United States: D.C. Circuit Rules A Provision Of The SEC Conflict Minerals Rule Violates The First Amendment

Last Updated: April 23 2014
Article by William J. Walsh and AnnMarie Sanford

On April 14, 2014, the D.C. Circuit Court of Appeals in Nat'l Ass'n of Mfrs. v. SEC, 2014 BL 102614, D.C. Cir., No. 13-5252, 4/14/14) (available at http://www.cadc.uscourts.gov/internet/opinions.nsf/D3B5DAF947A03F2785257CBA0053AEF8/$file/13-5252-1488184.pdf) upheld all aspects of the Securities and Exchange Commission (SEC)'s conflict mineral rule, except for holding unconstitutional as compelled speech a provision of the rule that required a company to describe its products as not "DRC conflict-free" in a post on its Web site if its products are not free of certain "conflict minerals" (e.g., tin, tungsten, tantalum and gold) originating in the Democratic Republic of the Congo (DRC).

The court cited prior case law holding that "[t]he right against compelled speech is not, and cannot be, restricted to ideological messages" and "the speaker has the right to tailor the speech, [which] applies ... equally to statements of fact the speaker would rather avoid." Id. at 19. The court questioned whether designating a product as "DRC conflict-free" was factual and non-ideological because "[p]roducts and minerals do not fight conflicts. The label 'conflict-free' is a metaphor that conveys moral responsibility for the Congo war." The court reiterated prior holdings that in this type of First Amendment case, the government must show a substantial government interest that is directly and materially advanced by the restriction, and that the restriction is narrowly tailored. Id. at 21.

The SEC rule did not satisfy that standard because the SEC did not present evidence that less restrictive means would fail. Id. at 22. Specifically, "issuers could use their own language to describe their products, or the government could compile its own list of products that it believes are affiliated with the Congo war, based on information the issuers submit to the Commission." Id. at 22. In fact, the court noted that a centralized list compiled by the SEC in one place may even be more convenient or trustworthy to investors and consumers. The SEC failed to explain why the alternatives to regulating speech would be any less effective. The right to explain compelled speech is inadequate to cure a First Amendment violation. The opinion suggests that issuers may provide their own more detailed and nuanced explanation of what "DRC Conflict-Free" means on their Web sites, if they voluntarily choose to do so.

There may not be much practical impact of this successful First Amendment challenge, since it appears that the SEC is free to post on its Web site its conclusion that the issuer's products are not "DRC conflict-free." The ruling does avoid forcing companies into any confusing "admission" that may be interpreted to imply a degree of support for the conflict that simply does not reflect reality, and allows a company to use its own characterization of the facts reported to the SEC. Otherwise, this decision gives the SEC a green light to proceed on the other aspects of the Conflict Minerals Rule.

Even this First Amendment victory could be short-lived. One member of the panel of three judges deciding the case suggested that the D.C. Circuit hold the First Amendment portion of the opinion in abeyance until the D.C. Circuit en banc rules concerning a similar First Amendment compelled speech case involving a U.S. Department of Agriculture rule requiring labeling requirements for meat. The majority disagreed with that suggestion, even though the en banc ruling might require a rehearing of the First Amendment ruling on the Conflict Minerals Rule.

To the disappointment of the trade associations challenging the rule (and many companies that were following this challenge), the court upheld the remaining challenges to the SEC regulations. Specifically, the court held that the SEC "did not act arbitrarily and capriciously by choosing not to include a de minimis exception," because conflict minerals "are often used in products in very limited quantities" and such an exception "could 'thwart' the statute's goals by leaving unmonitored small quantities of minerals aggregated over many issuers." Id. 9-10. This provision bore a "rational connection" to the facts, so it was upheld.

The court also upheld the requirement to conduct "due diligence" if, after inquiry, an issuer "has reason to believe that its necessary conflict minerals may have originated in 'covered countries'," because the statute does not say in what circumstances an issuer must perform due diligence before filing a report and, therefore, since the statute "is silent or ambiguous with respect to the specific issue at hand" then the SEC "may exercise its reasonable discretion in construing the statute." Id. at 10.

The SEC's expansive interpretation of persons covered, which includes issuers that only contract to manufacture, was upheld. The court reasoned that the SEC interpretation of persons covered: (a) "reconciles otherwise confusing and conflicting provisions 'into an harmonious whole';" (b) "provided policy justifications and structural inferences supporting its decision;" and (c) was rational. Id. at 13.

The court also upheld a two-year phase-in period for larger issuers and a four-year phase in for small issuers. The court reasoned that "large issuers could exert greater leverage to obtain information" than smaller issuers, and thus did not require the longer phase-in period afforded to smaller issuers. Id. at 14.

Finally, the court held that the SEC "exhaustively analyzed the final rule's costs" and the court found "it difficult to see what the Commission could have done better" since the SEC determined that it was unable to readily quantify the benefits because it "lacked data" and, therefore, relied on Congress's determination that the costs were "necessary and appropriate." Id. 16.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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William J. Walsh
AnnMarie Sanford
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