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The D.C. Circuit is currently rehearing NAM v. SEC, the 2014 case in which it threw out part of the SEC’s Conflict Minerals Rule on First Amendment grounds.The question posed by NAM v. SEC involves high stakes: Can the D.C. Circuit apply a commercial speech test to a securities disclosure rule?
The Conflict Minerals Rule requires companies to disclose, in SEC filings and on their Internet websites, whether they have used certain “conflict minerals” from the Democratic Republic of the Congo.In the 2014 case, the D.C. Circuit found that the Rule (and Section 1502 of the Dodd-Frank Act) violated the First Amendment “to the extent [they] require regulated entities to report to the [SEC] and to state on their website that any of their products have ‘not been found to be ‘DRC conflict free.’”
The opinion treated the securities regulation as commercial disclosure and declined to decide whether intermediate scrutiny or strict scrutiny applied, because this aspect of the disclosure could not satisfy the Central Hudson test.
The Conflict Minerals Rule is paradigmatic securities regulation.Congress located the statutory mandate for the Rule in the Securities Exchange Act of 1934, embedding it in the deepest bedrock of securities law. It applies only to issuers subject to the regulatory authority of the SEC, the federal agency responsible for securities regulation, which promulgated the rule and enforces it.To facilitate the disclosure, the SEC created a new securities disclosure form – Form SD, for “Specialized Disclosure” – that must be filed annually with the SEC.In short, it is difficult to imagine what more Congress could have done to make the Rule bona fide securities disclosure.
However, when the D.C. Circuit reviewed the Rule in NAM v. SEC, it refused to analyze it as securities regulation.The majority opined that the Rule “is not employed to sell securities” and only once referenced investors as a possible audience for the disclosures.Instead, the court characterized the Rule as commercial disclosure, i.e., disclosure to consumers.“The label ‘conflict free’ is a metaphor,” the court wrote, “that conveys moral responsibility for the Congo war.It requires an issuer to tell consumers that its products are ethically tainted.”
But the D.C. Circuit’s assertion was flat-out wrong: the Rule doesn’t require issuers to make any disclosures to consumers. Consumer disclosures take well-recognized forms: product labels, point-of-sale disclosures, and advertising disclaimers.No such disclosures were required by the Rule.If consumers want conflict minerals information about products, the best place to get it is the SEC’s EDGAR database – the only place where conflict minerals information is archived.In this way, conflict minerals information is no different from garden-variety securities disclosure, like executive compensation data, that interests investors and non-investors.
In recent years, some courts have analyzed First Amendment challenges to securities regulation under commercial speech standards, on the theory that securities transactions are really just a subtype of commercial transaction.If this theory is correct, virtually all securities regulation is subject to heightened scrutiny under the commercial speech doctrine.Intermediate scrutiny under Central Hudson would apply to securities regulation that restricts speech, as well as to securities regulation that compels disclosure, requiring both a substantial governmental interest and narrow tailoring.
Importantly, that was not the logic adopted by the D.C. Circuit when it applied the Central Hudson test to the Conflict Minerals Rule.Instead of reasoning that “sell[ing] securities” is just a form of commercial activity, the D.C. Circuit treated the type of securities disclosure at issue – in the court’s characterization, a disclosure of information that “conveys moral responsibility” for a “social” ill – as if it were not securities disclosure at all.
The difference between these two approaches is significant.Under the first formulation, all securities regulation falls within the scope of the First Amendment and is subject to commercial speech standards.As other scholars have noted, this approach is likely to seriously hobble federal securities regulation, because much existing securities regulation would probably fail heightened scrutiny.
But in the second formulation, only certain kinds of securities disclosure are potentially subject to heightened scrutiny.In the second approach, a court gets to second-guess Congress’s determination that a securities disclosure serves an informational function for investors.Like in NAM v. SEC, this is likely to take the form of a normative judgment in which the court decides what information investors should care about.
The framework the D.C. Circuit is constructing should be understood to place serious limits on laws that compel corporations to disclose corporate social responsibility information, regardless of which way the court decides NAM v. SEC on rehearing.So long as the D.C. Circuit accepts the original panel’s characterization of the Conflict Minerals Rule as commercial disclosure, CSR disclosures – on subjects like labor conditions, environmental harms, income inequality, and so on – will be routed down the path to heightened scrutiny, where they will only escape Central Hudson review if, under Zauderer v. Office of Disciplinary Counsel of the Supreme Court of Ohio, they are both “factual” and “uncontroversial.”
What NAM v. SEC is really about, then, is whether a court can suppress information that Congress and investors believe should be in “the mix” of investor information, by labeling the information “controversial.”
Moreover, this doctrinal approach threatens even disclosure of “pure” data, if the data could “convey moral responsibility” for a social problem.The proposed CEO Pay Ratio Rule, which mandates disclosure of a numeric ratio (relating the pay of a company’s CEO to that of its median employee), would be threatened under this approach, since income inequality is a controversial topic, and the public disclosure of a company’s ratio might “convey moral responsibility” for the company’s contribution to income inequality.
This approach could serve as a basis for invalidating much existing corporate disclosure on “controversial” subjects, including disclosures within other regulatory frameworks that have historically fallen outside the scope of the First Amendment, such as disclosures about health and environmental harms.
The solution to this problem is simple: the D.C. Circuit should defer to Congress’s judgment that investors are interested in conflict minerals information and conclude that the Conflict Minerals Rule is securities regulation.There is good evidence to back this up – investors’ comment letters to the SEC during the rulemaking process demanded conflict minerals disclosure.Where a disclosure mandate has all the hallmarks of securities disclosure and reasonably could serve an informational function for investors, the D.C. Circuit should not cast aside Congress’s judgment that the disclosures constitute information useful to investors.
There might be circumstances in which a court could rightly conclude that a corporate disclosure law was not entitled to rational basis review because it was not really securities disclosure.For example, if Congress enacted a law requiring a disclosure in a place where investors were unlikely to find it, the law could hardly serve an informational function for investors.But the facts of NAM v. SEC present no such case.
By history and tradition, the courts have located securities disclosure outside the scope of the First Amendment.The decision about what information should be in “the mix” when investors make decisions is a legislative judgment with far-reaching implications for corporate accountability.The D.C. Circuit should recognize Section 13(p) of the Securities Exchange Act as securities regulation and apply rational basis review.
Sarah C. Haan is Associate Professor of Law, University of Idaho College of Law. You can reach her by e-mail at shaan at uidaho.edu