SEC ‘Gag Orders’ at Risk as Skeptical Court Takes Up Challenge

The Securities and Exchange Commission’s controversial policy of silencing defendants who settle with the agency is under fire once again, as a federal appeals court wary of regulators weighs a constitutional challenge.

The SEC has long allowed parties to settle cases brought by the agency without admitting wrongdoing. But they must also promise not to publicly deny the SEC’s allegations—a policy that’s prompted pushback from SEC targets like Elon Musk and Mark Cuban.

A decision from a federal appeals court that the no-deny condition is unconstitutional would have far-reaching effects for the SEC’s policing of financial markets.

“I don’t know that there would be a more significant impact that I could imagine on SEC enforcement when it comes to getting cases resolved,” said Scott Mascianica, a Holland & Knight LLP partner and former SEC attorney.

The condition has been criticized by legal scholars and federal judges as a potential First Amendment violation. Musk and Cuban argue it stifles criticism and hides information from the market.

The “no-deny” policy—often referred to as the Gag Rule—will be back in the spotlight next month, when the US Court of Appeals for the Fifth Circuit hears arguments in a case challenging the policy. The challenge was brought by Christopher Novinger, a financial planner and radio host from Texas.

“We view this as one of the biggest, clearest First Amendment breaches by an agency that’s ever been done,” said Kara Rollins, an attorney with the New Civil Liberties Alliance, which represents Novinger and his company, ICAN Investment Group LLC.

The case wades into a relatively new area of First Amendment law, some legal scholars say. It also illustrates the procedural hurdles defendants confront when challenging the policy years after they settle.

Arguments in Novinger’s case are scheduled for Feb. 8 in New Orleans.

‘Stew of Confusion’

The SEC’s “neither admit nor deny” policy dates to the 1970s. It was a response to people who settled with the agency but then denied doing anything wrong. The SEC in court filings defends the condition as necessary to avoid creating “misleading impressions” about the basis of its enforcement actions.

“The no-deny provision ensures that if defendants were to publicly deny the allegations after settling without admissions, the Commission can seek to have its day in court and obtain findings of fact and conclusions of law,” the SEC has told the Fifth Circuit.

The policy is unusual among federal regulators—only the Commodity Futures Trading Commission insists on similar conditions, the NCLA said in court filings.

Various judges have been critical of the SEC’s approach. Judge Jed Rakoff in the US District Court for the Southern District of New York said in 2011 it created a “stew of confusion and hypocrisy unworthy of such a proud agency as the S.E.C.”

More recently, Fifth Circuit Judge Edith Jones said a “more effective prior restraint is hard to imagine.” Judge Ronnie Abrams, Rakoff’s colleague in the Southern District of New York, echoed Jones’ remark in an October 2022 opinion, saying the no-deny condition has all the hallmarks of a prior restraint on speech.

“What is the SEC so afraid of?” said Abrams, the daughter of noted First Amendment lawyer Floyd Abrams. “Any criticism, apparently—or, rather, anything that may even ‘create the impression’ of criticism—of that governmental agency.”

First Amendment Fight

The SEC settles the vast majority of its cases. And fighting the agency in court can be expensive—Cuban has said he spent over $12 million to beat insider trading charges at trial. Many targets of SEC investigations don’t have those resources, critics argue.

“These people either have to agree to these things and settle or bet their whole livelihood that they’re going to go all the way to the end against a government agency and win in order to tell their story,” said James Valvo, executive director of the nonprofit government watchdog Cause of Action Institute.

“We think that’s wrong from both a constitutional and a policy perspective,” said Valvo, who wrote an influential article in 2017 making the case that the no-deny condition violates the First Amendment.

The effect of the SEC’s approach is that investors get the facts of a case only from the agency’s perspective, some attorneys said. Nick Morgan, a partner in Paul Hastings LLP’s investigations and white collar defense practice, said investors should be entitled to hear the other side of the story.

“It’s contrary to the SEC’s own policy in every other context—the policy being full transparency,” said Morgan, who represented Cuban in filing an amicus brief in a previous case that challenged the SEC’s policy. Musk was also part of the brief.

The Tesla Inc. CEO, who’s been targeted in several SEC probes, is waging his own First Amendment fight at the Supreme Court, looking to invalidate an agreement with the SEC requiring his posts about Tesla on X be screened in advance.

The NCLA filed an amicus brief on Jan. 19 supporting Musk’s bid for review.

Voluntary Waiver?

Novinger settled with the SEC after he was accused in 2015 of fraudulently selling securities. As part of the settlement, he agreed not to make “any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis.”

The SEC in court filings argues parties who enter these agreements voluntarily waive their First Amendment rights. The Second Circuit agreed with the agency in a 2021 decision involving a former Xerox Corp. executive, Barry Romeril.

“A defendant who is insistent on retaining the right to publicly deny the allegations against him has the right to litigate and defend against the charges. Romeril elected not to litigate,” the Second Circuit said in its opinion. The Supreme Court declined to review the case.

Some appeals courts have taken a different approach, refusing to enforce similar conditions in government actions, Novinger’s attorneys have said in court filings. The Fourth Circuit, for example, voided a nondisparagement clause the city of Baltimore entered as part of a settlement in a policy brutality lawsuit, finding it violated the First Amendment.

There have also been constitutional questions about nondisclosure agreements between parties.

“This is a new and volatile area of First Amendment law,” said Rodney Smolla, a First Amendment scholar and president of Vermont Law and Graduate School. “There’s been momentum in the last several years for courts to be skeptical about whether they should enforce these agreements.”

An important factor for a court reviewing the SEC’s policy may be how coercive it views the agency’s take-it-or-leave-it condition, Smolla said.

“As it gets more and more coercive, the idea that you’re doing this voluntarily loses its oxygen,” he said.

The agency has on some occasions demanded retractions or corrections from defendants when it felt they made statements that crossed the line.

In one example the agency has highlighted, former Morgan Stanley CEO Phillip Purcell issued a letter expressing regret and saying the bank wouldn’t deny the SEC’s allegations after the agency rebuked Morgan Stanley for statements in 2003 downplaying the seriousness of charges against the bank.

Procedural Hurdle

For Novinger, the current appeal marks a return trip to the Fifth Circuit, a court that has shown a willingness to strike down longstanding SEC practices for constitutional reasons.

His current case will likely have to overcome procedural hangups that dogged his first challenge. During arguments in his first appearance, a judge told Novinger’s attorney he was “sympathetic to your arguments on the merits,” but there were procedural issues in trying to revise a settlement several years after it was entered.

Back at the district court, Novinger tried a different maneuver, filing a motion for declaratory judgment. A judge rejected the motion in March 2023, finding it was procedurally improper. The SEC argues the Fifth Circuit doesn’t need to entertain the First Amendment issues in this appeal.

Novinger, meanwhile, said he was “trapped in remedy purgatory.”

Even if Novinger isn’t successful, additional challenges are expected to surface. And the NCLA continues to press the SEC to rescind the no-deny policy, filing a renewed petition with the agency last month.

“There are enough well-respected jurists who have significant concerns about this policy, right or wrong, that I think we’re going to keep seeing the challenges,” Mascianica said.

The case is SEC v. Novinger, 5th Cir., No. 23-10525.