On April 14, 2014, the United States Court of Appeals for the District of Columbia Circuit (the Court) issued a highly anticipated decision regarding the legality of the so-called “conflict mineral” rule (the Rule) finalized and released by the Securities and Exchange Commission (SEC or Commission) in August 2012. In the Court’s decision, two members of the split three-judge panel concluded that the Rule and underlying statute violate the First Amendment to the extent they require regulated entities to describe products on their website and in a report to the Commission as not “DRC conflict free.” The majority’s opinion reasoned that “[t]he label ‘conflict free’ is a metaphor that conveys moral responsibility” for the war in the Democratic Republic of Congo (DRC) and, to the extent the Rule and underlying statute mandate that a company “tell consumers that its products are ethically tainted, even if they only indirectly finance armed groups,” they violate constitutional protections against compelled speech. Significantly, all other challenges to the Rule were rejected, such that most of the conflict minerals due diligence and reporting requirements remain intact.
While it appears unlikely that the decision will significantly alter the overall conflict minerals due diligence and reporting regime in the long-term, the Court’s decision causes immediate uncertainty about whether and when the SEC may issue interim guidance modifying or clarifying the reporting obligations and, in particular, whether the Commission will delay the initial reporting and disclosures that are due by June 2, 2014. Following a brief summary of the Rule and prior history of the case, this advisory highlights key aspects of the Court’s opinion and discusses its implications for issuers and other companies potentially affected by this decision.
SEC Rule Briefly Summarized
The Rule at issue was adopted by the SEC, pursuant to Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), for the purpose of implementing Congress’ statutorily-expressed intent to eliminate the minerals trade as a source of funding that has enabled and perpetuated decades-long armed violence in the DRC and its neighboring countries. The Rule applies directly to SEC-reporting issuers for which any one of four “conflict minerals” – tin, tantalum, gold, and tungsten – is necessary to the functionality or production of products they manufacture or contract to manufacture. Where these preconditions are satisfied, an issuer then may be required to: (1) conduct a reasonable country of origin inquiry (RCOI) to determine if the conflict minerals originated in a covered country; (2) file a Form SD describing the RCOI; and (3) depending on the results of the RCOI, (a) conduct due diligence on the mineral source and chain of custody and (b) file a report describing the due diligence process and disclosing the results.
While the Rule applies directly only to issuers, as described above, it has significant implications for their suppliers. Issuer customers require suppliers to respond to due diligence inquiries, which in turn requires suppliers throughout the supply chain to perform similar due diligence.
History of the Case and Highlights of this Decision
This case arose out of an industry challenge brought by the National Association of Manufacturers, the US Chamber of Commerce, and the Business Roundtable (collectively, Appellants). The Court’s decision on appeal followed from the prior judgment of the federal district court that wholly rejected Appellants’ claims. Appellants had challenged that, in issuing the Rule, the SEC disregarded its statutory obligations under the Exchange Act; that, in multiple respects, the rulemaking proceeding was arbitrary and capricious in violation of the Administrative Procedures Act; and that the public disclosures required by both the Rule and Section 1502 of Dodd-Frank compelled speech in violation of the First Amendment.
On appeal, relying on many of the same supporting legal theories, Appellants specifically challenged the SEC’s: (1) refusal to adopt a de minimis exception; (2) adoption of a trigger for due diligence and reporting obligations broader than the statutory threshold; (3) expansion of the due diligence and reporting obligations to reach not only product manufacturers but also sellers of products that are contracted to be manufactured; and (4) adoption of a shorter phase-in period for large issuers (two years) relative to small issuers (four years). Appellants further contended that the Commission failed to perform an adequate cost-benefit analysis. All of these claims were rejected, however, with the Court finding that the SEC had reasonably exercised its broad discretion in rulemakings and its delegated authority to interpret and fill in any gaps in ambiguous statutory language. In discounting Appellants’ cost-benefit analysis arguments, the Court further found that the SEC was not required to “measure the immeasurable,” given the impossibility of weighing the social benefit of saving lives in the DRC against the dollar-based economic costs of compliance with the Rule.
Leaving the majority of the Rule intact, as discussed above, the Court did find unconstitutional the requirement for covered companies to disclose on their web-site and in a report to the SEC, their products that, following due diligence, were not found to be “DRC conflict-free.” In this regard, the majority of the Court reasoned that the SEC could not justify such interference with free speech rights because the governmental objectives underlying this disclosure could be accomplished through less intrusive means.
Implications of the Decision for Issuers and Their Suppliers
Importantly, even in striking down the “compelled speech” component of the Rule, the Court suggested that the SEC could adopt less restrictive means to accomplish the intended result. For example, based on the SEC’s own analysis of information contained in companies’ conflict minerals reports, the SEC could itself publish the list of companies whose products were not found to be DRC conflict-free. In addition, the Court noted that the same First Amendment issue will be considered soon by the DC Circuit sitting en banc in another significant free speech case, and suggested that the two cases could be appropriately consolidated so that the parties to the conflict minerals challenge could participate in the Court’s en banc consideration of the issue.
Hopefully, the SEC will move swiftly to issue guidance clarifying the impact of the decision on its implementation and enforcement plans, most importantly, to confirm whether regulated issuers are still required to file initial reports on June 2nd or whether that deadline will be extended. The same result might also be accomplished if Appellants were to obtain a judicial stay barring enforcement of the Rule until it is revised to comply with the Court’s decision. Many of these immediate effects, however, may depend on how broadly the SEC interprets the decision—namely, whether the Commission concludes it can simply jettison the “not found to be ‘DRC conflict-free’” labeling requirement and otherwise proceed as planned, or whether it determines more significant revisions are in order.
Overall, absent a ruling that the underlying statutory provision in Dodd-Frank is unlawful more broadly, the Court’s decision is unlikely to have a significant, long-term impact on the conflict minerals due diligence and reporting regime. Nothing in the decision disturbs the RCOI and other due diligence requirements for covered companies, nor does it disrupt other aspects of the Form SD filing and reporting requirements. Therefore, issuers and suppliers of issuers would be well-advised to proceed with all prior compliance efforts and schedules unless and until the SEC issues guidance explicitly directing otherwise.