Dodd-Frank Opponents Consider New Legal Challenges

While some critics of the Dodd-Frank Act have called for a full repeal of the legislation on Capitol Hill, the more immediate strategy is to chip away at an array of its provisions through lawsuits challenging the cost-benefit calculations required in the rulemaking and through other legal challenges.

Last week, the U.S. Chamber of Commerce and a coalition of oil industry associations filed the latest Dodd-Frank legal challenge. They are seeking to halt a final rule issued by the Securities and Exchange Commission in August that requires oil, gas, and mining companies to disclose payments—totaling $100,000 or more—that are made to the United States or foreign governments in exchange for extracting resources.

Last year the Chamber of Commerce and the Business Roundtable succeeded in blocking an SEC rule, mandated by the Dodd-Frank Act, that would have required companies to allow shareholders to nominate their own candidates for the board of directors directly through the proxy statement. The SEC decided not to challenge the ruling.

Dodd-Frank opponents also mounted a successful challenge of limits the Commodity Futures Trading Commission was set to impose on firms trading in certain commodity contracts, also required by Dodd-Frank. The case was also based on questioning the cost-benefit analysis the CFTC included as part of its rulemaking.

As the cases multiply, many are starting to wonder whether the next big legal challenge will go after the mandated disclosure of “conflict minerals” in supply chains.

The complaint challenging the extraction payments rule, filed with the U.S. District Court for the District of Columbia along with a petition for review filed with the U.S. Court of Appeals for the D.C. Circuit, charges that the new rule violates the First Amendment and the Administrative Procedure Act on the grounds that it is “arbitrary and capricious.” The lawsuit claims the SEC failed to conduct an adequate cost-benefit analysis, that the Commission “grossly misinterpreted its statutory mandate, and that the regulation is “incompatible with the First Amendment” by forcing unwanted speech.

Enacted the same day the final extraction rule was issued, the conflict minerals rulemaking applies specifically to the mining of tin, tungsten, tantalum, and gold in war-torn Central Africa used to fund militant groups. During the two years it took the SEC to develop its long-delayed final rule, critics in the world of manufacturing and retail said tracking their supply chains for these substances would be a complex and costly challenge.

While none of the organizations that have filed suits challenging Dodd-Frank provisions would confirm that they are preparing a legal challenge to the conflicts minerals rule, they said they were not ruling it out.  “This is certainly an issue we are following closely,” Lisa Burgess, a spokesman for the U.S. Chamber of Commerce, said last month. “There has been no change in the status of our review,” a statement provided last week to our updated inquiry read. “We are continuing to assess the final rule to decide on next steps.” The National Association of Manufacturers, another critic of the rule, also said its review was continuing.

Nevertheless, the successes in challenging the cost-benefit analysis in some of the early cases may open the floodgates for more and more legal challenges to other Dodd-Frank rules, says Jane Luxton, a partner in the Environment and Energy Practice Group of law firm Pepper Hamilton. “On the other hand, I see the agencies getting more sophisticated with their response to these cases. It is as though the game is progressing with each side making moves and the courts in the middle playing referee.”

Luxton says a legal challenge could encompass several strategies, hoping that a judge will settle on just one of them as grounds to offer relief. The most challenging tactic may be disputing the cost-benefit analysis. In response to past challenges and a Congressional reprimand, the SEC hired additional staff devoted to a rigorous cost-benefit analysis before issuing the final rules.

“The rule may be challenged, or it may not be, but given that there is an imminent, soon-to-be-upon-us effective date [of Jan. 1], all companies need to take at least a preparatory look at compliance.”

—Michael Littenberg,

Partner,

Schulte Roth & Zabel

Unlike the challenge to extraction payments and proxy-access rules, a potential challenge to the conflict minerals rule could focus more on the benefit part of the cost-benefit equation. “All of the benefits of the rule go to artisanal miners and other people in countries in Africa, while all the costs are imposed on U.S. companies and those that have to file here,” Luxton says of that tack.

Curtis Dombek, a partner with the law firm Sheppard Mullin, doesn't see a “strong parallel” to claims made in the extraction actions that cite the revelation of trade secrets and company strategy as having a high cost.

“The minerals that are named—gold, tin, tantalum, and tungsten—are things that find their way into all kinds of products, and Congress did not draw a line that said at a certain de minimis level of component you no longer have to worry about the source," he says. “That's a nightmare to think about, but it is not forcing companies to disclose hyper-sensitive commercial information.” That the SEC did incorporate mitigating measures requested during the public comment process presents another obstacle for a lawsuit to overcome, he says. The Commission, for example, did provide a two-year “undeterminable” status for companies unable to completely source certain materials.

“If I'm a judge on the receiving end of a case that's trying to stop this rule, I have to deal with the fact that companies get a couple of years here to deal with this burden,” he says.

COMPLAINT DETAILS

The following are selections from API and Chamber of Commerce, et al. v. SEC (D.C. District Court).

SECTION 1504 AND THE EXTRACTIVE INDUSTRIES RULE VIOLATE THE FIRST AMENDMENT

Section 1504 of the Dodd-Frank Act and the Commission's Extractive Industries Rule force U.S. companies to engage in speech that discloses sensitive, confidential information that the Commission concedes will cause them substantial economic harm. This compelled, non-commercial speech is not necessary or essential to administering any governmental program.

DECLINING TO ALLOW PUBLIC COMPANIES TO SUBMIT PAYMENT INFORMATION CONFIDENTIALLY

Confidential submission of data and publication in aggregate form would have saved American businesses and their investors billions of dollars. The Commission therefore bore a heavy burden under the Exchange Act to justify its adoption of a much costlier alternative when publication of aggregate data would have furthered the purposes of the statute without nearly the same adverse effect on competition. Because the Commission erroneously concluded that its hands were tied, there is nothing approaching a reasoned explanation for the Commission's choice in the final Rule.

FAILING TO DEFINE “PROJECT”

The Commission's failure to define “project” is arbitrary and capricious under the Administrative Procedure Act.

It lay within the Commission's discretion to define the statutory term “project” as a geologic basin or province. This definition would have protected U.S.-listed companies from potentially billions of dollars in compliance costs, by providing certainty in application and by permitting companies to aggregate innumerable individual payments made under various contracts as long as they all related to extraction of a particular resource in a particular geologic area.

DENYING EXEMPTION TO PUBLIC COMPANIES IN CASES WHERE FOREIGN LAW PROHIBITS DISCLOSURE

The Commission, which solicited comments on possible exemptions, was bound under the Administrative Procedure Act to provide a reasoned explanation for why particular exemptions were or were not in the public interest. With respect to the proposed exemption for payments whose disclosure would violate the law of a foreign state, the Commission's circular reasoning that an exemption would not further the transparency goals of the statute was arbitrary and capricious.

INSUFFICIENT EVALUATION OF COSTS AND BENEFITS

The Commission's evaluation of the direct costs of the rule was flawed because the Commission extrapolated an industry-wide standard from data provided by two large companies, and likely underestimated the Rule's costs by assuming that smaller companies adapting the rule would incur costs amounting to the same percentage of total assets. The Commission was also required, but failed, to make a definitive assessment of the indirect competitive costs of the proposed rule.

FAILING TO SOLICIT ADDITIONAL COMMENTS AFTER RELEASING FLAWED COST-BENEFIT ANALYSIS FOR FIRST TIME IN FINAL RULE

In adopting the final Rule, the Commission relied on methodologies for calculating the costs and benefits that had not been disclosed or submitted for public comment previously in the rulemaking.

Those methodologies involved attempts at ball-parking industry-wide costs by pointing to raw data submitted by two companies (in the case of initial compliance costs) or three companies (in the case of ongoing costs and indirect costs). These formulae were flawed and were not made public until the day the Commission released its final Rule, whereas in fact the Commission was required under the Administrative Procedure Act to provide public notice and an opportunity for comment on its new methodology and cost assessment.

Source: API and Chamber of Commerce, et al. v. SEC.

Potential Lines of Attack

A cost-benefit challenge could tackle the lack of de minimis and sweeping breadth of how far the rules reach down supply chains. “Of course, the response to that would be that Congress meant to get at this problem and there's no way to get at this problem really unless you reach down through that supply chain, because otherwise you are just scratching the surface and materials will still be finding their way into the products,” Dombek says.

Like Luxton, he sees the “benefit” side of the equation as unique. “No one would deny the benefit of seeing an end to this horrible conflict in the Congo,” Dombek says. Nevertheless, he adds, courts “don't get in the business of making foreign policy decisions.”

A challenge as to how regulators implemented what the Dodd-Frank Act instructed it to do is another possible attacking point. “You can question Congress' wisdom in passing the conflict minerals legislation, but one can say that the SEC has done what Congress has demanded it to do, and Congress is the master of telling the agencies what to regulate,” Dombek says. Critics, however, could counter that the regulator went at the issue harder and broader than Congress intended.

“They could argue that the SEC has the authority to grant exemptions, notwithstanding that the Commission said it didn't feel it could adopt a de minimis or exempt out certain categories of issuers,” says Michael Littenberg, a partner at law firm Schulte Roth & Zabel. A challenge could claim that the SEC “acted in an arbitrary and capricious manner” and failed to use the discretion it had when adopting the Congressional mandate.

Littenberg wonders if, should there be a challenge, the SEC will stay the effectiveness of the rule. “They haven't as yet stayed the effectiveness of the resource extraction rule,” he says. “We are waiting to see if that happens. It was something the SEC did voluntarily in the context of the challenge to mandatory proxy access.” Also in question is whether a plaintiff could seek injunctive relief to stay the application of the rule if the SEC didn't do it voluntarily.

Complicating the prospect of a lawsuit is that “many consumer-facing businesses are supportive of the rule and have already spent a lot of time gearing up for compliance,” Littenberg says. Several of the U.S. Chamber's member companies have already publicly stated their disagreement with its opposition to the rule, including Microsoft, General Electric, and Motorola Solutions. Activism-minded advocates of the rule could also be expected to put forward their best arguments, threaten boycotts, and file amicus briefs, in their efforts to ensure the rule stands.

 “You hear rumors but no one has pulled the trigger yet,” Littenberg says of a potential lawsuit. “When you look at mandatory proxy access, it was challenged in roughly a week, yet here we are now on week seven? The rule may be challenged, or it may not be, but given that there is an imminent, soon-to-be-upon-us effective date [of Jan. 1], all companies need to take at least a preparatory look at compliance, even if they delay implementing a full-blown program. The effective date is too soon to ignore.”