SEC ‘gag rule’ rule is under fire in federal court

A federal appeals court could weaken a 50-year-old muzzle on companies and individuals that settle securities fraud allegations. And there’s a good chance the U.S. Supreme Court will weigh in on the matter soon enough.

The U.S. Securities and Exchange Commission’s (SEC) rule 202.5(e), in effect since 1972, is more commonly known as the “no admit, no deny” or “gag” rule. In a nutshell, a defendant in an SEC enforcement order waives its rights to discuss the matter once it’s settled with the commission.

The quid pro quo is the defendant doesn’t admit to any wrongdoing, freeing it from further legal proceedings though still on the hook to pay SEC penalties. The defendant also saves itself the time and money it would take to litigate. The SEC also benefits by not having to litigate more enforcement actions, at the taxpayers’ expense.

Now a nonprofit group is challenging the SEC’s policy on first amendment grounds. The New Civil Liberties Alliance (NCLA) contends the SEC gag rule amounts to prior restraint of a defendant’s speech. The 5th circuit appellate court will hear its appeal this spring.

The SEC rejected the group’s petition to repeal the gag rule in late January. The SEC says, “[t]here is a large body of precedent confirming that a defendant can waive constitutional rights as part of a civil settlement, just as a criminal defendant can waive constitutional rights as part of a plea bargain. … [A]ll settlements involve undertakings and waivers of constitutional rights, and courts have held that there is no per se rule against such agreements.”

Good chance that appeals court won’t get final say

The SEC’s gag rule has prompted a ton of grumbling over the years. Many plaintiffs argue going up against the SEC is too risky (and costly) a proposition. Settling is the only option that makes sense, but agreeing to settle hurts any organization’s reputation and can lead to a loss of business.

Legal analysts predict the 5th circuit won’t invalidate the gag rule, which would set up another appeal and possible Supreme Court review. The conservative high court continues to show a marked opposition to government overreach, making the possibility of a SCOTUS review likely.

Hint: Justice Samuel Alito, one of the two most ardent constitutional “originalists” on the high court (along with Clarence Thomas) is the associate justice for the 5th circuit (Louisiana, Mississippi and Texas). Alito will no doubt be keeping an eye on how the 5th circuit judges rule.