Before you answer the above question, you need to determine whether a preliminary review and, possibly, a more substantial due diligence process are required to be performed in accordance with the requirements of the United States Securities and Exchange Commission (SEC).
The first step for businesses is to follow the steps shown in Figure 1 to gain a preliminary understanding of the application of the laws to them. Significantly, the third and fourth steps in this process are elements that require a relatively substantial amount of analysis. This requirement is defined by the rules as a Reasonable Country of Origin Inquiry (RCOI). The purpose of an RCOI is to document a preliminary investigation into the source of minerals being used by a company. Such an inquiry must be “reasonably designed” to determine if minerals come from covered countries (as defined by the rules), and must be performed in good faith. Further, companies must seek and obtain relatively reliable information from their suppliers that minerals were not sourced from conflict zones. There is no clear definition of the steps to be taken in the RCOI process; however, companies must be able to make a reasonable determination from this inquiry that the source of the minerals is legitimate.
What this means is that companies must obtain from their suppliers a reasonably reliable representation that the necessary standards are being met, and this includes following up on incomplete information. In this sense, simply searching a database or watchlist in itself is not enough. After making their enquiries, companies must analyse supplier submissions, correct insufficient responses and even map supply chains where risk is higher. Employees must not ignore or be wilfully blind to warning signs.
In order to make a determination of where you stand in relation to the rules, you will also need to ascertain whether the conflict minerals are from recycled or scrap sources. This may not be evident from the purchasing arrangements and will require due diligence to work it out.
Here are a few ways to try and determine this answer through a well-constructed RCOI:
- Via the use of a questionnaire, ask the supplier whether the conflict minerals were recycled or from scrap sources. If you are prepared to rely on their certification it will mean a great reduction in further due diligence. Of course, you might want to review the veracity of the assessment and your reliance on unverified information.
- Determine whether or not the supplier has a recycling operation as part of their business – this may include some collection aspects, a smelter of reused material or some form of refining facility – and whether the input to that process is more than rock or unprocessed ore. If the entity appears to have a full scale mining operation (as explained below) they are probably not using recycled material.
- Try and establish from the questionnaire where the supplier obtained the conflict minerals and try and determine whether they are “used” or new minerals from a mining company or a trader of a mining company. This information may not be readily disclosed by the company and might need to be obtained through further enquiry, possibly including discreet investigations.
- Conduct research with the operations of the supplier (or their supplier) to see if there is a known recycling part of their business. This research is usually carried out through a site visit to their location – if there is a recycling element to the business then there is likely to be large stockpiles of recycled material on site. This may include used building materials or other substances which contain the raw product. Evidence of a recycling sector may also appear if the supplier advertises to collect or buy used material via their website or through their buying agents.
After conducting the above review you should be able to determine if you are an issuer with included conflict minerals from covered countries. If you are, if the minerals are not from recycled or scrap sources and you do not have a reasonably reliable representation from the supplier to suggest otherwise, you will need to conduct more comprehensive due diligence.
Understanding the due diligence process
The due diligence process requires the assessment of your supplier and of the people involved in the chain, right back to the source of the minerals. You want to determine answers to the following:
- Where did the supplier obtain the minerals? Was it from the mining company, a trader or some other intermediary? These questions are best obtained from a questionnaire process that the company can certify and attest.
- Who were all the intermediary companies located in the chain from extraction? This would include all companies involved in the every phase of extraction through to refinery and, ultimately, sale.
If any of the answers to these questions show a link to one of the covered countries, then further due diligence will need to be done. It may also be the case that the supplier does not have all the information and can only provide one level in the chain of supply themselves. If this happens you will need to ask further questions or conduct further due diligence down the chain.
If it can be established that the conflict mineral did come from a covered country, then the challenge will be to show that there were no links to armed conflict financing. To do this requires a further analysis of the company and on the ground due diligence.
Where to look in the extraction process for third parties
By way of example, there are a number of players involved in the extraction, refining and sale of gold. While these may differ in certain locations, there are a number of phases which will involve a number of potential participants, all of whom may become relevant in the exercise of conducting due diligence.
The first step of the due diligence process is understanding the potential number and details of the participants. To do this requires some awareness of the six main phases of gold production (by way of example):
- Finding the orebody
- Creating access to the orebody
- Removing the ore by mining or breaking the orebody
- Transporting the broken material from the mining face to the plants for treatment
The above phases apply to both underground and surface operations.
Finding the orebody
Many companies will identify targets where a potential deposit exists and then undertake exploration on that site. The exploration project is likely done with the permit holder of the exploration license – in many cases these permit holders are known as “junior partners”. These junior partners are often local companies, and there is a risk that they may have obtained their exploration licenses or permits illegally or by paying bribes. There is a therefore an additional need to conduct due diligence on these junior partners and their owners and operators to determine if paying them for the exploration permit or conducting a joint venture with them (which presumably involves paying them a fee for access or, at the very least, a share of the potential profits) will breach any conflict minerals rules if the company is linked to armed conflict financing.
Creating access to the orebody
There are two types of mining which take place to access the orebody:
- Underground – a vertical or decline shaft (designed to transport people and/or materials) is first sunk deep into the ground, after which horizontal development takes place at various levels of the main shaft or decline. This type of mining allows for further on-reef development of specific areas where the orebody has been identified.
- Open-pit – the top layers of topsoil or rock are removed in a process called “stripping” to uncover the reef.
In this situation, the mining company (or joint venture) is likely to have engaged multiple suppliers and partners to conduct drilling operations and provide resources and maintenance facilities. These companies would need to be the subject of due diligence, again to determine who they are and whether the company or the owners and operators have any links to armed conflict financing.
Removing the ore by mining or breaking the orebody
In underground mining, holes are drilled into the orebody, filled with explosives and then blasted. The blasted “stopes” or “faces” are then cleaned and the ore released is now ready to be transported out of the mine.
In open-pit mining, drilling and blasting may also be necessary to release the gold-bearing rock. Excavators then load the material onto the ore transport system.
There are likely to be a significant number of third parties involved in this process: explosive providers, machinery, rock tools, transport systems and local personnel providers, just to name a few. These third parties should all be assessed to determine whether the companies or their owners and operators have any links to armed conflict financing. A focus should be on local companies that are using local resources from a country of concern. These may include companies in the following lines of business:
- Mining engineering services
- Mine planning
- Provision of consumable resources
- Engineering services
- Financial, administration and human resource services
- Environmental or permitting services.
Transporting the broken material from the mining face to the plants for treatment
Underground ore is transported by means of vertical and/or horizontal transport systems. Once the ore is on the surface, conveyor belts usually transport it to the treatment plants.
Open-pit mines transport ore to the treatment plants in vehicles capable of hauling huge, heavy loads.
The transport systems and conveyor belts used to transport the ore are likely to be supplied by international companies, although the associated services may not be. Local suppliers used in this process should all be assessed to determine whether they or any of their owners and operators have any links to armed conflict financing.
Breaking up of ore to make gold available for treatment typically involves a form of crushing in a large mill. Once broken up, the gold ores are generally classified as a refractory ore – where the gold is locked within a sulphide mineral and needs to be oxidised (by several different forms) – or free milling – where the gold is readily available for recovery by the cyanidation process (the gold is agitated in an alkaline cyanide leaching solution followed generally by adsorption of the gold cyanide complex onto activated carbon). Gold adsorbed onto activated carbon is recovered by a process of re-dissolving the gold from the activated carbon, and then subsequently smelted into bars that are shipped to the gold refineries.
The processing is usually conducted on site at the mine and operated by the mining company or potentially a third party. Processing plant owners should be assessed to determine whether the company or the owners and operators have any links to armed conflict financing.
The bars are transported to a refinery for further refining. It is common that the refineries are located outside of the countries where the mining takes place. While South Africa’s Rand Refinery – who describes itself as one of the world’s largest gold refineries and processes “most of Africa’s gold” – has a capacity to produce 600 tonnes of gold annually, there are now more refineries appearing, including some located in South Sudan. The local operators of the refineries should all be assessed to determine whether the company or the owners and operators have any links to armed conflict financing. This should also include any traders or shipping or transport companies who move the gold from the processing site to the refinery.
Having identified the third parties, how do we know whether the company, the owners and operators have links to armed conflict financing?
Are any of the identified suppliers or intermediaries located in one of the countries of concern from Figure 1? While this is not indicative of the fact that they are be involved in financing armed conflict, there is a greater likelihood of this being the case if they are located in one of the countries where the armed conflict is taking place. This can be established by conducting corporate checks on their registrations, which will need to be done through actual primary resource material checking. This is often difficult in central African countries as the local registry offices are poor and technologically very basic.
The ownership of the third parties would need to be established to check whether the owners, operators, managers or employees are listed on any international watchlists or sanctions lists. As this would be unusual and is less likely to be found, research should also be conducted to determine whether the owners and operators are engaged in financing arms or conflict areas. An effective method of research would be a reputation analysis or detailed media research in local countries. It is highly unlikely that there is some “list” that can be checked to see who is engaged in international arms financing. This will need to be completed through looking at resources that know and understand the local market. It might be important to look at the principals of the company to see what tribal or other religious factions they belong to and then identify whether those factions are linked to arms conflict financing. It would be very difficult to prove if a donation has been made by a principal to a faction, but it might be possible to raise a red flag that one might be likely, based on the situation and the relationship between the company and the local armed conflict.
The ultimate test is that the subject company has engaged in financing armed conflicts. This test is very difficult to establish and will involve detailed levels of due diligence. There is no doubt that this research needs to be targeted to the companies that are most likely to have been the recipient of funds from the conflict minerals that are in the country of concern. Determining this shortlist of companies for review is a key aspect of the role of a compliance officer of an “issuer company” where the due diligence process has identified that they have used conflict minerals from a country of concern in their manufacturing processes. The answer is certainly not “run them against a watchlist check”.