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Breaking the bloody links in the smartphone supply chain

31 May

CONGO COMMODITIES

A tin buyer from Malaysia Smelting Corporation inspects freshly mined cassiterite, or tin ore, at Kanunka mine, Manono Territory, Katanga Province, Democratic Republic of Congo, on Oct. 26, 2013. Since the mid-1990s, when war broke out in eastern Congo in the aftermath of the genocide in neighboring Rwanda, Congolese minerals have acquired a bad name. Rebels, unscrupulous traders and members of the army helped themselves to tin ore, of which Congo is Africa’s biggest producer, gold and columbite-tantalite, or coltan, an ore used in smart phones and laptops.

Blood diamonds. Blood chocolate. Blood smartphones.

Silicon Valley technology companies are racing to comply with new federal rules that require them to disclose efforts to determine if their products contain materials that fund armed groups in the Democratic Republic of Congo.

By June 2, companies whose products use tantalum, tin, tungsten or gold — widely used in semiconductors, mobile phones and other electronics — are required by the Securities Exchange Commission to disclose steps taken to trace the origin of those minerals.

Companies must describe their efforts to determine the country of origin of these minerals, collectively known as “3TG.” If they have a reason to believe their minerals come from Congo or bordering countries, they must try to determine the minerals’ complete chain of custody, including the source mine if possible.

The rule is a result of years of pressure from human rights organizations such as the Enough Project, Amnesty International and Global Witness. They hope that increased transparency will pressure companies to make sure their minerals are not funding violence in Congo, where 5.4 million people have died since 1998 due to conflict-related causes according to an International Rescue Committee report.

As of May 29, 60 companies had filed with the SEC, including Intel Inc., considered a pioneer in developing a conflict-free supply chain. The company declared its microprocessors and chipsets “DRC conflict-free” while saying all other products were “DRC conflict undeterminable,” meaning the effort to trace the supply chain went cold at some point.

Thousands more companies are expected to file, including Silicon Valley brand names Apple Inc. and Cisco Systems Inc.

The challenges companies face in complying with the SEC conflict minerals rules: A long supply chain that can thread from Africa to Asia to North America, a lack of information on facilities in that supply chain, vague language in the SEC rule and of course, the cost of compliance.

Another issue? Some say not all companies are trying hard enough.

“One of the biggest frustrations for us is companies that are lazy,” remarked Bruce Calder, a vice president at Claigan Environmental, a firm that advised the SEC on the wording of the conflict minerals rules. His company has advised 30 firms on their disclosures.

He said he has seen companies fail to do basic research such as searching a refiner’s name and “DRC” in Google to find out if their 3TG could come from one of the 10 Central African countries covered by the law.

“There’s a lot of tracing a high schooler can do that a lot of companies say they can’t do,” Calder said.

That said, Calder points out that in his experience, when companies do find out they’re sourcing from a “negative actor, they cut them out.”

Spansion’s point man

One of the people responsible for finding out who the bad actors are is Rick Lattanzio, vice president of environmental health and safety at flash memory maker Spansion Inc., based in Sunnyvale.

When Lattanzio started work on tracing Spansion’s 3TG in late 2010, the complexity of its supply chain made him pessimistic about his chances for complying with the SEC rules, which were spawned by the 2010 Dodd-Frank legislation.

“It almost looked like an impossible task,” he said.

It’s not an unusual predicament for Silicon Valley companies.

Anywhere from three to nine intermediaries usually separate companies from the smelters who refine their minerals, never mind the actual mine it came from, according to accounting firms PwC and KPMG.

Companies have focused on tracing their 3TG back to the choke point of the mineral supply chain: Smelters where the raw mineral ore is refined.

Companies have been surveying their direct suppliers to establish the identity of their smelters.

While Intel wrote that it directly visited 29 of the company’s smelters to review their chain of custody information, many companies like Spansion have relied primarily on a smelter database put together by two industry groups.

The Electronic Industry Citizenship Coalition (EICC) and the Global e-Sustainability Initiative (GeSI) created the Conflict-Free Smelter Program, which lists known smelters as well as those that have been certified as conflict free.

Companies cross-reference their smelters with the database to determine which ones have, or have not, been declared conflict free.

But the database is not yet comprehensive, said Julie Schindall, EICC Director of Communications & Stakeholder Engagement.

A “very rough estimate” of the number of 3TG smelters worldwide is between 450 and 600, Schindall said. Only 300 are listed in the database that companies are working off of.

“It’s very, very difficult if not impossible at this time to say if that information is good,” she said. “That’s an ongoing challenge that we’re working on to try to verify so we know who really is a smelter of these minerals … and who could go through our audit program.”

The smelter program’s website currently lists 87 3TG smelters as conflict-free certified: 43 gold, 28 tantalum, 13 tin, and three tungsten.

Spansion filed its report on May 30, and it listed smelters it sources from that have not been declared conflict-free.

Lattanzio said he’s told customers that Spansion’s goal is to declare its tantalum, tin and gold conflict-free by 2015, but that he can’t make a commitment to tungsten because of a lack of certified smelters.

Incomplete information

Companies also have to contend with incompletely answered surveys from their suppliers.

Bobby Kipp, conflict mineral solution leader at the accounting firm PwC, said a survey his group conducted reported that only 28 percent of companies said they got good responses from 75 percent or more of suppliers they surveyed.

Matt Behan, KPMG leader of conflict minerals practice for the technology sector, said he’s seen suppliers declare themselves conflict free because their smelters are located in China — even though the source of minerals is determined by the location of its mine, not its smelter.

Companies are also not always critically analyzing their supplier’s responses.

“Some companies are just sending out a survey and inspecting what they get back on face-value, which we would not advise,” Kipp said.

Behan, who said KPMG has advised at least 60 companies on the rule, said he’s seen companies misinterpret what due diligence means.

“They think (sending out the) survey (to suppliers) is their due diligence … but it’s not,” he said. “It’s looking at the results that come back from the survey and testing them for reasonableness and following up in various ways … if they feel like they’re not 100 percent correct.”

Vague language has also led to confusion over what companies are actually required to report.

“Believe it or not, even though there are 356 pages in these rules… the rules themselves do not define in detail ‘Well, what exactly is a Reasonable Country of Origin Inquiry,’” said Kipp, referring to a specific step companies must take to determine what country their 3TGs are from.

Contents of filings reflect differing interpretations of what the SEC rules require companies to disclose.

Some filers, such as Hill-Rom Inc., list all known smelters in their supply chains. Affymetrix Inc., on the other, listed only the smelters in their supply chains that are certified “conflict free” by the Conflict Free Smelter program. CAE Inc., which declared its products DRC conflict free, lists none of its smelters.

“Right now it’s a little Wild West,” Lattanzio of Spansion said. “You have some general guidelines and procedures to go with … but they’re not very specific.”

Costs

All these difficulties create costs for companies that must comply with the new rules. When the SEC passed the final rule in 2012, its initial estimate for the total cost of compliance to companies was between $3 billion and $4 billion. That averages $500,000 to $667,000 for each of the 6,000 affected companies.

Claigan Environmental initially estimated costs would be much lower, pegging the total at $387 million.

Since then, Claigan has dropped the price and the number of companies that will be affected by the rules. Their most recent estimates put the total cost at $180 million for 2,200 companies, coming out to an average of $82,000 per company.

Claigan’s Calder said projected costs are lower for several reasons: The workload to comply has turned out to be lower than expected. Also, an April 14 court ruling eliminated a requirement for all reports to be independently audited. Other factors? The SEC granted exceptions for retailers, and companies are leveraging off earlier work done by Intel and the EICC.

Lattanzio said he couldn’t give a dollar figure for Spansion’s compliance costs, but he called Claigan’s 2011 estimate of $218,000 for a $1 billion revenue company “not unreasonable.” Spansion posted $972 million in revenue in 2013.

Results

Even before the SEC deadline, some say the ruling has already made a difference.

Lattanzio said he’s seen the number of smelters in Spansion’s supply chain decrease “significantly” from last year, and theorized that it could be because his direct suppliers are moving towards a smaller number of conflict free certified smelters.

“For instance, if we have a supplier, they may (have used) 7 or 8 different smelters,” he said. “And now they may be using for or five.”

Calder pointed to the 2013 defeat of the Congolese rebel group Mouvement du 23 mars, also know as M23, as proof that efforts to clean up conflict minerals have already made a difference on the ground.

According to a January 2014 UN report on the Congo, “The Group found no evidence that M23 was engaged in the minerals trade in 2013.”

The UN report also cites the Organization for Economic Cooperation and Development as advancing validation of mining sites and improved adherence to conflict-free standards.

But the report specifically noted that the continued illegal smuggling of 3TG out of the DRC to surrounding countries undermined the credibility of international certification efforts.

While only the 3TGs are singled out by the SEC, the whole minerals industry is paying attention to what’s happening, said analyst Simon Moores.

“It’s the first time that (a Western) government has gotten actively involved in … the minerals industries in such a way,” said Moores, who manages niche mineral research firm Industrial Minerals Data.

Moores focuses on minerals such as graphite and lithium, and 3TG don’t fall into his normal beat. But he said he there’s a “pretty high” probability that eventually the rule will be expanded to cover other countries and minerals.

“It’s not unreasonable when you think of things like blood diamonds, the coffee issues, the chocolate,” he said. “There’s a lot of different materials out there that have issues associated with them, these (the 3TG) just happen to be primarily metals that the electronics industry uses quite a bit.”

Interview transcriptions provided by TranscribeMe.com

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