The United States Court of Appeals for the District of Columbia today, in National Association of Manufacturers v. SEC, affirmed a district court judgment that the Securities and Exchange Commission (SEC) did not violate procedural requirements or misconstrue the statute in promulgating the Conflict Minerals Rule, but vacated the specific underlying statutory provision and the rule because the requirements compelled speech in violation of the First Amendment to the United States Constitution. Compelling reporting, disclosure, and publication to the extent that entails “compelled speech” pose a distinct constitutional limitation on both statutes and rulemaking under statutes. Agencies must consider carefully this developing caselaw in formulating any reporting requirement that will be publicly disclosed – and provide a detailed justification for such requirements in the preamble of any such rule – or counsel for regulated parties will, and should, press judicial review.
Dodd-Frank Act: In the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress required the SEC to issue regulations requiring companies using “conflict minerals” – gold, tantalum, tin, and tungsten mined from the Democratic Republic of the Congo or an adjoining country – to investigate and disclose the origin of those minerals. The statutory scheme applies only to “person[s] described” in the Act – those if conflict minerals are necessary to the functionality or production of a product manufactured by the company. A covered company must disclose annually, whether the necessary conflict minerals originated in the DRC or an adjoining country. If so, the company must file a report with the SEC, describing the due diligence measures taken to establish the source and chain of custody of the minerals, including a private sector audit of the report. The report must also list the products manufactured or contracted to be manufactured that are not “DRC conflict free.” A product is “DRC conflict free” if it’s necessary conflict minerals did not “directly or indirectly finance or benefit armed groups” in the covered countries.
Conflict Minerals Rule: The SEC promulgated a final rule that requires multiple steps by a company that can be counted several ways:
- A company must determine if it is covered by the rule: i.e. (a) they file certain reports with the SEC (“issuers” in securities law), and (b) the conflict minerals are necessary to the production or functionality of their products, whether directly or through contracted manufacturers, and in no minimum amount.
- The company must conduct a “reasonable country of origin inquiry” – a preliminary investigation designed to determine whether the company’s necessary conflict minerals originated in covered countries.
- If that inquiry results in the company knowing or acquiring a “reason to believe” that its necessary conflict minerals “may have originated” in a covered country, the company must “exercise due diligence on the source and chain of custody of its conflict minerals.”
- If, after performing its due diligence, the company still has reason to believe its conflict minerals may have originated in covered countries, it must file a report with the SEC describing its due diligence, a private sector audit of its efforts, and those products that have “not been found to be ‘DRC conflict free.’” The report must also provide detailed information about the origin of the minerals used in those products.
The SEC estimated that the total initial costs of the final rule would be $3 – $4 billion, and $207 – $609 million each year thereafter. The SEC was “unable to readily quantify” the “compelling social benefits” the rule was supposed to achieve in reducing violence and promoting peace and stability in the Congo. The SEC, in making choices in the final rule, relied on Congress’s judgment that supply-chain transparency would have those benefits by reducing the flow of money to destabilizing armed factions.
Statutory and Regulatory Rejection: The D.C. Circuit panel (unanimously) rejected statutory interpretation and Administrative Procedure Act (APA) process challenges to the SEC’s rule:
- The SEC was not arbitrary and capricious in rejecting a de minimis exception because a de minimis exception would be contrary to the general purpose of the statute, as an exercise of discretion, not because the statute plainly did not provide for such an exception.
- The SEC was within its discretion in interpreting the statutory requirements relating to whether a conflict mineral “did originate” or “may have originated” in the Congo.
- The SEC did not abuse its discretion in requiring a company to report on “contracted manufacturers” and rejected a structured statutory interpretation based on the inclusion and exclusion of the phrase “contracted to be manufactured” in different provisions – i.e. a rejection of a wooden application of the expressio unius est exclusio alterius canon of statutory interpretation in Congressional delegations of agency rulemaking authority.
The court also rejected the appellants’ argument that the economics of the rule violated the SEC’s underlying statutory obligations (a contention of merit in a number of cases over the past decade), finding that under the circumstances, the measurements and analysis were reasonable. Pointing out that Congress decided the premise that reporting and disclosure would benefit the peace and harmony of the Congo (which the SEC relied upon), the court opined that:
An agency is not required “to measure the immeasurable,” and need not conduct a “rigorous, quantitative economic analysis” unless the statute explicitly directs it to do so. …. Here, the rule’s benefits would occur half-a-world away in the midst of an opaque conflict about which little reliable information exists, and concern a subject about which the Commission has no particular expertise. Even if one could estimate how many lives are saved or rapes prevented as a direct result of the final rule, doing so would be pointless because the costs of the rule – measured in dollars – would create an apples-to-bricks comparison.
The analysis warrants reading, but is not the true linchpin on which this decision hinges. The regulatory and statutory decisions are necessary preludes to reaching a constitutional issue.
First Amendment Compelled Speech: In another example of the growing complexity of the issue, the majority of the court of appeals panel vacated the rule at a higher plane – the First Amendment to the United States Constitution. Appellants argued that the requirement that a company describe its products as not “DRC conflict free” in the report it files with the SEC and posting that report on its website unconstitutionally compels speech. Here, again, the court is faced with categorizing speech under the First Amendment:
- factual statements under rational basis to avoid consumer deception (or perhaps misrepresentation or fraud) under Zauderer, as contrasted with
- intermediate scrutiny of commercial speech under Central Hudson’s requirement that the government show a substantial government interest that is directly and materially advanced by the restriction; and the restriction is narrowly tailored (and as to this last the SEC provided no evidence), or
- strict scrutiny of any other compelled speech, particularly compelled speech with some ideological value.
The court gently, but clearly, interpreted the statement being compelled:
At all events, it is 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.
For that reason, the court struck down both the specific underlying Dodd-Frank provision and the SEC’s final rule “to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have “not been found to be ‘DRC conflict free.’””
Dissent & Another Consideration of the Problem: If this linchpin does not sound vaguely familiar, the dissent provides the answer. Judge Srinivasan, noting that the court of appeals had already ordered argument en banc rehearing of American Meat Institute v. Department of Agriculture, at that panel’s suggestion, and of which he was a member, suggests that the better course was to sever the administrative law and statutory issues and decide them as the panel did, but to hold the issues on the ultimate First Amendment claim in abeyance pending resolution of the en banc case. That separate procedural issue, freighted with the court’s own stare decisis (Lat: “to stand by things decided”) and interlocking panels, may well lead to en banc consideration of this case as well – at the behest of a judge of the court or upon motion of a party. Perhaps a stay of the statute (and dependent stay of the rule) is appropriate, and further orders may yet issue.