The SEC has proudly announced that including a $22 million award on August 30, 2016, its whistleblower awards have surpassed $100 million. The news comes in the wake of two recent SEC enforcement proceedings against companies based on confidentiality and waiver language in employee severance agreements. Like two prior similar actions, the SEC has taken the position that restrictive language in confidentiality, waiver or settlement agreements with employees violates the anti-whistleblower rules adopted under Dodd-Frank.
Background – The Dodd-Frank Act Whistleblower Statute
The Dodd-Frank Act, enacted in July 2010, added Section 21F, “Whistleblower Incentives and Protection,” to the Securities Exchange Act of 1934 (“Exchange Act”). As stated in the original rule release, the purpose of the rule was “to encourage whistleblowers to report possible violations of the securities laws by providing financial incentives, prohibiting employment related retaliation, and providing various confidentiality guarantees.” Upon enactment of Section 21F, the SEC established the Office of the Whistleblower and created the SEC Whistleblower Program (“Whistleblower Program”).
The whistleblower regulations are comprised of Section 21F of the Exchange Act and Rules 21F-1 through 21F-17 promulgated thereunder. The bulk of the whistleblower regulations relate to the submission of original information leading to successful enforcement actions, and the eligibility, calculation and payment of awards to the whistleblower. The regulations also implement measures to protect the whistleblower from retaliatory actions.
Rule 21F-2, “Whistleblower status and retaliation protection,” defines a whistleblower as follows:
(a)(1) “You are a whistleblower if, alone or jointly with others, you provide the Commission with information pursuant to the procedures set forth in § 240.21F-9(a) of this chapter, and the information relates to a possible violation of the Federal securities laws (including any rules or regulations thereunder) that has occurred, is ongoing, or is about to occur. A whistleblower must be an individual. A company or another entity is not eligible to be a whistleblower.”
(b) Prohibition against retaliation. (1) “[F]or purposes of the anti-retaliation protections…, you are a whistleblower if: (i) you possess a reasonable belief that the information you are providing relates to a possible securities law violation… that has occurred, is ongoing, or is about to occur, and; (ii) you provide that information in a manner described in Section 21F(h)(1)(A); (iii) The anti-retaliation protections apply whether or not you satisfy the requirements, procedures and conditions to qualify for an award.”
Rule 21F-17, “Staff communications with individuals reporting possible securities law violations,” which is the subject of the enforcement actions, provides:
(a) “No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement… with respect to such communications.”
Enforcement Proceedings
The SEC brought two enforcement proceedings against companies during the month of August based on restrictive language in confidentiality and waiver provisions in employee severance agreements. The two new proceedings are similar to two prior proceedings based on the same issue. The SEC enforcement proceedings claim that the restrictive language acts as a method to stifle or retaliate against whistleblowers.
In early 2016, the SEC began issuing requests to companies for copies of confidentiality agreements, non-disclosure agreements, employment agreements, severance agreements and settlement agreements entered into with employees and former employees of the companies. The initiative specifically requested copies of documents since the enactment of the Dodd-Frank provisions that grant awards and protections for whistleblowers. The SEC was also asking for copies of company human resource policies, employee memos, training guides and any and all documents that discuss “whistleblowers” either directly or indirectly.
The SEC’s concern is that corporations are retaliating against potential whistleblowers and attempting to curb the whistleblowing incentives in the Dodd-Frank Act by providing detriments to employment in contracts and policies veiled as confidentiality protections. The Dodd-Frank Act directly prohibits retaliatory conduct by companies.
In the action filed on April 1, the SEC charged KBR, Inc., with violating Rule 21F-17 under the Dodd-Frank Act. In this case, KBR required employees participating in internal investigations related to potential securities law violations, to sign confidentiality agreements that prohibited the employee from discussing the matter with outside parties without KBR approval with a consequence of discipline or termination in the event of a violation of such confidentiality agreement. As the investigations included allegations of securities law violations, the terms in the agreement were found to violate Rule 21F-17 of the Dodd-Frank Act, which specifically prohibits companies from taking any action to impede whistleblowers from reporting possible securities law violations to the SEC. KBR agreed to pay a penalty of $130,000 and to amend its confidentiality statement to make it clear that employees are free to report possible violations to the SEC and other federal agencies without KBR approval or fear of retaliation.
In its press release on the matter, Andrew J. Ceresney, SEC Director of the Division of Enforcement, was quoted as saying, “By requiring its employees and former employees to sign confidentiality agreements imposing pre-notification requirements before contacting the SEC, KBR potentially discouraged employees from reporting securities violations to us. SEC 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. We will vigorously enforce this provision.”
The SEC enforcement action came despite the factual conclusion that no employee had actually been prevented from reporting a violation to the SEC or had sought to do so.
On August 10, 2016, the SEC brought a settled administrative proceeding against BlueLinx Holdings, Inc., ordering a $265,000 penalty for a violation of Rule 21F-17 by illegally using severance agreements requiring outgoing employees to waive their rights to seek monetary compensation under the SEC Whistleblower Program. A violation of the agreement would result in a loss of severance payments and other post-employment benefits. Similarly, in a settled administrative proceeding on August 16, 2016, the SEC ordered Health Net, Inc., to pay a $340,000 penalty for violating Rule 21F-17 with a similar provision.
In both cases, the agreements specifically did not preclude a former employee from participating in an investigation, communicating with or cooperating with investigators or reporting wrongdoing, but it did prevent the employee from seeking monetary compensation for doing so. Like the earlier KBT case, there was no evidence that an employee had actually been deterred from taking action as a result of the provision in the severance agreements. However, the SEC notes that the financial incentive portion of the Whistleblower Program is “a critical component of the Whistleblower Program… that any individual could look towards in determining whether to take the enormous risk of blowing the whistle in calling attention to fraud.”
The SEC is sending a clear message that any efforts to chill whistleblowers will be considered a violation of the rules.
Success of Whistleblower Program
As indicated, the Whistleblower Program has been a resounding success since its inception, resulting in over $500 million in financial remedies against wrongdoers and the payout of $111 million in awards to 34 whistleblowers. On August 30, 2016, the second-largest award, at $22 million, was granted to a whistleblower. On September 20, 2016 a $4 million dollar award was announced. The funds to pay out the awards come from an investor protection fund entirely financed through monetary sanctions paid to the SEC from securities law violators.
Whistleblowers may be eligible to receive an award when they voluntarily provide unique and useful information to the SEC that results in an enforcement action and monetary penalty against a wrongdoer. The awards range from 10% to 30% of the amount collected when sanctions ordered are in excess of $1 million.
In an August 30, 2016 press release, SEC Chair Mary Jo White stated, “[T]he SEC’s whistleblower program has proven to be a game changer for the agency in its short time of existence, providing a source of valuable information to the SEC to further its mission of protecting investors while providing whistleblowers with protections and financial rewards.”
The same press release contains some interesting facts, including that the Whistleblower Office has received more than 14,000 tips. Moreover, to help ensure that employees continue to utilize the statute without fear of repercussions, the SEC has now brought a total of 5 enforcement actions against companies related to retaliation. One of these actions was for actual retaliatory conduct, and the other 4 related to confidentiality and severance agreements as discussed herein.
Conclusion
The SEC has found the whistleblower statute to be extremely beneficial in uncovering and prosecuting large-scale securities fraud. In essence, the whistleblower statute, and potential monetary awards for successful prosecutions, provides the SEC with an army of investigators well beyond what the agency could afford using its own resources. Several states have taken notice of the success of the program and enacted their own version of the whistleblower statute. Recently the State of Indiana awarded $95,000 to a whistleblower for helping bring an enforcement action against JP Morgan Chase for failing to disclose certain conflicts of interest to RIA clients.
When the SEC filed its first action back in April 2016, this firm made particular modifications to its forms of confidentiality agreements, non-disclosure agreements, employment agreements, severance agreements and employee settlement agreements. We urge all companies to seek the advice of competent counsel prior to entering into any such contracts, and of course, when conducting internal investigations which include allegations of potential securities law violations. Additional enforcement actions are expected as the SEC continues to review documents requested and provided by various employer companies.
The Author
Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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