In a lawsuit filed in a federal court in the District of Columbia, the Cato Institute – a well-renowned libertarian think tank – claimed that the Securities and Exchange Commission’s long-standing policy of requiring respondents never to contest any allegation in an enforcement action as a condition for a settlement is unconstitutional as it restricts freedom of speech. Cato alleged that, for the last 40 years, the SEC has routinely imposed an obligation of non-deniability in connection with all enforcement action settlements (“gag order”) pursuant to one of its regulations. (Click here to access 17 CFR 202.5(e).)
According to Cato, it has been unable to publish a book detailing alleged overreaching by the SEC written by a former subject of an SEC enforcement action who was accused by the Commission of “substantial wrongdoing” but settled his/her matter. In the manuscript, the author said he/she admitted to engaging in “certain limited conduct in order [solely] to avoid crippling litigation expense.”
Cato entered into a contract to publish the author’s manuscript. However, in its complaint, the non-profit organization claimed that it cannot “exercise its contractual right to publish the book” because the author is bound by a gag order.
Cato seeks a permanent injunction against the SEC from requiring gag orders in administrative and civil settlements. In its complaint, it argues that content-based regulations of speech are “presumptively invalid” under the First Amendment to the US Constitution.
Cato describes itself as a “public policy research organization …dedicated to the principles of individual liberty, limited government, free markets, and peace.” (Click here for additional information on Cato.)
My View: According to Cato, when a respondent resolves an enforcement action with the SEC, he/she must “agree not to take any action or to make or cause to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis.” The objective of this provision is to preclude a respondent from publicly challenging the legitimacy of a settlement and thus undercutting the rationale for the SEC’s enforcement action. Without this constraint, a respondent could publicly attack the basis of SEC allegations, effectively requiring the SEC to defend its conduct to ensure its legitimacy.
However, the purpose of a settlement is to avoid litigation expense by both the SEC and a respondent. Allowing after-settlement back and forth public attacks would solely transfer arguments from a court room to a more uncontrolled environment, and raise challenges for the SEC to use non-public information obtained during investigations to help support its allegations in non-judicial forums. (Click here to access 17 CFR 203.2 regarding how the SEC customarily treats as non-public information or documents obtained during investigations.)
That being said, as Cato points out, the overwhelming majority of SEC enforcement actions conclude in settlements because the cost of litigation is prohibitive, and respondents often shelve their principles in response to cost-benefit analyses. As a result, respondents often proffer settlements where they formally neither admit nor deny any allegations (as mandated by the regulator), when in fact they may dispute many if not most of the allegations.
There likely is some middle ground that allows a respondent to deny any or all of the SEC allegations, but, notwithstanding, acknowledge such factual claims solely for the purpose of a settlement. Some limited ability for a respondent to explain the basis for its denial may be warranted and the SEC could likely respond summarily.
Cato’s lawsuit raises important issues regarding how to balance First Amendment protections and government agencies’ legitimate need for finality in voluntarily settled enforcement proceedings even where settlements are achieved through what are effectively coercive processes.
(The policy of the SEC regarding settlements also exists at the Commodity Futures Trading Commission. (Click here to access Appendix A to Part 10 of the CFTC Rules.) In 2014, current SEC commissioner Hester Peirce criticized the CFTC for “back-door rule-making” through the imposition of undertakings in enforcement settlement orders, among other reasons. At the time, Ms. Peirce was a Senior Research Fellow at the Mercatus Center at George Mason University. (Click here for access to Ms. Peirce’s article “Regulating Through the Back Door at the Commodity Futures Trading Commission”; specific reference at pgs. 60 -62.))