SEC ‘Gag Rule’ Cancelation Removes a Settlement Bargaining Chip

The Securities and Exchange Commission last month rescinded its 54-year-old rule providing that defendants who settle with the agency may not deny the allegations against them. The SEC effectively made the rescission retroactive, announcing that it won’t take action against persons who previously agreed to “no admit, no deny” settlements but now wish to deny the allegations they settled.

Rule 202.5(e) has been under attack by advocates who contend that it constitutes a “gag” on settling defendants’ First Amendment rights. The SEC’s rescission release didn’t address those constitutional issues. Instead, the SEC determined that the rule wasn’t appropriate on policy grounds.

Practitioners previously speculated that settlements might become more difficult to achieve if the SEC couldn’t require no-denial commitments from settling defendants. The concern was that, if the SEC couldn’t prevent denials, it might write harsher consent orders or demand tougher settlement terms. However, if the SEC believes that no-denial commitments have little value, their disappearance might not materially affect the agency’s position on settlement negotiations and terms.

Background

In 1972, the SEC adopted a policy, codified in 17 CFR Section 202.5(e), that persons who settle with the commission can’t later deny the allegations they agreed to settle. Previously, defendants could settle, agree to a sanction, and then deny having engaged in the sanctioned conduct.

If a defendant who had agreed to abide by Rule 202.5(e) to obtain a settlement later denied the allegations, the SEC could have sought to reopen the proceedings. But the rule didn’t prevent a settling defendant from denying the allegations in other legal proceedings, including civil litigation. Nor did it prohibit a settling defendant from criticizing the SEC on matters other than the substance of the settled allegations.

The SEC’s “no admit, no deny” policy has received increasing attention, as some defendants who settled with the SEC later contended that the “gag” imposed an unconstitutional condition on their ability to settle and violated their First Amendment rights.

The New Civil Liberties Alliance, on behalf of several people who had settled with the SEC, filed a petition to amend the SEC’s rule. The petition contended that the rule violated the First Amendment, constituted a content-based infringement on free speech, deprived the public of knowledge about the SEC’s conduct of enforcement actions, and exceeded the SEC’s statutory authority. When the SEC denied the petition, the New Civil Liberties Alliance and other petitioners sought review in the US Court of Appeals for the Ninth Circuit.

The Ninth Circuit, in Powell v. SEC, unanimously denied the petition for review, holding that the rule wasn’t “unconstitutional across the board.” The ruling aligned with an earlier decision from the Second Circuit. Powell petitioned the US Supreme Court to hear the case.

SEC’s Rescission

On May 18, with the Powell certiorari petition pending, the SEC issued a release rescinding Rule 202.5(e). The SEC gave five reasons for the rescission, none of which was based on First Amendment issues:

• The SEC rejected the rule’s primary rationale that the no-deny policy benefits the public interest by avoiding creating the impression that the SEC lacks a basis for its enforcement actions and settlements. The SEC now takes the position that “the negative effect on the public interest” from defendants’ denials of settled allegations “may be minimal.” The SEC also “recognize[d] that the policy itself may create the incorrect impression that the Commission is trying to shield itself from criticism.”
• The SEC asserted that the rule’s benefits “have proven to be limited” because “there is no known instance” of the commission’s ever having taken action against a defendant who violated a no-deny commitment.
• The SEC believes that “technological changes in communication, particularly use of social media, have made the policy more challenging to implement.”
• The SEC sought to align itself with the majority of other federal agencies, including the Department of Justice, which don’t have a similar “no-admit, no deny” rule.
• The SEC observed that rescission of the rule “gives the Commission more flexibility in settling enforcement actions”because the rule “necessarily precludes settlements with defendants who do not wish to waive their rights.”

The agency also declared that it won’t enforce existing no-deny provisions in settlements that have already been entered.

The SEC views the rescission as a general statement of policy relating solely to agency organization, procedure, or practice—meaning notice and comment under the Administrative Procedure Act aren’t required.

Implications

For decades, defendants who were considering settlements with the SEC needed to decide whether they could commit to not denying the allegations against them, and the SEC theoretically was protected from settling defendants’ extrajudicial statements denying the alleged conduct.

The “no-admit, no-deny” requirement thus was a bargaining chip that the parties needed to consider in settlement negotiations.

The SEC now appears to have taken the position that the no-denial requirement never had much value to the commission. The SEC’s primary reason for rescinding the rule was that preventing a settling defendant from denying the allegations likely had only a “minimal” effect on the agency’s reputation.

If the SEC believes that the rule provided little value, the rule’s rescission might not cause the agency to be tougher on settling defendants. It’s unclear how the elimination of the “no admit, no deny” bargaining chip will play out in future settlements.

The rescission would seem to moot the certiorari petition in Powell, as the SEC has now argued to the Supreme Court. But given that Powell appears to be an ideological challenge to the rule, which future commissions could reinstate, the Powell parties and their amici might still try to convince the Supreme Court to hear the case.

As for defendants who previously settled with the SEC and agreed to “no admit, no deny” restrictions, they now appear to be free to say whatever they want without fear that the agency could vacate their settlements or reopen their proceedings.

This article does not necessarily reflect the opinion of Bloomberg Industry Group Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Jonathan Richman is a partner in Brown Rudnick’s white collar defense, investigations, and compliance practice group.

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