The Opaque Hand: Making Social (and perhaps Environmental) Change through Capital Markets

 Summary: In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Deep in this bulwark of financial regulatory overhaul, Congress passed a provision aimed to achieve a purely social good by requiring manufacturers to disclose their supply chains for minerals believed to fund the conflict in the Democratic Republic of Congo.  This piece is the follow-up to Back on the (Supply) Chain Gang that the Vermont Journal of Environmental Law published this year.


By  Christopher  M. F.  Smith, J.D.

On April 14, 2014, the U.S. Circuit Court of Appeals for the D.C. Circuit (D.C. Circuit) handed down an opinion that may give social and environmental activists a way to affect corporate change through the Securities and Exchange Commission’s (SEC) disclosure regime.  In National Association of Manufacturers (NAM) v. SEC, the D.C. Circuit ruled on a challenge to the SEC’s Final Rule for conflict-mineral supply-chain disclosure.  The National Association of Manufacturers, Business Round Table, and U.S. Chamber of Commerce (Industry Group) raised claims under the Administrative Procedure Act (APA), the Securities Exchange Act of 1934 (34 Act), the and First Amendment of the U.S. Constitution.  The D.C. Circuit held in favor of the SEC on all but the First Amendment Claim.

In 2010, Congress responded to the 2008 financial crisis that caused the Great Recession with the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).  An often overlooked provision of Dodd-Frank is section 1502.  Section 1502 mandates the SEC promulgate a rule for companies to disclose conflict-minerals their supply-chain.  The Smith_WordCloudpurpose of section 1502 is to squeeze off funding to militant oppressors of the Congolese people through the forces of U.S. capital markets.  Congress directed the SEC to enhance disclosure requirements to include supply-chain analysis for manufacturing minerals that are germane to the Democratic Republic of Congo.  These minerals serve as the revenue stream for militant guerilla oppressors   Dodd-Frank created a humanitarian based disclosure requirement to influence market demand through disclosure and transparency.

Very simply, the SEC promulgated a three-part rule.  First, the issuer must complete an inquiry in to the country of origin for the minerals Dodd-Frank enumerates. If the company has reason to believe that minerals may have originated in DRC, the issuer must complete a due diligence process to scrutinize and alter their supply-chain.  Last, the rule requires issuers to report their findings and describe the conflict disposition of their products, such as “DRC conflict free” or “not DRC conflict free” to the SEC in Form SD.  Issuers must also publish in that disposition on the   company website.  The Industry Group brought four APA claims, a 34 Act claim, and a First Amendment claim.  The D.C. Circuit District Court held for the SEC in all claims.  The D.C. Circuit heard argument on January 7, 2014.


NAM v. SEC: A (Very) Brief Synopsis

The first APA challenge claimed that the SEC’s decision not to exempt de minimis (minimal) users of conflict-minerals was arbitrary and capricious.  The D.C. Circuit deferred to the SEC’s reasoning that Congress did not write in a de minimis exemption, and the SEC interpreted that statutory omission as deliberate, based on the surrounding language.  Furthermore, such an exemption might diminish the impact of the rule because manufacturers often use conflict-minerals in very limited quantities.  Second, the Industry Group claimed that the threshold for completing the due diligence requirement contravened the statutory language and was arbitrary and capricious. The D.C. Circuit held that the requirement did not contravene the statute nor was it arbitrary and capricious because the statute was silent on the threshold and obligation of uncertain issuers. The SEC properly used its delegated authority to resolve ambiguities by ensuring issuers do not ignore red flags.

Third, thDRC_Mape Industry Group argued that the SEC went beyond the scope of its statutory authority by requiring issuers who contract to manufacture products that contain conflict-minerals comply with the rule rather than just manufactures themselves.  The D.C. Circuit held that the SEC reconciled a variation in two provisions of section 1502 by applying the rule to both.  The final APA claim concerned the phase-in period during which issuers may describe their products as “DRC conflict undeterminable” and avoid an independent, third-party audit.  The Industry Group claimed that distinguishing between large issuers and smaller reporting companies with two- and four-year phase-in periods was arbitrary and capricious because smaller reporting companies are in supply-chains of large issuers.  The D.C. Circuit adopted the SEC’s reasoning that large issuers can exert more leverage than smaller reporting companies to gather supply-chain information, thus the disparity in phase-in.

Next, the Industry group argued that the SEC did not follow the proper cost/benefit analysis, as required by the 34 Act.  The Industry Group only challenged the benefit side, rather than cost, stating that the SEC did not quantitatively determine whether the rule would fulfill Congress’s intent.  The D.C. Circuit held that Congress intended to achieve a “compelling social benefit” and  SEC could not possibly measure the positive effects of the rule, as it was a complex issue beyond the SEC’s expertise. The Court went on, bluntly stating “[e]ven if one could estimate how many lives are saved or rapes prevented as a direct result of the [] rule, doing so would be pointless because the cost of the rule – measured in dollars – would create an apples-to-bricks comparison.”  Finally, the Court stated that the SEC properly relied on Congress’s belief that transparency and closure were the means to their intended ends.

Last, the Industry Group challenged the requirement that issuers describe their products as “DRC conflict free” or not.  The D.C. Circuit held for the Industry Group, reasoning that describing products as “not DRC conflict free” indicates a moral viewpoint, essentially compelling issuers to declare blood on their hands.  The D.C. Circuit struck down the description requirement because it unconstitutionally compelled ideological commercial speech.


Implications for Social and Environmental Activists

Capital market activism is not new.  Most know it in the context of shareholder activists seeking social and environmental change through shareholder proposals to prescribe corporate behavior.  Section 1502 of Dodd-Frank and the SEC final rule create a purely humanitarian disclosure requirement to make social change by informing investors of issuer supply-chains for minerals financing conflict in the DRC countries.

It may be working.  Intel and HP, both issuers affected by the rule, began the Conflict-Free Smelter Program.  The program seeks transparency by smelters and refiners in their sources for conflict-minerals.  The limited number of smelting facilities makes it a key point in the supply-chain to deter conflict-mineral use.  The Intel-HP initiative may be proof that the rule will fulfill Congress’ intent.

The D.C. Circuit decision may be a foot in the door for social and environmental activists to make change through capital market disclosure.  The drafters of section 1502 sought to change corporate behavior through supply-chain transparency.  The five SEC victories in NAM v. SEC may be an encouraging sign for others who may want to use market forces to influence investor and issuer behavior.

In the comment period for the conflict-mineral rule, one letter suggested expanding supply-chain disclosure to include environmental considerations.  At the 2013 annual meeting of the ABA, former ABA President Laurel Bellows discussed addressing human trafficking through supply-chain disclosure and transparency.  After the NAM v. SEC decision, these ideas seem possible.

NAM v. SEC may be telling for social and environmental activists in several ways.  The APA rulings may inform those who seek other supply-chain disclosure rules, social or environmental.   The First Amendment ruling may be telling for food and agricultural activists who seek disclosure through labeling, such as the GMO law the Vermont State Legislature passed this year. If food producers challenge Vermont’s GMO Labeling law on First Amendment grounds, it will be interesting to see if NAM v. SEC serves as persuasive precedent.

The 34 Act claim is the most compelling part of the decision for capital market activists.  It appears that Congress’ belief that a particular addition to the SEC disclosure regime will fulfill its intent to achieve a compelling social good is benefit analysis enough to satisfy 34 Act’s analytical rulemaking requirements.  A supply-chain disclosure requirement for human trafficking seems analogous to conflict-mineral supply-chain disclosure, and may not require the SEC to quantify the benefit.  If Congress intended to achieve a compelling environmental good, perhaps such an intent combined with a belief that disclosure would achieve environmental good will satisfy the 34 Act benefit analysis.

Some foreign jurisdictions require disclosure of particular environmental metrics, such as emissions, chemicals/substances used, and waste produced.  NAM v. SEC could be an opening for this type of disclosure in the U.S.  The environment is beyond the SEC’s expertise, as were conflict-minerals.  It would be similarly difficult for the SEC to quantify the environmental impacts of environmental disclosure, as it is difficult for the SEC to determine the humanitarian impact of conflict-mineral supply-chain disclosure.  Therefore, in drafting environmental disclosure rules, the SEC may be able to rely on Congress’ intent and belief that disclosing such information would benefit the environment, rather than grasping at straws to quantify an environmental benefit.



Economist Adam Smith mused that an invisible hand of the market metaphorically promoted self-regulation by market participants.  In response to the stock market crash of 1929, Congress created an opaque hand of the market by establishing the SEC in the 34 Act.  Through regulatory requirements and anti-fraud enforcement provisions, informed investors influence corporate behavior.  It appears that Congress and the D.C. Circuit extended the power of that opaque hand to influence the market in order to achieve social, humanitarian good.

Before issuers began filing Form SD this week, supply-chain disclosure influenced corporate behavior. Two large issuers are working to divest manufacturing from the DRC conflict, as Congress intended.  Time will tell whether Congress’s political will could make further social change through the opaque hand of the SEC regulatory regime.  Perhaps achieving environmental change will be next.


Christopher graduated cum Laude from Vermont Law School in 2014.  Christopher is originally from Boston and graduated Magna cum Laude from Suffolk University with a Bachelor of Science in Politics, Law & the Courts and the History of Women & Gender.  Christopher focuses primarily in corporate finance law, in particular, capital formation and regulatory compliance for securities issuers.  While at Vermont Law Christopher completed the Business Law certificate, engendering a unique interest in the intersection of business and environmental issues.