U.S. Court of Appeals Strikes Down Reporting Requirement Under the SEC's Conflict Minerals Rules

by BakerHostetler

On April 14, 2014, the U.S. Court of Appeals for the D.C. Circuit issued its decision in National Association of Manufacturers, et al., v. Securities Exchange Commission, a case involving a challenge to the SEC’s conflict minerals rules. In a partial victory for the challengers, the Court held that the requirement that companies report to the SEC and on their websites whether any of their products have “not been found to be ‘DRC conflict free’” violates the prohibition under the First Amendment against compelled speech. The Court, however, upheld the basic premise of the conflict minerals rules, including the due diligence obligations imposed by the rules.

Whether the Court’s ruling on the First Amendment issue will result in significant changes to the reporting framework under the conflict minerals rules has not been determined, with the determination likely to turn on whether the SEC interprets the Court’s ruling narrowly or broadly, as summarized below. This Client Alert provides a brief summary of the conflict minerals rules and the Court’s decision, and our preliminary thoughts on the implications of the decision for the due diligence and reporting obligations under the rules.


The conflict minerals rules, adopted by the SEC in August 2012, impose substantial due diligence and reporting obligations on SEC reporting companies for which conflict minerals are “necessary to the functionality or production” of products that they manufacture or contract to have manufactured, including a requirement that companies disclose publicly their use of “conflict minerals” originating from the Democratic Republic of Congo (DRC) or surrounding areas. “Conflict minerals” are tin, tantalum, tungsten and gold, which are widely used in jewelry, health care devices, automotive and aerospace components, consumer electronics, communications equipment, and industrial manufacturing. The rules were developed under authority of Section 1502 of the “Dodd-Frank” Act to incentivize companies not to source their minerals from the DRC, where Congress has found that the mineral trade has been exploited to finance a conflict that has created a humanitarian crisis. See our Client Alert from August 27, 2012, for a detailed description of the due diligence and reporting obligations imposed by the conflict minerals rules.

Three business groups led by National Association of Manufacturers (NAM) challenged various aspects of the rules as violating certain statutory and regulatory provisions and the First Amendment.

Rejection of Statutory and Regulatory Claims

The three-judge panel of the D.C. Circuit Court unanimously upheld the bulk of the SEC’s conflict minerals rules in rejecting NAM’s rulemaking, statutory and regulatory challenges to the rules. Specifically, the Court found that:

  • the SEC’s decision to not adopt a de minimis exception to the conflict minerals rules was not arbitrary and capricious;
  • the SEC acted within its statutory interpretive discretion in substituting “may have originated” in the DRC in place of “did originate” in the DRC as the trigger for certain compliance obligations under the conflict minerals rules; and
  • the SEC did not abuse its discretion in expanding compliance obligations under the conflict minerals rules beyond “manufacturers” to also cover companies that sell products that they “contracted to [have] manufactured.”

The Court also rejected NAM’s argument that the SEC violated its statutory obligations by failing to perform an adequate cost-benefit analysis of its final rules. The Court found that, under the circumstances, the SEC’s analysis was reasonable despite its acknowledged inability to quantify the social benefits of the conflict mineral rules, noting that the SEC “is not required to ‘measure the immeasurable’” and observing the “apples-to-bricks” comparison in weighing the economic costs of the rules (measured in dollars) against the life-saving and rape-prevention benefits that “would occur half-a-world away.” The Court also pointed out that the SEC, in adopting the conflict minerals rules, appropriately relied upon the conclusion of Congress (as evidenced by its passage of Section 1502 of the Dodd-Frank Act) that reporting and disclosure regarding conflict minerals would benefit the DRC.

First Amendment Issue

A majority of the Court found that the requirement that companies report to the SEC and state on their websites whether any of their products have “not been found to be ‘DRC conflict free’” violates the First Amendment prohibition against compelled speech. The majority observed that “the label ‘conflict free’ is a metaphor that conveys moral responsibility” and the disclosure requirement at issue effectively compels an issuer “to tell consumers that its products are ethically tainted” and “confess blood on its hands” even if the issuer’s products “only indirectly finance armed groups” or the issuer “disagree[s] with that assessment of its moral responsibility.” Interpreting the disclosure requirement as compelled speech (and seemingly as compelled speech that has some ideological value), the Court applied strict scrutiny (rather than intermediate scrutiny or a more relaxed standard of review) to decide the First Amendment issue, reasoning that this type of compelled disclosure is similar to requiring companies to “disclose the labor conditions of their factories abroad or the political ideologies of their board members” (which would be “obviously repugnant to the First Amendment”). Under that heightened standard of review, the Court struck down both the specific underlying statutory provision of the Dodd-Frank Act and the SEC final conflict minerals rules to the extent the statutory provision and the rules require SEC reporting companies to report to the SEC and to state on their websites that any of their products have “not been found to be ‘DRC conflict free’.”

The same D.C. Circuit Court is expected to rule next month in a meat labeling case involving a similar compelled-speech issue. The ruling in that case, in particular on the applicable level of scrutiny to be used to decide the First Amendment question at issue, could affect the continued viability of the ruling in the conflict minerals case.

Implications of the Decision

The initial disclosures under the SEC’s conflict minerals rules are required to be filed on Form SD by June 2, 2014. While the SEC and NAM analyze next steps, the extent of the impact of the Court’s decision on the approaching deadline and the required disclosures is uncertain. Pending revision of the conflict minerals rules to eliminate the objectionable compelled speech requirement, the SEC could voluntarily suspend the initial reporting obligation or, at NAM’s request, the Court could stay or enjoin enforcement thereof. It is possible that the SEC will issue a public clarification in the near term as to how companies should proceed with respect to the June 2 deadline.

With respect to the existing reporting requirements under the conflict minerals rules, if the SEC interprets the Court’s decision narrowly, it may be able just to eliminate the objectionable requirement that companies report whether any of their products are “not DRC conflict free” and substantially retain the existing reporting framework under the rules. On the other hand (and seemingly less likely), the SEC may decide to alter the reporting requirements under the conflict minerals rules fundamentally if it interprets the D.C. Circuit Court decision broadly as finding the existing reporting framework to be constitutionally deficient in its entirety or to a substantial degree.

With respect to the long-term ramifications of the Court’s decision, by finding in favor of the SEC on all of NAM’s claims other than the First Amendment claim, the Court’s decision seemingly recognizes the SEC’s authority to impose due diligence and other compliance obligations on companies that source conflict minerals in the products they manufacture or contract to have manufactured. Thus, the Court’s decision may have only a minor practical effect on the conflict minerals compliance obligations for most of the companies that are subject to the rules.

BakerHostetler will continue to monitor the procedural and substantive developments resulting from the D.C. Circuit Court’s ruling, including the steps taken by the SEC to address the decision, and provide clients with updates and guidance as appropriate.

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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