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Can Annual Reports Save Lives?

Category: World of Business


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Can Annual Reports Save Lives?

By Jason ZWEIG / December 17, 2011
 

Buried deep in the 849 pages of last year's Dodd-Frank financial-overhaul law is a provision that has begun turning financial regulators into a human-rights police force. It also gives investors something new to worry about.
 

Alarmed by atrocities in the Democratic Republic of the Congo, Congress ordered the Securities and Exchange Commission to require companies to disclose whether raw materials essential to their products include minerals from Congo or neighboring nations.
 

The financial law thus puts a handful of harried securities lawyers at the SEC into an unprecedented and unlikely role: figuring out how publicly traded companies should demonstrate whether they have scrubbed their global supply chains of any taint of human-rights violations in Central Africa.
 

The minerals in question—cassiterite, columbite-tantalite, gold and wolframite—are widely used in consumer electronics and other products, although Congo supplies no more than 20% of global demand for these raw materials.
 

For years, however, the revenues from Congolese mines have financed warring factions that engage in kidnapping, child labor, rape, mutilation and murder. By compelling companies to disclose to the investing public whether they use any of these "conflict minerals," Congress hoped to stop the flow of money to abusers of human rights.
 

The SEC reckons that 1,200 companies may have to file the new disclosures; other estimates range up to five times higher.
 

People familiar with the matter say that the conflict-minerals rule has led to more meetings between outside interested parties and the SEC staff than any other issue in years—partly because the area is so far outside the agency's expertise, partly because it arouses such intense passions.
 

The SEC has been wrestling with the conflict-mineral rules for months, and there isn't any word on when the final regulations will be released. But companies already are warning that they will have to make the disclosures—and that the regulations could constrict supply, raise costs and even drive away customers.
 

So far this year, 42 U.S. companies—14 in November alone—have mentioned the pending conflict-mineral rules in their financial statements, up from just two in all of 2010. Their stock prices didn't seem to react to the disclosures.
 

Most of these companies make or distribute semiconductors, cellphones or other electronics equipment. But they also include a chemical producer, a solar-energy concern and Helen of Troy, which makes hair dryers, foot baths, kitchen mitts and electronic mosquito traps.
 

Buddy Barnes, chief financial officer of RF Monolithics, a Dallas-based maker of wireless equipment, says "we shouldn't be funding renegades who misuse their resources and abuse their people." His company relies on all four minerals, although RFM doesn't always know where they were mined.
 

Mr. Barnes estimates that it would cost RFM $1 million to conduct its own audit of the mineral suppliers used by its contract manufacturers. RFM, which has a minuscule stock-market value of $11 million, had net income of $228,000 in its latest fiscal year and $312,000 the year before.
 

"For us, it's the difference between being profitable and not," says Mr. Barnes, who is hoping that larger companies will set up a system of verifying "conflict-free" suppliers that firms like his could piggyback on.
 

Marcia Narine, a visiting law professor at the University of Missouri–Kansas City, spent a week and a half in Congo in September. She worries that thoroughly investigating how minerals are produced there may not yet be practical.
 

Prof. Narine tells the story of a 63-year-old woman who reported to the authorities that she had been raped by militants—who then came back and cut off her lips as punishment. With some penalties for telling the truth, asks Prof. Narine, "How can we be sure the information we're getting is accurate?"
 

That also is a concern for "socially responsible" funds, those portfolios that invest only in companies that pass specific environmental and social tests. The chaos in the Congo region makes the traffic in minerals so hard to trace that screening out a misbehaving company from a portfolio isn't yet feasible.
 

Bennett Freeman, a senior vice president at Calvert Investments, says that it is "virtually impossible" at this point to prove that a company's products don't contain conflict minerals, but he is optimistic that the new rule will change that over the next few years.
 

In the meantime, more such requirements are possible. "In a shrinking world," says Tamar Frankel, an expert on securities law at Boston University, "investments and political issues may be so closely related that they cannot be separated anymore."
 

Considering that interventions by other means have so often failed, financial disclosures—whether they work or not—may become the next weapon for combating crimes against humanity.

 

Write to Jason Zweig at intelligentinvestor@wsj.com



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