A. Who is a Protected Whistleblower?
The following is from an excellent SIFMA presentation provided by Wayne Carlin and Cheryl Haas.
On February 21, 2018, the U.S. Supreme Court issued its decision in Digital Realty Trust v. Somers, 138 S. Ct. 767 (2018), holding unanimously that Dodd-Frank prohibits retaliation against whistleblowers only if they report suspected wrongdoing to the SEC directly. Accordingly, whistleblowers who report their suspicions to their employer or another entity without also going to the SEC will receive no protection from retaliation under Dodd-Frank. The unanimous opinion invalidated an SEC interpretive rule which construed the anti-retaliation protections of Dodd-Frank as applying to employees who reported potential violations to their employers, even if no report was made to the commission.
The Supreme Court focused on the clear statutory language, ruling that Section 78u-6 “describes who is eligible for protection- namely a ‘whistleblower’ who provides pertinent information ‘to the commission.’” The Court stressed that the “core objective” of the Dodd-Frank Whistleblower Program was to “motivate people who know of securities law violations to tell the SEC.” Id. (quoting S. Rep. No. 111-176 at 38). The Ninth Circuit in Digital Realty had previously held that an employee was entitled to anti-retaliation protections notwithstanding his failure to report the wrongdoing to the SEC. 850 F.3d 1045 (9th Cir. 2017). That court reasoned that the meaning of “whistleblower” under the statute was ambiguous and thus deferred to the Commission’s interpretation that the term as broad enough to cover those who report wrongdoing internally instead of to the Commission. The Supreme Court decision resolved a Circuit split: the Ninth Circuit’s decision was consistent with the holding of the Second Circuit in Berman v. Neo@Ogilvy LLC, 801 F.3d 145 (2nd Cir. 2015) but in opposition to the Fifth Circuit, which came to a contrary result in Asadi v. G.E.Energy (USA), LLC, 720 F. 3d 620 (5th Cir. 2013).
Whistleblowers who report internally but do not to the SEC may still have some recourse against retaliation under state law or Sarbanes-Oxley. However, the process is more cumbersome and lengthier. Thus, whether the ruling has a significant impact on how and where whistleblowers make their initial reports remains to be seen. On June 28, 208, the SEC announced that it had voted to propose new whistleblower rule amendments. See SEC Press Release, SEC Proposes Whistleblower Rule Amendments (June 28, 2018). Among other things, the SEC proposed rule amendments in response to the Supreme Court’s holding in Digital Realty which essentially invalidated the Commission’s rule interpreting Section 21F’s anti-retaliation protections to apply to internal reports. The proposed rules would modify Rule 21F-2 by, among other things, establishing a uniform definition of “whistleblower” that would apply to all aspects of Exchange Act Section 21F- i.e., the award program, the heightened confidentiality requirements, and the employment anti-retaliation protections. For purposes of retaliation protection, an individual would be required to report information about possible securities laws violations to the Commission “in writing.” The SEC anticipates new rules being adopted in FY 2020.
On July 9, 2019, the House of Representatives passed the Whistleblower Protection Reform Act of 2019 (H.R.2015). The Act would clarify that whistleblowers who report potential violations of securities laws to their employers are protected by the anti-retaliation provisions of Dodd-Frank, effectively overturning the holding in Digital Realty. The bill is now awaiting action in the Senate.
Under the SEC whistleblower-reward program, the SEC issues rewards to eligible whistleblowers who provide original information that leads to successful SEC enforcement actions with total monetary sanctions exceeding $1 million. The SEC has awarded approximately $387 million to 67 whistleblowers since issuing its first award in 2012. In FY 2019, the SEC awarded approximately $60 million to eight, significantly less than the $168 million awarded last year. The SEC’s proposed rule amendments would give the agency additional discretion to increase or decrease the size of the award under certain circumstances and allow the payment of awards to whistleblowers even when the matter is resolved outside of the context of a judicial or administrative proceeding.
B. Impeding Whistleblowing Activity
In April 2015, the SEC brought its first enforcement action against a company for using improperly restrictive language in confidentiality agreements with the potential to stifle the whistleblowing process. See SEC Press Release, Agency Announces First Whistleblower Protection Case Involving Restrictive Language (April 1, 2015). In that case, the SEC charged Houston-based technology and engineering firm, KBR, with violating whistleblower protection Rule 21F-17 enacted under Dodd-Frank. KBR required witnesses in certain internal investigation interviews to sign confidentially statements with language warning that they could in fact discipline and even be fired if they discussed the matters with outside parties without the approval of the law department. The SEC found that these terms violated Rule 21F-17 which prohibits companies from taking any action to impede whistleblowers from reporting possible securities violations to the SEC. The SEC said that its rules prohibit employers from taking measures through confidentiality, employment, severance, or other type of agreements that may silence potential whistleblowers before they can reach out to the SEC.
C. More Recent Actions
The SEC has been very focused on whistleblower-related issues. In FY 2017, the SEC instituted administrative proceedings against four companies for violating Rule 21F-17. In the space of one week in August 2016, the SEC brought two enforcement actions reiterating its focus on protecting the rights of whistleblowers. In each case, companies attempted to remove the financial incentives for departing employees to submit whistleblower reports to the SEC. The result instead was a pair of administrative orders (on a neither admit nor deny basis) finding that each company violated SEC Rule 21F-17, which prohibits any person from taking any action to impede a whistleblower from communicating with the SEC about possible securities law violations. In the Matter of BlueLinx Holdings Inc., Rel No. 78528 (August 10, 2016); In the Matter of Health Net, Inc., Rel. No. 78590 (August 16, 2016).
Both of these cases involved severance agreements entered into with individuals in connection with the termination of their employment relationship, as a condition to the receipt of severance payments and benefits. As is common, such agreements included language that memorialized the departing employee’s obligation to maintain the confidentiality of company information. Notwithstanding the confidentiality provisions, BlueLinx included language in its agreements that acknowledged, among other things, the employee’s right to “file a charge” with the SEC. The BlueLinx agreements went on, however, to provide that “Employee understands and agrees that Employee is waiving the right to any monetary recovery in connection with any such complaint or charge…” Similarly, Health Net’s severance agreements included a provision in which the departing employee expressly waived the right to file an application for a whistleblower award pursuant to Section 21F of the Securities Exchange of 1934. Health Net removed the specific reference to the Exchange Act from later agreements, but still retained language providing that the employee waived any right to monetary recovery in any proceeding based on any communication by the employee to any government agency.
While the principal focus of these cases is the relatively unusual interference with financial incentives discussed above, the BlueLinx agreements also included a more common-place provision requiring employees to notify the company’s legal department in the event that they believed they were required by law or legal process to disclose any confidential information. BlueLinx thus raises the question whether the SEC would assert that a notice requirement without an express carve-out for whistleblowing violates Rule 21F-17, even if it is entered into at a time when no investigation is in progress or contemplated and even if there are no provisions in the agreement directly aimed at deterring whistleblower activity.
On September 29, 2016, the SEC filed its first stand-alone retaliation action against International Game Technology, a casino-gaming company. In the Matter of Game Technology, Rel. No. 78991 (Sept. 29, 2016). IGT agreed to pay a half-million-dollar penalty for discharging an employee because he reported to senior management and the SEC that the company’s financial statements might be distorted. The SEC found that the employee was removed from significant work assignments within weeks of raising concerns and fired approximately three months later.
A number of recent actions continue to focus on agreements that improperly hurt or discourage employees or former employees from reporting suspicions of wrongdoing to the SEC. On December 17, 2016, the SEC announced a settlement with Neustar, Inc., pursuant to which the company agreed to pay a penalty of $180,000 to settle charges involving its severance agreements. See SECPress Release, Company Violated Rule Aimed at Protecting Potential Whistleblowers (Dec. 19, 2016). Those agreements contained a broad non-disparagement clause forbidding former employees from engaging with the SEC in “any communication that disparages, denigrates or maligns or impugns” the company. The next day, the SEC revealed an agreement to settle charges with SandiRidge Energy Inc. See SEC Press Release, Company Settles Charges in Whistleblower Retaliation Case (Dec. 20, 2016). The company used retaliation language in its separation agreements prohibiting outgoing employees from participating in any government investigation or disclosing information potentially harmful or embarrassing to the company. On January 19, 2017, financial services company HomeStreet Inc. agreed to pay a $500,000 penalty to resolve charges that it conducted improper hedge accounting and then took steps to impede potential whistleblowers. See SEC Press Release, FinancialCompany Charged with Improper Accounting and Impeding Whistleblowers (Jan. 19, 2017). Those steps included suggesting to one individual that the company might deny indemnification for legal costs during the SEC investigation and requiring several employees to sign severance agreements waiving potential whistleblower awards or risk losing their severance payments and other post-employment benefits.
Most recently, the SEC filed an amended complaint against Collectors Café alleging that it had violated Rule 21F-17 by interfering with an investor’s ability to communicate with eh SEC about possible misconduct in the company. See Amended Complaint, SEC v. Collectors Café Inc. et al, 19-cv-04355-LGS-GWG (S.D.N.Y. 11/4/19). The Complaint alleges that the company included a representation in a stock purchase agreement with investors who had raised concerns with the company about their investments that they had not and would not contact any third party for the purpose of commencing or promoting an investigating, including governmental or administrative agencies. This is the first time that the SEC has applied the rule outside the context of the traditional employer/employee relationship.
These enforcement actions confirm that the SEC continues to focus on protecting whistleblower rights. Companies should review all forms of agreements with employees, including standard form separation agreements and releases, to ensure that the terms do not prohibit an employee from exercising any legally protected whistleblower rights, and should not consider including an express exclusion with that effect. In light of the SEC’s position in Collectors Café, companies should also pay particular attention to these issues when preparing agreements with outside investors.