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June 03, 2013 Articles

Business Groups Assert Conflict with SEC's Conflict Minerals Rule

A significant segment of U.S. business anxiously awaits the D.C. Circuit's decision.

By Reagan E. Bradford – June 3, 2013

Beginning in the 1990s, the Democratic Republic of the Congo (DRC) has endured one of the deadliest conflicts of the modern era, including “some of the world’s worst human rights atrocities.” Democratic Republic of the Congo Relief, Security, and Democracy Promotion Act of 2006, PL 109-456, § 101(5). By many accounts, the ongoing and deadly conflict is perpetuated by the illegal development and export of the considerable mineral resources in the DRC, including tin, tantalum, tungsten, and gold (conflict minerals). According to the U.S. Department of State, the “[c]landestine trade in minerals and other natural resources facilitate[s] the purchase of small arms to commit abuses and reduce[s] government revenues needed for increasing security and rebuilding the country.” U.S. Department of State, 2011 Human Rights Report for the DRC 15. In response to this continuing crisis, the United States has, among other efforts, enacted legislation providing hundreds of millions of dollars to DRC for humanitarian aid and other assistance.

Most recently, section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 charges the Securities and Exchange Commission (SEC) with issuing a rule requiring publicly traded firms “to disclose annually” whether “conflict minerals [that] are necessary to the functionality or production of a product manufactured” by the firm “did originate in [the DRC] or an adjoining country.” Pub. L. No. 111-203, § 1502, 124 Stat. 1376, 2213–18 (2010) (codified in relevant part at 15 U.S.C. § 78m(p)). If a firm falls within these requirements, it must publicly report “the measures taken by the person to exercise due diligence on the source and chain of custody of such minerals, which measures shall include an independent private sector audit.” In addition, the firm must describe “the facilities used to process the conflict minerals, the country of origin of the conflict minerals, . . . the efforts to determine the mine or location of origin with the greatest possible specificity,” and the products that “are not DRC conflict free.”

Following a contentious rulemaking process, which included over 13,000 comments, on August 22, 2012, the SEC promulgated a final rule for section 1502 of Dodd-Frank in a 3–2 decision (Conflict Minerals Rule). See 77 F.R. 56,334. Therein, the SEC outlined a complex process aimed at “compelling social benefits” to “decrease the conflict and violence in the DRC” and “to reduce the amount of money provided to armed groups.” In fact, the Conflict Minerals Rule includes a “Flowchart Summary of the Final Rule,” which depicts the multifaceted procedure for compliance.

By the SEC’s calculation, initial compliance will cost $3 to $4 billion, with continued compliance costing an additional $200 to $600 million per year. Not surprisingly, shortly after adoption of the Conflict Minerals Rule, several well-known business groups asserted legal challenges in federal court to the Conflict Minerals Rule.

On October 22, 2012, the National Association of Manufacturers (NAM), the Chamber of Commerce of the United States of America, and the Business Roundtable (BRT) filed their amended petition for review in the U.S. Court of Appeals for the District of Columbia Circuit seeking to modify or void the Conflict Minerals Rule. To say that the petitioners represent a significant segment of U.S. business would be an understatement: NAM is the nation’s largest industrial-trade association; the Chamber of Commerce directly represents 300,000 members and indirectly represents an underlying membership of more than three million businesses; and BRT is an association of chief executive officers of leading U.S. companies with more than $7.3 trillion in annual revenues and nearly 16 million employees, its membership composing nearly a third of the total value of the U.S. stock market.

The petitioners filed their opening brief on January 16, 2013, asserting essentially three objections to the Conflict Minerals Rule: (1) The SEC failed to meet its statutory obligations to consider the effects of the Conflict Minerals Rule; (2) the SEC misinterpreted section 1502 of Dodd-Frank and arbitrarily rejected alternatives that would have significantly reduced costs; (3) section 1502 of Dodd-Frank compels speech in violation of the First Amendment. The SEC filed its initial brief on March 1, 2013, challenging each of the objections raised by the petitioners. The legal challenge by the petitioners has drawn numerous amicus curiae filings; however, the scope of this article will analyze the points made by the petitioners and the SEC in their initial briefs.

Claim: The SEC failed to Meet Its Statutory Obligations 
The petitioners first argue that the SEC failed to meet its statutory obligations when considering the effects of the Conflict Minerals Rule. The SEC “has a unique obligation” pursuant to 15 U.S.C. § 78c(f) “to consider the effect of a new rule upon ‘efficiency, competition, and capital formation,’” as well as a unique duty under 15 U.S.C. § 78w(a)(2) not to approve any “rule or regulation which would impose a burden on competition not necessary or appropriate in furtherance of the purposes of this chapter.” Bus. Roundtable v. SEC, 647 F.3d 1144, 1148 (D.C. Circ. 2011). The petitioners claim that while acknowledging a multi-billion-dollar price tag for implementation, the SEC did not determine that the Conflict Minerals Rule would have any benefits, and, in fact, moved forward despite evidence that it could be counterproductive to helping the DRC.

Congress intended section 1502 of Dodd-Frank to achieve two benefits: (1) “to decrease the conflict and violence in the DRC” and (2) “to reduce the amount of money provided to armed groups.” 77 F.R. 56,335; see section 1502(a), (c)1) of Dodd-Frank. The petitioners assert that the SEC made no determination that the Conflict Minerals Rule would achieve those benefits and that the SEC conceded as much by stating that “we are unable to readily quantify [the benefits] with any precision both because we do not have the data to quantify the benefits and because we are not able to assess how effective Section 1502 will be in achieving those benefits.” 77 F.R. 56,335, 56,350. To support this point, the petitioners also quote extensively from the two SEC commissioners (Paredes and Gallagher) who dissented to the adoption of the Conflict Minerals Rule. Commissioner Paredes noted that “[t]he best of intentions cannot substitute for a rigorous analysis by this agency of whether the social benefits that section 1502 strives for are likely to be realized by the final rule,” and that the SEC “has no expertise when it comes to the humanitarian goal of ending the atrocities that besiege the DRC.” He further stated that the SEC’s lack of expertise “does not excuse the [SEC] from its statutory obligation to determine as best it can the economic implications of the rule it has proposed.” Commissioner Gallagher concluded that the SEC erred by promulgating the Conflict Minerals Rule “with no empirically founded sense of what the particular benefits are as compared to the significant, identifiable costs.”

Indeed, the petitioners point to numerous comments received by the SEC that described how the anticipated final rule was already causing negative impacts in the DRC. Commenters, which included non-profit organizations, DRC mining cooperatives, and DRC industry groups, stated that with “[e]ach passing day children die from lack of food and medicines,” and that “we can confirm today that as expected” there is “more smuggling,” a very big decrease in revenue,” and a “huge impact” on the innocent Congolese population. According to the petitioners, these effects are taking place because the Conflict Minerals Rule created a de facto embargo on the significant minerals of the DRC.

The petitioners also contend that the SEC underestimated the Conflict Minerals Rule’s costs and further increased the costs without corresponding benefits. With regard to implementation and compliance costs, the SEC received numerous comments. Tulane University estimated initial costs to be $7.93 billion, exclusive of upstream costs. The NAM commented that the initial cost will be between $9 and $16 billion. The SEC disregarded these comments because there were other cost estimates that were lower; however, the SEC did note that “the cost of compliance . . . will be borne by the shareholders,” possibly “divert[ing] capital away from other productive opportunities.” 77 F.R. 56,350.

The SEC rejects these arguments entirely, contending that the petitioners have misconstrued the SEC’s obligations, requiring it to “second-guess the wisdom of Congress’s determination that conflict minerals disclosure will yield social benefits in the form of decreasing conflict and violence in the DRC.” Instead, the SEC urges that its economic analysis is limited to the “degree to which its rule furthered [the] disclosure regime and the benefit of its rule to issuers and users of the information.” (Emphasis added.) Acknowledging that the comments were “decidedly mixed” on the Conflict Minerals Rule’s potential for successfully changing the situation on the ground in the DRC, the SEC highlighted that “Congress chose a side in this debate by enacting Section 1502” and the SEC “reasonably determined not to second-guess Congress’s judgment, but rather design[ed] a rule to help achieve the intended humanitarian benefits in the way that Congress directed.”

Finally, with regard to cost assessment, the SEC asserted that, although largely a qualitative assessment, the SEC fully complied with the Administrative Procedures Act when weighing the costs of the Conflict Minerals Rule. According to the SEC, the fact that it received comments that suggested that higher costs were possible does not render the final rule arbitrary, especially in light of the fact that it relied upon a “mid-level estimate” among all comments.

Claim: The SEC Misinterpreted Section 1502 
The petitioners’ second challenge centers upon the way in which the SEC interpreted section 1502 when promulgating the Conflict Minerals Rule. The petitioners identify four misinterpretations of section 1502 of Dodd-Frank: (1) The SEC misinterpreted section 1502 as precluding a de minimis exception; (2) the Conflict Minerals Rule’s “reasonable country of origin inquiry” is contrary to section 1502; (3) the Conflict Minerals Rule’s inclusion of non-manufacturers is contrary to section 1502; (4) the SEC’s phase-in period is arbitrary and capricious.

The lack of a de minimis exception is a “fundamental flaw in the rule,” according to the petitioners. Without one, “even minute or trace amounts of a conflict mineral could trigger disclosure obligations.” 77 F.R. 56,298. As an example, the petitioners noted that the plastic used in shoes can contain minute amounts of tin, thus requiring disclosure in a context that is unlikely to have any effect on the DRC. The SEC forcefully rebuts this argument, explaining that “[t]he co-sponsors of Section 1502 made this very point in a comment letter, writing that they ‘carefully considered,’ but ‘intentionally’ decided not to include a de minimisexception, instead using the ‘necessary to the functionality or production’ language to limit the scope of the disclosure requirement.”

As to the reasonable-country-of-origin inquiry, the petitioners take exception to a section they claim requires companies to file a report and conduct an audit when their business has a reason to believe that their minerals “may have originated” in the region. The SEC suggests that the petitioners have misinterpreted the Conflict Minerals Rule because if a company can conclude that its minerals “did not” originate from the covered area, no report or audit is required. According to the SEC, “[a] report is required only if an issuer encountered a red flag during its reasonable country of origin inquiry and its due diligence does not reveal the source of its materials.”

Section 1502 expressly applies to a company if “conflict minerals are necessary to the functionality or production of a product manufactured by” that company. 15 U.S.C. § 78m(p)(2)(B) (emphasis added). The petitioners contend that this statutory language should have precluded application to non-manufacturers and the SEC exceeded its authority by requiring disclosure of companies who contract for the manufacture of products. The SEC refutes this point through statutory construction. The SEC points out that section 1502 also requires issuers that must file a Conflict Minerals Report to describe their “products manufactured or contracted to be manufactured that are not DRC conflict free.” The SEC emphasizes the words “or contracted to be manufactured,” arguing that the petitioners’ narrow construction renders these words meaningless, violating the basic tenet of statutory construction that each term must be given meaning.

Finally, the petitioners assert that the SEC’s use of differing phase-in periods for small companies (four years) and large companies (two years) was arbitrary and capricious. The SEC recognized that “many smaller companies are part of larger companies’ supply chains and would need to provide conflict minerals information so that the larger companies could meet their obligations under the rule.” 77 F.R. 56,361. This staggered phase-in period posed a problematic question to the petitioners: “If small companies cannot comply with the rule for four years, and large companies will have to rely on small companies to comply, how will large companies be able to comply in two years?” The SEC answers this question by again maintaining that the petitioners misread the rule. The SEC contends that the transition period “simply allows issuers whose reasonable country of origin inquiry and due diligence do not determine the source of their minerals to describe their products as ‘DRC conflict undeterminable’ and not audit their Conflict Minerals Report.” Thus, smaller companies will still be tracing their covered minerals, which should not inhibit larger companies from reporting on a shorter phase-in period.

Claim: Section 1502 Compels Speech in Violation of the First Amendment
Lastly, the petitioners seek to vacate the Conflict Minerals Rule on the ground that it runs afoul of the First Amendment. The petitioners argue that section 1502 is unconstitutional because it compels companies to publicly state on their websites and in SEC filings that its products are “not DRC conflict free.” According to Commissioner Gallagher’s dissent, this requirement is a “scarlet letter” that forces “a company to associate itself publicly with groups engaged in human rights violations” so as to “stigmatize the company and harm its business.” In addition, the petitioners claim it will be a false statement, as a company may be forced to make such a statement simply because it was unable to trace its supply chain to determine the minerals’ origins. A court will apply either a strict or intermediate scrutiny (for commercial speech) standard of judicial review in reviewing this First Amendment challenge, and the petitioners claim that the rule will fail both standards, as the compelled speech does not materially advance the government’s interest in helping the DRC conflict.

The SEC responded by noting that “mandatory disclosures of purely factual information have never been understood to ‘compel speech’ in violation of the First Amendment.” Additionally, the SEC observes that the disclosure requirement “applies only to issuers who know that their conflict minerals originated in the Covered Countries or had reason to believe that they did and have been unable to dispel that belief after two or four years of due diligence.” The final rule also changed the disclosure from “not DRC conflict free” to “not been found to be DRC conflict free,” and further allows companies to “add disclosure or clarification.” These facts, in the SEC’s view, dispel any concern of inaccurate disclosure.

With an undeniably worthy cause but undoubtedly high price tag at stake, it is not unexpected for there to be a strong debate on the wisdom and effectiveness of the Conflict Minerals Rule. The business community, Congress, the DRC, and many others will anxiously await the District of Columbia Circuit’s ultimate decision on the Conflict Minerals Rule and the process through which it was promulgated.


Keywords: energy litigation, conflict minerals, Frank-Dodd, oil, gas, SEC, rulemaking


Reagan E. Bradford is an attorney at Chesapeake Energy Corporation in Oklahoma City, Oklahoma.

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