SEC Prevails In Lawsuit Challenging Conflict Mineral Rules

SEC Prevails In Lawsuit Challenging Conflict Mineral Rules

Section 1502 of Dodd-Frank directed the SEC to develop and issue rules requiring increased transparency regarding the use of “conflict minerals” from the Democratic Republic of the Congo or DRC and its neighboring countries. The directive is based on the notion that the “exploitation and trade of conflict minerals originating in the [DRC] is helping to finance conflict characterized by extreme levels of violence in the eastern [DRC], particularly sexual and gender-based violence, and contributing to an emergency humanitarian situation.” The provision thus requires companies to disclose annually to the SEC if the minerals in their products “originated or may have originated in Congo” to help ensure activities involving such minerals do not finance or benefit armed groups. If so, then the company must file an additional report with the SEC with a description of the products manufactured using the minerals.

The Commission developed rules which require issuers to conduct a “reasonable country of origin inquiry” regarding their conflict minerals. If, after the inquiry, the company determines that its conflict minerals did not originate in the covered countries, the issuer must disclose that conclusion to the SEC along with its predicate. If the issuer concludes that the conflict minerals did originate for a covered country – or if it cannot make that determination – a report must be prepared and filed with the agency. The rule does not require any label to be affixed to products manufactured with conflict minerals.

Plaintiffs challenged the validity of the rules, asserting two key claims. First, they challenge the rules under the Administrative Procedure Act. Second, they argue that the rules violate the First Amendment. The Court rejected both.

First, the Commission’s rules do not violate the APA, according to the court. On this issue the test is whether the action of the agency is arbitrary, capricious, and an abuse of discretion. When, however, the issue turns on an agency interpretation of the statute the two part Chevron deference test is applied.

Here, plaintiffs contend that the SEC failed to analyze properly the costs and benefits of the rules as required by the Exchange Act. Yet Sections 3(f) and 23(a)(2) of that Act do not mandate the type of analysis Plaintiff’s claim. Under those provisions the only obligation of the SEC is to consider the impact that a rule or regulation may have on various economic related factors. While the Commission may consider a variety of economic factors “there is no statutory support for Plaintiffs’ argument that the Commission was required to evaluate whether the Conflict Minerals Rule would actually achieve the social benefits Congress envisioned,” the Court concluded. This point distinguishes this case from those relied on by Plaintiffs where the SEC, in promulgating other rules, did not conduct an adequate economic analysis.

Likewise, Plaintiff’s contention that the Commission wrongly failed to implement any type of de minimis exception is incorrect. Here, the SEC is entitled to deference under Chevron since the question is one of statutory interpretation. Viewed in this context “the Court has no trouble concluding that the SEC’s interpretation – that it possessed discretion to determine whether a de minimis exception was appropriate – was permissible. Indeed, this is the very interpretation Plaintiffs themselves champion. The Court thus rejected the challenge.

The Court also rejected Plaintiffs claim that the rules were overly broad because they required due diligence and reports not just when there is reason to believe the minerals did originate in the region, but also whenever there is “reason to believe the minerals may have originated” in the region. In this provision the SEC simply exercised its interpretative authority the Court concluded to “gap-fill this silence . . .” in the statute left by Congress.

Similarly, the Court rejected a claim that the Rule was overbroad because it covered not just those who manufacture but also those who contract to manufacture. Again “the Court is convinced that the Rule’s application . . . is an amply reasonable construction of Section 1502.”

Finally, the Court concluded that Plaintiff’s constitutional claim was without merit. Here, plaintiffs clamed the rules contravene the First Amendment because they require that issuers make public disclosure of the information about their use of conflict minerals on their website. The test here is one of “intermediate scrutiny” which focuses on whether the asserted governmental interest is substantial, the regulation directly advances that interest and the fit between the ends and the means chosen to accomplish those ends is it reasonable. In this regard the Court concluded that “the conflict minerals disclosure scheme directly advances the interest of Congress “in promoting peace and security in and around the DRC.” And, in any event, the disclosure required is only that the issuer make available on its website the materials filed with the SEC.

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