On July 23, 2013, the United States District Court for the District of Columbia (District Court) rejected an industry challenge to a rule (the Rule) issued in August 2012 by the Securities and Exchange Commission (SEC or Commission), which implemented certain “conflict mineral” disclosure requirements mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank).[1] Section 1502 of Dodd-Frank manifests Congress’ intent to eliminate the minerals trade as a source of funding that, for decades, has enabled and perpetuated widespread armed violence in the Democratic Republic of the Congo (DRC) and its neighboring countries. Through Section 1502, Congress sought to accomplish this goal by amending the Securities Exchange Act of 1934 (Exchange Act)[2] to require SEC registrants to make annual disclosures if they manufacture or contract for the manufacture of products that contain or are reasonably believed to contain certain “conflict minerals”—tin, tantalum, gold and tungsten— sourced from a covered country.[3]

The National Association of Manufacturers, the US Chamber of Commerce and the Business Roundtable (collectively, Plaintiffs) initially filed suit challenging the Rule with the District of Columbia Circuit Court of Appeals (Circuit Court). However, after the Circuit Court ruled in a separate case involving a similar challenge to an SEC rule implementing Section 1504 of Dodd-Frank that jurisdiction properly resided with the lower court,[4] Plaintiffs requested transfer of the instant case to the District Court. Proceeding on an expedited basis, the District Court heard summary judgment motions based on briefs filed in the Circuit Court involving multiple claims under the Administrative Procedures Act (APA) and the US Constitution. Specifically, Plaintiffs asserted that in issuing the Rule, the SEC disregarded its statutory obligations under the Exchange Act, that the rulemaking proceeding was arbitrary and capricious in multiple other respects, and that the public disclosures required by both the Rule and Section 1502 of Dodd-Frank compelled speech in violation of the First Amendment.

In an extensive and detailed opinion summarized below, the District Court denied summary judgment sought by Plaintiffs, instead finding that the SEC pursued the rulemaking in a manner that was neither arbitrary nor capricious, and that nothing about the Rule or the underlying statute infringed on Plaintiffs’ First Amendment rights. Given the uncertain time frame and outcome of any appeal, SEC reporting companies would be well advised to forge ahead with efforts to implement conflict minerals compliance programs in anticipation of the May 31, 2014 deadline for the first disclosures, which will relate to the 2013 calendar year.

The SEC Complied with the Exchange Act and Properly Evaluated Costs and Benefits

The District Court began its examination with Plaintiffs’ claim that the SEC abdicated its statutory responsibilities by failing to conduct an adequate cost-benefit analysis of the Rule’s potential impacts. In particular, Plaintiffs argued that the SEC improperly deferred to Congress’s determination that conflict minerals disclosures would decrease violence in the DRC, rather than conducting an independent analysis of the social benefits of the rule, and arbitrarily underestimated aspects of the Rule’s costs. On this basis, Plaintiffs contended that the SEC violated Exchange Act Sections 3(f) and 23(a)(2) by failing to consider whether the Rule would “promote efficiency, competition, and capital formation” and would not “impose a burden on competition not necessary or appropriate in furtherance of the purposes of” the Exchange Act.[5]

Expressing its disagreement on several grounds, the District Court preliminarily observed that it was not clear that the requirements in Exchange Act Sections 3(f) and 23(a)(2) even applied, since they were not expressly referenced in Section 1502 of Dodd-Frank, and Congress had already concluded the disclosure requirements were necessary and in the public interest.[6] Further, assuming the cited statutory provisions applied, the District Court observed that they merely obligate the SEC to consider enumerated economic factors and permit but do not require it to weigh the costs and benefits of a proposed action. Elaborating further, the District Court reasoned that neither case law nor the statutory text mandate that the SEC conduct a wide-ranging analysis to independently verify that the Rule actually would achieve the benefits Congress intended, particularly where such benefits are humanitarian in nature and not susceptible to quantification. The court further noted that cases in which a rule has been invalidated based on the Commission’s failure to satisfy the cited statutory obligations have involved “shortcomings on the Commission’s part with respect to the economic implications of its actions.”[7]

With respect to Plaintiffs’ challenge to the SEC’s analysis of the Rule’s costs, the court cited multiple examples in the rulemaking record that it found illustrated the SEC’s sufficient consideration of the Rule’s impact on efficiency, capital formation, and competition. Finally, the court concluded that, while Plaintiffs might disagree with the Commission’s specific calculations of estimated costs and number of suppliers potentially affected, the wide range of estimates commentators submitted during the rulemaking process, and the Commission’s efforts to strike an appropriate balance between those estimates, belied allegations that the SEC’s analysis was arbitrary or unreasonable.[8]

The SEC Properly Exercised Its Discretion In Declining to Adopt a De Minimis Exception

In assessing the merits of the SEC’s decision not to adopt an exemption for issuers that use only de minimis quantities of conflict minerals, the court considered two arguments advanced by Plaintiffs—(1) that the Commission improperly believed it was precluded from considering a de minimis exception and therefore was not entitled to Chevron deference during review, and (2) that even if the Commission believed the statute permitted it to make such an exception and that it was therefore exercising its discretion in refusing to adopt one, that decision was arbitrary and capricious. In contrast to the determination reached in the parallel proceeding challenging Section 1504 of Dodd-Frank, the court here found no evidence clearly suggesting the SEC believed its interpretation of Section 1502 was compelled by Congress. Accordingly, since the statute was silent as to the availability of a de minimis exception, the Commission’s exercise of discretion in declining to adopt one was entitled to deference. While acknowledging that the SEC’s “explanation could have been more thorough in some respects,” the District Court found that the SEC had appropriately weighed the input it received and concluded, based on its determination that conflict minerals are often used in minute amounts, that a de minimis exception would jeopardize the effectiveness of the Rule.[9] Thus, the SEC’s failure to adopt such an exemption was neither arbitrary nor capricious.

Deference is Due—Reasonable Country of Origin Inquiry, Inclusion of Issuers that Contract to Manufacture Products, and Adoption of Different Phase-In Periods

Plaintiffs also challenged as arbitrary and capricious the SEC’s imposition of reporting requirements on issuers that, based on a reasonable country of origin inquiry, have reason to believe their conflict minerals “may have originated” (as opposed to “did originate”) in a covered country; its application of the Rule both to companies that manufacture and contract to manufacture products containing conflict minerals; and its adoption of different transition periods for large and small issuers without sufficient regard to the interdependency of compliance challenges faced by such companies. In each instance, the court determined that the SEC exercised its discretion based upon a permissible and reasonable construction of Section 1502.

The Disclosure Requirements Do Not Compel Speech in Violation of the First Amendment

In addition to claims advanced under the APA, the District Court considered Plaintiffs’ assertion that the Rule and Section 1502 improperly compelled burdensome and stigmatizing speech in violation of the First Amendment. The court focused on the constitutionality of requiring companies to post conflict minerals disclosures on their own public websites, rather than merely filing such reports with the Commission. Based on the "commercial nature" of the disclosures as well as the SEC's determination that the disclosures were not aimed at preventing misleading or deceptive speech, the court applied "intermediate scrutiny" to the constitutional challenge. Thereunder, a challenged regulation can survive on findings that the stated government interest is substantial, the regulation directly advances that stated interest, and there is a reasonable fit between the targeted objectives and the means chosen to achieve those objectives.

Recognizing Plaintiffs' concession that the government has a substantial if not compelling interest in the promotion of peace and security in the covered countries, the court focused its evaluation on the remaining elements. Viewed together, these elements address whether the SEC ought to have proven a stronger cause-and-effect relationship between the implementation of the due diligence and reporting requirements and the likely outcome on the availability of funds for conflict minerals-based violence in the DRC. The court’s conclusion hinged on the “particularly deferential” review that applies at “the intersection of national security, foreign policy, and administrative law” and on the court’s observation that covered companies have ample opportunity under the Rule to add qualifying comments and explanation to any public disclosure they may be required to make. Thus, again, the court upheld the SEC’s chosen methods and means.

Implications of the Decision

Unlike the District Court’s decision in the parallel proceeding regarding Dodd-Frank Section 1504, the court addressed each of the major challenges raised by Plaintiffs to Section 1502. Further, because the SEC generally maintained that it was exercising its discretion in interpreting Section 1502, its interpretations are accorded considerable deference under the Chevron standard of review. As a result, Plaintiffs will face an uphill battle if they seek to further challenge the Rule on appeal. The timeline for any such appeal is also uncertain.

With this in mind, the initial conflict minerals compliance reporting obligations are fast approaching. It is therefore prudent to assume that, absent Congressional intervention, the due diligence and reporting obligations set forth in Section 1502 and the implementing Rule are here to stay. Issuers should expect to file their first conflict minerals disclosures with the SEC on or before May 31, 2014 for calendar year 2013, requiring potentially significant efforts before that time to conduct the reasonable country of origin inquiries and due diligence called for by the Rule.

In the meantime, other authorities, including Canada and the European Union, are considering adopting their own conflict minerals disclosure regimes. The scope of such regimes is not yet defined, nor is the extent to which SEC filings may be recognized under such regimes, raising the prospect of further compliance challenges on the horizon for multinational companies.