Feb 2, 2024 - Economy

SEC's so-called "gag rule" draws dissent from commissioner

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Photo: Joshua Roberts/Bloomberg via Getty Images

The U.S. Securities and Exchange Commission this week said it would not amend its controversial "gag rule" tied to settlement agreements.

Why it matters: The long-standing policy has been criticized over the years by targets of its enforcement actions, advocacy groups and even judges, who say the policy flies in the face of the First Amendment.

Catch up fast: The U.S. regulator has the authority to take people and companies to court over violations of securities laws, but the agency often settles first — a decision a lot of accused parties take to avoid the cost and time of defending themselves in court.

  • In the 70s, the SEC decided it was important that no one ever think it sanctioned companies for violations that didn't actually occur.
  • So, it made a policy that it would only settle with parties that agreed not to deny the commission's claims, as SEC Secretary Vanessa Countryman explained in a letter to the New Civil Liberties Alliance on Tuesday, which had brought the petition to amend the rule.
  • It's rule 202.5(e), commonly referred to as the "gag rule."

What they're saying: "The no-deny provision ensures that if a defendant reneges on a settlement and publicly denies the allegations, the Commission has the opportunity to ask a court to permit it to test that denial," Countryman explains in her letter.

  • The SEC, according to Countryman, views a settlement as a lost opportunity to "present evidence and prove its claims in federal court."

One of the rule's latest critics is SEC commissioner Hester Peirce. In a dissent published Tuesday titled "Unsettling Silence, she takes a shot at the commission's logic that it's the one making a concession by avoiding litigation.

  • "When it settles, the Commission does not need to prove the allegations in court—which is expensive, time-consuming, and difficult—and it gets a benefit it could never obtain through litigation—the permanent silence of the defendant," she writes.

Peirce also contends that the policy makes the SEC less accountable, protecting the interests of the agency, and its leadership, against the public interest.

  • She cites the Cause of Action Institute's James Valvo, who wrote of the policy, "Defendants who have been through an agency's enforcement process are often the most informed and in the best position to raise red flags about that process."

Of note: The Commodities Futures Trading Commission has the same policy.

Zoom out: One industry that's surely paying attention is crypto.

  • In 2023, more than 1 in 20 enforcement actions issued by the SEC targeted a company related to the digital assets space, according to data from Cornerstone Research and the SEC.

💭 Our thought bubble: Those of us following the push and pull of the SEC and the crypto industry have gotten all too familiar with a turn of phrase in settlements with blockchain companies, variations on: neither admitting nor denying wrongdoing.

  • What many of us didn't realize is that defendants' non-denial is a matter of policy.

The bottom line: The policy stands, but it's illuminating to know it's there.

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