The Securities and Exchange Commission finds itself yet again at a legal crossroads concerning its embattled Conflict Minerals Rule. One path leads to the Supreme Court; the other, a retreat from a cornerstone of the rule’s disclosure requirements.
And at stake is not just the Conflict Minerals Rule alone, but potentially a wide range of other government regulations and rule proposals crafted in response to social issues and worker protections.
On Nov. 10, the U.S. Court of Appeals for the D.C. Circuit denied requests from the SEC and Amnesty International for an en banc rehearing—one argued before a full complement of the court’s judges—of an earlier decision that found certain disclosure requirements in the rule to be unconstitutional. Specifically, the court took issue with disclosures and audits that ultimately would force companies to declare whether their products do or don’t use Congolese minerals that help fund violent militias.
For now, that decision resolves a lawsuit against the SEC and the Conflict Minerals Rules brought by the National Association of Manufacturers, U.S. Chamber of Commerce, and the Business Roundtable.
The real question is what the SEC does next. It has 90 days to ask the U.S. Supreme Court to review the appellate court’s decision. The agency hasn’t signaled its intentions yet, and the decision is not necessarily an easy one. An appeal to the Supreme Court might reestablish the SEC’s authority to set rules—or it could backfire if the high court upholds the lower court’s decision, and perhaps even creates new case law that undermines other securities rules and disclosure requirements.
The D.C. Circuit’s opinion, and denial of the en banc request, “strikes a potentially significant blow to the securities regulation regime and the integrity of the U.S. capital markets,” says Michael Siebecker, law professor at the University of Denver. “The ruling opens a path for corporations to challenge many of the securities laws, rules, and regulations based on their First Amendment protections.”
The Supreme Court has “never clearly articulated definitions for commercial speech, political speech, or the boundaries between them,” Siebecker says. It has “obliquely suggested that certain aspects of the securities laws, rules, and regulations remain outside the reach of the First Amendment,” but not offered “any sound jurisprudential grounds for creating an island of immunity for the securities laws from First Amendment attacks.”
The D.C. Circuit Court’s ruling is already prompting critics of other disclosure demands to make a similar argument. The U.S. Chamber of Commerce has announced that it will focus its legal firepower on defeating the Conflict Minerals Rule’s disclosure requirements, rather than the SEC’s similarly controversial pay ratio rule. Prevailing in the former battle clears a path to defeating the latter, its spokespeople have explained.
“I don’t imagine that the entire edifice of the securities disclosure laws is going to crumble as a result of these cases, but I can imagine that, especially with regard to some of the disclosure mandates with a social component, business groups might be interested in challenging those on this basis,” says Cydney Posner, special counsel in the law firm Cooley’s business department.
“Companies will need to still conduct due diligence of their supply chains, engage with suppliers to refine that due diligence, and be prepared, if there is action down the road that puts these requirements, including the audit requirement, back in place,”
Kelly Babson, Partner, Nixon Peabody
It isn't just covered companies that are closely monitoring the situation. "There were amicus briefs by people who might seem to have nothing to do with conflict minerals,” Posner says. “They are concerned, however, that the potential impact is broader than it might have first appeared.” For example, an amicus brief was filed by a diverse group of organizations, among them: the Public Health Law Center, Campaign for Tobacco-Free Kids, American Cancer Society Cancer Action Network and Tobacco Control Legal Consortium. They argued that the court’s limits on mandatory disclosures could apply to any number of public health labeling requirements, and perhaps even apply to OSHA warnings to employees about workplace hazards, environmental notifications, and mandatory disclosures to consumers in financial transactions.
Social Policy and Securities Law
The Conflict Minerals Rule is a supply chain issue forced into securities law, says Frank Murray, senior counsel with Foley & Lardner, and the two are not a naturally good fit. “If you are going to do it in this case, there are other square pegs you can jam into the round hole as well.”
The concern, he says, is the slippery slope of further advancing social or political agendas through rulemaking. On that basis, the Supreme Court’s conservative majority might be more than wiling to take the case.
“You have a possibility that the Supreme Court could weigh in again on some of these commercial speech issues,” Murray says. “It is not a concern about misleading anyone [as past restrictions on commercial speech have focused on], it is more a concern about trying to stigmatize companies and advance policy goals through the concept of disclosure.”
Selections from an amicus brief signed by the American Cancer Society and other health advocates in support of the SEC's Conflict Minerals rule is below.
Mandatory commercial disclosures in many contexts besides advertising and product labels play a crucial role in protecting the public. Required notifications of hazards protect public safety (authorizing OSHA to require warnings to employees about workplace hazards, information about stored hazardous chemicals to be reported and made publicly available).; environmental protection depends on extensive notification requirements (requiring reporting of toxic chemical emissions). Required disclosures protect consumers in financial transactions (mortgage brokers must make specific disclosures about loan fees and terms, credit reporting agencies must provide specified disclosures). Personal privacy is protected by requiring health plans and health care providers to inform patients of their privacy rights. Requiring home lenders to make public information about the race, national origin, sex and income of loan applicants and actual borrowers, helps deter discriminatory lending practices.
None of the foregoing disclosures occur in advertisements or on product labels. Therefore, according to the rule of the panel, all would be reviewed under standards at least as stringent as those of Central Hudson Gas & Electric Corp. v. Public Service Commission (1980), a test under which no regulation has survived Supreme Court review for two decades.
A holding with such drastic implications for such an extensive body of jurisprudence surely involves an important question of law. Many important protections are similarly threatened by the holding that any disclosures – however undisputed their factual accuracy – are subject to more stringent review if they concern an issue about which there is public controversy or where there is controversy over the significance of the facts to be disclosed. Under the panel majority’s rule, the requirement that automobile manufacturers disclose mileage ratings and affix a label to the fuel compartment of vehicles capable of operating on alternative fuels would apparently be subject to heightened scrutiny because of public controversies about climate change. Similarly, disputes about the ethics of animal research would trigger enhanced review of straightforward recordkeeping and reporting requirements for research facilities, and disagreements about mandatory vaccinations would support heightened scrutiny of requirements that schools report immunization rates.
The imposition of a proof-of-effectiveness standard would delay or prevent such basic warning label regimes as those governing the presence of allergens in food, the safety of children’s toys, and the serious side effects of prescription drugs. Indeed, it is difficult to see how even the most commonsense regulation requiring, for example, signs stating the maximum occupancy for public meeting spaces, or that employees should wash their hands after using the restroom, or just “EXIT,” could readily survive a similar ex ante demand for proof of effectiveness. In sum, the panel’s holding would invite legal challenges to, and demand judicial reconsideration of, a wide array of disclosure regimes that benefit the public in numerous ways and that have never been considered constitutionally problematic. Whether such an overhaul of regulatory jurisprudence is called for is surely a question of exceptional importance.
Source: Public Health Law Center.
A Supreme Court ruling could mean the difference between scaling back rules shaped by social concerns, or giving the government a “green light,” he adds.
The pressing question for compliance officers is what the latest turn of events means for public companies covered by the rule. The consistent advice from experts is to ignore the noise and stay the course.
“At this point the denial of the rehearing essentially means that the status quo is preserved,” says Kelly Babson, a partner at law firm Nixon Peabody. “What that means, in practical terms, is that absent any further guidance by the SEC or legal action, which is probably unlikely, companies will essentially be in the same position they were a year ago with respect to their disclosure obligations under the rule, other than the specific portions that have been invalidated.”
The SEC issued guidance in August that maintains required Form SD disclosures and supply chain due diligence, without requiring a declarative admission of conflict minerals use. Layman’s translation: yes, you have to keep going through the exercise of Conflict Minerals Rule compliance; you just aren’t compelled to disclose what you find.
“We don’t have the labeling requirements of the rule, but the rest of the requirements stand,” Babson says. “Companies will need to still conduct due diligence of their supply chains, engage with suppliers to refine that due diligence, and be prepared, if there is action down the road that puts these requirements, including the audit requirement, back in place,” she says.
Meanwhile, you still have activists and vocal supporters of the rule to contend with. “They are reviewing filings and can play the shame game,” Babson says. “They are prepared to call out issuers who don’t appear to be taking it seriously and in compliance with either the technical terms or spirit of the rule.” There are also a variety of sustainability reporting initiatives that don’t necessarily apply to U.S. public companies, but some want these frameworks to be adopted anyway and do the work that regulators may be denied.
For now, companies should continue to monitor further litigation and regulatory developments, Babson says. Aside from a Supreme Court appeal, the SEC could also propose amendments to the current rules to address the First Amendment issues found by the Court. “In any of these cases, however, it is unlikely that the constitutional issues would be resolved prior to the 2016 filing deadline,” she says.