In November 2014, the D.C. Circuit Court of Appeals granted the petitions of the SEC and Amnesty International for panel rehearing in connection with the conflict minerals case, National Association of Manufacturers, Inc. v. SEC. Today, a three-judge panel of the D.C. Circuit, by a vote of two to one,  reaffirmed its initial judgment that the requirement in the conflict minerals rule to disclose whether companies’ products were “not found to be DRC conflict free” amounted to “compelled speech” in violation of companies’ First Amendment rights. Is another en banc review on the horizon?  How will the SEC address the decision? 

By way of background, in April 2014, a three-judge panel struck down a portion of the SEC’s conflict minerals rule on First Amendment grounds. In that case, the Court decided that the requirement to disclose whether companies’ products were “not found to be DRC conflict free” amounted to “compelled speech” in violation of companies’ First Amendment rights.  Both the SEC and Amnesty International filed petitions with the D.C. Circuit requesting a rehearing en banc regarding the First Amendment issue, but requested that the Court hold the petitions in abeyance pending issuance of the en banc decision on a similar issue in American Meat Institute v. U.S. Dept. of Agriculture. The precise question that was before the en banc panel in AMI was “[w]hether, under the First Amendment, judicial review of mandatory disclosure of ‘purely factual and uncontroversial’ commercial information, compelled for reasons other than preventing deception, can properly proceed under [the more lenient standard of]  Zauderer v. Office of Disciplinary Counsel… or whether such compelled disclosure is subject to review under Central Hudson Gas & Electric v. PSC of New York….” The en banc panel in AMI held (with two dissents) that “Zauderer in fact does reach beyond problems of deception, sufficiently to encompass the disclosure mandates at issue here.” Moreover, specifically citing the NAM conflict minerals case, the Court indicated that “[t]o the extent that other cases in this circuit may be read as holding to the contrary and limiting Zauderer to cases in which the government points to an interest in correcting deception, we now overrule them.” (For a more complete discussion of these cases and legal standards, see my posts of4/14/147/16/147/29/14,  9/14/14.)  With AMI decided, the Circuit Court granted the petitions of the SEC and Amnesty to consider the question of what effect, if any, AMI had on the Court’s prior judgment that the conflict minerals disclosure requirement violated the First Amendment, that is, to consider whether, under Zauderer and AMI, the mandated conflict minerals disclosure could satisfy the test for “purely factual and uncontroversial” commercial information.

Clearly displeased by the en banc decision in AMI that the more lenientZauderer standard was not limited to issues of deception, the three-judge panel first turned to a kind of variant: “whether Zauderer, as now interpreted in AMI, reaches compelled disclosures that are unconnected to advertising or product labeling at the point of sale.” (Interestingly, the Court first raised, but did not directly address, the issue of whether the case even involved commercial speech, an issue discussed in the dissent, and instead focused its argument on the “narrower subsidiary” issue of advertising.) The Court took particular note of the SEC’s acknowledgement that the statute and related rules were directed at achieving social, not economic benefits and “were  ‘quite different from the economic or investor protection benefits that our rules ordinarily strive to achieve.’” However, the Court viewed Zaudereras intentionally confined to voluntary advertising: the case did not hold that “any time a government forces a commercial entity to state a message of the government’s devising, that entity’s First Amendment interest is minimal. Instead, the Zauderer Court – in a passage AMI quoted,… – held that the advertiser’s ‘constitutionally protected interest in not providing any particular factual information in his advertising is minimal.’”  Accordingly, the Court held that “Zauderer has no application to this case.” To the point that AMI did not even address the advertising issue (and related cases drawing that distinction), the Court presumed that the majority either was unaware of the cases “or believed that product labeling at the point of sale was simply an adjunct of advertising.”

For the same reasons as stated in the prior opinion, the Court also reiterated its view that “the SEC’s ‘final rule does not survive even Central Hudson’s intermediate standard.’” Nevertheless, given the uncertainty surrounding these First Amendment issues, the  Court elected to add an “alternative ground” for its decision, and evaluated the rule under Zauderer and Central Hudson, arriving at the same conclusion.  Applying those tests, the Court first determined that the U.S.’s  interest in “ameliorat[ing] the humanitarian crisis in the DRC” was a sufficient governmental interest.

As the next step, evaluating the effectiveness of the measure to achieve that interest, the Court viewed the notion that the rule could diminish the humanitarian crisis in the DRC to be “entirely unproven” and “pure speculation”; Congress held no hearings on the rule, and some post hocevidence suggested that the rule may even have had the effect of exacerbating the crisis.  Although some  contended that the rule would alleviate the crisis, the effectiveness of the underlying  conflict minerals provision in Dodd-Frank had not been “proven to the degree required under the First Amendment to compel speech,” nor had the SEC been able to satisfy its burden of showing that the rule would alleviate the crisis to a material degree. “This in itself,” the Court concluded, “dooms the statute and the SEC’s regulation.”

The Court next turned to the critical third step of the Zauderer analysis, whether the compelled disclosures were “purely factual and uncontroversial.”  Amnesty contended that the term “purely factual and uncontroversial” was merely descriptive and not intended to be a legal standard. However, the Court viewed the holding in AMI – to which the Court emphasized that it was bound —  to require that “the disclosure to be of ‘purely factual and uncontroversial information’ about the good or service being offered.” Nevertheless, the meaning of those terms was not defined, and the only guidance in the opinion appeared to be  that the term “controversial”  meant something other than a “dispute about simple factual accuracy.”  Moreover, the Court agreed with NAM that the use of a statutory definition of “conflict free” would not rescue the rule.  Finally, the Court saw no reason to change its oft-quoted initial conclusion that the mandated language “was hardly ‘factual and non-ideological’”:

“We put it this way: ‘Products and minerals do not fight conflicts. The label ‘[not] conflict free’ is a metaphor that conveys moral responsibility for the Congo war. It requires an issuer to tell consumers that its products are ethically tainted, even if they only indirectly finance armed groups. An issuer,including an issuer who condemns the atrocities of the Congo war in the strongest terms, may disagree with that assessment of its moral responsibility. And it may convey that ‘message’ through ‘silence.’…. By compelling an issuer to confess blood on its hands, the statute interferes with that exercise of the freedom of speech under the First Amendment.’”  (See this post .)

Accordingly, the Court concluded again that the conflict minerals provision of Dodd-Frank and the SEC’s implementing rule “violate the First Amendment to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have ‘not been found to be ‘DRC conflict free.’” (The Court limited its holding with respect to the statute itself to the extent that the statute imposed the particular description requirement. If the description was rather an SEC invention, then the statute would be untouched.)

Judge Srinivasan dissented. He contended that no one takes issue on a First Amendment basis with all the different sorts of disclosures that public companies must make about their products for the benefit of the investing public, and there’s no reason why disclosure about the country of origin of its products  (as in AMI) should be viewed differently. In addition, he viewed the term “DRC conflict free” as a “statutorily defined term of art denoting products that are free of ‘conflict minerals that directly or indirectly finance or benefit armed groups’ in the DRC or adjoining countries.” The aim of the rule, he maintained, is to use anticipated consumer reaction to “dissuade manufacturers from purchasing minerals that fund armed groups in the DRC region. That goal is unique to this securities law; but the basic mechanism—disclosure of factual information about a product in anticipation of a consumer reaction—is regular fare for governmental disclosure mandates. Many disclosure laws, including the law upheld in AMI, operate in just that way.” (Notably, in response to the dissent’s argument here, the majority, quoting Charles Dickens, issued this potential invitation: “‘Whatever is is right’; an aphorism that would be as final as it is lazy, did it not include the troublesome consequence, that nothing that ever was, was wrong.”)

Because of value of truthful, factual information to consumers, he contended,

“when the government requires disclosure of truthful, factual information about a product to consumers, a company’s First Amendment interest in withholding that information from its consumers is ‘minimal.’ …That is why countless disclosure mandates in the commercial arena…raise no serious First Amendment question. The sum of the matter is this: in the context of commercial speech, the compelled disclosure of truthful, factual information about a product to consumers draws favorable review. That review takes the form of the permissive standard laid down by the Supreme Court in Zauderer. I would apply that approach here. Like the mine-run of uncontroversial requirements to disclose factual information to consumers in the commercial sphere, the descriptive phrase “‘not been found to be ‘DRC conflict free’’’ communicates truthful, factual information about a product to investors and consumers: it tells them that a product has not been found to be free of minerals originating in the DRC or adjoining countries that may finance armed groups.”

While companies might prefer to avoid that label, the same could be said of labels on products with a high calorie count. The key here to determining the standard, in the dissent’s view, was whether the regulation restricted (Central Hudson) or expanded  (Zauderer) the flow of truthful commercial information.

He concluded that the “precise form”  of the speech (i.e., that it’s not advertising) should not be determinative and that the  speech at issue – which he characterized as “geographic origin” — was certainly commercial speech aimed  at a prospective stock purchase  or sale decision, and thus a commercial transaction. The majority’s limitation of Zauderer to advertising or product labels was just a “newly minted constriction.” (Would the majority apply the more lenient standard had the language appeared on a product label instead,?)  The Zauderer court referred to advertising, he argued, because that was the factual context of the case.

The starting premise in all commercial speech cases, the dissent contended, is that “the First Amendment values commercial speech for different reasons than non-commercial speech.” The Zauderer standard, he suggested, is intended to protect commercial speech the value of which is “in providing consumers with useful information about products and services.” To qualify as “purely factual and uncontroversial” under Zauderer, he argued, quotingAMI, “the disclosed information must in fact be ‘factual,’ and it must also be ‘uncontroversially’ so, in the sense that… there could be no ‘disagree[ment] with the truth of the facts required to be disclosed.’”  In the dissent’s view,  “uncontroversial” should not be read as “wholly untethered to the core question of whether the disclosure is ‘factual.’ If a disclosure is factual, and if the truth of the disclosed factual information is incontestable (i.e., if the facts are indisputably accurate), the interest in arming consumers with truthful, factual information about products calls for relaxed review under Zauderer.” Just because the conflict minerals rule “touches on a ‘controversial’ topic, that alone cannot render the disclosure ‘controversial’ in the sense meant byZauderer.” Had that been the case, he argued, AMI would have had a different result.

Applying those principles, he concluded that the rule’s mandatory language is “purely factual and uncontroversial” disclosure. The question of whether a product has been “found to be ‘DRC conflict free’” mandates a factual response under a defined term of art. Moreover, companies can elaborate on the meaning –even using language suggested by the SEC as appropriate — if there is concern that it will be misunderstood.

He also argued that, even though Zauderer should apply, the rule would  even satisfy the tougher Central Hudson standard. He maintained that the governmental interest was actually narrower than under the majority’s view –reducing funding to armed groups in that region from trade in conflict minerals –and therefore, the rule advanced that purpose by illuminating for consumers and investors a manufacturer’s use of conflict minerals from the DRC region.  Finally, he concluded that the rule was reasonably designed to encourage manufacturers to voluntarily reduce their reliance on conflict minerals that funded armed conflict.  The majority’s approach was flawed, he reasoned, because they should have deferred to Congress’s assessment of effectiveness (even if Congress did not foresee all the repercussions of the rule) and should not have relied on post hoc evidence.

Until we hear further from the SEC on its reaction, if any, to this decision, presumably the statement by Keith Higgins, the director of Corp Fin,Statement on the Effect of the Recent Court of Appeals Decision on the Conflict Minerals Rule, operative since April 2014, will continue in effect.