On April 14, 2014, the U.S. Court of Appeals for the District of Columbia Circuit (D.C. Circuit) issued its long-anticipated ruling in the industry challenge to the Securities and Exchange Commission’s (SEC) conflict minerals rules, and – as we forecast in a previous blog post – free speech issues proved to be critical to the Court’s decision. In fact, the First Amendment challenge to the rules’ requirement that companies self-identify as “not conflict-free” was the only issue on which the Court sided with the industry challengers, as it rejected the various other challenges the National Association of Manufacturers (NAM) and other industry groups had lodged to the breadth of, and burdens imposed by, the SEC’s conflict minerals rules. A copy of the Court’s full decision is available here.
The Court’s decision leaves intact the underlying framework of the conflict minerals disclosure and reporting regime, but prohibits the SEC from requiring companies to identify themselves – or their products – as “not found to be ‘DRC conflict-free’” in the conflict minerals reports required under the SEC’s rules. This result raises a natural question for companies affected by the rules – namely, what does this ruling mean for our conflict minerals reporting obligations, both near-term and long-term?
By striking down one aspect of the SEC’s conflict minerals reporting requirements, the Court’s decision will unquestionably impact the initial conflict minerals disclosures publicly traded companies would otherwise be due to file by June 2, 2014 – but precisely what that impact will be is yet to be determined, as the SEC is no doubt reviewing the decision and evaluating its next steps. One option for the SEC would be to suspend the initial reporting obligation altogether, pending a revision of the conflict minerals rules to remove the “speech” requirement that the panel majority found objectionable. Even if the SEC does not voluntarily suspend the upcoming obligation to file conflict minerals reports, NAM is likely to request that the D.C. Circuit order the SEC to stay enforcement of the conflict minerals reporting obligation pending the SEC’s revision of the rules to comply with the Court’s ruling. Whether companies would be required to file a conflict minerals report in the coming weeks could well turn on how broadly the SEC interprets the constitutional deficiencies in its rules. If the SEC reads the D.C. Circuit decision narrowly, it may conclude that the rules can be remedied simply by removing the obligation for companies to use the words “not DRC conflict-free” in their reports, which might allow the SEC to maintain the current June 2, 2014 deadline for filing of initial conflict minerals reports. (Few issuers were likely to use that “not DRC conflict-free” descriptor in their initial conflict minerals reports anyway, as most issuers would presumably use the “conflict undeterminable” designation available to companies during the rule’s phase-in period.)
From a longer-term perspective, the Court’s decision largely validates the SEC’s ability to require companies to perform due diligence on, and provide factual information about, the sourcing of conflict minerals in the products they manufacture or contract to have manufactured. Thus, the decision will likely have little impact on the “nuts-and-bolts” of conflict minerals reporting for most publicly traded companies and their suppliers, as the First Amendment objections to the current rules center on the requirement that companies self-identify their products as “not found to be ‘DRC conflict free.’” The Court did not prohibit the SEC from taking the factual information provided in a company’s conflict minerals report and using that information to issue its own determination that the company’s products are “not conflict-free.” In fact, the Court practically invited such a result, noting that “if issuers can determine the conflict status of their products from due diligence, then surely the Commission can use the same information to make the same determination.” The SEC may be unwilling to perform such a role, however, given the amount of resources that would be required to review the conflict minerals reports of all issuers and make such determinations – particularly when such supply chain considerations are outside the SEC’s traditional area of expertise.
The extent to which the D.C. Circuit ruling will lead to substantive changes in companies’ reporting obligations depends in large measure on how broadly the SEC interprets the First Amendment problems with the current rule. If the SEC interprets the D.C. Circuit decision as rendering the entire public reporting aspect of the existing rule constitutionally suspect, the SEC would need to fundamentally restructure the conflict minerals rules, which would require another round of notice and comment rulemaking. If the SEC interprets the D.C. Circuit decision more narrowly, as implicating only the “scarlet letter” aspect of requiring companies to self-identify as “not DRC conflict-free” in their conflict minerals reports, the SEC could seek to retain the existing due diligence and reporting framework, and merely remove the requirement that companies expressly describe themselves or their products in their conflict minerals reports as “not DRC conflict-free.” Such a result would permit companies that meet the existing standards for identifying themselves or their products as “DRC conflict-free” to continue to tout their “conflict-free” status in their conflict minerals reports. Conversely, companies that are unable to meet the “conflict-free” standards would not have to publicly declare themselves “not conflict-free,” but their “not conflict-free” status would be implicit (though unstated), based on their inability to describe themselves as “conflict-free.” This revised regime would be analogous to how the government regulates certain claims in food labeling: the government establishes the standards a product must meet before it can label (and market) itself as “organic,” but does not require products falling short of those standards to stigmatize themselves as “non-organic.”
Even if the D.C. Circuit’s ruling does not trigger a wholesale reexamination and restructuring of the conflict minerals reporting regime in the SEC’s existing rules, the D.C. Circuit’s decision will likely either: (a) shift from companies to the government the responsibility for identifying a company or its products as “not DRC conflict-free,” or (b) make that designation implicit, rather than explicit, in a company’s conflict minerals report. However, by leaving intact the SEC’s existing policy choices with respect to companies’ duties to investigate the sourcing of conflict minerals in their supply chains, the D.C. Circuit’s ruling is unlikely to lead to a significant reduction in the due diligence and fact-gathering obligations imposed on publicly traded companies and their suppliers.