of requests/responses that must be sent, tracked, reviewed and dispositioned – which can result in more effort on the back end than is needed to narrow the inquiry scope on the front end.
- The “rifle”. Here, companies narrow the supplier outreach by first screening/filtering products, materials, components and suppliers. This means that companies have to spend more time up front in evaluating suppliers (and what is purchased from the suppliers) in the context of the company’s own processes and products.
There is no right or wrong way – each company should carefully evaluate what suits their specific needs the best. To make things more complicated, recommendations from third parties are likely to differ.
We checked in with a handful of world-leading, household name consumer electronics manufacturers, semiconductor manufacturers, medical/pharmaceutical manufacturers and retailers (none of whom are our clients in order to get objective feedback) on this question. Without exception, these companies pulled the trigger on the “rifle”: screening suppliers and products first in order to identify the universe of those to include in the RCOI process.
These commenters focused on 3TG content as the main pre-screening criterion, with the second being an assessment of the level of influence exercised over contract manufacturing. One consumer electronics manufacturer did state that “generic” contract manufactured products are not screened out at this point.
The group also checked supplier responses against their own internal expectations and product knowledge to confirm the appropriateness/accuracy of the responses, rather than wholly relying on the supplier response.
These companies felt it was important to maximize their involvement in scoping decisions and narrow their RCOI to only those suppliers that were appropriate to be included.
The Legal View
Generally speaking, the lawyers who responded to our request leaned toward the rifle shot (albeit a very large caliber rifle in some cases), but also pointed out potential benefits to the shotgun.
Brian V. Breheny, Skadden, Arps, Slate, Meagher & Flom LLP:
Although the steps that a company takes to conduct its reasonable country of origin inquiry should depend on the company’s particular facts and circumstances, such as the company’s size, products, relationships with suppliers and other factors, I think employing an internal screen process to narrow down the list of suppliers that will be in the survey pool will generally be the most prudent approach to the inquiry. A more focused survey should garner more reliable results.
Bruce Dallas, Davis Polk & Wardwell:
The rules and the adopting release are silent as to what an issuer must do to determine whether a conflict mineral is “contained in” a product. The adopting release makes clear, however, that conflict minerals are “intentionally added” even if they are only present in an off-the-shelf sub-component from a third-party vendor. [See text accompanying note 230.] And, “the issuer should report on the totality of the product and work with suppliers to comply with the requirements.” [Emphasis added, text accompanying note 231.] An issuer should rely on a vendor’s representation that a product does not contain conflict minerals only if the representation appears reasonable given the issuer’s expectations based on its own knowledge of what the supplier is providing. For example, electronic components are likely to at least contain tin, because of its prevalence in solder, and an issuer should at least question an electronic component vendor’s representation to the contrary. While it should not be necessary for issuers to go to extraordinary lengths, such as performing mass spectrometry analyses or hiring outside experts, they should not accept unreasonable representations at face value.
Eric Gotting, Keller & Heckman:
Michael Littenberg, Schulte Roth & Zabel:
The Rule does not mandate that specific procedures be followed in determining whether 3TG is contained in a product or product component. To the extent that supplier questionnaires are used to assist in this determination, I recommend that issuers review the responses for reasonableness. For example, is the response consistent with the issuer’s understanding of the materials content of the product, is it consistent with information received from other suppliers of similar products and components and is the conclusion consistent with other information in the supplier’s response.
I do not advocate blind reliance on supplier responses that with minimal review clearly do not pass the smell test.
In addition, I recommend that, where practicable to do so, issuers exclude from their outreach efforts suppliers that are clearly out of scope. Particularly for issuers with very large supply chains, this can result in significant time and cost-savings on the back end. But, issuers should document their scoping determinations and how they arrived at them.
Jeffrey Perry, King & Spalding:
Surveying all suppliers gives the company the ability to say that they “surveyed all their suppliers” and they would have a “no CMs” response rate baked into their reportable statistics.
Excluding the suppliers of generic /commercial-off-the-shelf (COTS) products cuts down the “noise” in the outreach effort and under most circumstances would be a focused, good faith inquiry likely to result in higher fidelity data for the company vis-a-vis smelters and/or refiners in the supply chain.
At the end of the day, outsourcing vs. internalizing the initial exercise of calling balls and strikes is a business decision.
From Day One, our position is that issuers are typically best served by screening suppliers/products on the front end to reduce the subsequent RCOI effort. Certainly this doesn’t hold true in every situation and each company will make their own decision based on several factors. Some points to consider:
- Supplier response rates may be inappropriately diluted should “out of scope” suppliers be included but not respond, and time/effort to track those down may not be considered the best use of resources.
- Don’t rely too much on supplier responses without fully confirming the appropriateness or accuracy of them in the context of the company’s circumstances and products.
- In situations where an issuer cannot themselves determine the 3TG content of a part/material from a supplier, include that supplier in the RCOI.
- IT platform providers may be ambivalent about the approach/number of suppliers surveyed, or they can be motivated by larger numbers of suppliers (where their pricing structure is directly proportional to the number of CMRTs to be managed).
- Likewise, consultants may carry biases into their recommendations, especially where the consultant and IT provider are part of the same company or have mutual financial incentives such as finders fees or sales commission sharing.