U.S. District Court Upholds the Conflict Minerals Rule

by Foley Hoag LLP - Corporate Social Responsibility
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Gold NuggetOn July 23, the District Court for the District of Columbia rejected a challenge to the conflict minerals rule adopted by the Securities and Exchange Commission in August 2012 and published in September 2012.  Plaintiffs seeking a review of the rule included the National Association of Manufacturers, the Chamber of Commerce, and the Business Roundtable.

Plaintiffs had challenged the rule under the Administrative Procedure Act (“APA”), stating that several specific aspects of the rule were arbitrary and capricious. Plaintiffs had also sought to have the rule’s disclosure requirements declared to be unconstitutional violation of the First Amendment.

The SEC’s Cost-Benefit Analysis

In granting the SEC’s cross-motion for summary judgment, the District Court rejected Plaintiffs’ challenge to the sufficiency of the SEC’s analysis with regard to the costs and benefits of the rule.  Noting that the SEC was directed by Congress to issue the rule, the Court disagreed with Plaintiffs’ assertion that the SEC improperly deferred to Congress in evaluating the rule’s intended humanitarian benefits. The Court stated that

the SEC rightly maintains that its role was not to ‘second-guess’ Congress’s judgment as to the benefits of disclosure, but to, instead, promulgate a rule that would promote the benefits Congress identified and that would hew closely to that congressional command.

The Court also found that the SEC had a reasonable basis for its estimates of the costs of the rule, noting that the Commission  had weighed estimates provided by various commentators and exercised appropriate discretion in concluding which figures were most appropriate.

No De Minimis Exemption

Plaintiffs had also challenged the SEC’s decision not to provide a de minimis exemption for the rule.  Plaintiffs had argued the SEC had improperly concluded that it was precluded from exercising its exemptive authority by the language of Section 1502. The SEC had argued that it did not believe it lacked authority to provide for exemptions to the rule, but rather stated that it had decided not to exercise this authority.

The Court agreed with the SEC, noting that the Commission’s adopting release had provided both policy-based and practical reasons for declining to adopt a de minimis exemption. Specifically, the SEC had found that a de minimis exemption would undermine the intended impact of the rule, in part because conflict minerals are often used in very small quantities in manufactured products.

The Reasonable Country of Origin Inquiry

The SEC rejected Plaintiffs’ argument that the SEC should have only required due diligence and reporting from companies that utilize conflict minerals that actually did originate in the DRC and adjoining countries (“Covered Countries”).  Under the rule, companies that know or have reason to believe that minerals may have originated in the Covered Countries must conduct due diligence to trace the source and the chain of custody of those minerals.

The Court noted that Section 1502 is silent with regard to the question of how companies should determine whether the minerals originated in the Covered Countries. The Court found that the SEC’s adoption of a reasonable country of origin inquiry process was a “reasonable and permissible construction of the statute.” Companies that conduct the reasonable country of origin inquiry and find that conflict minerals may have originated in Covered Countries are required to conduct due diligence.

Application to Companies that Contract to Manufacture

Plaintiffs had also challenged the SEC’s decision to apply the rule to companies that contract to manufacture products, rather than limiting the rule to companies that manufacture products directly.  The Court found that the SEC’s decision to apply the rule to companies that contract to manufacture was “an amply reasonable construction of Section 1502.” The Court specifically noted that the SEC had sought to emphasize that in order to be subject to the rule, companies must exercise actual influence over the manufacturing of the products in question.

Two Phase-in Periods

The Court rejected Plaintiffs’ assertion that the SEC’s decision to adopt a four-year phase-in period for small companies, while only allowing two-year phase-in period for larger companies, was arbitrary and capricious.  The Court observed that the SEC had explained this decision by explaining that smaller companies may lack the leverage to obtain detailed information from suppliers. The Court stated that it could not “conclude that this determination was unreasonable.”

First Amendment Challenge

Plaintiffs had also argued that the disclosure requirements imposed by the rule improperly compel “burdensome and stigmatizing” speech in violation of the First Amendment of the U.S. Constitution. Specifically, Plaintiffs had challenged the requirement that disclosures be made publicly available on corporate websites.

The Court held that the rule should be assessed on the basis of an “intermediate scrutiny” standard of review. In order to survive such scrutiny, (1) the asserted government interest must be substantial, (2) the regulation must directly advance the government interest asserted, and (3) “the fit between the ends and the means chosen to accomplish those ends is not necessarily perfect, but reasonable.”

Plaintiffs did not contest that the government’s interest in promoting peace and security in the DRC is substantial. They did, however, argue that conflict minerals rule does not directly and materially advance that interest – the second prong of the intermediate scrutiny analysis.  The Court disagreed, finding that due to the foreign relations context of the rule, Congress should be afforded considerable deference in making the “informed judgment” that the required disclosures advance the goal of promoting peace and security in the DRC.

With regard to the third prong, Plaintiffs argued that the requirement that companies publish disclosures on corporate website did not constitute a reasonable fit with Congress’s objective of promoting peace and security in the DRC. The Court disagreed, noting that:

[A]ll that Section 1502 and the Final Rule require is that companies publish copies of their Form SD’s and/or Conflict Minerals Reports—i.e., verbatim copies of disclosures already prepared for and filed with the Commission—on their websites.  Neither Section 1502 nor the Final Rule requires companies to separately or conspicuously publish on their website a list of products that have not been found to be ‘DRC conflict free,’ as Plaintiffs intimate, nor must companies physically label their products as such on the packaging itself.

Plaintiffs had argued that the disclosure is intended to serve as a “scarlet letter” because companies must identify products that are not found to be “DRC conflict free.” The Court found that the disclosure requirement was reasonable, noting that “the description must be made, if at all, in the body of a Conflict Minerals Report, not through some standalone, conspicuous disclosure…. Even then, issuers remain free to include whatever additional clarification or explanation they deem necessary.”

Ultimately, the Court found that the conflict minerals disclosure requirements survive intermediate scrutiny and rejected the Plaintiffs’ First Amendment claims.

 

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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