by Jeff Schwartz
The Dodd-Frank Act transformed the SEC and securities regulation into tools of global justice. Although the statute was principally concerned with reregulating the financial industry in the wake of the 2008 economic collapse, it also took on broader social issues. Section 1502 of the Act is perhaps the most important and controversial example. This provision required the SEC to draft securities regulations mandating that companies disclose, among other things, the use of conflict minerals that originate from the Democratic Republic of the Congo or the surrounding region.
This mandate goes against the grain of securities law. Such regulations are generally aimed at investor protection, whereas this addition has clearly humanitarian ambitions. As the statute itself explains, the conflict minerals rule was inspired by Congress’s belief “that the exploitation and trade of conflict minerals originating in the Democratic Republic of the Congo is helping to finance conflict characterized by extreme levels of violence in the eastern Democratic Republic of the Congo, particularly sexual- and gender-based violence, and contributing to an emergency humanitarian situation therein.”
Despite questions about institutional competence, the SEC gamely took on the challenge of writing the regulations. Several months after Dodd-Frank, the agency issued proposed rules on conflict minerals, and in August 2012, the agency issued its final rules.
As widely anticipated, its efforts were challenged in court soon thereafter. The plaintiffs (the National Association of Manufacturers, the U.S. Chamber of Commerce, and the Business Roundtable) originally brought suit in the D.C. Circuit, but transferred the case to the District Court, when, in an analogous case, the circuit court ruled that it lacked original jurisdiction over such claims.
This summer the District Court for the District of Columbia upheld the regulations. In doing so, it rejected three primary objections. First, the plaintiffs claimed that the SEC violated the Securities Exchange Act of 1934 in failing to adequately consider the costs and benefits of the rules.
The court responded that such an analysis was not required. According to the court, the agency is required to consider the effect of its rules on the functioning of capital markets. Namely, the Commission must consider how a rule would impact “efficiency, competition, and capital formation.” The SEC’s analysis need not, however, include a wide-ranging cost-benefits calculus.
The court distinguished prior cases, where SEC rules had been struck down, as hinging upon the agency’s failure to adequately consider economic implications—something the SEC must do to assess how its rules would impact the market. In contrast, the claim here was that the agency failed to consider the extent of the humanitarian benefits that would flow from the conflict-mineral disclosures. In the court’s words, “no statutory directive obligated the Commission to … independently confirm that the Final Rule[s] would actually achieve” Congress’s humanitarian goals.
Plaintiffs also took issue with the SEC’s failure to include a de minimis exception. Because this claim challenged the SEC’s interpretation of Dodd-Frank, the court conducted a Chevron analysis to address it. The court, in the end, upheld the agency’s reading of the statute— “that it possessed discretion to determine whether a de minimis exception was appropriate.” Building on this holding, the court looked at the SEC’s exercise of such discretion. According to the court, the SEC’s decision to not provide a de minimis carve-out survived scrutiny under the Administrative Procedure Act, because it was not “arbitrary or unreasonable.”
Finally, plaintiffs challenged the rules under the First Amendment. In particular, they decried the requirement that companies post conflict-minerals disclosures on their websites.
Because of the commercial nature of the compelled speech at issue, the court applied intermediate scrutiny to this mandate. This approach requires that the challenged rules involve a substantial government interest, directly advance that interest, and represent a reasonable fit between means and ends.
Plaintiffs acknowledged that promoting peace in the Congo region was a substantial government interest, but challenged the latter two prongs of the test. One argument was based on the lack of empirical support for the notion that the new rules would directly aid peace efforts. The court, though, was unsympathetic. It reasoned that empirical evidence was unnecessary in the foreign-relations context. In this arena, rules only need be based on “informed judgment,” and this was shown here.
With regard to fit, the plaintiffs argued that compelling companies to disclose on their websites when products are not “conflict free” creates an “unfair stigma.” In rejecting their claim, the court noted that this would not be a stand-alone disclosure, but would be included in the mandated Conflict Minerals Report, where it could be accompanied by clarifying information.
The court’s decision is a clear victory for proponents of the conflict minerals rules. The celebration may be short-lived, though, for the ruling has already been appealed to the D.C. Circuit, and the appeal has been granted an expedited review. This circuit has struck down SEC rulemaking in the recent past, so a supportive ruling is far from assured.
The timing of all of this leaves us in a strange place. The first compliance deadline is May 31, 2014. Given the complexity of the rules, and uncertainty with regard to when a circuit-court decision will ultimately be issued, companies cannot take a wait-and-see approach to compliance. This means we may be left with the worst of both worlds. If the D.C. Circuit does overrule the SEC’s work before next May, companies may end up making a good portion of the expenditures they hope so desperately to avoid, while the transparency that human-rights groups seek remains elusive.
Jeff Schwartz is an Associate Professor of Law at the University of Utah S.J. Quinney College of Law. He received his undergraduate degree, summa cum laude, from the University of California, Los Angeles, and his law degree, Order of the Coif, from the University of California, Berkeley. His research centers on securities law, investment-management regulation, and retirement policy, with a special focus on how social science and political philosophy inform regulatory analysis.