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Friday
Dec072012

Legal Challenges to the Conflict Minerals Regulation

On November 21, 2012, the National Association of Manufacturers, together with the Chamber of Commerce of the United States and Business Roundtable (“Challengers”) filed in the U.S. District Court for the District of Columbia a preliminary statement of issues as part of its suit seeking to bar implementation of conflict minerals regulation (the “Rule”). Those regulations, adopted by a 3-2 vote of the SEC require public companies to disclose annually whether any "conflict minerals" that are "necessary to the functionality or production of a product" manufactured by the company originated in the DRC or an adjoining country (referred to as the "covered countries"). "Conflict minerals" refers to gold, tin, tungsten and tantalum – which are used in a wide variety of products.  For a more in-depth discussion of these regulations, go here.  

The preliminary statement identified the following issues:

  • Whether the SEC's economic analysis of Rule 13p-1 and Form SD is inadequate;
  • Whether the SEC's refusal to adopt a de minimus exception to Rule 13p-1 is erroneous, arbitrary and capricious, or an abuse of discretion;
  • Whether the SEC's interpretation of Exchange Act §13(p) as including non-manufacturers who "contract to manufacture" products is erroneous, arbitrary and capricious, or an abuse of discretion;
  • Whether the SEC's interpretation of "did originate" in Exchange Act §13(p) as "reason to believe . . . may have originated" is erroneous, arbitrary and capricious, or an abuse of discretion;
  • Whether the standard and requirements imposed by Rule 13p-1 's "reasonable country of origin inquiry" are erroneous, arbitrary and capricious, or an abuse of discretion;
  • Whether the structure of the transition period established by the rule is erroneous, arbitrary and capricious, or an abuse of discretion;
  • Whether Exchange Act §13(p) compels speech in violation of the First Amendment;
  • Whether the SEC otherwise acted in a manner that was arbitrary and capricious, an abuse of discretion, unlawful, or contrary to a constitutional right within the meaning of the Administrative Procedure Act or other applicable law in adopting Rule 13p-1 and Form SD.

Challengers also moved for and were granted expedited consideration of their petition, claiming that “the delay will cause irreparable injury and…the decision under review is subject to substantial challenge....”  USCA Case #12-1422, Document #1406293 Filed:  11/21/2012.  Challengers identify irreparable injury stemming from the “extraordinary costs” implementation of the Rule will impose upon them given the difficulty of determining country of origin and other matters relevant to compliance.  This claim has anecdotal support in statements given at a general session panel of controllers at the Financial Executive International annual Current Financial Reporting Issues Conference.  For instance, Stephen Cosgrove, the Controller of Johnson & Johnson said that his firm had been trying to gather the information required by the Rule for months but has had difficulty.  “[I]t’s clear to me that the kind of process they were getting would get you approximate data, but not up to the standard of what you would need to be able to certify to the SEC.” (BNA Corporate Counsel Weekly, http://news.bna.comccln/display/batch_print_display.adp )

Challengers acknowledge that companies will have to incur some portion of the Rule’s costs while the litigation is being heard because the first compliance period begins earlier than the litigation could be completed.  However, they assert that under their proposed expedited review schedule, briefing would conclude in March of 2013, greatly increasing the possibility that the case can be decided before the end of 2013.  Challengers claim that this would enable the "challenge to the Rule [to] be resolved well before the first disclosures and reports under the Rule would be due, in May of 2014, and preferably before the start of the Rule's second compliance period, in January of 2014. If Petitioners' challenge is successful, expedited consideration would help Petitioners avoid the astronomical costs of finalizing compliance infrastructure, preparing disclosures, preparing and obtaining private sector audits of reports, and beginning a second year of compliance."

Clearly hoping to replicate the success Business Roundtable had with their challenge to proxy access,) Business Roundtable and Chamber of Commerce of the United States of America v. SEC. --- F.3d ----, 2011 WL 2936808 (C.A.D.C.)) Challengers focus in their motion for expedited consideration on errors in the SEC’s economic analysis of the Rule, claiming that  that the SEC "never estimated the benefits of the Rule and even acknowledged that there might be no benefits at all.” In addition, they claim that the SEC misinterpreted Section 1502 (the section of Dodd-Frank pursuant to which the Rule was promulgated) by wrongly concluding, among other things, that the statutory text left it no authority to create a de minimus exception despite its general exemptive authority and wrongly interpreting the term ‘manufacture' as including those who ‘contract to manufacture.’  Finally, Challengers assert that the Act compels speech in violation of the First Amendment by forcing companies to state that certain of their products are not ‘DRC conflict free.'"

It is of course impossible to predict the final outcome of the challenge to the Rule. The enormous costs imposed by the Rule –initially estimated by SEC staffers at $71 million and later revised upward to $3 billion to $4 billion for initial compliance and $206 to $609 million for annual compliance, the fact that the Rule passed on a 3-2 vote and the fact the challenge is being heard in the DC Circuit Court and involves Business Roundtable as a petitioner suggest it has some chance of success.  That must be balanced however with the recent increase in violence in and corresponding international attention being paid to the DRC.  If advocates of the Rule can make the case that the disclosure sought by the Rule would truly help to mitigate the dire conditions in the DRC they may make the case for the Rule to be upheld.

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