What is the SEC so afraid of?

A lot is going on with the Securities and Exchange's (SEC) Gag Rule, an unlawfully adopted rule that has disgraced the agency for 50 years.

First challenged by the New Civil Liberties Alliance (NCLA) through a 2018 petition that SEC failed to act on for over five years, NCLA recently renewed that petition on behalf of three gagged clients, one of whom has been silenced for two decades. SEC's gag power is now on constitutional appeal to the U.S. Court of Appeals for the Fifth Circuit in SEC v. Novinger and was argued on Feb. 8. SEC's power to gag is also the subject of Elon Musk's pending petition for certiorari at the U.S. Supreme Court. The National Labor Relations Board's designation of Mr. Musk's tweets as an unfair labor practice - another variety of government infringement of speech - was recently argued before the Fifth Circuit en banc, which was receptive to Tesla's case. Then just recently, SEC finally issued an order denying relief on NCLA's renewed administrative petition, prompting a powerful dissent from one Commissioner. That denial means petitioners can take SEC's Gag Rule to a federal circuit appeals court.

But first, some background on the Gag Rule itself.

SEC's Gag Rule

SEC's adoption of its Gag Rule - which imposes, as a condition of settlement, that defendants may never deny or even create the impression of a denial of any of SEC's charges against them or permit others to do so - was conceived in secrecy and adopted through deception. In 1973, SEC slipped this Gag Rule into the Federal Register "effective immediately" without notice and comment, portraying it as just a housekeeping rule that did not bind anyone outside the agency. That violated the Administrative Procedure Act's requirement for notice and comment. SEC has since used the rule to threaten settled parties into silence - and charge Elon Musk with contempt. So much for the rule not binding persons outside the agency! Worst of all, SEC-drafted non-negotiable settlement orders require defendants to say they have "consented" to the gag and waive all notice and opportunity to be heard. These "consents" are then incorporated into a final order of the court, in violation of the Federal Rules of Civil Procedure which forbid such incorporation. Because defense costs run into millions of dollars, 98% of defendants settle, leaving virtually all SEC enforcement actions permanently shrouded in secrecy.

This is an outlier power

Out of hundreds of federal agencies, only two outliers - SEC and CFTC - have adopted a Gag Rule. No other agency or government actor requires people charged by the government to surrender their future First Amendment rights as a non-negotiable condition of settlement. Dozens of federal agencies are able to robustly regulate Americans without gagging them for life when they settle. The Department of Justice itself, which brings and settles securities cases all the time, imposes no such settlement condition.

Nor could it. The Unconstitutional Conditions Doctrine forbids it.

NCLA's petition for repeal of the Gag Rule

NCLA's 2018 petition lays out a hornbook of First Amendment doctrines offended by SEC's Gag Rule: It is a quintessential prior restraint, which the Supreme Court calls "the most serious and the least tolerable infringement on First Amendment rights." It not only serves no compelling public interest but disserves the public interest in transparency and accountability by the most restrictive means. The Gag discriminates on speech's content - and viewpoints to cement SEC's view - and only SEC's view - as the only historical record. The Gag violates due process in two ways, by denying defendants a hearing, and through its vague and far-reaching terms that forbid creating even an impression of denial and forbidding defendants from "permitting others" to suggest SEC might have been wrong. Defendants who say truthfully that they did not admit must also say they don't deny the charges, government-scripted speech that both compels speech and violates the Fifth Amendment's right against self-incrimination. By silencing defendants, the Gag violates the right to petition and the right of a free and open press to hear defendants' side of the story. The Gag violates third parties' First Amendment-protected interest in hearing speech, something that cannot be waived by a settling target. Under the Unconstitutional Conditions Doctrine, SEC cannot gag defendants, even with their agency-compelled "consent." Last, but far from least, SEC has no lawful authority to gag anyone. Ever. Not one of the securities laws provides for any such penalty. Such lawless and unconstitutional expansions of agency power were recently called out by Justice Neil Gorsuch last term, when he recognized that agencies use the federal government's resources and power to "outlast and outspend" defendants to secure consent decrees "as leverage to extract settlement terms they could not lawfully obtain any other way."

Courts are complicit

Making these manifold constitutional violations worse, these "consents" are incorporated by reference into court orders enforceable by the judiciary's civil and criminal contempt power. So in 2019, NCLA sued in the Southern District of New York on behalf of former Xerox CFO Barry Romeril, because the Second Circuit's controlling law forbade such a court-entered prior restraint, even between private parties and even upon "consent." Crosby v. Bradstreet Co., 312 F.2d 483, 485 (2d Cir. 1963) held that a court judgment that included a "prior restraint" on speech is "void" and the affected parties "must be granted relief therefrom." Once the Crosby restraint was brought to the circuit court's attention - even some thirty years after the injunction - the Second Circuit promptly set aside the gag:

"Such an injunction, enforceable through the contempt power, constitutes a prior restraint by the United States against the publication of facts which the community has a right to know and which Dun & Bradstreet had and has the right to publish. The court was without power to make such an order; that the parties may have agreed to it is immaterial."

Despite this controlling precedent, a Second Circuit panel refused to apply it for Romeril. And the Second Circuit, as it nearly always does, refused en banc rehearing. NCLA's petition for certiorari, led by preeminent First Amendment advocate Floyd Abrams, argued that the Second Circuit decision also conflicted with at least three circuits which prohibit governments from setting unconstitutional settlement conditions: the Fourth Circuit (don't- speak-to-the-press as a condition of settling police brutality cases), Ninth Circuit (two cases: one concerning a "consent" not to run for office, and the second prohibiting criticism of a county commissioner), and Sixth Circuit (a condition infringing on future free expression). Nonetheless, NCLA's petition in Romeril was denied in 2022.

The problem is in the ask

The very demand that those who wish to settle with SEC must abandon their constitutional rights is itself unconstitutional. The problem is in the ask, and neither "consent" nor putative waiver affords a solution. The government may not condition anyone's ability to receive government action on the surrender of their constitutional rights under a long line of Supreme Court authority. Indeed, the Court declared in 1963 that it was by then "too late in the day to doubt that the libert[y] of religion and expression may be infringed by the denial of or placing of conditions upon a benefit or privilege." SEC's demand for such a gag and, in the case of Elon Musk securing preclearance from Tesla for his tweets, impermissibly coerces settling parties into surrendering their freedom of expression that is protected by the First Amendment.

Congress itself could not pass a law requiring that Americans who settle their cases with the government agree to be gagged for life. The Supreme Court has long recognized that even murderers retain their First Amendment rights to speak and publish about their prosecutions. SEC's self-arrogated power to concoct such tyrannous penalties infringes the First Amendment and the public's right to hear what SEC's targets have to say. As Professor Philip Hamburger argues, "consent is irrelevant for conditions that go beyond the government's power."

New cases - and some progress

Continuing its quest to invalidate the SEC Gag, NCLA brought a second action in Texas on behalf of Christopher Novinger, who, like Barry Romeril, would like to tell his side of the story. That case failed on its first appeal on procedural grounds, but two concurring judges on the three-judge panel said:

"nothing in the opinion ... approves of or acquiesces in the SEC's longstanding policy that conditions settlement of any enforcement action on parties' giving up First Amendment rights. ... If you want to settle, SEC's policy says, "Hold your tongue, and don't say anything truthful--ever"--or get bankrupted by having to continue litigating with the SEC. A more effective prior restraint is hard to imagine. ... I think it will not be long before the courts are called on to fully consider this policy."

More recently, S.D.N.Y District Judge Ronnie Abrams questioned SEC's gag as abhorrent to basic First Amendment principles:

"SEC routinely demands that defendants sacrifice the ability to ever deny the allegations against them--indefinitely silencing them from speech otherwise protected by the First Amendment. The threat held over the head of defendants ... is not easily overstated. Should they ever publicly refute the accusations against them, or even so much as "create the impression" that the SEC got something wrong, the Commission may reopen their cases or seek to hold them in contempt, thereby subjecting them to the risk of enormous financial and professional penalties, if not imprisonment. Truth is no defense. No matter how weak, or strong, the allegations in the [SEC] complaint may be--indeed, even if the testimony of key witnesses proves to be false--if defendants ever consider publicly defending themselves, the [Gag] prevents them from doing so."

Judge Abrams did not limit her criticism to SEC. She also called out the federal judiciary for its "troubling" complicity in this routine violation of civil liberties:

"Perhaps most concerning, the federal judiciary is made complicit in this practice--normalizing lifetime gag orders in the process. Courts are called upon to turn a blind eye to First Amendment rights being used as a bargaining chip; to endorse consent decrees, giving No-Admit-No-Deny Provisions the imprimatur of judicial sanction; and to enforce them should defendants ever step out of line. This is troubling indeed."

Despite her misgivings, Judge Abrams approved the settlement because she was constrained by the Second Circuit's flawed decision in Romeril, a decision that stands in direct conflict with Crosby, which remains the law of the Second Circuit.

SEC upholds the Gag Rule and Commissioner Peirce dissents

SEC's recent refusal to repeal its unconstitutional Gag Rule demeans the agency and its professed commitment to transparency and disclosure in the financial markets. The letter denying NCLA's petition is internally contradictory, first asserting that SEC gags are negotiated terms of settlement, but later admitting that SEC will not settle without a gag. SEC's assertion that the agency does not try its cases through press releases is cruelly untrue. Its gag scheme ensures that SEC's press releases are the final and only public word on every settled case. Enforcement targets such as Romeril and Novinger are left powerless to defend themselves in the court of public opinion - forever. SEC's letter falsely implies that Congress delegated this gag power, an implication belied by SEC's secretive adoption of the Rule without notice and comment.

Commissioner Peirce's powerful dissent eloquently notes, "the American public, not government censors" must be the arbiters of the validity of speech. NCLA will appeal the Commission's denial to a circuit court of appeals in the next several weeks - another case to watch.

The big picture

News reports in recent years have revealed a disturbing Brave New World of government censorship. Much of this came to light when an outspoken critic of the government - Elon Musk - bought one of its principal censorship organs, Twitter, and opened its files to public view. Aghast and exposed, the administration seems to have declared a whole-of-government war on Musk. Yet, love or hate the guy, Elon Musk is one of the most prominent, intelligent, and closely watched public figures in the world. Any restriction on his public speech is problematic, given that his gags involve a publicly traded corporation whose shareholders are entitled to transparency (per SEC requirements) from their senior executives. They deserve to hear what Musk and the company have to say about SEC's charges and why he and Tesla paid $40 million, half of which was paid by company shareholders, to settle the case. It is absurd that SEC, of all agencies, demanded a settlement provision that restricts Musk and Tesla from freely providing such information to their shareholders - and incidentally why SEC held on to the $40 million for many years despite SEC's obligation to pay the money over to Tesla shareholders within 60 days!

As Commissioner Peirce's dissent, quoting Judge Abrams in part, notes:

"What is the SEC so afraid of? Any criticism, apparently--or, rather, anything that may even 'create the impression' of criticism--of that government agency." The public cannot be sure what to believe if the government actively seeks to squelch contrary voices. As the FTC has observed, a government regulator that is confident in its investigative work, procedural practices, and legal analysis does not need to demand silence on the part of settling defendants."

SEC's hypocrisy on transparency is particularly irksome. When penalizing J.P. Morgan for inserting gags in its settlements, SEC's enforcement head Gurbir S. Grewal admonished public companies that "you simply cannot include provisions that prevent individuals from contacting the SEC with evidence of wrongdoing, ... For several years, [J.P.Morgan] forced certain clients into the untenable position of choosing between receiving settlements or credits from the firm and reporting potential securities law violations to the SEC. This either-or proposition not only undermined critical investor protections and placed investors at risk but was also illegal." The First Amendment in fact does not prohibit private confidentiality agreements, but it most certainly forbids the government from requiring a gag, which NCLA founder Philip Hamburger describes as regulatory extortion.

Nothing new under the sun

Noted scholar Max Weber observed: "[b]ureaucratic administration always tends to be an administration of "secret sessions" [and] in so far as it can, it hides its knowledge and action from criticism." The secrecy and insulation from criticism that SEC has erected through its Gag Rule is antithetical to every principle the First Amendment demands of and from our government. As Sen. Daniel Patrick Moynahan recognized: "Information is power, and it is no mystery to government officials that power can be increased through controls on the flow of information." Through its Gag Rule, SEC monopolizes the narrative of how it regulates Americans. No agency has a monopoly on the truth. The First Amendment forbids it.

Courts once protected the public's profound and inviolable interest in knowing how its public officials wield power. The Massachusetts Supreme Court held of the "highest moment that those who administer justice should always act under the sense of public responsibility, and that every citizen should be able to satisfy himself with his own eyes as to the mode in which a public duty is performed.'" Or, as George Washington put it when addressing his army on the life-or-death question of suppressing mutinous speech: "For if Men are to be precluded from offering their Sentiments on a matter, which may involve the most serious and alarming consequences, that can invite the consideration of Mankind, reason is of no use to us; the freedom of Speech may be taken away, and, dumb and silent we may be led, like sheep, to the Slaughter."

SEC interferes with this ability to know how our government operates in the most extreme and self-favoring of ways - a lifetime gag against any criticism by the very people most knowledgeable about its enforcement practices. It is time for the courts to untie the SEC's gag.

The cases are Tesla v. NLRB, Fifth Circuit No. 21-60285; SEC v. Novinger, Fifth Circuit, No. 23-10525; Petition for Writ of Certiorari, Musk v. SEC, Supreme Court No. 23-626; and Petition to Amend, No. 4-733, Securities and Exchange Commission.