Monday, January 13, 2014

SEC Defends Regulations Implementing Conflict Minerals Provisions of Dodd-Frank Sec. 1502 in DC Circuit Oral Argument

The DC Circuit court of appeals heard oral argument in a case posing a challenge to the SEC regulations implementing the conflict minerals provisions of the Dodd-Frank Act. The regulations are being challenged by a business consortium composed of the National Association of Manufactures, Chamber of Commerce, and Business Roundtable. Section 1502 of the Dodd-Frank Act directs the Commission to issue rules requiring companies to disclose their use of conflict minerals if those minerals are necessary to the functionality or production of a product manufactured by those companies. Under the Act, those minerals include tantalum, tin, gold or tungsten. The argument was heard before a three-judge panel composed of Circuit Judge Srinivasan, Senior Circuit Judge Sentelle, and Senior Circuit Judge Randolph. Peter Keisler argued for the business coalition, while Tracey Hardin argued for the SEC.

Under the final regulations, a company that uses any of the designated minerals would be required to conduct a reasonable good faith country of origin inquiry reasonably designed to determine whether any of its minerals originated in the covered countries or are from scrap or recycled sources. If the inquiry determines that the company knows that the minerals did not originate in the covered countries or are from scrap or recycled sources or the company has no reason to believe that the minerals may have originated in the covered countries and may not be from scrap or recycled sources, then the company must disclose its determination, provide a brief description of the inquiry it undertook and the results of the inquiry on new Form SD filed with the Commission.

The company also would be required to make its description publicly available on its Internet website and provide the Internet address of that site in the Form SD. Under the final regulation, companies that are required to file a Conflict Minerals Report would have to exercise due diligence on the source and chain of custody of their conflict minerals.

The final regulations became effective on November 13, 2012, and the first reports and disclosures it requires are due to be filed with the SEC by May 31, 2014. Ultimately, the Commission declined to adopt any categorical de minimis exception as part of the final rules.

Peter Keisler, counsel for the business group, argued that the SEC has misconstrued the statute. The Commission greatly magnified the cost of the statute by misconstruing Section 1502 and rewriting a crucial standard. Section 1502 uses the language conflict minerals that did originate in the Democratic Republic of the Congo, while the SEC regulations use may have originated. The SEC changed did to may, said counsel. Section 1502 says you have to file a conflict minerals report if the conflict minerals did originate in the DRC, he continued, while the SEC rules say may have originated. Thus, he argued that the mere possibility could trigger may have originated.

Mr. Keisler also contended that a de minimis exception is particularly compelling here, where the application of the rules can impose massive costs without achieving the desired objective, but the SEC said that any de minimis exception would be contrary to the legislative intent. Congress authorized the SEC to grant a de minimis exception, the business coalition advocate noted, and this area cries out for a de minimis exception.

However, on questioning from Senior Circuit Judge Sentelle, counsel conceded that there is no reported case striking down an agency regulation for not including a de minimis exception.

Senior Circuit Judge Randolph pointed out the SEC’s conclusion that small uses of these minerals could be significant. Mr. Keisler argued for a per company de minimis exception as a good solution.

This is a shaming statute, emphasized Mr. Keisler, a ``scarlet letter’’ designed to impact a broader debate. Circuit Judge Srivanasan noted that as a result of the statute, investors are getting information about the company about which they are thinking of investing in.

Tracey Hardin for the SEC noted that the SEC had to make discretionary decisions when implementing Section 1502, adding that the Commission exercised a reasonable interpretation of the statute. The SEC’s reporting trigger is not contrary to the terms of the statute, she said, contending that there is nothing unreasonable about the SEC’s interpretation. The may have originate language triggers an obligation to move on to due diligence.

Section 1502 was silent on how a company determines that its minerals originated in a conflict jurisdiction.

Senior Circuit Judge Sentelle noted that the website posting required by the SEC regulations is a regulation of speech and should not go beyond a statutory requirement just because the Commission thinks Congress wanted this. This is compelled speech.

On Senior Circuit Judge Randolph query on the statutory objective, Ms. Hardin said that the objective of Section 1502 is to promote peace and security in the DRC. It is to increase public awareness of the use of conflict minerals. He questioned how website disclosure would help decrease the use of conflict minerals. Responding to a question on how the SEC will enforce the conflict minerals regulations, SEC counsel said that disclosures will be periodically reviewed. There would be a Rule 10b-5 requirement.

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