Are the Securities Laws a First Amendment Free Zone?

By Cydney Posner

When does the First Amendment prevent the Government from compelling companies to make specified disclosures? Isn't that what the securities laws are all about? Are the securities laws just exempt from First Amendment challenges? After all, the USSCT has long recognized that "the exchange of information about securities" is among the "[n]umerous examples … of communications that are regulated without offending the First Amendment…." (Ohralik v. Ohio State Bar Assn (1978)) But is that really all there is to it? What if the compelled statements may denigrate a company's products? Just where is the line drawn?

Two recent decisions of the D.C. Circuit continue to fuel this controversy, especially in the context of recent expansion by Congress and the SEC of disclosure obligations related to issues of social responsibility. In the first case, American Meat Institute v. U.S. Dept. of Agriculture (D.C. Cir. 2014), AMI argued that the USDA's country-of-origin labeling rule compelled disclosure in violation of the First Amendment. A three-judge panel upheld the regulation, but invited en banc review to resolve the issue for the circuit. The invitation was accepted, the opinion vacated and oral argument heard in May, although no decision has yet been issued. Following on the heels of AMI, in National Association of Manufacturers v. Securities and Exchange Commission (D.C. Cir. 2014), a different three-judge panel struck down a portion of the SEC's conflict minerals rule on First Amendment grounds. In that case, the court decided that the requirement to disclose whether companies' products were "not found to be DRC conflict free" amounted to "compelled speech" in violation of companies' First Amendment rights. Both the SEC and Amnesty International (as Intervenors-Appellees) filed petitions with the D.C. Circuit requesting a rehearing en banc regarding the First Amendment issue, but requested that the Court hold the petitions in abeyance pending issuance of the AMI en banc decision on the related legal issue.

Both cases focus on the applicable standard of review for compelled commercial speech disclosures. The usual test for commercial speech (generally, expression related solely to the economic interests of the speaker and its audience or speech that does no more than propose a commercial transaction) was articulated by the USSCT in Central Hudson Gas & Electric Corp. v. Public Service Commission (1980), as a four-part analysis: "At the outset, we must determine whether the expression is protected by the First Amendment. For commercial speech to come within that provision, it at least must concern lawful activity and not be misleading. Next, we ask whether the asserted governmental interest is substantial. If both inquiries yield positive answers, we must determine whether the regulation directly advances the governmental interest asserted, and whether it is not more extensive than is necessary to serve that interest." That test was further refined by the USSCT In Zauderer v. Office of Disciplinary Counsel (1985), where the issue involved not a restriction on speech but rather an affirmative obligation to disclose factual and non-controversial information. In Zauderer, the USSCT held that compelled commercial speech "rights are adequately protected as long as disclosure requirements are reasonably related to the State's interest in preventing deception of consumers," provided that the requirement is not "unjustified or unduly burdensome disclosure" so as to chill protected commercial speech. Observing that the protection of commercial speech under the First Amendment is premised principally on "the value to consumers of the information such speech provides," the Zauderer Court viewed the more lenient "reasonable-relationship" standard to be justified because the "constitutionally protected interest in not providing any particular factual information …. is minimal." In 2010, the USSCT reaffirmed Zauderer in Milavetz, Gallop & Milavetz, P.A. v. U.S. (2010), where the court affirmed application of a more relaxed level of scrutiny to disclosure requirements that were designed to prevent consumer deception. (Another case that might slip into the mix is SEC v. Wall Street Publishing Institute, Inc. (D.C. Cir. 1988), in which the Court allowed the SEC to seek an injunction, without offending the First Amendment, requiring a magazine to disclose consideration it received in exchange for stock recommendations. Although the Court declined to view the case as involving commercial speech, it nevertheless applied a more lenient level of scrutiny on the basis of "the federal government's broad powers to regulate the securities industry.")

While both NAM and AMI involve compelled disclosure, however, neither appears to fit squarely under Zauderer because neither involves the likelihood of consumer deception. In AMI, the Court concluded (in the now-vacated decision) that the COOL rule involved factual and non-controversial commercial speech and saw no valid reason not to extend the application of Zauderer beyond preventing deception to other governmental interests (such as informational purposes). The precise question that is now before the en banc panel in AMI is "[w]hether, under the First Amendment, judicial review of mandatory disclosure of ‘purely factual and uncontroversial' commercial information, compelled for reasons other than preventing deception, can properly proceed under Zauderer v. Office of Disciplinary Counsel… or whether such compelled disclosure is subject to review under Central Hudson Gas & Electric v. PSC of New York…." In effect, was the reference in Zauderer to consumer deception at the heart of the decision and therefore a limitation on application of the test or was it incidental to the decision in that the preventing deception was the purpose of the regulation at issue in that case? Notably, at least two other circuits have extended the Zauderer test to apply to protect other legitimate state interests beyond consumer deception.

By contrast, the fact that there was no suggestion that the conflict minerals rule was related to preventing consumer deception was critical to the Court's refusal to apply the Zauderer rational-basis review standard in NAM. Moreover, the Court viewed the conflict-free label requirement to be offensive to the First Amendment because it was "far from clear that the description at issue –whether a product is ‘conflict-free' – is factual and non-ideological. Products and minerals do not fight conflicts. The label ‘conflict free' is a metaphor that conveys moral responsibility for the Congo war. It requires an issuer to tell consumers that its products are ethically tainted, even if they only indirectly finance armed groups. An issuer, including an issuer who condemns the atrocities of the Congo war in the strongest terms, may disagree with that assessment of its moral responsibility. And it may convey that ‘message' through ‘silence.' … By compelling an issuer to confess blood on its hands, the statute interferes with that exercise of the freedom of speech under the First Amendment." (It is worth noting here that, although the Court questions whether the NAM disclosure requirement is "purely factual and non-ideological," Amnesty argues that Zauderer's reference to "purely factual and uncontroversial information" was merely descriptive of the disclosure in that case and not necessarily a condition to application of the reasonable-relationship review test.) In addition, the NAM Court dismissed Amnesty International's contention that, whether or not Zauderer applied, a lenient level of scrutiny should be applied under Wall Street Publishing: that opinion "concerned the same consumer-deception rational as did Zauderer" and, in NAM, "the ‘conflict free' label is not employed to sell securities. To read Wall Street Publishing broadly would allow Congress to easily regulate otherwise protected speech using the guise of securities laws. Why, for example, could Congress not require issuers to disclose the labor conditions of their factories abroad or the political ideologies of their board members, as part of their annual reports? Those examples, obviously repugnant to the First Amendment, should not face relaxed review just because Congress used the ‘securities' label." Interestingly, because the Court found that the rule did not survive even the intermediate standard of Central Hudson, the Court stated that it did not need to decide whether strict scrutiny might be the more appropriate standard, perhaps implicitly suggesting that the rule involved more than just commercial speech.

As discussed in this article in Compliance Week, views diverge on whether any other securities laws are potentially open to challenge on a First Amendment basis. Some of the commentators interviewed for the article went so far as to suggest that these cases might lead to First Amendment challenges to Reg FD or restrictions on speech such as the quiet period. However, those regulations are more clearly within the SEC's traditional purview, even though they may involve restrictions on speech. Other commentators quickly dismissed the possibility that the securities laws were in any jeopardy. According to one law professor, "[b]enchmark cases like Central Hudson Gas & Electric Corp. v. Public Service Commission have established how the government should navigate the free speech concerns that arise from securities regulation and other impositions, such as country-of-origin labeling, drug interaction disclosures, and warning labels on cigarette packages and hazardous chemicals. Bottom line: If compelling disclosure can prevent confusion, deception, or danger to investors and consumers, it is likely constitutional. ‘The argument that is commonly made is that the SEC's rules are just exempt from the first amendment, and I find that a very unsatisfying assertion….This doesn't mean all, or even most, securities regulations are now invalid. As long as they have the purpose of preventing deception, then they are fine.'" Similarly, a former co-chief counsel of the SEC's Division of Risk, Strategy, and Financial Innovation, does not see "grander implications. ‘Does this have the potential to swallow up all securities laws because they force companies to speak? Not at all; this is an extremely tiny, narrow First Amendment holding at the tag end of a big rule that was 99 percent upheld'…."

Still, it is possible that these cases may have some impact on the recent trend to require disclosure regarding issues of social responsibility, which may or may not have anything to do with consumer deception or investor protection and may even tread on political turf: in addition to the conflict minerals rule, the mine safety disclosure rule, the recently disallowed resource extraction disclosure rules and the recently introduced House bill, "Business Supply Chain Transparency on Trafficking and Slavery Act of 2014" (which, if adopted, would amend the Exchange Act to require disclosure regarding measures companies have taken to identify and address conditions of forced labor, slavery, human trafficking and forms of child labor within the company's supply chains) all have the potential to raise First Amendment issues in this context. States have also imposed disclosure requirements that could come into question, for example, California's own supply chain transparency provision. <br>In the article, one professor was disturbed that, under the modern trend toward "name and shame" disclosure, parts of the disclosure regime have evolved into "part of the punishment." While "[t]ime will tell what rules will face new constitutional challenges, … the SEC ‘has got to pay attention' when it crafts future rules…'The court ruling is a sign that securities disclosure is not some sort of first amendment free zone'…." According to another professor, disclosure requirements related to corporate social responsibility are "'at great risk…. If corporations can insulate themselves from regulation or liability under the First Amendment by claiming the mandatory disclosures or corporate speech regulations touch some political chord—as the D.C. Circuit's opinion suggests—investors will no longer be able to rely on corporate communications regarding corporate social responsibility matters that remain at their core, political matters….As a result, the quickly burgeoning market for CSR may well collapse.'" Moreover, that professor suggested, "a Supreme Court appeal remains a possibility, which could force a broader consideration of how the First Amendment applies to disclosure requirements. ‘The Supreme Court has never clearly articulated definitions for commercial speech, political speech, or the boundaries between them.'" (And, depending on the outcome of these cases, there may be a split in the circuits on the application of Zauderer.) <br>Interestingly, SEC Chair Mary Jo White has also been critical, although not from a First Amendment perspective, of Congressional mandates requiring the SEC to regulate outside of its core mission: "some more recent disclosure directives from Congress have been quite prescriptive, essentially leaving no room for the SEC to exercise its independent expertise and judgment in deciding whether or not to make the specified mandated disclosures…. The Dodd-Frank Act is, of course, a landmark piece of legislation that is designed to address the causes of the financial crisis and reduce the likelihood it will happen again. And most of the more than 90 rulemakings and studies required of the SEC relate to that overarching purpose and our core mission…. But other mandates, which invoke the Commission's mandatory disclosure powers, seem more directed at exerting societal pressure on companies to change behavior, rather than to disclose financial information that primarily informs investment decisions. That is not to say that the goals of such mandates are not laudable. Indeed, most are. Seeking to improve safety in mines for workers or to end horrible human rights atrocities in the Democratic Republic of the Congo are compelling objectives, which, as a citizen, I wholeheartedly share. But, as the Chair of the SEC, I must question, as a policy matter, using the federal securities laws and the SEC's powers of mandatory disclosure to accomplish these goals." (See this Cooley news brief of 10/4/13.)

Obviously, the results in AMI and NAM need not be the same, and there may be sufficient critical factual differences between the two to provide a roadmap for assessing these types of rules. And, even if the mandated disclosure in NAM is viewed as more controversial than the disclosure required in AMI, is it of the same order as in other cases where laws compelling speech were invalidated -- e.g., New Hampshire license plates displaying the motto "Live Free or Die" or a requirement that public school students salute the flag? It remains to be seen whether the First Amendment will provide a fertile field for other serious challenges to any current or proposed securities laws.

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