War in the Democratic Republic of Congo has been deadly, with millions murdered. So the United States government has taken its most significant step to try to halt the horror: send in the Securities and Exchange Commission.
Not surprisingly, having your capital markets regulator engage in foreign policy may not be the best solution to ending a war.
The problem arises from the noble attempt to stop the sale of conflict minerals, the focus of those who are pushing for a nonmilitary way to curb the fighting in Congo. Conflict minerals include coltan, cassiterite, gold and wolframite, and while you may not be familiar with some of these, they are widely used in electronics. Your cellphone may very well contain them.
Humanitarian groups say these minerals are being mined by combatants in Congo and neighboring countries and sold to pay for military activities that lead to abuses of human rights. Activists from the Enough Project, a nonprofit group that seeks t o end crimes against humanity, have been working to stop the trade in these minerals, seeking to deprive the Congo war of financing.
So where does the S.E.C. come in?
The Dodd-Frank Act was intended to overhaul financial regulation, but it was also turned into an aircraft carrier as legislators dumped in almost every financial reform proposal ever dreamed of. The 1,500-some-odd provisions of the Dodd-Frank Act not only enhance the regulation of banks, they also require shareholder advisory votes on executive compensation and require the S.E.C. to explore ending the arbitration of investor claims.
Way at the back, in Section 1502, legislators addressed conflict minerals. This provision directs the agency to promulgate rules requiring public companies to disclose whether they handle conflict minerals that originated in Congo and about a dozen or so neighboring countries and to detail the procedures used to monitor this trade.
Last week, the S.E.C. adopt ed rules covering conflict minerals, and they are doozies.
They require that every one of the 6,000 or so public companies determine whether they manufacture a product for which conflict minerals are “necessary to the functionality or production of a product.†If so, then the company must conduct an inquiry that is “reasonably designed†to determine whether the conflict minerals came from Congo or adjacent war-torn areas.
If the company has reason to believe that conflict minerals came from Congo or related areas, it must report to the S.E.C. on its efforts to monitor the source and chain of custody of those minerals and have those efforts overseen by an independent auditor.
For human rights advocates, these steps, which are supported by the State Department, appear to be a simple but important effort to ending the horrific combat in Congo.
But if that was the intent, these rules may not be the best route.
For public companies, these pro visions are expensive. A company like Ford Motor or Caterpillar, let alone Apple, can use parts and minerals from tens of thousands of suppliers and produce hundreds of products.
The S.E.C. estimates the initial compliance cost to be $3 billion to $4 billion, with continuing costs of $207 million to $609 million a year. Industry-sponsored estimates go higher, pinning the cost at $8 billion to $16 billion.
While you might think that it would be easy to define conflict minerals and regulate their supply, the S.E.C. found that it was very hard. The agency had to deal with how to treat recycled conflict minerals, what exactly it means for conflict minerals to be necessary for a product and how hard companies must work to review their supply chains, among other issues. All in a world where gold mined anywhere is hard to trace.
As you might expect with a complex issue, a complex rule has resulted. The S.E.C.'s release explaining its conflict minerals rule is 356 pages long. Companies are going to have to spend millions just to understand the rules.
But even beyond their expense and complexity, the real question is whether these rules are appropriate. Transparency and disclosure appeal to everyone. Who can argue with companies being more transparent?
But disclosure can have perverse effects. In the case of executive compensation, more disclosure likely allowed executives to know what others were paid and demand higher pay for themselves.
In this case, disclosure may impose substantial costs on companies without corresponding benefit.
Along these lines, an S.E.C. commissioner, Troy A. Paredes, wrote that he voted against the rules because they failed to assess “whether and, if so, the extent to which the final rule will in fact advance its humanitarian goal as opposed to unintentionally making matters worse.â€
The problems could be manifold. These new rules could lead to manufacturers simply refusing t o buy any of these minerals from Congo and surrounding area. This would be a de facto boycott that could harm the populace more than it would help. The rules could also have little benefit as smugglers simply circumvent them.
Or the new rules could allow foreign companies to step in and buy these minerals at a lower cost, hurting American businesses while doing nothing to stop the fighting. As the S.E.C. has acknowledged, these rules “may provide significant advantage to foreign companies that are not reporting in the United States.â€
There are already companies waiting to profit. The Enough Project rates manufacturers for their diligence in auditing their supply chains to exclude conflict minerals. The bottom 10 on the Enough Project's list are all Asian companies, for whom these rules are not likely to apply.
So the rules effectively apply only to public companies listed in the United States. This could be a deterrent to foreign manufacturers listing i n the United States or even to American companies remaining public.
And finally, these are only disclosure rules. Companies may simply ignore the embarrassing effect of disclosure, as they do the rules regarding disclosure of executive compensation.
It may well be that the advocates are right and this is all worthwhile. According to Darren Fenwick, senior government affairs manager of the Enough Project, “Even before implementation, the conflict rules have served as a catalyst for companies and countries to already take steps to prevent usage of illicit conflict minerals.†Along these lines, the group recently released a report asserting that there had already been a 65 percent decrease in profit from trading in three of the conflict minerals.
But Thomas P. Quaadman, vice president of the United States Chamber of Commerce's Center for Capital Markets Competitiveness, wrote in the Congressional newspaper The Hill that it was uncertain whether these rules worked and that there was a likely possibility of “negative consequences for American businesses.â€
The debate shows the real problem here. An understaffed and overwhelmed regulatory agency is being forced by Congress to deal with issues involving American foreign policy.
According to the law firm Davis Polk, as of July 30, the S.E.C. has missed the deadline to complete 52 rules under the Dodd-Frank Act.
The agency could certainly use the time it will devote to conflict minerals to catch up with reforming the financial system. In such circumstance, the better route is to have the State Department promulgate more general rules that deal with the issue and apply to all companies.
Instead, we have not only a capital markets regulator but a foreign-policy maker in the offing.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.
