The SEC isn’t backing down from the June 2, 2014 deadline that it imposed for initial compliance, despite a recent decision by the U.S. Court of Appeals for the D.C. Circuit that vacated a key provision of the rule.
SEC’s action was mandated by passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama in July 2010. It took the agency more than two years to come up with a rule that requires publicly traded companies to declare whether their products contain any amount of tantalum, tin, tungsten or gold sourced from mines in the Democratic Republic of the Congo that are controlled by armed gangs engaged in murder, rape and forced labor.
The original SEC rule required companies to undertake a country-of-origin inquiry, tracing the presence of any conflict minerals all the way back to the source. (Even the determination of country isn’t enough, though, since not every mine in the DRC is controlled by the gangs.) They would then have to issue annual reports stating whether their products were “DRC conflict-free,” “not found to be conflict-free,” or, during the initial stages of the SEC program, “conflict undeterminable.” The findings would have to be posted on the companies’ websites.
The D.C. Circuit struck down just one aspect of the SEC rule – the part that requires companies to state if their products are “not found to be conflict-free.” That would violate the First Amendment’s protection against compelled speech, the court said, interpreting the wording as “a metaphor that conveys moral responsibility for the Congo war.” Such a label could have a harmful effect on a company or brand’s reputation, it said.
The decision hasn’t stopped SEC from going ahead with the rest of its rule, requiring companies to show that they exercised due diligence in tracing the origin of their raw materials. For products that would have been classified as “conflict undeterminable” or “not found to be conflict-free,” they still must disclose the smelters or refiners employed, and country of origin of those materials. In addition, they must detail their efforts at determining the mine from which the minerals were sourced.
SEC noted that the court had “no First Amendment objection to any other aspect of the conflict minerals report or required disclosures.” It therefore denied a motion by the National Association of Manufacturers, U.S. Chamber of Commerce and Business Roundtable for a stay of the entire rule.
Exactly how companies can conform to the remaining portions of the rule is uncertain. “SEC is saying, ‘Give us the factual information you would have given us without attaching labels,’” says attorney Frank Murray, senior counsel with Foley & Lardner LLP. “But some of that was only required if you had made a determination that the label had already been assigned.
“Confusion is the operative keyword right now,” adds Murray. It’s unclear how companies can comply with the rule without being branded with the “scarlet letter” inherent in a finding of “not conflict-free” or even “undeterminable.”
SEC could have stopped at asking companies to report on their country-of-origin inquiries and due-diligence efforts, Murray says. By asking for additional information, based on a determination that a given product is not necessarily conflict-free, SEC appears to be forcing companies to make disclosures that could violate the spirit of the D.C. Circuit ruling.
At least two SEC commissioners took issue with the agency’s insistence on pushing ahead with enforcement of the rule. Daniel M. Gallagher and Michael S. Piwowar said in a statement that “disclosures about the due diligence process should not be seen as severable from the unconstitutional scarlet letter of not DRC conflict-free.”
By invalidating the entire rule, the two commissioners said, SEC would allow Congress to reconsider whether the Dodd-Frank provision “achieves the benefits that it was supposed to attain.” They suggested that the opposite is true – that the rule has been “profoundly counterproductive” because it has led to an embargo by importers on all minerals from the DRC, not just those from conflict mines. As a result, they said, an estimated one million legitimate miners “cannot sell their products up the supply chain to U.S. companies.”
NAM had asked the D.C. circuit to grant an emergency stay of the entire rule. But last week, the court refused to block SEC's June 2 deadline.
The conflict-minerals case is unusual in at least one respect. It represents a sharp departure from the mission of the SEC, whose disclosure requirements are usually meant to protect investors against misleading financial information. “This is probably the first major effort to try to address socially responsible sourcing within the U.S. through disclosures,” says Murray. “This is certainly outside the SEC’s area of expertise.”
Businesses aren’t off the hook, though. Barring a full stay from the court, the bulk of the SEC rule is still set to take effect on June 2. A group of investors promoting responsible sourcing, including Boston Common Asset Management and the Interfaith Center on Corporate Responsibility, called on affected businesses “to continue preparing the required disclosures, which remain essentially unaltered by the court’s opinion.”
The group said it was “troubled” by the court’s application of the First Amendment to the SEC rule. “If applied broadly,” it said, “this approach could block Congress from passing laws requiring disclosure of corporate information in the public interest. This outcome could have a potentially damaging impact on shareholder access to information that is fundamental to brand valuation and risk assessment.”
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