Since 1972, the SEC has had a policy that defendants settling civil claims with the Commission can’t go out afterwards and deny the allegations – which is not-so-affectionately known as the “gag rule.” As Liz shared in early 2024, the “neither admit nor deny” policy is, not surprisingly, not roundly supported by companies and other defendants. It’s also drawn criticism – on 1st Amendment grounds – from a federal court.

But, earlier this month, the Ninth Circuit denied a facial First Amendment challenge to the rule. Here’s more from this O’Melveny alert:

Petitioners in the case asked the Ninth Circuit to review the SEC’s denial of a request to amend Rule 202.5(e) to eliminate the provision prohibiting a defendant from denying the SEC’s allegation in a settlement. Because the petitioners were not challenging the application of the Rule to any specific factual scenario, the Court framed the challenge as a facial one. The Court, therefore, could only rule in favor of the petitioners if Rule 202.5(e) would be unconstitutional in all or most of its applications.

Applying the Supreme Court’s framework from Town of Newton v. Rumery, 480 U.S. 386 (1987), the panel concluded that the SEC’s policy is not facially invalid, principally because settling parties may voluntarily waive certain constitutional rights, including their First Amendment rights. The Court pointed out that Rule 202.5(e) applies only when a party agrees—voluntarily—not to deny the SEC’s allegations as a condition of settlement. It also relied on the limited scope of the SEC’s potential remedy for a breach, which is to return to court to ask that the court reopen the case, as providing an additional safeguard against misuse of the Rule. The Ninth Circuit’s holding aligns with the Second Circuit, which has also held that Rule 202.5(e) does not violate the Constitution.

However, the Court left open the possibility of as-applied challenges and took issue with some more expansive language in SEC settlements.

Although the Court rejected the facial challenge, it pointedly declined to immunize the Rule against future attacks. It noted that First Amendment concerns “could well arise in a more particularized, as-applied type of challenge.” For instance, if the SEC were to enforce the Rule in a way that chilled general criticism of the agency, courts may find such applications unconstitutional. In fact, the Court stated that one of the rationales put forth by the SEC in support of the Rule—that “it is necessary to silence defendants in order to promote public confidence in the SEC’s work”—would be an improper rationale in light of the “robust First Amendment protections for speech critical of the government.”

The panel also noted troubling language in some SEC settlement agreements that potentially extend beyond the Rule—for example, prohibiting defendants from making statements that merely “create the impression” that the SEC’s allegations or findings lack a factual basis or from “permitting” others to speak on their behalf. The Court explicitly left open the possibility that these broader restrictions could fail under future legal scrutiny. Additionally, the Court left open the possibility of challenges to the Rule’s unrestricted time period: “[n]or do we decide if it would be constitutional for the facial restrictions in Rule 202.5(e) to apply in perpetuity.”

On LinkedIn, Scott Mascianica says a defendant’s decision may not be as “voluntary” as it seems.

[F]ighting the SEC or settling with the agency can be a “Hobson’s choice” for individuals and entities: dig in and continue to face a financial crippling investigation or litigation OR settle and give up your right to deny the allegations against you. There is no door #3.

For many parties embroiled in SEC investigations or litigation, there is the appearance of a voluntary choice when it comes to resolving matters. In reality, for many, the only option available is to settle on terms set by the agency. Such settlements preclude a settling party from denying the allegations in the charging document; instead, the settling party is limited to stating that they neither admit nor deny the allegations.

He is quick to note not to blame SEC enforcement attorneys for these settlement terms — “their hands are tied by the rule.”

– Meredith Ervine