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E-MailThe Honorable Mario Mancuso is a corporate partner and of the International Trade and Investment Practice at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank publication authored by Mr. Mancuso, Michael T. Gershberg, and Jocelyn Ryan.
On August 18, 2015, a divided three-judge panel of the U.S. Court of Appeals for the D.C. Circuit confirmed its earlier ruling striking down part of the Securities and Exchange Commission’s (“SEC”) Conflict Minerals Rule (the “Rule”) as unconstitutional. Nat’l Ass’n. of Mfrs. v. SEC, No. 13-5252 (D.C. Cir. Aug. 18, 2015). The court again held that requiring issuers to describe their products as “not been found to be ‘DRC conflict free’” in reports filed with the SEC and posted on issuers’ websites violates the First Amendment.
The Decision
The ruling dealt only with the requirement in the Rule that issuers characterize their products using the label “not been found to be ‘DRC conflict free,’” and the court held that this requirement amounts to compelled speech in violation of the First Amendment’s right to freedom of speech. The decision is a narrow one and leaves unaffected the remaining disclosures required under the Rule, such as disclosure of facilities used by the issuer, country of origin of the issuer’s products and the efforts undertaken by the issuer to obtain such information.
In its initial decision in 2014 striking down the requirement that an issuer characterize its products as described above, the D.C. Circuit refused to apply a rational basis test to determine whether the Rule passes constitutional muster, and instead applied intermediate scrutiny, a standard that is more difficult to satisfy. Relying on precedent, the court reasoned that rational basis only applies to certain “purely factual and uncontroversial” disclosures required to correct what otherwise would be misleading advertising. For a more thorough discussion of that decision, please see our memorandum dated April 22, 2014.
Following the D.C. Circuit’s initial decision on the Rule, the D.C. Circuit, sitting en banc, decided a case in which it upheld U.S. Department of Agriculture regulations compelling disclosure of country of origin information on meat products. Am. Meat Inst. v. U.S. Dep’t of Agric., 760 F.3d 18 (D.C. Cir. 2014). Notably, in American Meat Institute, the court held that the less exacting standard of review could be applied to “factual and uncontroversial” disclosures mandated by the government for any purpose. In light of this decision, which represented a departure from precedent in the circuit, the court granted the petitions of the SEC and intervenor Amnesty International for a rehearing of its decision on the constitutionality of the Rule to determine whether the analysis in American Meat Institute would affect the outcome.
Upon rehearing the case, the court found that the disclosure required by the Rule is distinguishable from the disclosure considered in American Meat Institute because that case addressed disclosure in product labeling at the point of sale. In contrast, the Rule requires disclosure to the SEC and on the issuer’s website once a year. While it may be reasonable to extend to point of sale packaging the standard of review previously reserved for deceptive advertising, the court found that it does not follow that such a standard should be extended to the reporting requirements under the Rule. The court noted that the goals of the Rule are also distinct from the economic or investor protection benefits that underpin other SEC disclosure requirements.
Further, the court found that stating that a product is “conflict free” or “not conflict free” connotes moral judgment about the product and is not merely a factual statement. The court held that the government cannot force a company to morally condemn itself in this way and “confess blood on its hands.”
The court noted that deciding whether a heightened level of scrutiny applies to the Rule is not even necessary because the Rule does not even satisfy the lower standard of review. The court found that there is no evidence to support the propositions that the Rule will decrease revenue of armed groups in the Democratic Republic of the Congo and that such loss of revenue will ease the humanitarian crisis in the region, which the court assumed were the goals of Congress in enacting the legislation. The court noted that the government cannot regulate commercial speech based on speculation or conjecture, and highlighted the high cost of complying with the Rule.
The court concluded that the Rule’s disclosure requirement violates the First Amendment rights of issuers so far as it requires an issuer to report to the SEC and state on its website that its products “have not been found to be ‘DRC conflict free.’’’
Key Takeaways
Because this is a developing and changing area of the law, it is fairly likely the SEC will appeal the ruling and request that the case be heard by the D.C. Circuit sitting en banc. This process may delay final resolution of the litigation for at least several months. Issuers should continue to comply with the Rule, as modified by the April 29, 2014 guidance issued by the SEC ’s Division of Corporate Finance. Pursuant to the guidance, issuers do not need to identify their products as “DRC conflict undeterminable” or “not been found to be ‘DRC conflict free,’” but still must disclose the facilities used to produce the conflict minerals, the country of origin of the minerals, and the efforts undertaken to determine the mine or location of origin of the minerals. In addition, unless a company voluntarily chooses to describe its products as “DRC conflict free” no private sector audit is required at this time.
