- District Court ruling affirmed in part and reversed in part
- Case remanded for further proceedings
The court of appeals ruled today that the SEC‟s conflict minerals rule violates the First Amendment to the extent the rule requires companies to report that their products have “not been found to be 'DRC conflict free.'" Challenges to the rule under the Administrative Procedures Act and Securities Exchange Act of 1934 were rejected by the court.
The appellate court directed the lower court to proceed in light of the opinion. It is unclear whether the district court will be forced to stay enforcement of all or some portion of the rule prior to the first Form SD deadline of May 31, 2014.
The U.S. Court of Appeals for the D. C. Circuit in National Association of Manufacturers, et al. v. SEC found that the rule unconstitutionally compels speech to the extent an issuer must describe a product as not “DRC conflict free” in new Form SD and on the company‟s website. The court rejected the more lenient “rational basis” review asserted by the SEC, holding that this weaker standard of review was limited to cases in which disclosure requirements are reasonably related to preventing consumer deception – and no party in the case had suggested that the conflict minerals rule was related to preventing consumer deception.
Interestingly, the court went on to state that it was unclear whether the description was factual and non-ideological, elements required to meet the less stringent standard. The court stated:
“The label “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.” [Citations omitted]
The court then concluded the conflict minerals rule is unconstitutional to the extent an issuer must describe a product as not “DRC conflict free.” The court did not have to decide whether to use the “strict scrutiny” standard of review or an intermediate test for commercial speech. Since the SEC had failed to present any evidence that alternatives to such compelled speech would be less effective, the court found that the rule was not shown to be “narrowly tailored” as required under the intermediate scrutiny standard.
With respect to the other challenges to the rule, the court affirmed the lower court, finding that:
- The SEC did not act arbitrarily and capriciously by choosing not to include a de minimis exception. The court believed that the SEC could reasonably decide that a per-issuer exception could “thwart” the statute‟s goals by leaving unmonitored small quantities of minerals aggregated over many issuers.
- The SEC‟s due diligence threshold for “uncertain issuers” was not arbitrary or capricious. The court agreed the SEC had a rational basis for requiring issuers who merely have “reason to believe” that conflict minerals “may have originated” in covered countries to conduct due diligence, to prevent issuers from ignoring red flags in their reasonable country of origin inquiry. It also noted that the SEC reduced the costs of the final rule by declining to require due diligence by issuers who encounter no such red flags.
- The SEC‟s application of the rule to companies that only “contract to manufacture” products was not arbitrary or capricious, even though the statute was arguably ambiguous.
- The SEC‟s provision of a longer, four-year temporary phase-in period for smaller reporting companies than the two-year period for larger companies to describe products as “DRC conflict undeterminable” was not arbitrary or capricious.
- The SEC‟s cost-benefit analysis was reasonable. Even though the SEC failed to determine whether the final rule would actually achieve its purpose, the court concluded that approach was justifiable due to lack of a statutory requirement and the lack of available data.
As a result, the court affirmed the district court‟s decision in part and reversed such decision in part and remanded the case for further proceedings consistent with the appellate court‟s opinion. As required under court rules, the court directed the clerk to withhold issuance of the mandate to the district court “until seven days after disposition of any timely petition for rehearing or petition for rehearing en banc”. Because the decision as to unconstitutionality only relates to a portion of the rule and, in any case, remains subject to further judicial proceedings, companies should continue with efforts to prepare for filing their Form SDs.
In a separate concurring opinion, one of the three judges did not join the First Amendment portion of the court‟s opinion. The judge believes the appellate court should have deferred consideration until after an en banc court decides a pending case that is expected to address whether the relaxed “rational basis” standard is available only when regulations seek to prevent consumer deception. The judge notes that if the en banc court determines that such standard can apply in other contexts, then the conflict minerals decision would presumably need to be reconsidered. Although the judge disagreed with the majority‟s decision on the First Amendment challenge, he believes the lower court would be justified in staying enforcement of that aspect of the rule pending disposition of the First Amendment claim, in light of the threat of irrevocable harm and the balance of equities.
We hope to be in a position soon to provide greater clarity on the requirements applicable to public companies. We will continue to monitor the case for further developments and watch for additional action by the staff of the SEC.