The following is a transcript of Elm’s opening comments and answers to questions posed by SEC staff at this week’s Conflict Minerals Roundtable in Washington DC. These comments were presented by Lawrence M. Heim, CPEA of Elm’s Atlanta office.
I would like to thank the Commission for allowing me to appear and make a few comments. I am here present the technical environmental health and safety auditing perspective and reflect experiences and thoughts from practitioners in these types of audit programs.
As a bit of disclosure Elm was one of the original audit firms for the EICC CFS. We withdrew from that relationship at the end of December 2010. So we do have experience with and understanding of the CFS program.
Through the past 18 months, we have had numerous conversations with customers, clients and other companies who contacted us with questions on conflict minerals management programs and audits. We have a number of projects that are on-going and the comments I bring forward reflect those discussions and projects.
The most important point I want to emphasize relates to the idea of audits being a key aspect of credibility in the conflict minerals management program. There are a number of known audit schemes such as OECD Due Diligence Guide which references audits and auditor competence standards.
If there is nothing else that I impress upon the Commissioners and the staff here today – recognize one element: the auditor standards currently referenced in OECD and ancillary audit initiatives are the lowest common denominator globally for auditor qualifications in the environmental, health and safety audit profession. And yet the global supply chain of 3TG is resting on the shoulders of that lowest level of auditor competence. If there is nothing more that you take away from my comments, I ask that you consider that.
There is no question that the emotional nature of the issue is driving zero tolerance in the market. Nobody wants to be associated with the atrocities in the DRC and rightly so. But this zero tolerance is pushing company processes toward unreasonable standards. One particular situation I dealt with involved having to determine and convince parties after an audit that the individual atoms in a particular product were conflict free. That is not reasonable.
These audits – critical linchpins for credibility in conflict minerals processes – push towards absolute certainty and drive companies to attempt to develop management systems to manage to the atomic level. That is not reasonable or achievable. It is important to understand reasonable assurance in contrast to absolute certainty, a company’s desire to pass an audit, and what that audit means in the overall business context relative to customer demands and contractual requirements. A level of audit specificity of absolute assurance is therefore driving management system development costs and expectations to a very unreasonable level.
With that I will conclude my opening comments.
Response to SEC question on Independent Private Sector Audit
It is important to start off with a clarification of what we are talking about here. In a number of conversations I have had, there is a great deal of confusion as to what it is we are auditing and where does the audit fall in the process. We have CFS audits which is part of this process, we are talking about some audits within ITRI and the chain from the mouth of the mine to the smelter, other audits are now being discussed in the recently announced private-public partnership and then there is the audit within the conflict minerals report. It is important to recognize that and clarify that the discussion today is of the audit of the conflict minerals report – a singular element of the process.
It is our view that the conflict minerals report audit is a management systems audit; it is not an audit more related to the outcome or the results. It is about assessing the existence of the processes, how well they are implemented and communicated throughout the organization, whether or not the data for making decisions exists – and is used – throughout the organizations and then made available not only within the organization but also through the supply chain. We view it – coming from the traditional EHS management system approach – as what we call a management systems audit. Therefore for us, the content of the report is that element.
Response to SEC question on Performance Audit Standards for the Independent Private Sector Audit
We are not CPAs but we have been doing environmental management systems audits for 25 years and are quite familiar with audit standards. We began taking a detailed look at Yellow Book as soon as we were aware of the passage of the law. Relative to traditional EHS auditors/standards – what are the gaps and differences and whether or not as practitioners we would be able to support these efforts. And there is a difference. Where we came down to is performance audits: in our discussions with clients we landed on performance audits as what we think seems to make sense.
You are correct – we do believe that the competitive market would be opened up quite widely if this was not limited to CPAs having to perform that particular element of implementation.
Response to SEC question on Need for a Specific Audit Standard
We struggled at times in developing proposals for companies who requested this of us. We have our audit process that we believe is correct, would meet 1502 and would be aligned with the current proposed regulations as well, but whether that is what the final standards would be, certainly we don’t know yet. If there are substantive changes in that, that will obviously impact scope and cost.
The other thing is obviously we develop our costs and scope based on our costing structure which is quite a bit different from what the Big 4 cost structure is, so that is another element of pricing that goes into it.
There does need to be some acceptable “stake in the sand” for a standard. Otherwise – and we have already run into this in proposal situations – we have been up against firms who don’t understand what the scope is, so the costs for what they bring forth is massive because it is so broad. We bring a narrow focus based on our experience and a significantly lower cost. The question is then “why is there this large gap in scope and cost differential between the two?” and the answer is we don’t really know what the audit standard is just yet.
Response to SEC question Applicability of Reporting to Scrap/Recycled Materials
It is important to recognize there may be some misunderstanding about what it gets you if you claim a material as scrap or recycled. There is a sense out there by some companies that it is a complete exclusion from the applicability of the regulation and law and that is not the case. As the proposed rule is written, it gets you a somewhat more streamlined report and due diligence process that must be implemented but it isn’t an exclusion.
As a comparison or perhaps contrast, EPA has spent decades trying to define “scrap” in various applications and they do it in the context of whether or not it is a solid or hazardous waste. They have spent two decades trying to define this and they are still continually refining that so I think it is a complex question.
Whether or not it should be subject to the full due diligence and conflict minerals report, I believe that is too onerous. It seems once you have defined a material as scrap, once you can verify through a reasonable inquiry or perhaps some level of – I don’t want to use the word audit – but some kind of evaluation and can reasonable rely on that evaluation to say “yes this does meet the definition of scrap under 1502 regulations”, it seems to me that it is appropriate for that process to end right there. I don’t see any value and have not had clients express that there is any value in continuing to move the process forward. It is an unnecessary expenditure and effort.
Response to SEC question on Type/Location/Timing of Report Within Corporate Disclosure
I can’t comment on the type of report or the location of the report – that is not what my expertise is. I do think it is relevant to the overall timing of implementation to spend a minute and explain a little about the reality of what is happening today. We have heard a lot about various types of reports and requests being pushed through the supply chain in order to gather the information. Well the reality is what is happening today is that these first tier suppliers that get these – and they come in all forms. Some are coming in through the EICC standard reporting template, which is an excellent effort at trying to reduce the impact and the burden on suppliers for trying to figure out how to report this information – what is it they need to look at. That is an excellent effort, but not everybody has adopted that. I have clients who are getting email requests, letters, phone calls – a variety of formats, forms and contents. I am even seeing some clients who are getting conflict minerals requests for minerals that are not conflict minerals – they are outside the scope of 3TG.
What is happening now is first off, these requests are coming and sometimes the first tier suppliers are able to look at this and say yes we can answer some of these questions and they will answer them and send them back. More frequently than I think is perhaps recognized, these suppliers look at it say “we don’t have any idea how to answer these questions – we don’t even really know what these questions mean but we’ll pass it on to our supplier because this impacts their material that we buy from them”. So this is getting pushed down through the supply chain several levels. What that means is delays – delays in issuers getting the information flowing up through the supply chain to them. That is what is happening right now.
That is exacerbated by the point that Irma from Kraft made earlier which is that there are still a lot of companies who don’t know about this requirement, the law or the regulations. Keep in mind, this regulation is geared toward – and specifically applicable to – publicly traded companies – issuers and registrants. If I am a privately-held company, then why would I pay a whole lot of attention to what SEC is doing because I don’t have to answer to SEC. I do answer to my customers but I may not be paying attention to rulemaking under SEC because I am a privately held company and have a couple million dollars a year in sales. But my customers are going to drive this down to me, but I don’t know that yet. There is a lot of that lack of awareness in lower levels of the supply chain that exist. That is creating delays in responsiveness to the information requests as well.
And finally, another element that is creating delays in being able to move forward with this, in getting this information, comes to this whole point about absolute certainty. There is a great deal of fear in the lower levels of the supply chain. With the audits that are driving toward in some cases atomic level of expectations of certainty, companies are trying to manage and figure how to build management systems to deal with that level of certainty and that is causing delays because companies don’t know how to implement unreasonable parameters such as that.