SEC Consent Judgments: Speak Now, or Forever Hold Your Peace
Most investors are likely unaware that they can petition the SEC for new rules or changes to old ones. They can even ask that rules be entirely repealed. All that’s needed is to send a proposal to the secretary of the SEC—now Vanessa Countryman—and wait for results. Petitioners come from wildly different backgrounds. Most are lawyers (often representing individuals or entities that have been sued by the Commission) or people who more broadly object to rules they believe to be unfair or even unconstitutional. For ordinary investors, objections to the “pattern day trading” rule, which is administered by FINRA, not the SEC, have long been popular—and even students occasionally weigh in. See the petition of Atticus Wong, a high school student in California, who wrote in connection with a class project about civic engagement.
The SEC explains the submission process simply:
Petitions must contain the text or substance of any proposed rule or amendment or specify the rule or portion of a rule requested to be repealed. Persons submitting petitions must also include a statement of their interest and/or reasons for requesting Commission action.
All petitions will be forwarded to the appropriate division or office of the Commission for consideration and recommendation. Following submission of the staff’s recommendation to the Commission, petitioners will be notified of any action taken by the Commission.
The agency will then post the petition on the appropriate page on its website, which is likely the last the petitioner will ever hear of it. Apparently, the Commission is not obliged to give serious consideration to any of the petitions it receives. When it responds at all, it usually does so only after years of delay, and the petitions graced by its acknowledgment are almost always denied.
Early last year, Kara McKenna Rollins, an attorney who now works for the New Civil Liberties Alliance (NCLA), wrote an article in the Yale Journal on Regulation about the petition process, giving the SEC failing marks for its administration. She argues that although the Commission writes and adopts new rules aggressively and brings enforcement actions with equal enthusiasm, it seems to have little interest in dealing with the petitions it receives. She shows that of the 77 petitions it was sent between January 2018 and early 2023, it had “substantively responded” to only five. Only one petition reached the final rule stage and was adopted by the Commission.
The point of departure for Rollins’s article was an unusual situation involving Coinbase Global (COIN), which describes itself as a “cryptocurrency exchange platform.” On July 21, 2022, Coinbase sent a long and thoughtful petition to the SEC, asking that “the Commission propose and adopt rules to govern the regulation of securities that are offered and traded via digitally native methods, including potential rules to identify which digital assets are securities.”
It was not an unreasonable request. The agency has been dragging its feet on rulemaking in the crypto sector for years; one commissioner, Hester Peirce, calls what it’s doing “regulation by enforcement” and objects to it. The SEC did not merely ignore Coinbase’s petition. Worse yet, on March 22, 2023, it sent the company a Wells notice, indicating that the Enforcement Division intended to bring suit, though the final decision on that would rest with the Commission. Coinbase, clearly frustrated, countered swiftly with an unusual move. On April 24, it filed a petition for a writ of mandamus with the U.S. Court of Appeals for the Third Circuit.
The power of mandamus is held only by federal appellate courts. It is considered “an extraordinary remedy, which should be used in exceptional circumstances of peculiar emergency or public importance.” It is used to “compel an officer or employee of the United States or any agency thereof to perform a duty owed to the [petitioner].” It is not available if any other means of relief exists. The relief sought by Coinbase was simple:
Coinbase brings this mandamus action to seek modest, but meaningful and time-sensitive, relief: a writ requiring the Securities and Exchange Commission (SEC or Commission) to act on Coinbase’s pending rulemaking petition to provide clarity for the crypto industry. Coinbase does not ask the Court to instruct the agency how to respond. It simply requests that the Court order the SEC to respond at all. The Commission has repeatedly demonstrated that its mind is made up to deny the petition. But the Commission’s delay in formally announcing that decision has enabled it to improperly delay judicial review at a critical moment for the industry.
The SEC responded on May 15, 2023, asking that mandamus be denied because Coinbase had not met the “high bar” for relief it required. It notes that the company filed its petition “fewer than ten months ago, supplemented aspects of the petition fewer than three months ago, and sought to supplement the record again only weeks ago.” Yet, it expects the Commission to enact, or at least to agree to enact, “a comprehensive new regulatory regime for the trading of crypto assets that are securities.”
It added that it had done what was needed: it opened a file and began receiving public comments. It did not get all that many; the most substantial were from Coinbase itself. The court filings in the case continued. Almost immediately, on June 6, 2023, the SEC charged Coinbase for operating as an unregistered securities exchange, broker, and clearing agency. On December 15, the Commission got around to voting on the petition and rejected it. Chair Gary Gensler was pleased, saying, “[t]he existing securities regime appropriately governs crypto asset securities…” His two fellow Democratic commissioners agreed with him; Republicans Hester Peirce and Mark Uyeda dissented. They offered a brief explanation of their votes. Three days later, the Third Circuit Court of Appeals dismissed the petition for mandamus as moot. It cannot have been a positive experience for Coinbase.
The SEC’s So-Called “Gag Rule” and the Petition to Amend It
Compared to most submitted to the Commission, the ill-fated Coinbase petition was dealt with quickly. The SEC says all petitions received are sent to the appropriate “division or office” for review. But as Rollins’s statistics indicate, most seem not to attract even minimal notice from the staffers who deal with them. Very few receive comments, and it seems almost none make their way to a commissioner’s desk. Of those that do, most are rejected.
On January 30, 2024, another one suffered that fate, but the questions it raises are perhaps worth considering. Fifty years ago, the SEC was led by William Casey. At the end of 1971, he formed an advisory committee to examine enforcement practices and put his friend John Wells in charge. The committee came to be known as the Wells Committee. One of the practices the committee recommended was to notify most enforcement targets of a pending enforcement action and allow them to present a response that might fend off the planned action. Those communications from the enforcement division are still called “Wells notices” today, and the responses are called “Wells submissions.”
It was in 1972 that the agency officially promulgated a formal policy governing settlements. Settlements themselves were nothing new. Most civil litigation, whether brought by a government agency or not, settles in the end. In most cases, it’s in the interest of both sides to wrap up the matter as quickly as possible. In its discussion of enforcement actions, the Wells Committee’s report, in fact, balances the necessity for some form of sanctions with the need to allow for rehabilitation of the wrongdoers, whether an individual or entity. Wells believed less damage would be done to the issuer in question, and to investors in it, if the matter were settled quickly, without the publicity that might be attendant on a trial.
That was not the only advantage of settlement. It also saved both the defendants and the SEC time and money. Trials are expensive for both sides of any case. In 2013, then-Commissioner Luis Aguilar reported in a speech that “[t]he SEC currently settles approximately 98% of its Enforcement cases and, in 2012, we went to trial in only 22 out of the 734 cases we brought.” No one objected in the past, or objects now, to the settlement of civil litigation. The sticking point is, and has been for about 15 years, the “Gag Rule” adopted in 1972:
(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.
(17 C.F.R. § 202.5(e) (1972))
From the SEC’s point of view, what’s important about that is that it makes it impossible for anyone to imagine that a sanction is being imposed for conduct that did not occur. Impossible for anyone who thinks the way the authors of the Code of Federal Regulations do, at least.
And that isn’t all. The real sticking point for some is that a defendant or respondent who signs such a consent agreement is bound by it forever. Should he at any time—even 40 years in the future, while writing a memoir for his grandchildren—deny that the allegations made against him in the relative complaint are true, the SEC will be entitled to ask a judge to vacate the consent judgment and reinstate the case in federal district court. Increasing numbers of people see that as a violation of the defendant’s First Amendment rights. After all, had he gone to trial and been found liable, he’d probably have been sanctioned, but he’d be free to claim loudly and publicly that he’d never done what he was alleged to have done.
That argument is, as we shall see, increasingly fashionable nowadays, but it cuts both ways: Yes, he could have gone to trial and preserved his First Amendment rights. But by signing the consent judgment that required him never to admit nor deny the truth of the allegations, he’d signed away those rights. The choice was his from the start.
The Petition
Perhaps curiously, the petition at the center of our discussion does not involve any specific case, nor does it champion any actual wronged defendants. Its purpose is to show that the “Gag Rule” is wrong, unfair to potential defendants, and violative of their constitutional rights. Its formal title was “Request for rulemaking to amend the rule restricting speech that is set forth in 17 C.F.R. § 202.5(e) (“The Gag Rule”).” It was originally filed on October 30, 2018, and “renewed” on January 30, 2023.
The entity responsible for its filing was the New Civil Liberties Alliance, a far-right-of-center organization with this mission:
NCLA views the administrative state as an especially serious threat to constitutional freedoms. No other development in contemporary American law denies more rights to more Americans. Although Americans still enjoy the shell of their Republic, there has developed within it a very different sort of government—a type, in fact, that the Constitution was designed to prevent. This unconstitutional administrative state within our U.S. government is the focus of NCLA’s concern. NCLA urges Americans to recognize the administrative threat and join our civil liberties movement against it.
No one would deny that the “administrative state”—also called, more dramatically, the “Deep State”—can be tiresome. All government bureaucracies offer up frustration by the bucketful. But it should be remembered that from the beginning of time, no productive civilization has existed without one, from the Assyrians to the Egyptians to the Romans, and, in other parts of the world, the Chinese and other Asian cultures. Government bureaucracies all over the world spread literacy, kept historical records, encouraged and facilitated local commerce and international trade, and more.
But what are NCLA’s specific objections to the “Gag Rule,” and in what way would it amend what’s been SEC policy for 50 years? NCLA says that “on its face and as applied in perpetuity in Consent Orders” it “fails to pass constitutional or legal muster under many doctrines,” and then cites some of them. “It is a forbidden prior restraint” is perhaps the most convincing. Going on: it “prohibits truthful speech”; “as applied in Consent Orders unconstitutionally compels speech”; it’s a “content-based restriction on speech”; it’s an “unconstitutional condition”; it “violates the First Amendment’s right to petition”; and more.
NCLA proposes to fix these deficiencies and examples of unconstitutional overreach quite simply. One only needs to consult Appendix A at the end of the petition. The plan is simply to remove most of the text (see 17 C.F.R. § 202.5(e) above) and replace it with:
(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, a defendant or respondent may consent to a judgment or order in which he admits, denies, or states that he neither admits nor denies the allegations in the complaint or order for proceedings.
But wouldn’t that encourage what the SEC said 50 years ago it wanted to avoid? That the alleged violative conduct didn’t really occur? How many defendants and respondents would sign on the dotted line and continue to protest, perhaps to investors, to the press, in corporate communications, that they’d been wrongly accused but had to bow to pressure brought by the government?
Once again, any defendant who doesn’t wish to settle doesn’t have to do so. He can go to trial. Regardless of the outcome, he’ll have every right to insist on his good, even perfect, conduct.
Interestingly, NCLA attempts to make common cause with Judge Jed Rakoff, who presides in the Federal District Court for the Southern District of New York. Rakoff was appointed by President Bill Clinton in 1995 and—while not a firebrand—is generally considered to have liberal leanings. He’s not an unqualified fan of big government, though, for reasons entirely different from NCLA’s. The story of how he went up against the SEC is an interesting one, and is still controversial today.
On October 19, 2011, the SEC filed a complaint against Citigroup Global Markts Inc., charging that in 2006-2007, it had misled investors about a $1 billion collateralized debt obligation that it then hedged by taking a short position that it did not disclose, and that would not benefit those investors. The case was assigned to Rakoff. The SEC had already settled with Citigroup for $285 million in disgorgement, prejudgment interest, and penalties. All Rakoff needed to do was sign off on the settlement agreement and dismiss the case.
He refused to do that, explaining his reasons in a 15-page order filed on the day the SEC announced its settled action. By declining to play along, he’d endangered a raft of other settlements the agency had worked out with other giant corporations. The story made headlines in newspapers all over the country, and all over the world, to the embarrassment of Big Business and the SEC.
In his Opinion and Order, Rakoff explained that rather than simply rubber stamp the consent judgment as expected, he’d asked both parties some questions to which they’d replied in writing. That was followed by oral arguments. The judge professed to be perplexed and commented with more than a little sarcasm:
Since then, the Court has spent long hours trying to determine whether, in view of the substantial deference due the S.E.C. in matters of this kind, the Court can somehow approve this problematic Consent Judgment. In the end, the Court concludes that it cannot approve it, because the Court has not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment.
That was because Citigroup had neither admitted nor denied any of the charges laid against it by the SEC. Rakoff insists that the SEC and Citigroup cannot just agree upon the terms of a settlement precisely because the SEC is a government agency, part of whose mission is to act in the public interest. He called the “neither admit nor deny” policy “hallowed by history, but not by reason” and criticized the SEC’s insistence that because Citigroup did not deny the allegations made against it, they must be true, noting that: “As a matter of law, an allegation that is neither admitted nor denied is simply that, an allegation.” More pointedly, he adds:
As for common experience, a consent judgment that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies. This, indeed, is Citigroup’s position in this very case. See Citigroup Mem. at 6-8.
In its petition, NCLA approvingly quoted a part of Rakoff’s opinion that echoed, or at least served, its own beliefs:
An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free-roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts – cold, hard, solid facts, established either by admissions or by trials – it serves no lawful or moral purpose and is simply an engine of oppression.
Rakoff refused to approve the consent judgment. His decision was highly controversial. He was hailed as a hero by many investor advocates, and a few other judges followed his example. In June 2013, new SEC chair Mary Jo White announced that the enforcement division would be seeking admissions of wrongdoing in some settlements. That initiative became official policy, but has resulted in very few consent judgments of the kind promised.
Both the SEC and Citigroup appealed the case to the Second Circuit. On June 11, 2014, the Court of Appeals reversed Rakoff’s decision, concluding, “Trials are primarily about truth. Consent decrees are primarily about pragmatism.” The case was remanded to the district court, and Rakoff had no choice but to approve the consent judgment. On August 5, he did so reluctantly and unhappily:
Accordingly, in an Order that will be filed separately today, the Consent Judgment will be approved.
Nonetheless, this Court fears that, as a result of the Court of Appeal’s [sic] decision, the settlements reached by governmental regulatory bodies and enforced by the judiciary’s contempt powers will in practice be subject to no meaningful oversight whatsoever. But it would be a dereliction of duty for this Court to seek to evade the dictates of the Court of Appeals. That Court has now fixed the menu, leaving this Court with nothing but sour grapes.
The NCLA Petition is Denied
Nearly 10 years have passed since Judge Rakoff submitted to the Second Circuit. The SEC hasn’t made significant changes to the way it deals with civil litigation and consent judgments. More entities—civil liberties activists like NCLA and Libertarian think tanks like the Cato Institute, which attempted to bring related litigation of its own—have raised their voices in protest, to little effect. A few targets of SEC litigation have gone to court asking for do-overs—see the 2022 Fifth Circuit’s order in SEC v Christopher A. Novinger and ICAN Investment Group, L.L.C–but so far without success.
The NCLA petition had received no attention from the SEC. On December 20, 2023, Kara Rollins, who’d earlier written about the petition process in the Yale Journal on Regulation, sent a letter to the Commission’s secretary, Vanessa Countryman, reminding her of the petition and adding some new material, including a plea for “justice” for Christopher Novinger, who’d lost his appeal some months earlier.
Finally, on January 30, 2024, the Commission came to a decision, voting to deny the petition 4:1. The odd commissioner out was Hester Peirce. On the same day, Countryman wrote to Margaret Little, the NCLA attorney who’d written the petition, explaining the Commission’s decision at some length. Countryman notes at the outset that consent judgments have “attributes both of contracts and of judicial decrees.”
They resemble contracts because they “are entered into by parties to a case after careful negotiation has produced agreement on their precise terms”… And they are decrees because they are memorialized in a judgment over which a court retains jurisdiction… The Commission settles cases by this method rather than entering into out-of-court, non-public settlements followed by a voluntary dismissal.
She then went on to cite the agency’s favorite line: the agreement mustn’t allow anyone to think the (mis)conduct alleged had not occurred, so the no-admission, no-denial clause is necessary. She further points out the obvious: that the defendant in any SEC civil action is entirely free to go to court and present his case to a judge and jury. Just as obviously, “[t]here is a large body of precedent confirming that a defendant can waive constitutional rights as part of a civil settlement, just as a criminal defendant can waive constitutional rights as part of a plea bargain.” Countryman closes by repeating that in these settlements, “the parties reach a mutually acceptable resolution.”
Chair Gary Gensler wrote approvingly of the decision, emphasizing some of the points made by Countryman. Commissioner Hester Peirce, who’d disagreed with her colleagues when the vote was taken, put together a rather long comment in which she said unequivocally that “this issue warrants a spot on our rulemaking agenda.” Unlike her fellow commissioners, the Second Circuit appellate panel, and several other appeals courts, she believes the no-admit, no-deny policy raises constitutional issues. In support of that and other contentions, she cites the Opinion & Order in SEC v. Fernando Motta Moraes, handed down by Judge Ronnie Abrams of the S.D.N.Y. on October 28, 2022.
Abrams is, at least in this case, even more willing to speak her mind than was Jed Rakoff. She comes out swinging:
In its normal practice of settling enforcement actions, the SEC routinely demands that defendants sacrifice the ability to ever deny the allegations against them—indefinitely silencing them from speech otherwise protected by the First Amendment. The threat held over the head of defendants by this so-called “No-Admit-No-Deny Provision” (the “Provision”) is not easily overstated. Should they ever publicly refute the accusations against them, or even so much as “create the impression” that the SEC got something wrong, the Commission may reopen their cases or seek to hold them in contempt, thereby subjecting them to the risk of enormous financial and professional penalties, if not imprisonment. Truth is no defense.
She continues in the same vein for nine pages, though she explains on page two that “[c]onsistent with Second Circuit precedent… the Court will approve the agreement, but it will not do so silently.”
In her own argument, she acknowledges that while defendants may waive their First Amendment rights, they should not be manipulated or coerced into doing so. She is concerned that these actions may violate the unconstitutional conditions doctrine: “The government may not ‘condition[]’ the ‘conferral of a benefit . . . on the surrender of a constitutional right.'” Abrams closes by asking, “What is the SEC so afraid of? Any criticism, apparently—or, rather, anything that may even ‘create the impression’ of criticism—of that governmental agency.” She then approves the consent agreement “at the request of the parties,” ironically.
Hester Peirce clearly admires Abrams’s willingness to speak her mind, and clearly wishes she could have sparked more interest at SEC headquarters in the issues raised. We’re not sure what conclusions to draw at this point. Current-day concerns about the “Deep State” are exaggerated and—especially when they involve Taylor Swift—sometimes absurd. But Judge Rakoff and Judge Abrams made a good case for keeping an eye out for overreach that can lead to the denial of constitutional rights.
If only one bewildered defendant is persuaded to waive those rights by an SEC attorney who wants a win, and a defense lawyer who just wants to close what won’t be a very profitable case, it will be one too many. Perhaps we should be on the watch for new cases and for new legal analyses of the issues involved.
To speak with a Securities Attorney, please contact Brenda Hamilton at 200 E Palmetto Park Rd, Suite 103, Boca Raton, Florida, (561) 416-8956, or by email at [email protected]. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
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