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 Neily 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 their 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 the 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.

40 thoughts on “Unsettling Silence (Or Can The SEC Make You Gag?)

  1. Mike

    Even if the memoir isn’t published yet, he still discussed it with Cato. Doesn’t that already violate the gag order?

    1. SHG Post author

      Or he discussed it with Clark Neilly, who is an attorney and with whom it can be discussed under attorney/client privilege so as not to violate the gag provision. If you have any other basic questions, remember reddit loves you.

      1. Mike

        Reddit is bullshit. I’d rather get a real answer from an annoyed snarky curmudgeon than an ignorant quick take from a 12 year old troll.

          1. Guitardave

            Glad the SRS* is free. Thanks.
            * Stupidity Reduction Service
            (this post made me vividly recall saying, more than once, “..well, if they settled they must be…”)

  2. Skink

    Holy Crap! Down here in the Swamp, governmental agencies are, except for some obvious stuff, forbidden from including confidentiality clauses in settlement agreements. It’s part of the open government laws. Do we have any FOIA lawyers i this here Hotel?

    1. SHG Post author

      The Swamp is a fascinating place. If we ever franchise this here Hotel, we will certainly open one up in the Swamp. With free wifi.

      1. Skink

        But the Swamp is hardly on the cutting edge. There may be an outlier, but I’d bet a gator and a python that all states forbid this kind of secrecy in civil settlements with the government.

  3. Richard Kopf


    Apparently, the man at issue here entered a guilty plea in an SEC prompted criminal case and not an Alford plea. In an Alford plea, as you well know, one does not contest criminal guilty but one does not admit t either. Alford pleas have to be specifically approved by federal judges.

    I think the argument against gag orders is a good one for civil suits involving the government where there is no guilty plea to a criminal charge. The fact that this person entered into a contemporaneous guilty plea to criminal charges while settling with the government in a manner that gagged the defendant from claiming his innocence, will make CATO’s case a hard one to win in my opinion.

    It is a hard reality that libertarians, like the rest of us, cannot have their cake and eat it too. All the best.


    1. SHG Post author

      There’s the specifics of any individual case (not sure where you’re seeing a crim plea in this instance, but maybe I just missed something) and the SEC policy in the CFR. As for Alford pleas, like pleas themselves, they require the acquiescence of the govt before the judge gets his claws into them. Many offices, and many prosecutors, won’t allow them at all, so whether the court will accept them remains a mystery.

    2. losingtrader

      Having personally spent hundreds of thousands of dollars on securities lawyers dealing with mere general requests for information from SEC, you’re correct about the business decision aspect. But, SEC seems more politicized than any organization in government.

      How’s this for a request: Please provide us with any email or instant meesage you possess in which any of the following were referenced: Washington Mutual, Lehman Brothers, Goldman Sachs, Bear Stearns, AIG, or Morgan Stanley.

      That 2008 request only cost $63,000.

      And the request was made of thousands of firms and individuals in an aborted attempt to prove something something ….that maybe some of these firms were “talked” into insolvency.

  4. Patrick Maupin

    There may be enough information in even the excerpts you quoted to be able to figure out the identity of the plaintiff in this lawsuit.

    An investigative journalist could connect the dots, and make public the information about the plaintiff, and the underlying civil and criminal cases his complaint was based on. The SEC could be Machiavellian enough to tell the judge that, in this case, Noerr-Pennington has rendered the gag order moot, so they are releasing the plaintiff from his promise and now he can publish. The journalist gets a scoop; the IJ gets donations for standing up for us and filing suit; Cato and the plaintiff get to publish the book and reap the resultant profits (and did I mention donations?); the SEC gets to continue business as usual for now; and the public gets a torturous roadmap of how to maybe avoid this trap if they want to write books in the future about how they almost became the next Bernie Madoff.

    1. SHG Post author

      Knowing Clark and IJ, I wonder if they will allow themselves to be bought off so easily. I don’t think so. They’re like a dog with a bone.

      1. Patrick Maupin

        The IJ will almost certainly play with this bone until the judge takes it away from them, and their Disney-protagonist-like approach to transparently and publicly telling the bad guy to stop or face the consequences is usually admirably charmingly useful to both their front-end and back-end operations.

        But if the judge takes away this bone due to the lack of an actual controversy, the IJ will have no one to blame but themselves for their premature free publication.

        1. SHG Post author

          If they picked the wrong vehicle to fight this battle, then they will get what they deserve. But they’re pretty good about picking carefully. And they may still lose, but that’s the nature of the beast.

          1. Patrick Maupin

            They’re certainly no EFF. I always used to groan when those guys got involved in a lawsuit, because they always seemed to EFF them all up.

            1. SHG Post author

              Just between us, there’s an aspect to all “movement” types that lends itself to believe to dearly, and refuse to step back and see both sides, nuances or complexities. And they are a bit resistant to consider the possibility that their beliefs may be just a wee bit wrong.

            2. Patrick Maupin

              As you know, I am stupidly engaging in some pro se litigation. In an effort to be somewhat smart about my stupidity, I did a lot of research on pro se cases at the appellate level.

              I found that, while the judges may not bend over backward to help out pro se litigants, many of them bend over backward to cross their t’s and dot their i’s in the opinions, in the description of how the pro se litigants’ efforts were insufficient. I uncovered a veritable roadmap of the worst possible things a pro se litigant could do.

              The belief that the righteousness of a position is so obvious that it doesn’t need to be thoroughly cited or meticulously argued was mistake number 1. My research gave me flashbacks to reading about some of the EFF’s earlier efforts.

  5. Denver

    I used to do these deals as a lawyer for the SEC. In exchange for “without admitting or denying” the allegations the defendant/respondent agrees to the “gag” clause. If they don’t want the gag clause they don’t get the without admitting or denying language in the final settlement order. It is a straight up deal that people choose to enter into. It is done because if you agree to neither admit nor deny as part of a “plea”/settlement absence of the gag clause allows you to have your cake and eat it too if you are a defendant/respondent. It isn’t forced on anyone, defendants/respondents get to choose what they want to do.

    1. SHG Post author

      In retrospect, do you see any excessive leverage you might have had to compel the target to take a deal?

      Edit: It occurs to me that I really should write some day about the absurdity of the “neither admit nor deny” phrase, as if there would ever be any settlement that included “we completely deny any wrongdoing, but pay because it’s cheaper than fighting with these assholes.”

      1. Denver

        Think of it as similar to a non-disclosure clause in an ordinary civil suit. There are incentives on both sides: avoiding risk of trial,, for defendant/respondent avoiding potential collateral licensing loss risks and avoiding insurance non-coverage. There have been people who have breached their big boy adult deals where the SEC has revoked the deal as a result.

        Is there leverage — lots by the government, there always is.

        It is mandated by the logic of the without admitting or denying ask by the defendant/respondent.

        But it is bad policy in my opinion because: 1) it encourages the SEC to do cases for stats, and incentives it not to take on hard/cutting edge cases where there is a risk of loss at trial; and 2) because it relieves defendants of high costs from a loss where there are findings due to estoppel from a trial loss and hence findings (ie, summary judgment in civil case by investors, no insurance coverage/collateral licensing losses, etc) it lowers the deterrent effect on others because it lowers the cost of losing the case

        1. Patrick Maupin

          “Think of it as similar to a non-disclosure clause in an ordinary civil suit.”

          Yeah, the SEC has every reason to keep the exact contours of behavior it finds actionable a trade-secret.

          1. Dudeman

            There is no “cost” to the SEC to settle or not settle, it’s about convenience. Sure, there is attorney time, but there is no institutional cost. If the SEC needs more attorneys to prosecute cases because more cases are going to trial, there is an institutional gain in leveraging that for a bigger budget – the governmental version of increasing profit.
            In a civil suit, there is a mutual incentive to settle because, at least, there is a savings in the outlay of money for the parties’ attorneys.

      2. Casual Lurker

        “…absurdity of the ‘neither admit nor deny’ phrase…”

        This always reminds me of the CIA’s official “Glomar response”:We can neither confirm nor deny…

        (I’m done for today. You can relax now. ;-))

        1. SHG Post author

          As you’re no doubt aware, by the time you do these mass comments, the posts have aged off the front burner, so it’s really just the two of us left. It’s a shame that your contributions, occasionally interesting and occasionally…less so (while I’m sure some are some dolts unaware of the difference between psychiatrists and psychologists, do you think I am? Is it really your place to play translater for the hard of thinking on my blawg if I chose not to explain the obvious?), aren’t there when people are reading. But if you’re into a chat just between the two of us, that’s nice too.

  6. Jake

    A case that is sure to be important to the many Americans who still haven’t gone back to work since 2008, lost their pensions, and now spend most of their spare time polishing AR-15s and marching in ‘freedom rallies’.

  7. Matthew Scott Wideman

    All this and the SEC couldn’t catch Bernie Madoff. Advocare and the rest of the “triangle”. Multi-level marketing scams still exist.

  8. szr

    The SEC policy looks excessive to me. Compare it to the Federal Trade Commission’s:

    “The [settlement] agreement may state that the signing thereof is for settlement purposes only and does not constitute an admission by any party that the law has been violated as alleged in the complaint.” 16 C.F.R. § 2.32.

    Obviously there are differences between SEC and FTC settlements, but I haven’t heard anyone complain that FTC settlements are undermined by settling parties who then complain.

      1. szr

        You’re right that the comparison between the SEC and FTC settlement agreement regulations isn’t ideal. But it may bolster an argument that the SEC’s policy is not narrowly tailored.

  9. RedditLaw

    SHG said, “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.”

    I must say that I have been informed by none other than criminal law practitioner Renato Mariotti on Twitter that if a party appears in court and lays a factual basis on the record with competent counsel, then what that person said was true and trustworthy. I think that Mr. Mariotti had more to say, but I’m sure that he had to hurry off and negotiate some plea settlements with his AUSA buddies for his white-collar clients over lunch.

    So, why would these people want to come back and lie about their plea? I confess myself baffled.

    1. SHG Post author

      While Renato was a former federal prosecutor, which he oddly notes first in his twitter bio as if what he does now is worthless and it’s his only means of establishing credibility in the eyes of his fans, he isn’t a CDL and some of his views on these issues are mind-numbingly fucking wrong and stupid possibly inaccurate.

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