Money, Gold And Judges: D.C. Circuit Holds SEC’s Conflict Minerals Rule Violates The First Amendment

by Orrick - Securities Litigation and Regulatory Enforcement Group
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http://blogs.orrick.com/securities-litigation/files/2012/10/iStock_000012866856XSmall-200x150.jpgOn April 14, 2014, a divided panel of the U.S. Court of Appeals for the District of Columbia held in National Assoc. of Mfg., et al. v. SEC that the required disclosures pursuant to the SEC’s Conflict Minerals Rule violated the First Amendment’s prohibition against compelled speech, throwing that rule into uncertainty and possibly opening the door to constitutional challenges to similar disclosure rules.

The Conflict Minerals Rule requires companies and foreign private issuers in the U.S. to disclose their use of “conflict minerals” both to the SEC and on their websites.  The Rule, which was adopted pursuant to Section 1502 of the Dodd-Frank Act as a response to the Congo War, defines “conflict minerals” as gold, tantalum, tin, and tungsten from the Democratic Republic of Congo (“DRC”) or an adjoining country, which directly or indirectly financed or benefited armed groups in those countries.  The deadline for satisfying the Rule, which became effective in November 2012, is May 31, 2014.  The National Association of Manufacturers, along with Business Roundtable and the U.S. Chamber of Commerce, challenged the Rule in the district court and then appealed to the Circuit Court.

The Commission argued that the constitutionality of the Conflict Minerals Rule should be analyzed under the more lenient rational basis test.  The court disagreed, however, and ruled that rational basis review under the First Amendment only applies to disclosures that are made to prevent consumer deception, or that contain purely factual and uncontroversial information.  The court concluded that rational basis review did not apply because the SEC’s required conflicts mineral disclosure did not fall into either of those two circumstances.  Rather, the disclosure “compel[s] an issuer to confess blood on its hands,” conveying far more than mere factual, non-ideological information.  Thus, the court held, the Conflict Minerals Rule is subject to the more rigorous test set forth in Central Hudson.  Under Central Hudson, the government must show (1) a substantial government interest that is; (2) directly and materially advanced by the restriction; and (3) that the restriction is narrowly tailored.  The court then held that the Conflict Minerals Rule could not meet the requirements of Central Hudson because the SEC offered no evidence that the rule was narrowly-tailored.

The court’s ruling, however, may not have a long life.  As the dissent notes, there is case pending before an en banc panel of the D.C. Circuit in which it will consider the precise question of whether the lenient rational basis test is limited to disclosures intended to prevent consumer deception.  If the en banc panel disagrees with the majority in National Assoc. of Mfg., the constitutionality of the Conflict Minerals Rule disclosures will likely be reconsidered.

Separately, the D.C. Circuit held that the Conflict Minerals Rule did not violate the Administrative Procedure Act because the SEC did not act arbitrarily or capriciously by not including exceptions for de minimus uses of conflict materials.  Moreover, the court found that the SEC’s decisions in the drafting of the Rule bore a “rational connection” to the facts, which is all that is required to fulfill the Administrative Procedure Act.

With this ruling, several of the SEC’s required disclosures could be vulnerable to attack as compelled speech in violation of the First Amendment, particularly those that are not explicitly related to preventing consumer deception.  For example, the SEC’s required disclosure of executive compensation could arguably be at risk.  By requiring companies to disclose not only its executives’ compensation, but also its criteria for making those compensation decisions, it is arguable that the SEC is requiring disclosure of more than “purely factual and non-ideological information” because it requires the company to state the values that are most important to it when determining an executive’s compensation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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