In a previous article, we discussed a recent paper published by NGOs the Enough Project and Responsible Sourcing Network/As You Sow (backed by two socially-responsible investment firms) that outline their expectations for annual Form SD and Conflict Minerals Reports (CMR) content. By doing so, the nature and costs of CMR audits – if triggered by issuers’ individual circumstances – could be impacted directly and even indirectly.
Companies may consider employing some of the report’s recommendations. In doing so, however, companies will directly increase the cost and efforts required for the independent private sector audit of the CMR, if that is triggered.
The audit criteria are established by way of the issuer’s own description of its due diligence activities. SEC’s regulations are not prescriptive in this way and intentionally allow issuers flexibility in this narrative. The level of specificity in the narrative, including numerical performance indicators, will drive the level of audit effort required.
The audit effort and cost may not be a key factor to some companies in considering the nature of their CMR report, but they should be aware of this factor as part of their considerations.
In a recent seminar we participated in with Michael Littenberg of Schulte Roth & Zabel, Michael suggested that users/readers of CMRs are less likely to be the financial community typically the audience for SEC filings. Rather, NGOs will be the primary audience for CMRs, meaning that general expectations for content may indeed differ from the basics of SEC compliance.
The Enough/Responsible Sourcing Network paper supports that position. With two socially-responsible investment (SRI) funds backing – and participating in – the paper’s position, that could be taken as an indicator of the financial community position on the subject as well (although the position of two investment firms certainly may not be representative of the broader financial community).
There is a possibility that the CMR audit could be impacted in terms of the basis of “significance” or “materiality” – concepts rooted in the users’/readers’ perspective. Materiality (used in financial statements and the GAO Attestation standard) and significance (used in the GAO Performance Audit standard) are essentially the same in relation to CMR auditing, but for our purposes, we will focus on “significance”/Performance Audits.
In GAO’s Government Auditing Standards (the standards required to be used for CMR audits), Section 6.04 provides the definition/scope of “significance” in a Performance Audit. Among the relevant components of the concept are
- the relative importance of a matter within the context in which it is being considered, and
- the needs and interests of an objective third party with knowledge of the relevant information.
Further, Section 6.11 states that auditors should assess “significance within the context of the audit objective by gaining an understanding of … the needs of potential users of the audit report…”
Given these statements, one could argue that NGO/SRI users of the audit report have established their expectations, therefore drawing a line in the sand on significance which CMR auditors would need to recognize in their audit activities and report.
We bring this discussion forward but in reality, it is probably academic rather than practical. We don’t believe that SEC’s intended scope as reflected in the narrow audit objective for the CMR is likely to be expanded as a result of the paper. At the same time, issuers should be mindful of the thought.
We continue to recommend that issuers view the CMR as a regulatory filing and not the appropriate place to tell a broader story about social responsibility achievements. Companies should look to their CSR report to “tell their story” and possibly include indicators/other content sought by NGOs, keeping that separate from the regulatory filings and outside the potential scope of the CMR audit. We suggest that audit costs would be best managed by establishing a bright line between what is to be audited and what is outside those boundaries. Blurring the lines or setting wider boundaries for the audit will increase the cost and perhaps set a precedent with much wider implications for issuers generally.