As Marcia just discussed, the D.C. Circuit recently issued its decision in its rehearing in National Association of Manufacturers v. SEC (“NAM”), and it once again held that neither the SEC nor Congress may require public companies to disclose whether they use in their products certain “conflict minerals” that originated in the Democratic Republic of Congo or adjoining countries. Marcia has a really important discussion of the question whether a disclosure requirement is even likely to be effective to accomplish Congress’s goals, but I also find the new opinion fascinating and fraught in its own right – and, incidentally, deeply disdainful toward the en banc opinion in American Meat Institute v. U.S. Department of Agriculture, 760 F.3d 18 (D.C. Cir. 2014) (“AMI”). Probably not coincidentally, neither of the two judges in the NAM majority were part of the en banc decision in AMI, because both have senior status (the third member of the NAM panel, Judge Srinivasan, was in the AMI majority, and dissented in NAM).
[More after the jump]
Acting pursuant to Dodd Frank’s mandate, the SEC promulgated its rule requiring conflict minerals disclosures on companies’ websites and in their SEC filings. But as Marcia pointed out, the SEC has never been a fan of the conflict mineral disclosure requirement, and essentially promulgated its rule under protest. The SEC’s position has always been that such disclosures do not benefit investors – indeed, the requirement was apparently included in Dodd Frank to shame companies publicly and drive consumer behavior, rather than to provide a guide to investor decisionmaking. For this reason, the SEC has openly stated that the conflict minerals rule is “different from the economic or investor protection benefits that our rules ordinarily strive to achieve” and not intended to “generate measurable, direct economic benefits to investors or issuers.” Instead, the SEC declared that the rule is “directed at achieving overall social benefits.” In fact, in its briefing defending the constitutionality of its rule before the DC Circuit, the SEC refused even to offer a justification for it, or explain how disclosure would provide any kind of benefit at all – it simply declared that Congress wanted the rule, and therefore the SEC’s assessment of its benefits was irrelevant.
The DC Circuit, via Judges Randolph and Sentelle, has now declared (for a second time) that the rule represents unconstitutional “compelled speech.”
The SEC’s begrudging constitutional defense of the rule rests on the Supreme Court’s decision in Zauderer v. Office of Disciplinary Counsel of Supreme Court, 471 U.S. 626 (1985). In that case, the Supreme Court held that the government may require sellers of products to include “factual and uncontroversial information” in their advertising, subject to a relaxed standard of review.
In its original NAM opinion, the DC Circuit rejected the argument that Zauderer applies to the conflict minerals rule, holding that Zauderer was limited to disclosures meant to prevent deception (which this rule clearly was not), and that conflict minerals disclosure is neither purely factual nor uncontroversial. As a result, the circuit held, the rule could only survive if it satisfied some form of heightened scrutiny – which the SEC failed to show.
After the NAM decision came down, the DC Circuit issued its en banc decision in AMI – in which Judges Randolph and Sentelle took no part – and held that Zauderer is not limited to compelled disclosures meant to prevent deception. Instead, Zauderer review is appropriate even for compelled disclosures that serve other government interests.
After AMI was decided, the NAM panel reconsidered the conflict minerals rule, to decide whether AMI changed anything.
Ultimately, the panel – via Judge Randolph, joined by Judge Sentelle – held that it did not. First, they expressed their extreme discomfort with AMI. Judge Randolph opened his opinion in NAM by reminding the reader that Justice White in Zauderer – speaking “with his customary precision” – said that its holding was limited to disclosures aimed at combatting deception. They described AMI as unclear and “puzzl[ing].” They admitted that they found “persuasive” the plaintiffs’ argument that a test based on whether a disclosure is “factual and uncontroversial” is both inconsistent with Zauderer and difficult to apply, yet they declared themselves “bound” by AMI’s holding to the contrary.
So, not big fans of AMI, basically.
With their disapproval of AMI thus established, they concluded that AMI is limited only to advertising and point of sale disclosures, and not to other forms of compelled speech.
The conflict mineral rule, they then held, does not count as advertising or a point of sale disclosure, and therefore may not be evaluated under Zauderer. Instead, the disclosure would have to satisfy either intermediate or strict scrutiny. But, the conflict minerals disclosure, which is obscure both with respect to its mechanism of operation and likely effectiveness, does not satisfy either standard of review. The court also reiterated its earlier holding that, even under Zauderer, the disclosure failed because it was neither purely factual nor uncontroversial.
What leaps out from this opinion is the holding that Zauderer applies only to advertising and point of sale disclosures, and that the conflict minerals rule does not count as either. Why? As far as I can tell, it’s because the SEC itself has admitted that the conflict mineral rule does not serve the goals of investor protection.
Well, that’s a holding that opens a whole can of worms. First and most obviously, most required SEC reports probably aren’t advertising or point of sale disclosures. I mean, proxy statements aren’t aimed at sales at all, and SEC filings aren’t distributed concurrently with trades. I can’t even imagine the chaos that would occur if all SEC disclosure requirements henceforth had to be justified under a heightened form of scrutiny.
But leaving that point aside, as numerous scholars have recently pointed out, there are lots of disclosure requirements that are only loosely tied to the goals of investor protection. Instead, many disclosure requirements might be justified as having an investor protection “hook,” but more likely are motivated by a desire for transparency in the operations of companies with a large economic footprint. See, e.g., Donald C. Langevoort & Robert B. Thompson, “Publicness” in Contemporary Securities Regulation after the JOBS Act, 101 Geo L.J. 337 (2013); Hillary A. Sale, The New ‘Public’ Corporation, 74 Law & Contemp. Probs. 137 (2011).
NAM, if allowed to stand, might require a revisiting of any number of disclosure requirements, from the requirement of disclosure of how diversity is considered in the selection of directors, 17 C.F.R. § 229.407(c)(2)(vi), to the new regulations regarding disclosure of CEO pay ratios.
The basic problem is that we may want businesses to operate with a certain degree of transparency simply as a general course, but we don’t actually have a Bureau In Charge of Making Corporations Disclose Stuff We Want to Know. So these requirements tend to get shunted to the SEC, even when there’s not much fit with the SEC’s mission of protecting investors and maintaining orderly markets. But see Cynthia A. Williams, The Securities and Exchange Commission and Corporate Social Transparency, 112 Harv. L. Rev. 1197 (1999) (arguing that the SEC has the authority to require disclosure simply in the public interest). And I suspect that even apart from the formal constraints of the First Amendment, there’s a bit of discomfort with openly requiring businesses to disclose information to the general public simply as a condition of doing business, rather than as a condition of selling securities. I.e., if disclosure is not rooted in its benefits to investors, there’s no reason it should be required only of companies that sell securities publicly, but the implications of that argument would be to dramatically expand disclosure requirements even to “private” companies, or at least to revamp the definitions of public and private so that they no longer exclusively rely on securities sales. The easier solution is to deny the dilemma exists, and find reasons to tie all disclosure requirements to the needs of investors.
Judge Srinivasan, writing in dissent in NAM, took a compromise approach – he justified the rule as providing useful information to investors (despite the SEC’s refusal to do so), but also justified the rule as providing information to consumers of the issuers’ products (unconcerned by whether such a purpose is within the SEC’s bailiwick, though, to be fair, for First Amendment purposes, why should it matter which agency promulgates the rule?).
In any event, the dissenting opinion of Judge Srinivasan, coupled with the majority’s open skepticism of AMI, suggests we’re not done with this yet.
Poor SEC. Trapped dying on a hill that it never wanted to climb in the first place.