On Wednesday, the SEC took a long-awaited step in fulfilling one of its responsibilities under the Dodd-Frank Act. The U.S.regulator finalized a rule requiring public companies to disclose the use of conflict minerals—defined as cassiterite, columbite-tantalite, gold, and wolframite—in their manufacturing of products. More specifically, companies that use conflict minerals, necessary to the functionality or production of a manufactured product, must annually disclose whether any of those minerals originated in the Democratic Republic of the Congo or an adjoining country.
The use of these minerals is widespread in manufacturing companies, and the SEC acknowledges this new rule will apply to many public issuers. In perhaps a more poignant acknowledgement, the SEC admits that some companies may incur “significant compliance costs” as a result of implementing the new rule; although the SEC attempted to reduce this burden.
Why will compliance be so costly for companies? Those affected by the rule will have to undergo a rigorous multi-step process to determine the origins of the minerals. First, a public company must determine whether it uses conflict minerals in the production or functionality of a product. Under certain circumstances, companies contracting to manufacture a product must also take this first step. With no bright-line rules in place, each management team must rely on the SEC’s guidance to determine whether the rule applies. Companies concluding that their products are without conflict minerals are free of any additional regulatory obligations. Companies finding the opposite to be true, however, will be required to move to the next step.
Companies using conflict minerals will then conduct a reasonable inquiry into the minerals’ origins. If the inquiry reveals that the minerals come from the Congo or one of the surrounding countries, the company must then exercise due diligence on the source and chain of custody of the materials. Based upon this review, an additional independent audit may be triggered to assess whether proper due diligence measures were followed.
Finally, companies using any conflict minerals will be required to disclose the measures taken in a country of origin investigation and, in some cases, the identity of any products manufactured with conflict minerals. Additional disclosures may be required in certain circumstances.
This rule goes into effect on Jan.1, 2013, but the first reports with the described disclosures are due May 31, 2014. Until then, boards of directors have a significant oversight responsibility—while management will undertake the multi-step process, boards must ensure the inquiry and due diligence procedures are in compliance with the rule.
The description above only scratches the surface of a long and complex rule. Those interested in obtaining more information should take advantage of SEC resources and previous reports by NACD. We have followed this issue from the beginning and produced several informative pieces. For a brief synopsis of the rule and its implications, view our latest NACD BoardVision. For a deeper understanding of this rule’s background, view this Directorship article and this NACD blog entry.
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Risk Oversight: Risk Committees Can Play a Role, But They Are Not the Whole Story
In the wake of the ﬁnancial meltdown of 2008, and before the Dodd-Frank Wall Street Reform and Consumer Protection Act was introduced, there were rumblings in the marketplace calling for all companies to have board-level risk committees. Such calls stemmed from the assumption that if corporate America had speciﬁc committees of independent directors to oversee all of the company’s risks, the problems that led to the banking crisis and the subsequent meltdown of Lehman Brothers and Bear Stearns could have been avoided. The concept went so far as to be included in early drafts of Dodd-Frank, but the act was eventually narrowed to require risk committees only on the boards of ﬁnancial institutions.
Interestingly, most, if not all, of the ﬁnancial institutions that failed during the most recent recession already had risk committees on their boards before the crisis, so the requirement within Dodd-Frank was not earth shattering. However, when the National Association of Corporate Directors (NACD) examined the board structure and committee responsibilities outside of ﬁnancial companies, a much different approach came to light. Risk at most non-ﬁnancial companies was over seen by the audit committee of the board prior to the failure, and still is.
NACD believes that the full board should approve and oversee the risk management policies developed and recommended by management. Risk oversight by a board risk committee—especially one that works in isolation from management and other board committees—could weaken both risk management and risk oversight.
The full board should have primary responsibility for risk oversight, with the board’s standing committees supporting the board by addressing the risks inherent in their respective areas of oversight. It is rare that any one committee—such as the audit committee or a risk committee—would have the time, resources, and expertise to oversee the full range of risks facing a company. Moreover, the critical link between strategy and risk points to the need for the full board—rather than any one committee—to have responsibility for risk.
A risk committee cannot, and should not, replace the board’s active engagement in risk oversight. Active, proper, and effective risk oversight requires the full board’s attention.
High-Proﬁle Risk Issues
In a blast of legislation, the 2010 Dodd-Frank Act mandated that ﬁnancial institutions have risk committees. Jumping ahead two years to this spring, the Federal Reserve Board recently proposed rules to put this mandate into place, requiring certain ﬁnancial institutions (any publicly traded non-bank ﬁnancial company supervised by the Board of Governors and any publicly traded bank-holding company with consolidated assets of $10 billion or more) to establish board level risk committees. These committees would be explicitly responsible for oversight of the enterprise risk management practices of the company.
However, recent events have proven that risk requires more thought than simply forming a committee dedicated to its oversight. While corporate crisis is not a new story, several high-proﬁle stories have led some to question the current structures in place to oversee risk. In many of these cases, companies have not been able to recognize the ultimate level of risk presented in strategies. Especially in large corporations with multiple business units, it can be difﬁcult to identify the total level of risk presented, given inter- and intra-business correlations.
The inability to recognize the interconnectivity of risk can skew the balance of risk and reward companies believe they have in place. Absent the recognition of interrelation within the organization—which can amplify the risk presented—the board may believe it has established an appropriate balance of risk and reward based on what the company can bear. Factoring in interconnectivities, the board may ﬁnd itself in hot water if strategies take a turn for the worse.
In addition to the required risk committees already possessed by most large ﬁnancial institutions, the Federal Reserve Board included an additional provision: that each committee include at least one risk management ‘‘expert.’’ However, the given deﬁnition of ‘‘risk-management expertise’’ was vague at best, ultimately lacking a comprehensive explanation of acceptable experiences and background.
Amid reports on the Olympics and presidential race, the flagging economy has been firmly in the news this week. In the second quarter of 2012, U.S.economic growth slowed to an annual rate of 1.5 percent, even slower than its 2 percent growth in Q1 2012. This lack of growth suggests the economy is at risk of stalling, a sentiment echoed in NACD’s Board Confidence Index (BCI), which dropped over 8 points in the second quarter to 52.4. The BCI’s second lowest score since its inception in September 2011, this overall index denotes directors’ uncertain view of the state of the economy.
Since its introduction in 2010, NACD’s BCI has trended with peer indices—showing fluctuations and improvements, but generally not enough to support a fully recovered economy. The University of Michigan and Thomson Reuters’ measure of consumer sentiment for July followed suit, dropping to its lowest point since December 2011. However, after the Conference Board’s Consumer Confidence Index dropped to a five-month low in June, it regained several points in July, moving to 65.9 from 62.7. According to Richard Curtin, chief economist of the University of Michigan Consumer Sentiment Index, the continued decrease in confidence is the result of consumer expectations, specifically the belief that “current economic policies are incapable of solving the problems facing the economy.”
This lack of confidence in the government’s ability to address economic issues early is evident in the boardroom. When asked about the nation’s progress in the past three months, as well as expectations for the next three months, levels dropped below 50 points, indicating little confidence in the nation’s short-term prospects. Confidence in the economy’s progress over the last year took the largest hit—dropping from 64 in the first quarter to a slightly more than uncertain 56 in the second quarter. In its history, it is not unusual for director confidence in the short term to waver in the 50s. However, when long-term scores drop to this range, it is not uncommon for the overall index score to significantly drop.
Current fears of a stalled recovery are not going unnoticed, however. Following its two-day meeting this week, the Federal Reserve is prepared to launch another round of stimulus to bolster the economy. While the bank has not yet formally announced this intervention, if unemployment and growth continue on the current path, it is only a matter of time.