Judges keep knocking SEC gag rule but defendants can't find a way to evade it

The seal of the U.S. Securities and Exchange Commission (SEC) is seen at their headquarters in Washington, D.C., U.S., May 12, 2021. Picture taken May 12, 2021. REUTERS/Andrew Kelly

(Reuters) - A Manhattan federal judge blasted the U.S. Securities and Exchange Commission on Friday for requiring defendants, as a condition of settlement, to give up the right to deny the agency’s accusations.

Don't expect the SEC to give up the policy anytime soon, however.

U.S. District Judge Ronnie Abrams approved a settlement between the SEC and private equity fund executive Fernando Moraes, who was accused of trading on insider information about the 2018 buyout of Dun & Bradstreet Corp. But Abrams said she was doing so with great reluctance because she is convinced that the SEC’s longstanding policy of gagging defendants as a condition of settlement is “inconsistent with the spirit of the First Amendment and our nation’s time-honored tradition of protecting free expression.”

Abrams is not the only federal judge recently to espouse that view. In July, as I’ve reported, two judges on the 5th U.S. Circuit Court of Appeals raised 1st Amendment concerns about the SEC’s gag clauses. The SEC, wrote 5th Circuit Judge Edith Jones, won't settle unless defendants agree to the gag provision, leaving them no choice but to stay silent or "get bankrupted by having to continue litigating,” Jones said. “A more effective prior restraint is hard to imagine.”

But the 5th Circuit, like Abrams, ended up deciding that it was not empowered to block the SEC’s policy. Jones’ prior restraint comment was in a concurrence joined by Judge Kyle Duncan. In the 5th Circuit’s main opinion, the court rejected an attempt by Christopher Novinger, a Texas financial planner and radio show host who settled an SEC action in 2016, to revise his settlement to eliminate a provision prohibiting him from disputing the agency's allegations.

The Moraes and Novinger cases – along with another recently fizzled challenge to the SEC policy – show why it’s so hard, as a matter of procedure, for judges to impose change on the SEC, even when courts believe the government should not condone a policy that effectively forces defendants to waive their constitutional rights.

I want to be clear that Abrams, Jones and Duncan are offering a minority view among judges who have considered the SEC’s decades-old gag order policy. As the SEC told Abrams in an Oct. 18 letter responding to her sua sponte order calling on the agency to explain why its gag clauses don't impinge on defendants’ 1st Amendment rights, the SEC has a compelling interest in litigating its cases in court, rather than in after-the-fact press releases or tweets.

The gag provision, the SEC said, simply gives the agency a right, if a defendant denies the agency’s accusations after settling, to vacate the deal and litigate to prove its allegations.

Every year, federal judges approve hundreds of SEC settlements that include the provision. In fact, the 2nd Circuit, where Abrams is a trial judge, upheld the SEC’s policy just a year ago in SEC v. Romeril, rebuffing a former Xerox Corp executive’s bid to modify the terms of his 16-year-old settlement to permit him to discuss the case. The appeals court ruled that Romeril, who had a lawyer in the SEC proceeding, voluntarily waived his 1st Amendment right when he agreed to the SEC’s gag provision as part of his settlement agreement.

Romeril subsequently petitioned the U.S. Supreme Court to review the 2nd Circuit ruling, arguing (among other things) that the SEC’s demand for gag orders in settlements is an unconstitutional condition. “A private party’s supposed ‘consent’ can hardly give the federal government a power of suppression denied it by the First Amendment,” the Romeril petition said.

The Supreme Court denied review, but Abrams picked up on that theme in Friday’s decision. The unconstitutional conditions doctrine, she said, holds that the government cannot wield its power to coerce people to give up their constitutional rights – yet, in Abrams’ view, that is exactly what the SEC is doing when it requires settling defendants to waive their right to deny accusations against them. (As Abrams noted, it’s not entirely a coincidence that she homed in on arguments from the Romeril Supreme Court petition: Romeril’s lead counsel on the petition was Floyd Abrams, who is her father. “Rare though it may be, occasionally we must acknowledge when our parents happen to get it right,” she quipped.)

The SEC’s power to coerce defendants to waive their rights has been a key component of challenges to the agency’s policy. Defendants who have agreed to settlements that include gag provisions are at risk of criminal contempt if they violate their deals, so their only procedural route to undoing the gags is to argue that the provisions are void under the federal rules. So both Romeril and Novinger told federal appellate courts that they were deprived of due process, in part because they were forced to accept the gag policy as a pre-condition of settlement.

Both the 2nd and 5th Circuits rejected those arguments, finding that the procedural rule – which has been interpreted to cover only jurisdictional and notice deficiencies – does not fit the theory that the SEC improperly forced Romeril and Novinger to abandon their 1st Amendment rights. Novinger also failed to persuade the 5th Circuit to accept his alternative theory that it is no longer equitable to enforce the gag rule as a matter of public interest. The appeals court said that rule is intended to address changed circumstances, so it doesn’t apply to the gag provision in Novinger's case.

In the case before Abrams, Moraes counsel Max Nicholas of Spears & Imes declined the judge’s invitation to weigh in on the propriety of the SEC’s gag rule. He did not respond to my email query. The SEC declined to comment.

The New Civil Liberties Alliance, which initiated both the Romeril and Novinger challenges to the SEC gag rule, is now trying a procedurally different tack. The group has returned to a Texas trial court in the Novinger case, filing a motion for a declaratory judgment that the SEC gag provision is unconstitutional. The SEC responded that Novinger can’t get past the procedural rules via declaratory relief.

Novinger counsel Peggy Little of NCLA said she’s encouraged that the trial judge is still considering the motion.

“There has to be a remedy for this,” she said. “We can’t have courts entering unconstitutional orders.”

Read more:

U.S. federal judge in New York criticizes SEC 'gag orders' policy

SEC gag order challenger loses federal appeal (but there's a silver lining)

Free speech scholars – and Elon Musk – urge Supreme Court to review SEC gag orders

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Alison Frankel has covered high-stakes commercial litigation as a columnist for Reuters since 2011. A Dartmouth college graduate, she has worked as a journalist in New York covering the legal industry and the law for more than three decades. Before joining Reuters, she was a writer and editor at The American Lawyer. Frankel is the author of Double Eagle: The Epic Story of the World’s Most Valuable Coin.