By Marsha Z. Gerber, Cristina K. Lunders and Christian Menefee
On April 14, 2014, a divided panel of the US Court of Appeals for the D.C. Circuit found unconstitutional one part of the disclosure requirements in the Securities and Exchange Commission's (the "SEC" or the "Commission") Conflict Minerals1 Rule (the "Rule"), which was adopted by the Commission in August 2012 pursuant to Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"). Specifically, in National Association of Manufacturers, et al., v. Securities and Exchange Commission,2 the court found that the Rule and corresponding statute violate the First Amendment to the extent that they require Issuers3 to disclose and state on their website that any of their products are "not 'DRC conflict free.'"4 [enhanced opinion available to lexis.com subscribers].
Synopsis of the Rule
The SEC adopted the final version of the Rule on August 22, 2012. The Rule went into effect on November 13, 2012 and requires Issuers subject to the Rule to submit disclosures for the 2013 calendar year no later than May 31, 2014.
The Rule requires Issuers to disclose their use of Conflict Minerals, which originate from the Democratic Republic of the Congo ("DRC") or an adjoining country ("Covered Countries"). Disclosure is required by Issuers that: (i) file reports with the SEC under Section 13(a) or Section 15 (d) of the Securities Exchange Act of 1934, and (ii) use Conflict Minerals that are necessary to the functionality or production of a product manufactured or contracted to be manufactured by that Issuer. The Rule requires Issuers to make disclosures to the SEC and to provide those disclosures or a link to those disclosures on the Issuer's publicly available website.
Issuers must make various disclosures based on the origin of their Conflict Minerals and whether those minerals were used to finance or benefit armed groups. For Conflict Minerals mined after January 31, 2013, an Issuer must conduct a reasonable country of origin inquiry ("RCOI") to determine if it knows or has reason to know that its Conflict Minerals may have originated in a Covered Country. If an Issuer makes that determination, the Issuer must exercise due diligence on the source and chain of custody of the Conflict Minerals following a nationally or internationally recognized framework to determine if the Conflict Minerals are from a scrap or recycled source. The Issuer must disclose Conflict Minerals from a scrap or recycled source by submitting a Form SD to the SEC. This form should disclose the source of the Conflict Minerals and briefly describe the due diligence measures taken by the Issuer to determine the source.
For Conflict Minerals that are not from a recycled or scrap source, in addition to submitting a Form SD with the required disclosures, the Issuer must exercise additional due diligence to determine whether the Conflict Minerals financed or benefitted armed groups. The Issuer must also submit a Conflict Minerals Report ("CMR") detailing the additional due diligence measures taken.
In the Conflict Minerals Report, the Rule as adopted requires that the Issuer label the Conflict Minerals as: (1) "DRC conflict free," meaning that the Issuer has confirmed that the minerals were not used to finance or benefit armed groups in Covered Countries; or (2) "not 'DRC conflict free.'" The Issuer must obtain an independent private sector audit ("IPSA") to verify the due diligence framework and measures taken by the Issuer.
Lastly, the Rule provides a grace period ("Temporary Transition Period") of two years for Issuers and four years for Smaller Reporting Companies.5 During this time only, Issuers may label their Conflict Minerals in their CMR as "DRC undeterminable." An Issuer may use this label if it is unable to determine the origin of the Conflict Mineral, or is unable to determine whether the mineral directly or indirectly financed or benefitted armed groups in a Covered Country. In this case, the CMR must include a description of the products and minerals, what facilities processed the minerals, and the steps taken by the Issuer to mitigate the risk that any of these minerals benefitted armed groups, including any steps to improve its due diligence. Notably, the Issuer is not required to obtain an IPSA.
The D.C. Circuit vacates the Rule's labeling requirement for Issuers with products they determine are "not 'DRC conflict free."'
In National Association of Manufacturers, et al., v. Securities and Exchange Commission, the DC Circuit held that the Rule and corresponding statute are unconstitutional to the extent that they require Issuers to report to the SEC and state on their website that they determined their products are "not 'DRC conflict free."' (the "Not-Conflict Free Label")6
The National Association of Manufacturers (the "NAM") challenged only the Rule's requirement of a Not-Conflict Free Label, and not the "DRC conflict free" or "DRC conflict undeterminable" labels.7 The NAM argued that by forcing companies to associate themselves with "groups engaged in human rights violations," the Not-Conflict Free Label compelled speech in violation of the First Amendment.8 The court ruled that this disclosure requirement essentially mandated that Issuers tell consumers that their products are "ethically tainted," therefore conveying some responsibility for the war in the Congo and adjoining areas, in violation of the First Amendment.9
First Amendment standards would only permit compulsion of such speech when the government could show that it has a substantial government interest that is advanced by a narrowly tailored restriction.10 The court found that the Not-Conflict Free Label requirements were not narrowly tailored to the government's goal of disclosing to the public companies' use of minerals that finance armed groups in the DRC and surrounding areas.11 The court noted that the SEC could instead adopt alternative disclosure options that do not compel companies to publicly "confess blood on their hands," and still achieve the government's goal of identifying companies that may use minerals that benefit armed groups.12 The court provided the example that the SEC, as opposed to Issuers, could label products based on the due diligence information Issuers submit.13
The NAM case does not change the Rule's due diligence framework for Issuers. Specifically, if Issuers have Conflict Minerals that are necessary to the functionality or production of a product manufactured or contracted to be manufactured, they must still conduct an RCOI and file a Form SD, and may need to exercise source and custody due diligence, file a CMR, and obtain an IPSA.
However, the NAM case, if not challenged by the SEC14, does create some practical uncertainty for companies attempting to comply with the Rule's disclosure requirements. If Issuers determine that their respective products are "not 'DRC conflict free,"' it would appear that the DC opinion calls into question whether, without any additional action from the SEC before the May 31 deadline15, they are still required to report that determination in their SD or CMR or state it on their website. However, if there is such a determination, without further SEC action the finding puts those Issuers in an awkward position as to what designation, if any, should be disclosed. One thing is clear at this time. Compliance with the Rule requires significant readiness steps. Affected Issuers should therefore continue to comply with the Rule's RCOI, source and chain of custody due diligence, and IPSA requirements, and prepare to submit a Form SD and CMR, if currently required under the Rule. We will continue to provide updates as to additional SEC guidance or other action before the approaching May 31, 2014 deadline.
As the May 31, 2014 deadline approaches, and courts and the SEC continue to issue guidance that impact the reporting requirements, companies subject to the Rule should ensure that they stay abreast of updates and best practices for fulfilling their disclosure requirements and seek guidance as necessary to understand the evolving best practices in the area.
1 The term 'conflict mineral' is defined in Section 1502(e)(4) of Dodd-Frank as (A) columbite-tantalite, also known as coltan (the metal ore from which tantalum is extracted); cassiterite (the metal ore from which tin is extracted); gold; wolframite (the metal ore from which tungsten is extracted); or their derivatives; or (B) any other mineral or its derivatives determined by the Secretary of State to be financing conflict in the Democratic Republic of the Congo or an adjoining country." See Conflict Minerals, Adopting Release No. 34-647716, 17 C.F.R. Parts 275 and 249b, n.6 Aug. 22, 2012).
2 National Association of Manufacturers, et al., v. Securities and Exchange Commission, NO. 1:13-cv-00635 (D.C. Cir. April 14, 2014).
3 The term "Issuer" means any natural person, company, government, political subdivision, agency, or instrumentality of a government that issues or proposes to issue any security. See Securities Act of 1933, § (2)(a)(4), 15 U.S.C. § 77B(a)(4).
4 See National Association of Manufacturers, NO. 1:13-cv-00635 at 23.
5 A "Smaller Reporting Company" is defined as an Issuer that is not an investment company, an asset-backed Issuer, or a majority-owned subsidiary of a parent that is not a Smaller Reporting Company and that meets the public float requirements in the Securities and Exchange Act of 1934. See 17 C.F.R. § 240.12B-2.
6 See National Association of Manufacturers, NO. 1:13-cv-00635 at 23. Although the final page of the majority opinion states that it applies to products that Issuers "have not found to be 'DRC conflict free,"' both the rest of the opinion and the appellant briefing indicate that the court was referring to products that Issuers determine are "not 'DRC conflict free.'" See id. at n. 8; see also Opening Brief for Appellant at 52, National Association of Manufacturers, NO. 1:13-cv-00635 (D.C. Cir. April 14, 2014).
7 See id. at 17.
8 Opening Brief for Appellant at 53, National Association of Manufacturers, NO. 1:13-cv-00635 (D.C. Cir. April 14, 2014).
9 See National Association of Manufacturers, NO. 1:13-cv-00635 at 20.
10 See id. at 21.
11 See id. at 22-23.
12 See id. at 16, 22.
13 See id. at 22.
14 It is too early to know if the Commission will appeal the ruling, but if the Commission is consistent with what it did following this same court's previous ruling on the Dodd-Frank Section 1504 final rule, which put the provisions of that rule in question, it will not challenge this conflicts minerals rule opinion. It also currently seems unlikely that the plaintiffs in this case will appeal those parts of the ruling that rejected their other challenges to the Rule. However, the Commission can most probably be expected to publish additional guidance prior to the May 31, 2014 deadline, may still extend the deadline, or, if not, can certainly be expected to ultimately revise the Rule to be consistent with the court's opinion in NAM, assuming no further appeal challenges.
15 See footnote 14 herein.
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