On July 23, 2013, the US District Judge Robert Wilkins issued his opinion on the lawsuit filed by the National Association of Manufacturers (NAM) against the US Securities and Exchange Commission (SEC) seeking vacature of the regulation. The Court considered a number of issues and denied NAM’s suit on all counts.
The final regulation remains in effect as was adopted by the Commission on August 22, 2012.
Our summary of what we see as key matters and comments is below. Of course, since we are not attorneys, this is not a legal analysis, nor is it exhaustive.
A threshold issue that was repeated on several points is whether SEC had the discretion to make certain decisions or whether it was compelled by the language of the statute to interpret the requirements in a manner different from what the final regulation stated. In other words, was the SEC’s decision-making arbitrary and capricious. The Court held on all matters that the SEC had – and appropriately used – agency discretion to make key regulatory decisions, rather than being unambiguously compelled by Congress to make specific alternative decisions.
The five main “technical” topics addressed by the opinion are whether:
- The benefits of the regulation were adequately quantified or considered by SEC
- The cost estimates determined by SEC were inappropriately low
- SEC inappropriately denied establishing a de minimis threshold
- There is a valid distinction between whether materials “may have” originated or “did originate” in the Covered Countries
- Contract manufacturing is included under the umbrella of “manufacturing”
The case included another challenge based on First Amendment issues, which we will not review as that is a constitutional law matter we consider beyond our technical purview.
Consideration of Benefits
The Court held that
No statutory directive obligated the Commission to reevaluate and independently confirm that the Final Rule would actually achieve the humanitarian benefits Congress intended. Rather, the SEC appropriately deferred to Congress’s determination on this point, and its conclusion was not arbitrary, capricious, or contrary to law (p. 24)
Precedents brought by NAM on other regulations proposed and adopted by SEC in the past were deemed not germane as
All of those cases involved rules or regulations that were proposed and adopted by the SEC of its own accord, with the Commission having independently perceived a problem within its purview and having exercised its own judgment to craft a rule or regulation aimed at that problem. (P. 21)
NAM argued that certain aspects of SEC’s cost estimates were “inconsistently and opportunistically” undervalued – most specifically in relation to the IT implementation costs and the number of suppliers impacted by the rule, and therefore were arbitrary. The Court disagreed and stated that, while NAM may disagree on the specific numbers, “…the Commission weighed comments received from the various parties and exercised its discretion in concluding which figures were most appropriate.. the Court cannot say that the SEC acted arbitrarily or capriciously in reaching this particular estimate.” (p. 27)
NAM argued that “the Commission wrongly failed to implement any type of a de minimis exemption from the Conflict Minerals Rule’s coverage” (p.27). However, the opinion determined that SEC had given consideration to the concept and “solicited feedback on the issue as part of the rulemaking process”, but ultimately “exercised its independent judgment in declining to adopt a de minimis exception”. (p. 33)
The opinion continued: “While it may be true that the adoption of some type of de minimis approach could also have been a reasonable, alternative option, this does not render the SEC’s contrary determination arbitrary or unreasonable.” (P. 36)
“May Have” Originated v. “Did Originate”
Part of this argument reviewed the concept of the Reasonable Country of Origin Inquiry (RCOI) and “how companies go about determining “whether” their minerals “did originate” in the Covered Countries in the first place.” (P. 38). Judge Wilkins held that
… the Commission rightly argues that “the statute is silent with respect to the disclosure obligations of issuers who, following [their] inquiry, do not know ‘whether’ those minerals ‘did originate’ in the Covered Countries… Congress did not directly speak to the precise circumstances triggering disclosure obligations (and, by implication, due diligence and reporting requirements) in enacting Section 1502. (P. 38)
The Court then turned to the specific language of “may have” originated or “did originate”. For ease of our summary here, the Court found that “Insofar as there is any discernible difference between these two articulations, it strikes the Court as a semantic one” and “… the two competing articulations effectively amount to a distinction without a difference.” (P. 42)
Precedents were cited by the Court demonstrating case law “has expressly characterized the word ‘manufacture’ as ‘an inherently ambiguous term,’ “ and “might well include entities that contract out the manufacture of products with necessary conflict minerals” (P. 44). Ultimately, “…the Court is convinced that the Rule’s application to issuers that ‘contract to manufacture’ is an amply reasonable construction of Section 1502.” (P. 46)
In reviewing the opinion, we made a few interesting observations.
- This is a rare win for SEC. Recent challenges to SEC’s rulemakings have been successful, resulting in vacated regulations. One could posit that the Commission did indeed carefully consider – and apply – lessons learned from those preceding losses.
- The Court was not tasked with – and did not take up – reviewing the question of whether verified conflict-free materials that do originate from Covered Countries are subject to the same administrative requirements as “conflict-sourced” materials from the Covered Countries (see our analysis of this matter). However, we note that consistently throughout the opinion, language used by the Court focused on the location of origin from Covered Countries without providing a distinction between verified conflict-free materials from the Covered Countries, and those materials determined to finance or benefit armed groups. We wonder if the Court’s seemingly careful and intentional use of that specific language is instructive on this point.
There is likely to be much speculation about appeals. But what is certain is this: the final rule remains in effect as it was published. Given that only 5 full months are left in the calendar year in which to develop a compliance program, it would not be prudent to delay compliance activities further.