Guest Commentary
by Steven A. Engel and Katherine M. Wyman, Dechert LLP*
Of the various U.S. departments and agencies responsible for policing U.S. activities abroad, the Securities and Exchange Commission (SEC) does not readily come to mind. Nonetheless, the Commission recently stepped into those waters by issuing two rules implementing provisions buried deep within the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Those rules put the SEC’s “mission” to “maintain fair, orderly and efficient markets” in the United States in direct conflict with their supporters’ interests in policing the activities of U.S. corporations in international hotspots. In all likelihood, litigation will soon follow.
Section 1502 of Dodd-Frank amended the Securities Exchange Act of 1934 (“Exchange Act”) by adding Section 13(p), which directs the Commission to issue rules requiring certain issuers to disclose their use of so-called “conflict minerals” (tantalum, tin, gold, and tungsten) that originated in the Democratic Republic of the Congo or in adjoining countries. Section 1504 similarly adds Section 13(q) and directs the Commission to put out rules requiring “resource extraction” issuers (namely oil, gas, and mining companies) to disclose certain payments made to U.S. and foreign governments.
Invoking these statutory directives, the Commission recently issued two new rules—13p-1 and 13q-1—that require affected companies to file annual disclosures on the new Form SD. Not surprisingly, the regulated issuers have significant concerns with the costs of these rules, which plainly seek to change substantive policy under the guise of onerous disclosure requirements that, in the Commission’s own estimate, will cost billions of dollars and could place U.S. issuers at a competitive disadvantage. With the costs to business so high, litigation challenges will surely follow. The Exchange Act requires challengers to bring suit within 60 days of the issuance of the rule, and the rules were issued on August 22, 2012. So the challenges will likely come soon.
The problem for the Commission is that while Dodd-Frank gave it a new foreign mission, the statute did not relieve the agency of its day job. The Commission remains obliged to promote efficient U.S. capital markets, and the new rules did not alter its “unique” statutory obligation “to consider the effect of a new rule upon ‘efficiency, competition, and capital formation,’ 15 U.S.C. §§ 78c(f), 78w(a)(2), 80a-2(c). Business Roundtable v. SEC, 647 F.3d 1144, 1148 (D.C. Cir. 2011) (internal case citation omitted). The Commission’s “failure to apprise itself—and hence the public and the Congress—of the economic consequences of a proposed regulation makes promulgation of the rule arbitrary and capricious and not in accordance with law.” Id. (internal case citation omitted).
The D.C. Circuit takes this duty seriously, and in recent years, the court has vacated several SEC rules for failing to complete the required cost-benefit analysis, including in last year’s Business Roundtable decision, which struck down the Commission’s proxy access rule, the first Dodd-Frank regulation to be subject to challenge. (One of the authors filed an amicus brief in that matter in support of the successful challenge.) In vacating the rule, the D.C. Circuit cited internal inconsistencies and contradictions, inadequate support, and a failure to address the “substantial problems” raised by the comments. Id. at 1149.
One of the core problems addressed in Business Roundtable was that Dodd-Frank asked the Commission to impose a rule that, while arguably involving investor protection, would plainly impede “efficiency, competition, and capital formulation,” in order to serve the competing policy interests of certain groups (notably labor unions and public pension funds) that wanted to increase their influence over corporate boards. In the course of issuing the proxy access rule, the Commission failed to account for the economic burdens of the rule, likely because a true accounting would have run counter to the goal of winning public acceptance for the rules.
The Conflict Minerals Rule and the Resource Extraction Rule have even less connection to the policies under the Exchange Act, and they may face similar difficulties. Once again, Congress, through Dodd-Frank, directed the Commission to issue rules that burden efficient capital formation in order to promote other policies, namely—in their supporters’ views—more ethical corporate behavior abroad and better governance in the Congo and other foreign hotspots.
The Commission admitted that the compliance costs with these rules would be substantial, estimating that the Conflict Minerals Rule could impose initial costs of up to $4 billion, with an annual compliance cost of somewhere between $200 and $600 million. See Conflict Minerals, Release No. 34-67716 at 240. The Resource Extraction Rule similarly would have start-up costs of over $1 billion, with an annual compliance cost of between $200 million and $400 million. Disclosure of Payments by Resource Extraction Issuers, Release No. 34-67715 at 140. Industry estimates run even higher. In addition, the Commission admitted that the rules “may provide significant advantage to foreign companies that are not reporting in the United States—and thus need not comply—but do compete directly with reporting issuers in the United States” Release No. 34-67716 at 299; Release No. 34-67715 at 157.
While the Commission was candid about the costs imposed by the new rules, it had a harder time explaining their benefits. The Commission described the “compelling social benefits” of “decreas[ing] the conflict and violence in the DRC” and “increas[ing] the accountability of governments to their citizens in resource rich countries.” Release No. 34-67716 at 242-243; Release No. 34-67715 at 141. The Commission deemed these benefits not “readily quantif[iable]” and conceded that they are “quite different from the economic or investor protection benefits that [its] rules ordinarily strive to achieve.” Release No. 34-67716 at 244; see also Release No. 34-67715 at 138, 183. In dissenting from the rules, two Commissioners criticized this failure to quantify the presumed benefits and expressed concern that the Conflict Minerals Rule, in particular, would actually intensify the problems that Congress had sought to address.
As with the proxy access rule, the dissenting Commissioners have identified a weak point in the rulemaking. It is difficult to see how the Commission could adequately fulfill its statutory responsibility by declaring the benefits of the rule to be “incalculable” and “speculative” and thereby avoiding considering whether the congressional directive could be counter-productive. The Commission left itself open to the challenge that in the face of such uncertainty, it still had the burden of making such calculations or considering whether the prudent course would to be minimize the known and quantifiable market effects by reducing the burdens of these disclosure obligations.
In truth, the Commission declined several opportunities to adopt alternatives that would reduce disclosure cost, and reasoned instead that any such alternatives would “frustrate, or otherwise be inconsistent with” congressional intent.” Release No. 34-67715 at 161, 202. In so doing, the Commission offered explanations that sounded quite similar to those advanced in Business Roundtable, where the Commission repeatedly dismissed questions about costs by pointing to the preexisting regulatory regime or by making vague references to congressional intent. It remains to be seen whether the D.C. Circuit will find those justifications more persuasive this time.
While the Commission’s rules may well be subject to judicial challenge, the Commission’s difficulty may be as much of Congress’s making as its own. Congress has charged the Commission with conflicting missions, directing that it regulate U.S. foreign trade policy, while at the same time pursuing its day job, namely promoting the efficient capital formation in the United States. In so doing, Congress may well have asked for regulations that inherently cost more than their economic benefits might justify. Even if that were true, Business Roundtable recognizes that when faced with such a conflicting mission, the Commission has the statutory responsibility to say so, rather than just sweep the issue under the rug.
*Mr. Engel is a partner in the Washington, D.C. and New York City offices of Dechert LLP. He was counsel of record to leading trade associations for the mutual fund industry on their amicus brief in Business Roundtable. Ms. Wyman is an associate in the firm’s Washington, D.C. office.