On August 18, 2015, a three-judge panel of the Court of Appeals for the D.C. Circuit issued its long-awaited decision in the rehearing petitioned by the Securities and Exchange Commission ("SEC") after the court’s April 14, 2014 ruling that a portion of the SEC’s conflict minerals rule was unconstitutional. In a split decision, the court affirmed its prior judgment that Section 1502 of the Dodd-Frank Act and the SEC’s final conflict minerals rule "violate the First Amendment to the extent the statute and the rule require [issuers] 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.’’" National Association of Manufacturers v. SEC, No. 13-5252, at 25 (D.C. Cir. August 18, 2015) ("NAM II"). The court’s opinion can be found here.

Effect of Court Decision

Under the conflict minerals rule, issuers currently are required to:

  • determine whether the rule applies and
  • if it does, conduct a reasonable country of origin inquiry to determine whether any of the products they manufacture or contract to manufacture contain any of the designated "conflict minerals" (tin, tungsten, tantalum and gold) that come from one of the covered countries; and
  • if any of those minerals do come from a covered country, conduct diligence on their supply chain and file a conflict minerals report on Form SD.

As discussed here in our earlier client alert, SEC staff issued guidance following the court’s prior ruling, indicating that companies need not describe products as "DRC conflict free," "DRC conflict undeterminable" or "not found to be ‘DRC conflict free’". The staff indicated that, pending further action, an audit will not be required unless a company voluntarily elects to describe a product as "DRC conflict free".

Subject to further clarification from the staff, it seems likely that the staff’s prior guidance will remain in effect as the SEC considers its alternatives, which could include appeal of the decision to the en banc court or proposal of a revised conflict mineral rule. This may mean that companies will not need audits for purposes of conflict mineral reports due next year.

The Court’s Original Opinion

In its April 2014 decision, the court of appeals ruled that the conflict minerals rule violated the First Amendment. National Association of Manufacturers v. SEC, 748 F.3d 359 (D.C. Cir. 2014) ("NAM I"). As discussed in our prior alert which can be found here, the court rejected the SEC’s contention that the more lenient "rational basis" review standard of Zauderer v. Office of Disciplinary Counsel of the Supreme Court of Ohio, 471 U.S. 626 (1985) ("Zauderer") should apply to the court’s First Amendment analysis of the conflict minerals rule. The court held that the Zauderer standard of review was limited to cases in which disclosure requirements were reasonably related to preventing consumer deception – and no party in the NAM I case had suggested that the conflict minerals rule was related in any way to preventing consumer deception.

The court then concluded that it did not need to decide whether to use strict scrutiny or the intermediate test articulated in Central Hudson for commercial speech (Central Hudson Gas & Electric Corp. v. Public Service Commission, 447 U.S. 557 (1980)), because the court determined that the conflict mineral rule did not even survive the Central Hudson standard.

Under Central Hudson, the government must show (1) substantial government interest that is (2) directly and materially advanced by the restriction, and (3) that the restriction is narrowly tailored. With respect to the latter requirement, the court found that the SEC had provided no evidence that any less restrictive measure would have failed to achieve the stated purpose of the statute and rule. Because of that failure, the court could not find that the required disclosure was "narrowly tailored" and thus concluded it was a First Amendment violation.

The SEC’s Petition for Rehearing

After the decision in NAM I, the court decided American Meat Institute v. U.S. Department of Agriculture, 760 F.3d 18 (D.C. Cir. 2014) (en banc) ("AMI"). The court in AMI decided that the Supreme Court’s decision in Zauderer applied more broadly than in forced disclosure in the context of consumer deception, concluding that some other governmental interests might suffice. Using theZauderer standard, the AMI court held that the government did not violate the First Amendment when it forced labeling of meats to disclose country of origin.

Accordingly, the AMI court essentially overruled the NAM I decision to the extent it was predicated on the conclusion that the more relaxed standard ofZauderer could only apply in the context of disclosures addressing consumer deception. In light of AMI, the court granted the SEC’s petition for rehearing to consider the effect of the decision on the court’s judgment in NAM I that the conflict minerals disclosure requirement violated the First Amendment.

The Court Now Reaffirms its Original Judgment

Zauderer does not apply; rule fails to survive Central Hudson. The opinion on rehearing begins with the majority’s analysis of the reach of the Court’s opinion in Zauderer, ultimately concluding that Zauderer does not apply to the conflict minerals rule analysis because Zauderer is limited to forced governmental disclosures when an entity is otherwise engaged in some commercial or voluntary advertising. Because the conflict minerals rule is not related to commercial or other advertising, the court concluded Zauderer "has no application to this case." NAM II at 11. The court then concluded that, for the reasons given in NAM I, the SEC’s conflict mineral rule does not survive the intermediate standard articulated in Central Hudson for commercial speech.

Additional ground for decisionrules fails to meet AMI analysis. The court also provided an alternative ground for its decision: the conflict minerals rule even fails to meet the two part test set forth in AMI. Applying the AMI two-part test, the court accepted that "ameliorat[ing] the humanitarian crisis in the DRC" was a sufficient governmental interest to satisfy the first prong and proceeded to the second step of evaluating the effectiveness of the measure in achieving the government’s interest.

It is here that the opinion emerges from a forced march through stilted precedent to a surprisingly frank discussion of the effects – intended and unintended, documented and projected – of the conflict minerals rule. Without the benefit of clear evidence, noting that Congress provided no record of examination of the likely impact , the court proceeds to "assume what judgments Congress made when crafting this rule." The court stated that given the extraordinary cost of compliance, there must have been the prospect from the outset that companies would "boycott mineral suppliers having any connection to this region of Africa" so as to avoid applicability of the rule. The court concludes,

The idea must be that the forced disclosure regime will decrease the revenue of armed groups in the DRC and their loss of revenue will end or at least diminish the humanitarian crisis there. But there is a major problem with this idea – it is entirely unproven and rests on pure speculation.

Id at 14-15.

The court states that in commercial speech cases under the First Amendment, the government may not rely on "speculation and conjecture," and concludes that this is what Congress did in holding no hearings on the likely impact of Section 1502. What’s more, the court finds, "post-hoc evidence throw further doubt on whether the conflict minerals rule either alleviates or aggravates the stated problem." The court acknowledges NAM’s argument on rehearing that the conflict minerals law "may have backfired," as U.S. companies are now avoiding the DRC and surrounding region, putting miners out of work,"exacerbating the humanitarian crisis and driving them into the rebels’ camps as a last resort." Id at 16 (citations omitted). The court also acknowledges competing arguments that the rule will help the crisis, but concludes that there is not sufficient proof to compel speech under the First Amendment. Id at 18.

Although the SEC’s failure to satisfy its burden to demonstrate the efficacy of the requirement "doom[ed]" the rule , the court proceeds to the evaluation of whether the compelled disclosures are "purely factual and uncontroversial" as it concludes is required under AMI and Zauderer to survive challenge. The court reverted to its decision in NAM I, concluding again that the description of a product as "conflict free" or "not found to be DRC conflict free" "was not purely factual and uncontroversial. The court recited its conclusion in NAM I that 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. . . And we continue to agree with NAM that ‘[r]equiring a company to publicly condemn itself is undoubtedly a more ‘effective’ way for the government to stigmatize and shape behavior than for the government to have to convey its views itself, but that makes the requirement more constitutionally offensive, not less so.’" Id at 25 (citations omitted).

Accordingly, the court reaffirmed its prior judgment. In a footnote, however, the court reiterates its prior position that the First Amendment is violated here only to the extent the particular descriptive term "not found to be ‘DRC conflict free’" is required, and states that if this is a discretionary choice by the SEC, the court’s holding does not reach the underlying statute. This suggests, of course, that a revised rule imposing some disclosure of issuers’ use of conflict minerals may be able to survive constitutional challenge. Whether the SEC will take on this challenge and initiate a new rulemaking is not known at this time.

In a lengthy dissent, Judge Srinivasan disagreed with the majority’s distinguishing the AMI decision and concluded that the conflict minerals disclosures are no different than the meat country of origin disclosures permitted by the AMI court. Judge Srinivasan seemed to take comfort in the fact that the rule permits issuers to explain the required disclosures as it sees fit in order to "eliminate any possibility of confusion." NAM II dissent at 3. His dissent concluded that the less stringent "rational basis" standard should be applied here, and that the government had met its burden under that standard. In addition, he found that the rule survives application of the more rigorousCentral Hudson standard. With respect to the majority’s recitation of the actual, although unintended consequences of the rule in its analysis of the effectiveness of achieving a valid governmental interest, the dissent took exception:

Those sorts of unintended, tertiary consequences should not form a basis for invalidating the Rule. Even assuming Congress (and the Commission in implementing Congress’s mandate) did not foresee all of the repercussions of the disclosure regime which might someday come to pass, the law was reasonably designed to further its aim of reducing funding for armed groups. . . . If unanticipated downstream effects eventually call into question the ongoing desirability of a law working as intended, it should be up to the political branches to alter or repeal it, not to the judicial branch to invalidate it.

NAM II dissent at 29.

What Issuers Should Do Now

Because the court has reaffirmed its prior decision, at a minimum issuers need to be prepared to comply with the rule as in effect in 2014. This means continuing to make the determinations required by steps one and two of the rule and when necessary to conduct the supply chain diligence required by step three. As discussed above, pending further guidance from the SEC staff, based on its prior guidance, it is likely that only issuers who choose to describe any of their products as "DRC conflict free" will be required to provide a third party audit in 2015.