SEC Conflict Minerals Rules Survive Challenge -- It's Time to Get Serious About Compliance
By Cydney Posner
As you know, in October of last year, the U.S. Chamber of Commerce, National Association of Manufacturers and the Business Roundtable filed a lawsuit challenging the SEC's conflict minerals rules and requesting that the rules be modified or set aside. (See my article of 10/23/12.) As reported last evening, yesterday, the district court for the DC Circuit denied the plaintiffs' Motion for Summary Judgment and granted the SEC's (and Intervenor Amnesty International's) Cross-Motions for Summary Judgment. (A copy of the opinion is attached below.) In concluding that the plaintiffs' claims lacked merit, the court found "no problems with the SEC's rulemaking and disagree[d] that the ‘conflict minerals' disclosure scheme transgresses the First Amendment." Generally, the court seemed to take the position that the SEC took into account appropriate information, public comments and Congressional intent and engaged in a reasoned decision-making and interpretive process the results of which were apparently deserving of the court's deference. (In contrast, the court in the case challenging the SEC's resource extraction rules, which were vacated by that court, was not shy about viewing the SEC's process to be inadequate and its statutory interpretations to be incorrect.)
With the initial filing of a Form SD due in May 2014, companies subject to the rules – especially those that were wagering on another SEC defeat in the courts -- should not delay their compliance efforts any further. Although the plaintiffs will probably appeal the court's order, any decision on appeal is unlikely to be timely.
Notwithstanding the result in the case challenging the SEC's resource extraction rules, the outcome in this case should not have come as a complete surprise. A Reuters article summarizing the oral argument regarding the conflict minerals rules (see my article of 7/2/13) began with the judge "question[ing] whether U.S. courts should intervene" in this case: "During roughly three hours of oral arguments, Judge Robert Wilkins of the U.S. District Court for the District of Columbia suggested to an attorney for the trade groups that federal courts should consider deferring to Congress on the matter. ‘This is a circumstance where a court should really defer to Congress and the executive in an area of foreign policy where the court has no expertise,' he said." (Probably a statement in connection with the First Amendment claims.) Not exactly a portent of success for the plaintiffs.
The plaintiffs' challenge included two separate categories of claims: first, the plaintiffs claimed that the adoption of the conflict minerals rules violated the Administrative Procedure Act, arguing that the SEC "ignored its statutory obligations under the Exchange Act in issuing the Rule and that the Commission's rulemaking was arbitrary and capricious in several other respects." Second, the plaintiffs contended that both the conflict minerals rules and Section 1502 of Dodd-Frank were unconstitutional because the obligation imposed on companies "to publish their conflict minerals disclosures on their own websites compels speech in violation of the First Amendment." [Citations and some internal quotations omitted throughout.]
APA Claims
The court viewed the "arbitrary and capricious" standard of review as a narrow one, entitling the SEC's action to a "presumption of regularity"; the court "will not second guess an agency decision or question whether the decision made was the best one." Where the case involves an agency's interpretation of a statute it is implementing, the court will apply the two-part Chevron test. Under Step One, if "Congress has directly spoken to the precise question at issue," then the "clear and unambiguous statutory language controls." (E.g., if the agency interprets the statute to compel a certain result and the court finds the interpretation to be incorrect, that's the end of the inquiry.) If the statute, however, is ambiguous, Step Two applies, and the court will consider "whether the agency's [interpretation] is based on a permissible construction of the statute."
Costs and benefits. The plaintiffs argued, among other things, that "the SEC failed to ‘analyze properly the costs and benefits' of the Rule as a whole by failing to ensure that the rules would not impose an unnecessary burden on competition. (Remember that this argument was successful in connection with the prior legal challenge to the proxy access rules.) The court disagreed that that type of analysis was required, arguing that the plaintiffs were reading "too much into this statutory language." First, the SEC was obligated only to "consider" the impact that the rules could have on various economic-related factors, especially in light of the humanitarian objectives that Congress had cited. As a result, the court was "easily convinced that the Commission discharged any potential responsibility to consider whether the Final Rule will ‘promote efficiency, competition, and capital formation,' and that the Commission appropriately considered the Rule's impact on competition more generally." In addition, the plaintiffs contended that the SEC failed to assess whether the humanitarian goals of the rules -- to decrease the conflict and violence in the DRC -- would be achieved. However, after reviewing the record, the court was "convinced that the Commission appropriately considered the various factors that Sections 3(f) and 23(a)(2) of the Exchange Act actually require. No statutory directive obligated the Commission to reevaluate and independently confirm that the Final Rule would actually achieve the humanitarian benefits Congress intended. Rather, the SEC appropriately deferred to Congress's determination on this point, and its conclusion was not arbitrary, capricious, or contrary to law—whether because of some statutory directive under the Exchange Act or otherwise."
Underestimate of costs. The plaintiffs also argued that the SEC arbitrarily underestimated the rules' cost, particularly with respect to IT costs and the estimated number of suppliers that would be affected by the rules. In each case, the court walked through the SEC's actions and considerations, including the balance that it struck. However, the court concluded that, while the plaintiffs may not agree with the SEC's conclusions, "their disagreement does not render the SEC's analysis on this point arbitrary or unreasonable."
No de minimis exception. The plaintiffs also contended that the SEC should have implemented a de minimis exemption, but failed to do so because it wrongly believed that the statute unambiguously foreclosed that possibility. In addition, even if the SEC did exercise its discretion on this point, plaintiffs argued, its rationale was conclusory and its analysis of the de minimis issue was arbitrary because it failed to analyze adequately the various de minimis proposals submitted during the rulemaking process. While the court acknowledged that the SEC did not explicitly indicate its belief that Section 1502 was ambiguous on the de minimis issue and that it did examine Congressional intent, the Court concluded, under Chevron Step One, that the SEC did not believe its "interpretation [was] compelled by Congress," but rather exercised discretion in declining to adopt a de minimis exception. (Interestingly, the Reuters article cited above reported that, during oral argument, counsel for the SEC "said [the SEC's] hands are tied because Congress did not intend to give a broad exemption from the rule for ‘de minimis' amounts of conflict minerals. Wilkins challenged this view, at one point telling the SEC attorney that the agency ‘seems to have not really performed the legal analysis correctly' and that the agency has an ‘inherent authority in every case' to issue an exemption.")
Turning then to Chevron Step Two, the court concluded that the SEC's interpretation of Section 1502 on the de minimis issue was permissible. The SEC had concluded that adopting a de minimis exception would "undermine the impact" of the rules after it had "weighed and evaluated feedback from commentators and stakeholders on both sides of the issue." On balance, while the court acknowledged that the SEC's "explanation arguably could have been more thorough in some respects, the Court cannot say that the Commission's determination was unreasonable or devoid of a ‘rational connection' in violation of the APA…. While it may be true that the adoption of some type of de minimis approach could also have been a reasonable, alternative option, this does not render the SEC's contrary determination arbitrary or unreasonable."
Reasonable country-of-origin inquiry. The plaintiffs' next argument was that the "reasonable country of origin inquiry" devised by the SEC was too broad a standard and "inconsistent with the statute," "requiring due diligence and reports not only when there is ‘reason to believe' that the minerals ‘did originate' in the region, but also whenever there is ‘reason to believe' that the minerals ‘may have originated' in the region…." Instead, the plaintiffs believed that the statute required due diligence only for minerals that "did originate" in the DRC countries. In the SEC's view, however, its interpretation of Section 1502 "struck the most ‘appropriate balance' in achieving the statute's objectives without imposing unnecessarily excessive costs on covered issuers. Concluding that the statute was ambiguous on this point, the court held that the SEC appropriately construed it as such, and, under Chevron Step Two, deferred to the SEC's interpretation of the statute as a "reasonable and permissible interpretation."
Contract to manufacture. The plaintiffs next contention was that the SEC should not have applied the rules to issuers that only "contract to manufacture" products with conflict minerals, as opposed to limiting the rules' application only to issuers that "manufacture" the products themselves. Again, the plaintiffs argued that the rules were inconsistent with statute and arbitrary and capricious. That Section 1502 refers to contracting to manufacture in one place, but not in another, led the court to conclude that the statute was ambiguous. (Indeed, the court viewed the term "manufacture" to be "inherently ambiguous," while, notably, the SEC, in its adopting release, refused to define the term "manufacture, " arguing that it was "generally understood.") Once again applying Chevron Step Two, the court was "convinced that the Rule's application to issuers that ‘contract to manufacture' is an amply reasonable construction of Section 1502. This is particularly true given the guidance supplied by the SEC in the Adopting Release, wherein the Commission emphasized its focus on the degree of influence and control that an issuer exercises over the manufacturing process, effectively excluding ‘pure retailers' from the scope of the Rule."
Different phase-in periods. The plaintiffs' final argument under the APA was that the SEC's adoption of a two-year phase-in for large companies, while allowing a four-year phase-in for small companies, was, once again, arbitrary and capricious, especially because larger companies rely on smaller company suppliers to perform part of their compliance efforts. And, once again, the court deferred to the SEC's judgment: "Simply put, while the Court does not necessarily disagree with Plaintiffs that it might have been equally reasonable for the SEC to adopt a uniform transition period for all covered issuers, this does not mean that it was unreasonable for the SEC to bifurcate the phase-in period, and the Court declines to substitute its judgment on this question for the Commission's."
First Amendment Claims
In these claims, the plaintiffs argue that Dodd-Frank § 1502 and the SEC rules improperly compel companies to make public disclosures on their own websites of "burdensome and stigmatizing speech" – i.e., in effect, that issuers' products could be contributing to violence in the DRC -- in violation of the First Amendment. (First, plaintiffs apparently failed to provide a required notice to the U.S. Attorney General. Nevertheless, the court went ahead to decide the issue.) In light of the commercial nature of the disclosures at issue, the court applied a standard of "intermediate scrutiny, " under which "the government must establish (1) the asserted ‘government interest is substantial,' (2) the regulation ‘directly advances 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.'" The plaintiffs challenged the rules under second and third elements of the test.
First, the plaintiffs argued that, with respect to Congress's interest in promoting peace and security in the DRC, "[i]t is difficult to think of a less direct way to benefit the DRC than imposing this disclosure requirement on U.S. public companies." However, the court was not persuaded, holding that the disclosure scheme satisfies the second element of the test in light of the foreign relations context in which Congress enacted Section 1502. In this area, "judicial review is particularly deferential." Based on the legislative history, the views of the State Department and other aspects of the record, the court viewed Congress's passage of Section 1502 to be "derived from its ‘informed judgment'" that requiring disclosure from companies using these minerals was "a reasonable step" in promoting peace and security in the DRC.
Second, the plaintiffs contended that the disclosure scheme – imposing issuers to accept a "scarlet letter"-- was not "a reasonable fit to accomplish Congress's objective in promoting peace and security in the DRC." But the court contended that the plaintiffs' argument distorted the disclosure requirements, which mandated only that companies publish on their websites copies of their Forms SD and Conflict Minerals Reports, which were already filed with the SEC. Moreover, the court took some comfort in the SEC's change in the mandated disclosure language, from "not DRC conflict–free" to "not been found to be ‘DRC conflict free,'" which, in the court's view, mitigated the risk that the disclosures would often falsely indicate that the issuer's minerals were definitively found to have assisted in financing the conflict. Accordingly, the court viewed this approach to be a "reasonable fit" under the third element of the test in promoting peace and security in the DRC and held that the plaintiffs' First Amendment claims failed.
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