The SEC’s decision to rescind its “gag rule"—a core element in more than a half century of enforcement settlements barring Wall Street defendants from publicly denying the regulator’s allegations—means it’s still able to push for tough terms in those deals, securities lawyers warned.
Chairman Paul Atkins framed the May 18 rollback as a move to support free speech, allowing companies and individuals named in SEC enforcement actions to criticize the government.
The Securities and Exchange Commission was one of just a few regulators that had required defendants settling enforcement actions to sign no-deny provisions. The Commodity Futures Trading Commission is now considering its own rescission of a similar policy, Chairman Michael Selig said at a Finra conference on May 12.
But overturning the “gag rule” doesn’t preclude the SEC from negotiating on a case-by-case basis to include admissions as a part of settlement terms, the agency said in its announcement.
The move may also prompt the SEC to include more specifics in litigation in anticipation of a defendant’s public disavowal, according to Coates Lear, a member at Shoemaker Ghiselli & Schwartz LLC and former senior enforcement attorney at the agency.
“Now that settling parties are free to say whatever they want about their case, I suspect that SEC enforcement lawyers may feel compelled to include a level of detail in the settled order or the complaint that they might have left out in the past,” he said.
“Going forward, especially if you start to see a lot of settling parties make use of this newfound freedom, I worry that the SEC enforcement staff is going to say, ‘we have to quote the email, we have to quote the text messages,’” Lear added.
An SEC spokesperson declined to comment.
‘Net Negative’
The “gag rule” has been the subject of emphatic critiques from SEC targets including Mark Cuban and Elon Musk, who supported a legal challenge to the rule that the US Supreme Court turned away several years ago.
Petitioners backed by the New Civil Liberties Alliance and other SEC critics are now pressing for the justices to review a different case, Powell v. SEC, challenging the policy on First Amendment grounds after the US Court of Appeals for the Ninth Circuit upheld the rule last year.
High court review is needed “to ensure the policy cannot return and that existing gag orders in settled cases cannot be revived in the future,” the NCLA said in an emailed statement.
Future SEC settlements will leave companies and individual defendants with latitude to release public statements that could rhetorically undermine the underlying enforcement action. Enforcement lawyers at the agency can plan for that refutation by baking details into legal documents that strengthen the credibility of the SEC’s case.
“If I were in my old job at the SEC and I knew that was a possibility, I would want to include in the settlement or the charging document facts that would take the wind out of the sails of potential future denials,” Lear said.
The SEC’s general enforcement approach under Atkins has narrowed the scope of fraud actions, zeroing in on Ponzi-like schemes and insider trading by individuals while largely leaving larger corporate entities out of the spotlight compared to his Biden-era predecessor.
But even with a scaled-back focus, the agency may decide to prepare more detailed complaints that anticipate post-settlement disputes of alleged fact now that it’s scrapped the no-deny policy.
“That could end up being a net negative for settling defendants,” Lear said. “Now they are free to say what they want about the case post-settlement, but the public document may be harsher than it otherwise would’ve been.”
Incentivizing Settlements
The ability to end an SEC case with a settlement—along with the opportunity to disclaim the agency’s charges—gives defendants a way to quickly address the reputational harm that can accompany an enforcement action.
“There will be more incentive to resolve cases more quickly and spend less time negotiating any factual allegations,” said Kathryn Campbell, counsel at Perkins Coie LLP who specializes in securities litigation. “Since defendants can still dispute underlying factual allegations while settling, this reduces potential fallout in parallel litigation, insurance coverage, and other areas.”
It’s unlikely, however, that the policy change will prompt an uptick in the overall number of settlements that the agency can reach with defendants, according to Susan Light, a partner and co-chair of broker-dealer regulation at Katten Muchin Rosenman LLP.
“I do think it will have other impacts, but I don’t think it will facilitate more settlements,” Light said. “Overall, it goes along with Chairman Atkins’ priorities and program to make the SEC a less aggressive area. Aligning it with other federal agencies was a priority of his.”
The SEC in its announcement also said that rescinding the no-deny policy and incentivizing quicker settlements could expedite its process of returning money to harmed investors.
The agency has been an inefficient “collection agent” when it comes to redistributing disgorged assets to fraud victims, Justice Neil Gorsuch said during oral arguments at the Supreme Court last month probing the SEC’s powers to recoup illicit profits from defendants.
Another possible outcome is that the SEC would explicitly require more public admissions from defendants as a settlement term, especially in cases with a parallel criminal investigation, Light said.
“There’s an off chance that the SEC gets angry because entities are settling and then putting out a press release saying the SEC had it all wrong,” she said. “This might backfire on the SEC.”