There is an important distinction issuers should be aware of between materiality in reporting and significance in the GAGAS Performance Audit standards as those relate to the Independent Private Sector Audit (IPSA) of conflict minerals reports (CMRs). And an ice cream party will help explain.
Materiality is a critical, but loosely defined, principle in accounting and financial reporting. It is a threshold relative to the size and particular circumstances of individual companies, above which information is expected to be important to decisions of the users of the information. Typically, materiality has a financial basis, “users” are considered “reasonable investors” (itself a loosely defined term) and “the information” refers to the total mix of information made available in SEC reporting. The term “significance” is used in the GAGAS Performance Audit standards and has a similar meaning.
However, in the context of the conflict minerals IPSA objectives, significance relates to the presence, absence and/or relevance of audit evidence corresponding to the specified audit objectives. In their final release of the conflict minerals disclosure requirements, the SEC addressed potential IPSA objectives that were considered but not adopted. Had they been adopted, significance in an IPSA would be more aligned with the general materiality definition for accounting/reporting. Some of these rejected objectives include whether the
- descriptions of procedures and controls performed are fairly described in the report;
- descriptions of the due diligence process are accurate and the results fairly stated;
- due diligence process conformed to a due diligence standard or was effective;
- conclusions were accurate.
This distinction between reporting principles and auditing standards is quite important. Determining significance for purposes of the second IPSA audit objective revolves around whether sufficient and appropriate evidence is available to support the description of due diligence measures undertaken as those are described in the Conflict Minerals Report; it does not involve determining whether the description of those measures diverges from the conflict minerals disclosure requirement or the conclusions made by the issuer.
If an issuer’s CMR description of due diligence measures performed contains significant omissions or other inadequacies, but the issuer provides the auditor with sufficient and appropriate evidence that the measures described were undertaken, the auditor should not have an adverse opinion or conclusion. Therefore, materiality in the SEC reporting context is not the same as significance in the IPSA context.
We have said in the past – should an issuer’s description of due diligence measures undertaken state that they threw an ice cream party for their sourcing staff, if the issuer provides sufficient and appropriate evidence for the auditor to confirm that the ice cream party was indeed provided for the sourcing staff, then the auditor should not have an adverse IPSA opinion or conclusion for the second objective. Obviously there is an expectation that an issuer won’t really omit material information from their due diligence description or talk about ice cream parties.
Issuers who are trying to balance their concern about materiality in their SEC filing versus creating an efficient and low cost IPSA could consider this approach:
- Become deeply familiar with various interpretations of “due diligence” and select an interpretation that meets internal requirements;
- Carefully consider what aspects of that interpretation are material to the letter and spirit of the law and disclosure requirements. You may want to involve senior management, the Board’s Audit Committee, Internal Audit staff and/or counsel in this process; then
- Limit the description of due diligence measures undertaken to those material aspects of due diligence.
For example, if an issuer interprets “due diligence” to be equivalent to OECD Steps 3 and 4, they should assess the most important (i.e., material) aspects of those two steps. They could decide that relying on CFSI smelter/refiner audits and conducting additional research into countries of origin are the most important aspects of Step 4. For Step 3, perhaps they view the foundation of risk management is making internal decisions about how to handle the business relationship with high-risk suppliers, and keeping management apprised. The issuer may then keep their CMR descriptions of measures undertaken to only these material aspects of Steps 3 and 4. In our opinion (and others whose views are important in this matter), this should satisfy the SEC reporting materiality threshold while concurrently managing the IPSA effort.
Without worrying about the calories and fat of the ice cream.
 Conflict Minerals Rule Final Release, Pages 284 – 286.
 See also SEC FAQ Numbers 17 & 21 http://www.sec.gov/divisions/corpfin/guidance/conflictminerals-faq.htm – q13