D.C. Circuit Ruling on Industry Challenge and New SEC (Securities and Exchange Commission) Conflict Minerals Disclosure Guidance
Companies preparing to comply with the Securities and Exchange Commission’s (“SEC”) conflict minerals due diligence and disclosure requirements by May 31st will need to assess several breaking developments impacting company reporting obligations under Section 1502 of Dodd-Frank and the SEC’s Conflict Minerals Rule.
On April 14, 2014, the U.S. Court of Appeals for the D.C. Circuit ruled on the industry group challenge to the Conflict Minerals Rule, affirming the Rule in large part and vacating one important reporting requirement on First Amendment grounds.
On April 7, 2014, the SEC released new guidance on conflict minerals reporting requirements in the form of additional questions and answers provided in the SEC’s Frequently Asked Questions (“FAQ”) document.
Recent D.C. Circuit Decision
In July 2013, Judge Robert Wilkins of the D.C. Federal District Court rejected each of the challenges that several industry groups brought against the Conflict Minerals Rule, holding that the SEC did not act arbitrarily and capriciously in crafting the Rule and that the Rule did not violate the First Amendment. Industry groups then filed a timely appeal to the D.C. Circuit Court of Appeals.
On appeal, the D.C. Circuit largely upheld the District Court ruling and many of the key components of the Conflict Minerals Rule, including the SEC’s decision not to adopt a de minimis exception, the Rule’s threshold for due diligence, the inclusion of issuers that “contract to manufacture,” and the Rule’s transition period for products found to be “DRC conflict undeterminable.”
However, the D.C. Circuit held that the Rule’s requirement that issuers report to the SEC and state on their website that any of their products have “not been found to be ‘DRC conflict free’” violates the First Amendment. The opinion states that “[p]roducts and minerals do not fight conflicts,” and that “the label ‘conflict free’ is a metaphor that conveys moral responsibility for the Congo war.” In a footnote to the decision, the Court indicated that the requirement to use the particular descriptor “not been found to be ‘DRC conflict free’” may have arisen as the result of the SEC’s discretionary choices and not by virtue of the statute itself. The implications of the decision with respect to Dodd-Frank Section 1502 are therefore not yet clear and may be a subject of review upon remand.
Currently, the Rule remains in effect until the Court’s mandate formalizing the decision is issued, which may take a week or months depending on whether any petitions for rehearing or rehearing en banc are filed. Any such petitions would need to be filed within 45 days, and after the time for a petition for rehearing expires (or if the petition is rejected), the case will be remanded to the lower court for further proceedings. Either party (or intervenor Amnesty International) may petition the Supreme Court for certiorari now or after the disposition of any petitions for rehearing.
In the meantime, it is possible that the industry groups could file a motion with the D.C. Circuit to stay the Rule or negotiate a resolution to change certain portions of the Rule or extend the reporting deadline with the SEC. Alternatively, the SEC could issue guidance independently or begin a process to revise the Conflict Minerals Rule.
New SEC Conflict Minerals Guidance
The SEC also recently released new guidance on the conflict minerals disclosure requirements under the Conflict Minerals Rule. The guidance was issued in the form of nine additional questions and answers in the SEC’s Frequently Asked Questions document (Questions 13-21), available here.
The guidance addresses several issues in the Conflict Minerals Rule that had been subject to discussion and interpretation among stakeholders, including when issuers must describe products as having “not been found to be ‘DRC conflict free’” or when the option to describe products as “DRC conflict undeterminable” is available, when the requirement to obtain an independent private sector audit (“IPSA”) is triggered, the scope of the IPSA, and the content of the Conflict Minerals Report. In light of the recent court decision, however, it is likely that the SEC will need to retract or modify the portions of this guidance that relate to the requirement to describe products as having “not been found to be ‘DRC conflict free.’”
The guidance includes the following noteworthy clarifications by the SEC:
If an issuer has any products that are described as “DRC conflict undeterminable,” the issuer is not required to obtain an IPSA during the transition period unless it describes any of its other products in the Conflict Minerals Report as “DRC conflict free.” See FAQs 14 and 15. According to the SEC, an issuer is not required to describe “DRC Conflict Free” products in the Conflict Minerals Report. However, if an issuer chooses to describe “DRC conflict free” products in the Conflict Minerals Report, the requirement to obtain an IPSA is triggered during the transition period even if other products are described as “DRC conflict undeterminable.”
If a product contains a combination of minerals that are “DRC conflict free” and “DRC conflict undeterminable” (i.e., the product contains some minerals for which issuer is unable to determine the origin or whether the minerals financed or benefited armed groups in the covered countries), the issuer may not describe that product as “DRC conflict free.” See FAQ 16.
The IPSA is not required to evaluate the completeness or reasonableness of due diligence measures undertaken by the issuer. Instead, the IPSA scope is limited to: (1) whether the issuer’s due diligence measures conformed, in all material respects, to the criteria set out in the nationally or internationally recognized due diligence framework; and (2) whether the issuer’s description of the due diligence measures it performed (as set forth in the Conflict Minerals Report) were consistent with the due diligence measures the issuer undertook. See FAQ 17.
The IPSA is not required to include the issuer’s reasonable country of origin inquiry, notwithstanding that the nationally or internationally recognized due diligence framework used by an issuer may contain procedures for obtaining information about mineral origin. Instead, the auditor should opine only on whether the design of the issuer’s due diligence framework is in accordance with the portion of the nationally or internationally recognized due diligence framework beginning after the country of origin determination, and on whether the issuer actually performed due diligence measures described in the report after the issuer determined it had reason to believe its conflict minerals may have originated in the covered countries. SeeFAQ 18.
Issuers are not required to include in the Conflict Minerals Report a full description of the design of their due diligence measures, notwithstanding the fact that the IPSA will evaluate whether the design is in conformity, in all material respects, with the nationally or internationally recognized due diligence framework. Instead, issuers must describe only the due diligence measures that were actually undertaken and that are the subject of the second part of the IPSA. See FAQ 21.