by T. GormanPosted on Posted in SECActions

The SEC’s conflict mineral disclosure rule, enacted under Dodd-Frank, is a continuing source of controversy. An initial challenge to the rules was brought by the National Association of Manufactures. That challenge was largely rejected by the district court and the D.C. Circuit. One provision, however, was held to contravene the First Amendment — a disclosure requirement that the products be labeled DRC Free with a corresponding statement on the firm website. National Association of Manufactures v. SEC, No. 13-5252 (D.C. Circ. 2014)(here).

On rehearing the result was the same. National Association of Manufactures v. SEC, No. 13-5252 (D.C. Cir. Opinion issued August 18, 2015). In the initial decision much of the controversy revolved around the standard of scrutiny that would be applied to the disclosure requirement. There the Court applied the teachings of Zander v. Office of Disciplinary Counsel of the Supreme Court of Ohio, 471 U.S. 626 (1985). While the circuit courts are split on the meaning of this decision, the D.C. Circuit has conclude that it is “limited to compelled speech designed to cure misleading advertising. Other government regulations compelling commercial speech are evaluated under Central Hudson Gas & Electric Corp. v. Public Service Commission, 447 U.S. 557 (1980). Zander utilizes a more relaxed standard than Hudson Gas.

In its earlier ruling the Court concluded that Zander was inapplicable because it was limited to situations where the disclosures were being compelled to cure what would otherwise be misleading advertising. That is not the case with the SEC’s conflict mineral rules.

Following the initial decision, however, the Court, sitting en banc, decided American Meat Institute v. U.S. Department of Agriculture, 760 F. 3d 18 (D.C. Cir. 2014)(en banc). There the Court concluded that Zander applies to “more than a state’s forcing disclosures in order to cure what would otherwise be misleading advertisements . . . Some other governmental interests might suffice.” In AMI the Court applied the Zander standard in concluding that the government had not violated the First Amendment by forcing companies to list country of origin information on meat cuts. This decision overruled part of the Circuit’s jurisprudence regarding Zander. In view of AMI the Court granted rehearing.

The conflict mineral rules do not deal with advertising or point of sale disclosures. Rather, they were directed at achieving “overall social benefits.” The Supreme Court has refused to apply Zander to cases not involving voluntary commercial advertising. Accordingly, the Court refused to apply it here. This puts the case in the same posture as the first time it was before the Court. Then the Court concluded that the final rule “does not survive even Central Hudson’s intermediate standard.” That holding still applies.

To bolster its decision, the Court added an alternate holding keyed to three points. First, under Central Hudson the court must assess the interest motivating the disclosure requirement. The SEC noted that it is ameliorating the humanitarian crisis in the DRC. This is sufficient under AMI and Central Hudson.

Second, the effectiveness of the measure in achieving that goal must be assessed. The SEC offered little on this point the Court noted. A review of various materials, including the potential costs, lead the Court to conclude that there was little but speculation. “[T]his presents a serious problem for the SEC because . . . the government must not rest on such speculation or conjecture . . . Rather the SEC had the burden of demonstrating that the measure it adopted would ‘in fact alleviate’ the harms it recited . ..” “This in itself dooms the statute and the SEC’s regulations” the Court concluded.

Finally, the Court considered if the compelled disclosures were “purely factual and uncontroversial.” The descriptions of “conflict free” or “not conflict free” are hardly factual and non-ideological. This requires an issuer to tell consumers if its goods are ethically tainted.” “By compelling an issuer to confess blood on its hands, the statute interferes with that exercise of the freedom of speech under the First Amendment.”

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by T. GormanPosted on Posted in SECActions

In Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010) the Supreme Court held that the reach of Exchange Act Section 10(b) is the water’s edge of the United States. Specifically, the court held that the Section only provides a cause of action if the purchase or sale of the security took place on a U.S. exchange or within the United States. The decision is based on a presumption that legislation has no extraterritorial reach absent an express Congressional intent to the contrary. Since the Exchange Act lacks any such expression Section 10(b)’s reach is limited by its focus – the location of the purchase or sale of the security.

Subsequently, Morrison has been followed in a series of Section 10(b) actions. The Second Circuit has also applied its teachings to RICO and the Commodity Exchange Act. In contrast, the Sixth Circuit, concluded that Morrison does not apply to another securities statute – Section 206 of the Investment Advisers Act. Lay v. U.S., Case No. 13-4021 (6th Cir. August 17, 2015).

Defendant Mark Lay was convicted of investment adviser fraud and on counts of wire fraud related to investments he made for the Ohio Bureau of Workers’ Compensation. Mr. Lay found MDL Capital Management, Inc. The firm became an SEC registered investment adviser.

One of the firm’s clients was the Ohio Bureau of Workers’ Compensation. That agency assists Ohio based employers and employees with expenses tied to work place injuries. For years Mr. Lay and his firm managed the Bureau’s funds in a U.S. based fund. Investments were primarily in U.S. long term treasury bonds. The fund made money.

Subsequently, Mr. Lay founded an “offshore” hedge fund in Bermuda. MDL Capital was its adviser, although there was no specific advisory agreement between the Bermuda fund and MDL. The investments of the Bureau were managed in both funds.

At one point Mr. Lay and MDL began leveraging the Bermuda fund. This was contrary to the agreement with the Bureau who was not informed. Losses were incurred. Rather than inform the fund, Mr. Lay and MDL sought permission to use leverage. It was denied. Eventually the Bureau learned of the leverage and the concealed losses. The agency withdrew its funds. Only $9 million of its $225 million investment was returned.

The District Court rejected Mr. Lay’s claim that Morrison compelled dismissal of the Section 206 charge. The Circuit Court agreed: “The problem with defendant’s argument is two-fold: (1) the Securities Exchange Act and the Investment Advisers Act seek to regulate different aspects of securities transactions, and (2) unlike Morrison, the only aspect of this case not tied to the United States is that the fund in question is based in Bermuda. All other aspects of the case are centered in the United States.”

The Advisers Act regulates person and entities who advise others on securities investments. Those persons register with the SEC and have fiduciary duties to their clients. Those include good faith, loyalty and fair dealing, the Court noted. In contrast, the Exchange Act does not specifically “prescribe a stand of conduct for investment advisers.” In addition, here virtually all of the conduct is domestic, unlike Morrison.

Finally, the focus of the Advisers Act is the prevention of wrongful practices by the adviser, the Court determined. This contrasts sharply with the Exchange Act which is centered on the purchase or sale of a security. According, the court concluded that Morrison does not apply to Section 206 of the Advisers Act.

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