State Department Issues Guidance Statement Regarding Implementation of Dodd-Frank to Address Problems with Conflict Minerals

Do you import jewelry, or serve as a broker for a jewelry importer? If so, then Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) will be of particular interest to you. Section 1502 of Dodd-Frank addresses the problem of the exploitation and trade of “conflict minerals” sourced from the eastern Democratic Republic of the Congo (DRC). Conflict minerals include gold, columbite-tantalite (coltan), cassiterite (tin), wolframite (tungsten) or their derivatives.

Section 1502 instructs the Securities and Exchange Commission (SEC), in consultation with the Department of State (State Department) to promulgate regulations requiring certain companies to report annually on their due diligence activities on the source and chain of custody of conflict minerals. Specifically, the State Department is instructed “to provide guidance to commercial entities seeking to exercise due diligence on and formalize the origin and chain of custody of conflict minerals used in the products and on their suppliers to ensure that conflict minerals mused in the products of such suppliers do not directly or indirectly finance armed conflict or result in labor or human rights violations.”

The SEC intends to issue regulations pursuant to Section 1502 of Dodd-Frank by the end of 2011. In the meantime, the State Department has urged that companies begin to perform their due diligence on the source and chain of custody of conflict minerals they are using in production of products and importing into the U.S. The agency instructs that such due diligence will provide useful information that will assist the State Department and the SEC in meeting Dodd-Frank’s goal of preventing further conflict in the eastern DRC. In its Guidance Statement, http://www.state.gov/e/eeb/diamonds/docs/168632.htm, the State Department has suggested that “companies should begin immediately to structure their supply chain relationships in a responsible and productive manner to encourage legitimate, conflict-free trade, including conflict-free minerals sourced from the DRC and the Great Lakes region.”

The State Department encouraged companies to follow Organization for Economic Cooperation and Development (OECD) guidance and framework when developing and implementing their own due diligence plans:

• Establish strong company management systems;
• Identify and assess risk in the supply chain;
• Design and implement a strategy to respond to identified risks;
• Conduct supply chain due diligence at specific points in the chain (preferably by independent third party); and
• Report on findings from supply chain due diligence.

The State Department will consider whether to revise its Guidance Statement after the SEC issues its regulations.

It’s How Much in Duty?

Many importers believe mistakenly that the price of their goods is simple to determine: cost of goods (manufacture plus materials), general expenses, profit, duty and fees. What happens when the duty bill turns out to be higher than anticipated and the goods are already sold? This can happen in three common ways:

(1) the importer did not know that there was anti-dumping duty on the products imported;
(2) the importer brought the goods in conditionally duty-free under a duty preference program, but then the duty-free treatment was denied by Customs and
(3) the importer misclassified the products.

How do we avoid these problems? Due diligence and internal controls.

First is the situation where an importer ships goods that are subject to an anti-dumping duty order (ADD) and the importer did not realize it at the time of entry. How can this happen? Here is an example. There is an ADD order on petroleum wax candles from China. An importer contracts with a Chinese manufacturer for soy wax candles, assuming that soy wax candles are outside the scope of the ADD order. Post entry of the soy wax candles, Customs sends a CBP Form 28 Request for Information, asking for a sample and description of the candle. Customs tests the sample and determines that the candles are 99% soy wax and 1% petroleum wax. Because the candles contain petroleum wax, and are Chinese-origin, they are subject to ADD.

You may ask how this happened. The importer relied on the manufacturer’s oral guarantee that the candles were 100% soy wax. However, the importer never tested the candles prior to importation—he simply accepted the manufacturer’s statement. The importer should have tested the candles prior to importation to ensure that they were 100% soy wax. If the importer knew that they were not 100% soy wax, he could have (1) priced the candles to account for the ADD, (2) sourced the candles from a different country or (3) prepared and submitted a scope ruling request to the Department of Commerce to try to obtain a ruling stating that candles that contain only 1% petroleum wax, which is considered de minimis, should not be within the scope of the order.

Next is the situation where an importer brings the goods in duty-free under a duty preference program, but then the duty-free treatment is denied by Customs. Let’s say the importer is a jewelry company that sources jewelry in India. Some jewelry imported from India is conditionally duty-free under the Generalized System of Preferences (GSP).

Customs issues a CPB Form 28 Request for Information, asking for an explanation of the manufacturing process in India, including information about where the gold is sourced and the processing steps taken in India. The jewelry company cannot obtain this information from the Indian manufacturer. Customs denies the GSP claim. Jewelry that was duty-free under GSP is no longer entitled to the duty preference and thus, the importer must pay duty on the imported jewelry. The importer could have avoided this situation had the company obtained the proper records from the manufacturer at the time it purchased the jewelry. Recordkeeping is an important part of good internal controls.

Last is probably the most common situation—the importer misclassified the goods. A supplier of rolls of polyurethane misclassified the goods, thinking the goods were duty-free only to find out after the goods were imported and sold that they were classified under a different provision that had 6.5% duty. The potential liability is large: (1) the importer owes duty plus interest on the previous entries; (2) the importer may be subject to penalties and (3) the goods have been sold and thus, the importer cannot recoup any of the increased duty costs.

This can occur when an importer does not conduct annual internal reviews of the company’s import operations and does not conduct regular post entry reviews. Both annual review and post entry reviews are considered best practices by Customs and are a necessary part of the exercise of reasonable care.

Don’t be surprised and find yourself asking, “It’s how much in duty?”