Among the big news at the Securities and Exchange Commission this summer was a reported change in the agency's long-standing policy of allowing accused wrongdoers to settle charges without admitting misconduct. Last month's settlement with Philip Falcone and his Harbinger Capital hedge funds, in which Mr. Falcone admitted wrongdoing, has been heralded as the first concrete proof that the agency will sometimes require admissions of culpability. Media reports suggest other cases may be coming.
But if a major policy change is under way, it is unusual that the agency has said nothing publicly about it. While recent media reports have quoted unofficial comments and internal emails of individual SEC officials, the agency has consistently defended no-admit settlements before courts and Congress. It has said—correctly—that no-admit settlements are the civil law-enforcement norm across all federal agencies and essential to the prompt and effective resolution of cases.
Ordinarily a federal regulatory agency puts a major policy shift into effect through an official statement explaining its reasons, or even a formal rule-making. This is a legal requirement. The Supreme Court has held repeatedly—most recently in the obscenity case FCC v. Fox Television Stations (2009)—that when an agency reverses existing policy it must "provide reasoned explanation" and "show that there are good reasons for the new policy." At a minimum, an agency cannot "depart from a prior policy sub silentio or simply disregard rules that are still on the books."
Philip Falcone, CEO of Harbinger Capital PartnersReuters
The SEC's no-admit settlement rule is "still on the books." The agency officially adopted rule 202.5(e) as part of the Code of Federal Regulations in 1972 and has never repealed or amended it. The SEC designed the rule primarily to prevent accused wrongdoers from publicly denying allegations after agreeing to a settlement. But fairly read, that was coupled with the proviso that the SEC would accept settlement offers whenever "the defendant or respondent states that he neither admits nor denies the allegations."
A policy mandating admissions of misconduct would conflict with the spirit if not the letter of the current SEC rule. The agency would therefore do well to initiate a formal rule-making before adopting any material change to its long-standing settlement policy. That would ensure deliberate and public consensus among the SEC commissioners based on appropriate input from the agency's career staff.
The SEC could arguably amend or repeal its existing rule without inviting comments from the public, if it found that the change related only to agency "procedures and practices." But the agency should welcome such input, given the likely consequences. For example, even supporters of a mandatory admission policy concede it would result in fewer settlements and more cases in protracted litigation. This would divert the SEC's limited resources from new investigations and other priorities.
Public input might also help address serious constitutional concerns a policy change would raise. Courts have long recognized that compelled speech—in this case, a forced public confession of wrongdoing—can offend the First Amendment, especially when the speaker disagrees with the message. This forced-speech concern would be especially acute if—as presaged by the Falcone settlement—the SEC keeps the part of its current rule that gags a settling party from publicly disputing the agency's allegations outside of the settlement.
The SEC might argue that admissions would be "voluntarily" made in exchange for avoiding costly litigation, but that argument would probably fall short. Just last term in Koontz v. St. John's River Water Management District, the Supreme Court reaffirmed the "unconstitutional conditions doctrine." That doctrine says, in essence, that regulators cannot coerce citizens into surrendering their constitutional rights as a condition of obtaining a governmental benefit or approval.
The SEC's no-admit settlement rule has served the agency well for more than 40 years. Any significant changes should be made carefully and transparently.
Mr. Ryan, a former assistant director of the SEC's division of enforcement, is a partner with the law firm King & Spalding LLP.