Rethinking the Role of Free Speech in Corporate Disclosure

Don't expect the Securities and Exchange Commission to start cutting back on the reporting it requires from public companies, but legal experts are debating whether a recent court decision could mean several of its disclosure requirements—including current regulations and those under consideration—are unconstitutional.

The debate stems from a ruling by the U.S. Court of Appeals for the District of Columbia that struck down part of an SEC rule requiring companies to disclose on their Websites whether some of their products may contain “conflict minerals.” The court decided that the online disclosures amounted to “compelled speech,” in violation of companies' First Amendment rights.  

“The D.C. Circuit's opinion strikes a potentially significant blow to the securities regulation regime and the integrity of the U.S. capital markets,” says Michael Siebecker, professor of law at the University of Denver's Sturm College of Law. The ruling leaves the door open for corporations to challenge many securities laws, rules, and regulations based on First Amendment concerns, he says.

The contested rule applies to the mining of tin, tungsten, tantalum, and gold in war-torn Central Africa that funds militant groups suspected of committing human rights violations. It requires companies to conduct a country-of-origin inquiry with suppliers to determine if the minerals originated from the covered countries; track and document the source and chain of custody; and include findings in a public conflict minerals report.

In 2012, the National Association of Manufacturers and the U.S. Chamber of Commerce mounted a legal challenge to the rule on the First Amendment issue and on the grounds that the SEC didn't conduct the proper cost-benefit analysis of the rule required by law. On April 14, Senior Circuit Judge A. Raymond Randolph, expressing the majority opinion of a three-judge panel, said the plaintiffs were correct to assert that declaring whether their products contain conflict minerals—in both SEC disclosures and on their own Websites—is unconstitutional compelled speech.

The rule, “requires an issuer to tell consumers that its products are ethically tainted, even if they only indirectly finance armed groups … By compelling an issuer to confess blood on its hands, the statute interferes with that exercise of freedom of speech under the First Amendment,” Randolph wrote.

While regulators consider the narrow effect of the ruling, fundamental questions are also emerging, as corporate reporting requirements have crept from the financials into environmental, social, and governance areas. Can the government force companies to reveal things that may harm them? Can businesses be compelled to address political and policy matters, rather than just disclosing factual information intended to protect investors? Where should regulators draw the line between requiring companies to give information to protect investors and what is considered compelled speech that could violate free speech?

Halting Disclosure Creep

Some view the court's ruling as in-line with past legal rulings on what the government can and can't force companies to report publicly, in advertising, or directly on products. The ruling was a good decision and consistent with past court rulings, says Antony Page, professor of law at Indiana University's Robert H. McKinney School of Law. Benchmark cases like Central Hudson Gas & Electric Corp. v. Public Service Commission have established how the government should navigate the free speech concerns that arise from securities regulation and other impositions, such as country-of-origin labeling, drug interaction disclosures, and warning labels on cigarette packages and hazardous chemicals. Bottom line: If compelling disclosure can prevent confusion, deception, or danger to investors and consumers, it is likely constitutional.

“The argument that is commonly made is that the SEC's rules are just exempt from the first amendment, and I find that a very unsatisfying assertion,” Page says. “This doesn't mean all, or even most, securities regulations are now invalid. As long as they have the purpose of preventing deception, then they are fine.”

Bruce Kraus, a partner at the law firm Kelley Drye & Warren and former co-chief counsel of the SEC's Division of Risk, Strategy, and Financial Innovation, also disagrees with those who see grander implications. “Does this have the potential to swallow up all securities laws because they force companies to speak? Not at all; this is an extremely tiny, narrow First Amendment holding at the tag end of a big rule that was 99 percent upheld,” he says.

The contested rule will now be sent back to a lower court for a review of whether the SEC's rulemaking, or language in the Dodd-Frank statute itself, is at the root of the free speech conflict.

“The D.C. Circuit's opinion strikes a potentially significant blow to the securities regulation regime and the integrity of the U.S. capital markets.”

—Michael Siebecker,

Professor of Law,

University of Denver

While all involved sort out the ramifications, a Supreme Court appeal remains a possibility, which could force a broader consideration of how the First Amendment applies to disclosure requirements. “The Supreme Court has never clearly articulated definitions for commercial speech, political speech, or the boundaries between them,” Siebecker says. “Although it has obliquely suggested that certain aspects of the securities laws, rules, and regulations remain outside the reach of the First Amendment, it has yet to offer any sound jurisprudential grounds for creating an island of immunity for the securities laws from First Amendment attacks.”

An End to Name and Shame?

The D.C circuit ruling may be a blow to the modern trend of weaving social issues into securities laws and “name and shame” tactics that leverage company disclosures to bring consumer and investor scrutiny upon their human rights and environmental policies.

The market for corporate social responsibility is “at great risk,” Siebecker fears. “If corporations can insulate themselves from regulation or liability under the First Amendment by claiming the mandatory disclosures or corporate speech regulations touch some political chord—as the D.C. Circuit's opinion suggests—investors will no longer be able to rely on corporate communications regarding corporate social responsibility matters that remain at their core, political matters,” he says. “As a result, the quickly burgeoning market for CSR may well collapse.”

The name and shame approach called into question isn't limited to human rights matters, says Loyola University Professor Trey Drury. “It is an area the SEC has been expanding over time” and that was advanced by the Sarbanes-Oxley Act. “You didn't have to have a financial expert on your audit committee, but according to SOX you had to disclose that you didn't and explain why you think it's appropriate not to have one,” he says. “Regulation by shame has been going on for a while and we are seeing it more often. If this ruling chills that, it's not such a terrible thing.”

That disclosure has evolved into “part of the punishment” is troubling to Eugene Volokh, a professor of law at the UCLA School of Law and an academic affiliate of the law firm Mayer Brown. “If you are talking about things that need to be disclosed in order to prevent people from being misled, those requirements in commercial advertising and securities disclosures would be constitutionally permissible,” he says. “But there is certainly room to challenge other restrictions.”

“The conflict minerals rule was stuck into Dodd-Frank and, as most people see it, has nothing to do with investor protection or deception,” says Roberta Karmel, Centennial Professor of Law at Brooklyn Law School and former SEC commissioner. “The court opinion makes it pretty clear that it was put in for another purpose, to help prevent these civil wars in the Congo, which is really clearly not a securities law purpose. In some ways that's narrow, but in other ways it could turn out to be kind of broad because you have other parts of the securities laws that you could say similarly do not have an investor protection purpose.”

Opening Floodgates?

Few expect that the conflict minerals rule is going away any time soon, and that forthcoming SEC guidance will keep most of its disclosure requirements intact. But could First Amendment concerns encourage legal challenges to other rules?

AN APPLES-TO-BRICKS COMPARISON

The following is from the U.S. Court of Appeals for the District of Columbia Circuit's opinion in the matter of National Association of Manufacturers v. SEC. Although the court took issue with certain disclosure requirements, it did provide the SEC with validation of its cost-benefit analysis.

We do not see any problems with the Commission's cost-side analysis. The Commission exhaustively analyzed the final rule's costs. It considered its own data as well as cost estimates submitted during the comment period, and arrived at a large bottom-line figure that the Association does not challenge. The Commission specifically considered the issues and concluded that the rule would impose competitive costs, but have relatively minor or offsetting effects on efficiency and capital formation.

The Association does not dispute those conclusions. Instead, the Association argues on the benefit side that the Commission failed to determine whether the final rule would actually achieve its intended purpose. But we find it difficult to see what the Commission could have done better. The Commission determined that Congress intended the rule to achieve “compelling social benefits,” but it was “unable to readily quantify” those benefits because it lacked data about the rule's effects. Id.

That determination was reasonable. An agency is not required “to measure the immeasurable,” and need not conduct a “rigorous, quantitative economic analysis” unless the statute explicitly directs it to do so. Here, the rule's benefits would occur half-a-world away in the midst of an opaque conflict about which little reliable information exists, and concern a subject about which the Commission has no particular expertise. Even if one could estimate how many lives are saved or rapes prevented as a direct result of the final rule, doing so would be pointless because the costs of the rule—measured in dollars—would create an apples-to-bricks comparison.

Despite the lack of data, the Commission had to promulgate a disclosure rule. Thus, it relied on Congress's “determination that the rule's costs were necessary and appropriate in furthering the goals” of peace and security in the Congo.

Source: National Association of Manufacturers v. SEC.

Free speech demands were already part of a successful challenge to a rule requiring oil, gas, and mining companies to disclose payments they make to governments—transparency advocates say it will discourage corruption. How about Regulation FD, the “fair disclosure” rule that restricts executives from discussing material information unless it is broadly released to the public? Is the “quiet period” prior to a public offering a restraint of speech? When regulators demand that companies post disclosures on their own Websites, as is increasingly the case, is that compelled speech?

“The more constitutionally problematic aspects of the disclosure regime are prohibitions on speech, rather than the mandates,” Loyola University Professor Drury says.  Regulation FD is likely safe, he says, because the intent is to make sure investors have equal access to the market. “That's at the core of what the SEC is supposed to be doing and would pass any test without too much trouble,” he says. “The SEC gets into trouble when it goes further and further afield of what it is traditionally supposed to be doing.”

“I could see problems with the quiet period rules in that you are preventing speech,” Indiana University's Page says. “Here is the government suppressing speech, which it can do if it is misleading or deceptive, but there is no sorting it out—it is all judged as bad. One might want the government to come up with something more precise, because it is a very blunt rule that captures lot of speech that isn't problematic.”

Time will tell what rules will face new constitutional challenges, but the SEC “has got to pay attention” when it crafts future rules, Volkov says. “The court ruling is a sign that securities disclosure is not some sort of first amendment free zone,” he says.