Unsettling Silence (Or Can The SEC Make You Gag?)

Whether you’re otherwise on board with the Cato Institute or the Institute for Justice, there’s one thing they do that should warm your cockles: they take the government to task when it overreaches. In a suit filed by IJ for its client, Cato, they reveal an astounding abuse by no more beloved an agency than the Securities and Exchange Commission.

Normally this is the point where we’d tell you who this person is and why the SEC went after him. But we cannot. As part of the agreement he reached to settle the matter, the plaintiff in the Cato suit had to accept a gag order that prevents him from discussing or criticizing the case. Even though the settlement does not require him to admit guilt, he is nevertheless forbidden from saying anything that would indicate that he thinks the “complaint is without factual basis.”

Because this gag order prevents him from talking about the case, it also prevents the Cato Institute from publishing his book. Cato and the Institute for Justice are thus not revealing the man’s identity because doing so would also reveal that he disagrees with, and is critical of, his settlement with the SEC. If he violates the gag order, SEC prosecutors could try to vacate the settlement and punish him more harshly.

The SEC has two modes of attack, civil and criminal, and has long favored the civil suit, which according to IJ results in about 90% settlements. As Cato’s Clark Neilly explains, the SEC includes a detail that’s come under serious scrutiny of late in its settlements.

The case began when a well-known law professor introduced us to a former businessman who wanted to publish a memoir he had written about his experience being sued by the SEC and prosecuted by DOJ in connection with a business he created and ran for several years before the 2008 financial crisis. The memoir explains in compelling detail how both agencies fundamentally misconceived the author’s business model—absurdly accusing him of operating a Ponzi scheme and sticking with that theory even after it fell to pieces as the investigation unfolded—and ultimately coerced him into settling the SEC’s meritless civil suit and pleading guilty in DOJ’s baseless criminal prosecution after being threatened with life in prison if he refused.

The underlying issue, that a government agency has misapprehended how a business functions and, through the squinted eyes of a lawyer who has never run a business but is certain they know everything about them, is wrong. Is it? For most businesses, the options are limited since businesses exist to do business and going to prison puts a serious crimp in doing business. Or more to the point, the investigation and prosecution are more than enough to destroy the business regardless, so win or lose, they lose. Settlement becomes the only viable option.

But the SEC doesn’t want anyone to think it might be wrong, overreaching and abusive. So rather than not be wrong, overreaching and abusive, it came up with a policy at 17 C.F.R. § 202.5(e).

The Commission has adopted the policy that in any civil lawsuit brought by it or in any administrative proceeding of an accusatory nature pending before it, 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. Accordingly, it hereby announces its policy not to permit a defendant or respondent to consent to a judgment or order that imposes a sanction while denying the allegations in the complaint or order for proceedings. In this regard, the Commission believes that a refusal to admit the allegations is equivalent to a denial, unless the defendant or respondent states that he neither admits nor denies the allegations.

It might be noted that many settlements include a confidentiality clause, preventing a party from telling its story. But this isn’t just any party. This is the SEC, an agency of the United States government, and these settlements aren’t arms-length transactions, but civil settlements achieved by leveraging the threat of federal criminal prosecution. Don’t try this at home, as it’s frowned upon.

The obvious SEC response would be that no one who is innocent of any wrongdoing should settle, and no innocent party should fear prosecution, since they’re innocent. If unicorns really did prance on rainbows, this would be a completely reasonable reaction. But unicorns don’t, and it’s nonsense.

It’s hard enough to defend an individual in a federal prosecution given the overwhelming advantage the government has, and which results in a 97% rate of conviction on negotiated pleas. This isn’t because the government is really good at picking out the guilty people, but that the risk of trial for a mere added period of imprisonment of life plus cancer is very persuasive, among many other things.

But businesses have a very different dynamic on top of the problems with an innocent party defending against a wrongful, or excessive prosecution. They aren’t fighting for their life, but for money. They’re businesses, and business is there only goal. to make money. By leveraging criminal prosecution, an extremely expensive and risky proposition, and offering an out by means of civil settlement that might allow a business to survive, there is simply no rational business decision to be made other than to acquiesce. Yeah, it’s an unprincipled choice, but what good is winning when the business is bankrupted, ruined, in the process? This is the quintessential Pyrrhic victory.

So they settle. And they sign off on the SEC’s policy that says they can’t challenge the conduct that SEC says was unlawful because that would make the SEC look sucky and abusive. From the SEC standpoint, it’s a great circular argument, since it would never seek a settlement with an innocent party, so the settling business is obviously guilty, and thus loses nothing by being compelled to waive its right to speak about it afterward.

The lawsuit from the Institute for Justice, filed in the United States District Court for the District of Columbia, seeks to have this gag order declared an unconstitutional violation of the Cato Institute’s First Amendment right to publish this man’s book. They’re asking for an injunction to stop the SEC from enforcing these gag orders.

For a party to refuse to settle because they have a story to tell, a story others should hear, is bad for business. For the SEC to gag parties from telling their story, on the other hand, is bad for the Constitution. Once again, Cato and IJ are taking up a cause that needs to be decided, and hopefully the Constitution, this time, will prevail.

Unsettling Silence (Or Can The SEC Make You Gag?) curated from Simple Justice