Analysis: US court ruling on SEC supply chain disclosure concerns SRI investors

Appeals court ruling cites companies’ freedom of speech

Last week, a U.S. appeals court upheld the majority of a Securities and Exchange Commission rule detailing how companies must report on the possible human rights conflicts within their minerals supply chains. But the attention of many socially responsible investors was caught to the one part of the rule with which the court did take issue: the requirement that companies must publicly declare whether or not their products are “conflict-free,” which the court struck down on the basis that the requirement violates companies’ freedom of speech. Some investors fear the opinion could stymie future rule-making efforts around corporate disclosure of ESG-related factors.

“The implications of the court’s ruling are, frankly, of great concern to us,” says Bennett Freeman, Calvert Investments’ senior vice president of sustainability, research, and policy. In 2011, Freeman testified at an SEC roundtable convened to discuss the rule.

Freeman says his concern is not focused on a potential de-clawing of the so-called “conflict mineral” rule itself—companies will still have to conduct an inquiry into their mineral supply chains and report on what they find. Rather, he worries that future efforts to develop corporate disclosure laws could similarly face the freedom-of-speech-violating chopping block.

Minerals like gold, tantalum (used in turbines and camera lenses), tin (plastics and phones), and tungsten (lighting, power tools, and golf clubs) become “conflict minerals” when they originate from the Democratic Republic of Congo or an adjoining country and have played some part in financing the armed groups committing humanitarian crimes there. The Dodd–Frank Wall Street Reform and Consumer Protection Act included a provision stating the companies must inquire into whether the minerals in their products are sourced from these problematic origins, and the SEC drew up the specific language explaining how companies should comply with the law.

But the Court of Appeals for the D.C. Circuit ruled that the SEC went too far when it required companies to sum up the findings of their due diligence by labeling their products in SEC filings and on their websites as “DRC conflict-free” or “not DRC conflict-free.” Forcing companies to make such a statement is a form of unconstitutional “compelled speech,” the court’s opinion explains, because it effectively forces companies to assume moral responsibility for atrocities in which they had no part. Compelled speech is legal only when it can be shown to protect consumers from fraud or when it protects investors, and the SEC didn’t claim that the “DRC conflict-free” label would do either.“What’s potentially disheartening to investors about this case is it could open up the possibility of having other types of ESG disclosure be scrutinized under the First Amendment,” says Lauren Compere, director of shareholder engagement at Boston Common Asset Management. Over the past several years, Boston Common met with SEC commissioners and submitted investor letters to advise on the development of the conflict minerals rule.

Emily Kaiser, a sustainability analyst at Calvert, echoes the concern. “From our point of view, the discussion of this issue is really frightening, because we rely on the SEC’s mandate to require publicly traded companies to disclose material information about their activities,” she says, “and if this court is worried about government requirements of factual disclosures, particularly those that can be construed in a moral way, that’s problematic for us.”

But others say they’re not so concerned that the court’s recent opinion will set a broad precedent for using freedom of speech to block transparency and disclosure requirements. Doug Park, a securities lawyer and director of education at the Sustainability Accounting Standards Board—a group working to develop guidelines on how companies should report on material ESG factors—says that he believes disclosure rules on ESG issues that are more clearly connected to investor risk, like water scarcity or other climate change issues, aren’t likely to confront freedom-of-speech roadblocks.

“So long as ESG factors are tied directly to investor protection and are material issues—and by that I mean they meet the securities law definition of materiality—they should be able to pass the test for compelled speech under the First Amendment,” Park says.

For her part, Calvert’s Kaiser stresses that she and her colleagues at the investment firm do consider corporate disclosures about conflict minerals financially material, and she expresses frustration that the SEC did not make a stronger case for the investor relevance of the “DRC conflict-free” label. It’s a lesson the firm will apply to its future ESG disclosure rule-making efforts, she says – language matters.

“I think what this tells us is we need to be careful about the words we use when we’re developing campaigns around initiatives that are meant to prompt corporate action,” Kaiser says. “Phrases that can coalesce interest from a consumer point of view can be problematic legally. The court’s decision-making tells us that we need to be more precise and neutral in our language when we’re figuring out how to communicate these ideas.” Link to ruling