On July 23, 2013, the US District Court for the District of Columbia issued an opinion and order rejecting a challenge brought by several business groups to the SEC's conflict minerals rule, Rule 13p-1 under the Exchange Act, and Section 1502 of the Dodd-Frank Act. Unless the decision is appealed and a stay of the rule granted during appeal, the first report under the conflict minerals rule must be filed by May 31, 2014.

Section 1502 of the Dodd-Frank Act directed the SEC to adopt a rule requiring companies that manufacture products containing certain minerals and their derivative metals, known as conflict minerals, to disclose:

On August 22, 2012, the SEC adopted a final rule under Section 1502, Rule 13p-1 under the Exchange Act. Under Rule 13p-1, reporting companies that manufacture or contract to manufacture products that contain conflict minerals necessary to the products' functionality must conduct a two-step diligence inquiry. In the first step, a company must conduct a "reasonable country of origin inquiry" to determine whether its conflict minerals originated in the DRC or an adjoining country or whether the minerals originated from recycled or scrap sources. Depending on the outcome of this inquiry, a company may need to move on to the second step. In the second step, a company must conduct due diligence into the source and chain of custody of the company's conflict minerals.

Companies must file a report of this inquiry on Form SD with the SEC and post the report on their websites. Companies that are required to conduct the second diligence step must also prepare a conflict minerals report, which must be audited (subject to certain exceptions during a transition period) and is filed as an exhibit to the Form SD. In some circumstances, companies may have to disclose in the conflict minerals report that their products containing conflict minerals have "not been found to be 'DRC conflict free'." Covered companies must make their first report under Rule 13p-1 by May 31, 2014.

In response, a group of business organizations (plaintiffs) filed suit in the US Court of Appeals for the District of Columbia Circuit against the SEC (National Association of Manufacturers, et al. v. Securities and Exchange Commission, No. 12-1422 (D.C. Cir., filed October 19, 2012)). On May 2, 2013, the Court of Appeals granted plaintiffs' motion to transfer the litigation to the US District Court for the District of Columbia on the grounds the District Court had jurisdiction over the case, while the Court of Appeals lacked jurisdiction (National Association of Manufacturers, et al. v. Securities and Exchange Commission, 1:13-cv-00635-RLW (D.D.C., transferred May 2, 2013)).

The plaintiffs challenged:

The court found that the Exchange Act does not require the type of analysis that the plaintiffs argued was missing. The court noted that the SEC is obligated only to consider the impact that a rule may have on economic-related factors, but Congress adopted Section 1502 to achieve humanitarian objectives, not economic. In particular, the court distinguished recent cases that found the SEC had failed to conduct an appropriate cost-benefit analysis, such as the proxy access decision, as cases involving rules that were proposed and adopted by the SEC of its own accord as a result of a need perceived by the SEC. The court contrasted those cases with the conflict minerals rule which the SEC promulgated according to an explicit statutory directive from Congress, "driven by Congress's determination that the due diligence and disclosure requirements it enacted would help to promote peace and security in the DRC." The court also found that the Exchange Act does not impose an obligation for the SEC to assess whether the conflict minerals rule would actually achieve the humanitarian benefits Congress had identified. Instead, the court found that the SEC appropriately deferred to Congress's opinion on this point. The court also noted that the SEC appropriately considered whether the rule would promote efficiency, competition and capital formation and the potential impact on competition more generally.

The court found that the SEC's analysis of the costs of the rule, based on its own data and assumptions and those of all commentators, used an appropriate methodology. The court noted that just because plaintiffs believed that the SEC was wrong did not cause the analysis to be arbitrary or capricious. In particular, the court found that the SEC appropriately considered whether a de minimis exception to the conflict minerals rule would undermine the impact of the rule and reasonably concluded, based on feedback from commentators, not to include this exception. The court noted that just because a de minimis exception could have been adopted did not cause the SEC's decision not to adopt one to be arbitrary or capricious.

The court examined similar arguments by the plaintiffs regarding the required reasonable country of origin inquiry, coverage of issuers that "contract to manufacture" products, and different transition periods for large companies and smaller reporting companies. The court determined that the SEC adequately evaluated these issues and did not act arbitrarily or capriciously in formulating the final rule.

Regarding the First Amendment issues, the court applied an intermediate scrutiny standard to evaluate whether the rule and the statute provision directly advance the government interest asserted and are a reasonable fit to accomplish those ends. The court deferred to Congress's expertise in foreign relations to determine that Congress had made an informed judgment that the disclosure scheme would promote peace and security in the DRC. The court noted that the rule and statute require only that companies post on their websites the Form SD and conflict minerals report, which must previously be filed with the SEC. The rule and statute do not require companies to disclose any other information, and do not prohibit companies from adding any explanation of the reports or other relevant information about their supply chains or sourcing practices that they believe may be more accurate. The court found a reasonable fit between the rule's and statute's requirements and Congress's objective of promoting peace and security in the DRC.

This decision means that the conflicts minerals rule continues in effect as adopted, and the SEC's recently issued guidance continues to apply. Reporting companies covered by the conflict minerals rule must file their first Form SD and (if required) conflict minerals report by May 31, 2014. The plaintiffs may ultimately decide to appeal the court's decision to the US Court of Appeals for the District of Columbia Circuit. The Court of Appeals could disagree with the court and vacate the rule on appeal. However, unless a stay of the rule is granted during the appeal process, companies are unlikely to have enough time to wait for an appellate court decision before needing to complete the necessary due diligence for the first Form SD. Companies should focus on implementing a conflict minerals compliance program now.

For more information on the conflict minerals rule and compliance, see Conflict Minerals Rule Compliance Toolkit.

For more information on the recent SEC guidance, see Legal Update, SEC Issues Conflict Minerals and Resource Extraction Rule FAQs.