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.
Follow our firm on LinkedIn and Twitter.
