In a much-anticipated ruling, the U.S. Court of Appeals for the D.C. Circuit ruled on April 14, in National Ass'n of Manufacturers v. Securities & Exchange Commission (No. 13-5252, D.C. Cir., Apr. 14, 2014), that the requirement imposed on companies to report in certain circumstances to the Securities and Exchange Commission (SEC) and on their public websites that their products have "not been found to be 'DRC Conflict-Free'" is a violation of the First Amendment. The court did not determine whether this violation stemmed directly from Section 1502 of the Dodd-Frank financial reform legislation or the SEC's implementing regulations, so it remanded the case back to the district court for further proceedings.
The court dismissed all of the other challenges to the rule, meaning that nearly all of the requirements of the rule remain in place and company compliance efforts should continue. The precise impact of this ruling on Section 1502—and perhaps many other forms of compelled government reporting on "ideological" issues—will be seen in the weeks to come. But reporting companies should evaluate their progress on their conflict-minerals compliance and consider whether adjustments to the reporting required by May 31, 2014,1 may be warranted.
Understanding the Ruling Itself, Part 1: SEC Victories
The National Association of Manufacturers (NAM) and other organizations challenged elements of Section 1502 and the SEC's implementing regulations in October 2012. 2 Judge Robert Wilkins of the U.S. District Court for the District of Columbia dismissed all of NAM's claims in a July 2013 ruling, which was then appealed.3
The D.C. Circuit upheld Judge Wilkins' opinion on all but one ground, marking something of a reversal of fortune for the SEC in Dodd-Frank cases, which have generally gone against the agency.4 In sum, the D.C. Circuit found in favor of the SEC on the following issues:
- No de minimis exception. The D.C. Circuit upheld the SEC's choice not to incorporate such a provision, based principally on a factual determination by the SEC that many companies only used minute amounts of the minerals and would thus be exempt from the rule under such a provision.
- Due Diligence Threshold. NAM challenged the requirement for a company to exercise due diligence on minerals sourcing where it only had "reason to believe" the minerals "may have originated" in the Democratic Republic of the Congo (DRC) or other covered countries, arguing that requiring due diligence where only certain red flags appeared was inconsistent with the statutory language. The D.C. Circuit recognized that the SEC "adopted an expansive rule" but then found that the agency had discretion to adopt such a requirement and indicating it did not go as far as it might have.
- Applying the rule to products that were "contracted to be manufactured." NAM argued that the statute's inconsistent use of this provision required the SEC to take a less expansive approach to when a company must implement the rule for products it contracts for with third parties. After evaluating statutory construction arguments, the D.C. Circuit held that the "[SEC]'s explanation was rational, and that is enough."
- Allowing for a two-year "phase-in" period. Although generally supportive of a period where companies did not have to report on the final results of their due diligence inquiries, NAM argued that the phase-in system developed by the SEC that allows smaller companies a longer period than larger ones was arbitrary. The D.C. Circuit disagreed saying that it recognized the logic of the SEC's approach, "even if it does not hold in all cases."
- Failing to calculate the benefits. In adopting its rule, the SEC admitted that it could not reasonably quantify the benefits of its actions, which were primarily intended to be felt in the context of the conflict and violence in eastern DRC. NAM argued that this represented a failure of the agency to meet its statutory requirements to measure the costs and benefits of its actions. The D.C. Circuit agreed with the SEC, noting Congress' conclusion that the rule would benefit the DRC through disclosure and transparency and that the agency need not "measure the immeasurable."
In sum, these findings keep the essence of Section 1502 and the SEC's rule in place. But the last part of the ruling changes what companies may need to say to the SEC and the public about their compliance efforts and due diligence findings.
Understanding the Ruling Itself, Part 2: NAM Victory
In the final portion of the ruling, the D.C. Circuit examined the argument by NAM that the requirement for companies to report in certain circumstances that their products have "not been found to be 'DRC Conflict-Free'" constituted the unconstitutional compelling of speech.5
The crux of the argument rested on what standard of review the D.C. Circuit would apply. The SEC and intervenor Amnesty International argued that a lower-level "rational basis" test should be used because the rule requires the reporting of "factual non-ideological information." The D.C. Circuit disagreed, but it did not indicate precisely what standard does apply. Rather, the court indicated, in what may end up being one of the most critical paragraphs of the opinion:
At all events, it is far from clear that the description at issue—whether a product is "conflict free"—is factual and nonideological. Products and minerals do not fight conflicts. 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." See Hurley, 515 U.S. at 573. 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. (emphasis added).
From this finding, the D.C. Circuit held that the requirement to use the phrase "not been found to be 'DRC Conflict-Free'" in certain cases violated the First Amendment. The court appeared to support NAM's suggestions that companies be allowed to use their own language to explain their findings or that the U.S. government compile a list of products it believes to be connected to the conflict in the DRC, based on information provided by companies. This would appear to be a possible fix for the SEC.
Understanding the Implications of the Ruling
As stated above, and contrary to some media reporting, the D.C. Circuit did not throw out the conflict-minerals rule; it upheld Congress and the SEC in all but one area. Whether there is a subsequent appeal by either side, the SEC conducts a rule-making to fix the First Amendment issue (and possibly opens up other aspects of the rule as well), or there is further litigation at the D.C. District Court remains unclear. We will continue to monitor this closely, but in light of this ruling, companies may want to consider the following efforts:
- Proceed with conflict-minerals compliance efforts. Filings on the first reporting year of 2013 are due on May 31, 2014, and the 2014 reporting year began on January 1. The country of origin inquiry process, due diligence thresholds, and other elements of the rule remain in effect.
- Consult experts if you were preparing to file a report finding one or more products have "not been found to be 'DRC Conflict-Free.'" This is the heart of the ruling, and if this is the outcome of a company's due diligence efforts, the company should consult experts to determine how to respond to the court's decision. Because many companies are expected to take advantage of the phase-in period, it is likely companies will only face this issue in future reports.
- Watch for an impact on the push for similar types of mandatory company supply chain reporting. Many companies voluntarily report on human rights and related concerns with respect to the impact of their raw materials sourcing, labor practices, and other supply chain practices. Section 1502 makes one type of this reporting mandatory, and activists continue to push to make other forms of voluntary reporting required. With a finding that "not been found to be 'DRC Conflict-Free'" is potentially an ideological statement that compels a company "to confess blood on its hands," this decision raises a real question as to whether the push to make other types of corporate reporting mandatory will face similar challenges in the future.