A federal district court this week rejected an industry challenge to a rule issued by the U.S. Securities and Exchange Commission that imposes certain investigative and disclosure requirements on companies that use “conflict minerals” in the manufacturing process. The July 23, 2013 ruling by District Judge Robert L. Wilkins of the U.S. District Court for the District of Columbia held that the SEC had not acted arbitrarily or capriciously in promulgating the rule and that the disclosure requirement did not violate the First Amendment.
Background on the SEC’s Rule
The district court’s decision addresses the final rule (“Final Rule”) on conflict minerals issued by the SEC on August 12, 2012. The Final Rule implements Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”), which required the SEC to establish disclosure requirements for companies that manufacture products containing “conflict minerals” from the Democratic Republic of the Congo and nine adjoining countries (“Covered Countries”). The goal of the new disclosure rules, as articulated by Congress, is to increase public pressure on companies to cease using minerals that are helping to finance conflict and accompanying human rights abuses in this region of the world.
The Final Rule imposes a disclosure requirement on many companies and industries. A company is required to make a disclosure if (i) the company files reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) conflict minerals are “necessary to the functionality or production” of a product manufactured or contracted to be manufactured by the company.
“Conflict minerals” are defined, without regard to country of origin, as:
- Cassiterite (tin),
- Columbite-tantalite (tantalum), and
- Wolframite (tungsten).
The term also includes any derivatives thereof and any other minerals or derivatives determined by the U.S. Secretary of State to be financing conflict in the Covered Countries.
A company that is required to satisfy the disclosure requirement must make a “reasonable country of origin inquiry” in good faith to determine whether any of the conflict minerals in its products originated in the Covered Countries or if the minerals are from scrap or recycled sources. The results of this inquiry will determine the substance and scope of the company’s disclosure and further investigatory requirements, and may require the company to disclose certain information on its public website.
The first reports under the Final Rule are due May 31, 2014, for products manufactured between January 1 and December 31, 2013.
For a more detailed explanation of the rule, the operations that trigger the rule and how to comply with the rule, see Goodwin Procter’s August 30, 2012 client alert, “SEC Issues Final Rule on Conflict Minerals Disclosures.”
The Rule Is Challenged in Court
Three plaintiffs – the National Association of Manufacturers, the U.S. Chamber of Commerce and the Business Roundtable – challenged the Final Rule. The plaintiffs alleged that:
The Final Rule, or at least certain aspects of it, were arbitrary and capricious and thus in violation of the Administrative Procedures Act, and
The Final Rule contravenes the First Amendment to the U.S. Constitution by compelling speech on companies’ own websites.
The Court Rejects the Challenge and Upholds the Rule
The court rejected both aspects of the challenge to the Final Rule.
Administrative Procedures Act
The plaintiffs raised multiple challenges to the Final Rule as arbitrary and capricious under the Administrative Procedures Act, but the court rejected each argument. Among other things:
- The plaintiffs argued that the SEC failed to analyze the costs and benefits of the Final Rule, but the court held that the SEC was not required to conduct a broad cost-benefit analysis, particularly because the benefits “related to humanitarian objectives that Congress concluded would be achieved by the rulemaking, rather than some sort of economic objectives….” (emphasis in the original).
- The court also found that the SEC sufficiently evaluated whether the Final Rule would promote efficiency, competition and capital formation, thus rejecting the plaintiffs’ contrary argument.
- Nor were the plaintiffs successful in arguing that the SEC failed to determine whether the Final Rule is necessary to decrease conflict and violence in the Democratic Republic of the Congo. The court held that the SEC was not required to “reevaluate and independently confirm that the Final Rule would actually achieve the humanitarian benefits Congress intended.”
- The court rejected the plaintiffs’ claim that the Final Rule should have contained a de minimis exception for manufacturers that use small amounts of conflict minerals in their products. They argued that the SEC wrongly thought itself precluded from considering a de minimis exception, but the Court ruled that the record showed that the SEC “exercised its independent judgment in declining to adopt a de minimis exception.” The court also held that it was not unreasonable for the SEC to decide against adopting a de minimis exception because an exception would undermine the impact of the Final Rule.
- The court also rejected the plaintiffs’ contention that the Final Rule should have been limited to companies that “manufacture” products with necessary conflict minerals, and should not include companies that “contract to manufacture” those products. The Court found the SEC’s interpretation of Section 1502 of Dodd-Frank to be permissible.
The plaintiffs fared no better on their First Amendment challenge. They argued that the Final Rule and Section 1502 of Dodd-Frank improperly compel “burdensome and stigmatizing speech” by compelling companies to publicly state on their websites that certain products are not conflict-free.
Although agreeing with the plaintiffs that the First Amendment protects against government infringement of the right to refrain from speaking, the court upheld the Final Rule as a valid restriction on commercial speech because it directly advances the government’s compelling interest in promoting peace in the Democratic Republic of the Congo and because it merely requires companies to publish “verbatim copies of disclosures already prepared for and filed with the” SEC, just as companies already publish other required SEC filings on their websites.
In anticipation of the Final Rule being invalidated by the court, many companies may have been delaying making the inquiries and gathering the information that will be needed to prepare their reports, the first of which are due May 31, 2014 for the 2013 calendar year. Although it is still possible for an appellate court to block the Final Rule, the rejection of this lawsuit by the district court increases the likelihood that companies will need to complete the investigation and reporting requirements related to conflict minerals by May 31, 2014.
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For more information, please contact your usual Goodwin Procter LLP attorney or Michael S. Giannotto.Goodwin Procter attorneys have written and presented extensively on the conflict minerals disclosure rule.
Michael S. GiannottoOf Counsel