Thursday, January 10, 2019

Constitutional challenge lodged against SEC gag regulation

By Rebecca Kahn, J.D.

Non-profit think-tank and publisher The Cato Institute has brought an action against the SEC seeking declaratory judgment that the 1972 “Gag Regulation” is unconstitutional under the First Amendment. Cato claims injury because a specific gag order prevents it from publishing an entrepreneur’s account that he was the victim of an overzealous SEC investigation (Cato Institute v. SEC, January 9, 2019).

Settlement terms. An American entrepreneur contracted with Cato to write a book about his experience at the center of an SEC investigation. Although the SEC agreed to settle his case with no admission of wrongdoing, no details could be revealed because, as part of the settlement, the SEC demanded that he agree to a gag order under Gag Regulation 17 C.F.R. Section 202.5(e), prohibiting him from ever discussing his case or even criticizing the agency’s handling of it.

Banned book. The entrepreneur wrote and sent a manuscript to Cato, telling the story of how he believes he was the victim of egregious government overreach at the hands of overzealous officials: how he had personally done nothing wrong, yet the government leveraged the threat of crippling fines and the prospect of years of costly litigation to extract a settlement from him when he ultimately admitted no wrongdoing. In 2018, Cato signed an agreement to publish the manuscript. But publishing the book is actually illegal. Moreover, Cato claims that the Gag Regulation prevents Cato from presenting panel discussions or other forms of public dialogue featuring individuals who have been subject to SEC enforcement actions.

Legal action. Represented by the Institute of Justice (IJ), Cato challenges the SEC’s use of gag orders to prevent parties to settlements from questioning or criticizing the agency. The complaint argues that doing so presents an unconstitutional, content-based restriction on the freedom of the press in violation of the First Amendment. The civil rights complaint “seeks to end the federal government’s decades-long use of gag orders in violation of the First Amendment . . . and to vindicate the Cato Institute’s basic First Amendment right to publish a book critical of official government conduct.”

Gag regulation. Since 1972 when the SEC first adopted the gag order policy, it has been a non-negotiable term of settlement in hundreds of cases, including, most recently, Elon Musk’s settlement. To justify the policy, the SEC explained that “it is important to avoid creating, or permitting to be created, an impression that a decree is being entered or a sanction imposed, when the conduct alleged did not, in fact, occur.” In other words, the IJ press release states, the SEC demands gag orders in order to prevent bad publicity about its enforcement activities.

The SEC is not alone in its use of non-negotiable gag orders. Following the SEC’s lead, the Consumer Financial Protection Bureau, the Commodity Futures Trading Commission, and numerous state agencies have adopted similar policies.

“The government cannot strip Americans of their First Amendment rights and impose a gag order, just because it wants to evade public oversight or criticism,” said IJ Senior Attorney Robert McNamara. “The best way to determine if government agencies are overstepping their bounds is to have a public debate about it, which is exactly what the SEC is suppressing by unconstitutionally imposing gag orders.”

As Cato and others have argued, the Commission’s use of “neither admit nor deny” settlements allows the government to impose punishment without actually establishing that any law was broken. The result is a system where the press and the public hear only one side of the story: The SEC issues press releases detailing its allegations at the beginning of an enforcement action, and then it enters into settlements in which the accused is forced to promise never to dispute any of those allegations in public.

In a December 11, 2018 hearing on SEC oversight by the Senate Committee on Banking and Urban Affairs, Sen. Tom Cotton (R-Ark) quizzed SEC Chairman Jay Clayton on the SEC’s policy. Clayton defended the no-admit-no-deny policy, stating that it has been an effective means to reach settlements and is in the interest of the public. “If we can settle matters quickly, we can move on to other matters. The no-admit-no-deny approach has enabled us to get to settlements, to get people their money back, [and] get bad actors out of the marketplace,” Clayton said. Cotton questioned whether the policy amounts to a prior restraint on speech which is content-based and therefore a violation of the First Amendment. Clayton replied that “the First Amendment does not permit all speech without sanction: you can't commit fraud.” Clayton added that the SEC’s policy is meant to “restrict people who have done prior wrong from telling people, ‘pay no attention to that.’”

“It is vital for citizens of a democracy to know how their government operates, particularly when it accuses fellow citizens of wrongdoing,” said Cato Institute Vice President for Criminal Justice Clark Neily. “The SEC’s policy of demanding lifetime gag orders as a condition of settlement flouts the First Amendment and prevents publishers like the Cato Institute from educating the public about the true nature and behavior of government.”

“Nothing is more fundamental to the First Amendment than an American’s right to publish a book critical of the government,” said IJ Attorney Jaimie Cavanaugh. “The SEC shouldn’t be in charge of deciding who is allowed to criticize the SEC. The government cannot use the threat of ruinous prosecution to ward off criticism of its actions.”