Another SEC Whistleblower Action

For the second week in a row, the Securities and Exchange Commission brought a “pre-taliation” charge against a company for bad provisions in its employee separation agreements. This time it was the real estate company CBRE that had a bad provision.

In response to a Congressional mandate in Dodd-Frank, the SEC adopted Rule 21F-17 in August 2011, which 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.

Back in 2016 the Securities and Exchange Commission filed a series of cases against companies that restricted departing employees from contacting government authorities. Some of the language the SEC found illegal was broad non-disparagement clauses that forbid former employees from engaging “in any communication that disparages, denigrates, maligns or impugns” the company. Companies responded by adding carve-outs that explicitly stated that employees could contact government regulators to reporting possible wrongdoing.

CBRE had an appropriate carve-out:

Nothing in this Agreement shall be construed to prohibit Employee from filing a charge with or participating in any investigation or proceeding conducted by the Equal Employment Opportunity Commission, National Labor Relations Board, the Securities and Exchange Commission, the Department of Justice, or a comparable federal, state or local agency.

What the SEC did not like is a representation earlier in the form separation agreement:

Employee represents and acknowledges [t]hat Employee has not filed any complaint or charges against CBRE, or any of its respective subsidiaries, affiliates, divisions, predecessors, successors, officers, directors, shareholders, employees, representatives or agents (hereinafter collectively “Agents”), with any state or federal court or local, state or federal agency, based on the events occurring prior to the date on which this Agreement is executed by Employee.

The SEC’s view was that the carve-out was prospective in application and did not fix the representation.

Last week’s whistleblower pre-taliation case against Monolith was clearly problematic. Allowing a complaint, but disallowing any financial rewards is clearly too cute and deters a whistleblower.

The CBRE language is not so obviously problematic. Some would argue that its fair to ask an employee if they’ve filed a complaint in the exit process.

If the form had a left a blank for an employee to fill in any exceptions to the representation, would that make the form okay? Probably not, based on this case. I think the case is trying to say that even asking if the employee has filed a complaint would be a deterrent and would violate Rule 21F-17.

Will these two be the last of the whistleblower cases form the SEC? The SEC’s fiscal year is fast approaching so we should expect a flurry of cases conclusions over the next week and a half..

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A New Regulatory Action to Help Potential Whistleblowers

In response to a Congressional mandate in Dodd-Frank, the SEC adopted Rule 21F-17 in August 2011, which 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.

Back in 2016 the Securities and Exchange Commission filed a series of cases against companies that restricted departing employees from contacting government authorities. Some of the language the SEC found illegal was broad non-disparagement clauses that forbid former employees from engaging “in any communication that disparages, denigrates, maligns or impugns” the company. Companies responded by adding carve-outs that explicitly stated that employees could contact government regulators to reporting possible wrongdoing.

Monolith Resources included that language in its separation agreements:

“nothing in this agreement is intended to limit in any way your right or ability to file a charge or claim with any federal, state, or local agency,”

But Monolith took away the financial aspect of a whistleblower by adding:

“You retain the right to participate in any such action, but not the right to recover money damages or other individual legal or equitable relief awarded by any such governmental agency.”

Monolith’s former employees could file a whistleblower complaint, but not get any cash. An interesting approach, but one that is clearly designed to impede whistleblower actions.

Monolith got hit with a $225,000 fine. There was no indication that any employee was impeded from communicating with the SEC and Monolith never enforced that provision.

Maybe there has been some prior action by the SEC on this type of pretaliation and I just missed it. Let me know.

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SEC 2019 Whistleblower Program Report

Section 924(d) of Dodd-Frank requires the Securities and Exchange Commissions Office of the Whistleblower to report annually to Congress on Office’s activities, whistleblower complaints received, and the response of the SEC to those complaints. In addition, Section 21F(g)(5) of the Exchange Act requires the SEC to submit an annual report to Congress. The SEC published the whistleblower report on November 15.

According to the report, the Office received slightly fewer tips and awarded significantly less to whistleblowers in FY 2019, as compared to FY 2018.

This past year, the SEC received 5,212 tips. That’s a slight decrease from FY 2018. That brings the total number of tips since the program started to over 33,000.

California, Pennsylvania, New York, Texas and Florida had the highest number of tips domestically. The only surprise in that list is Pennsylvania. The other four states would be on this list based on population. It seems to me that the Pennsylvania whistleblowers are more active.

For the year, the SEC handed out $60 million in awards to whistleblowers. That is a decrease from the $168 million in FY 2018. Most of that was taken by the $37 million award granted in March 2019 and $13 million award to another person for the same action. The other six recipients split the remaining $10 million.

The numbers are not good for whistleblowers. Over 5,000 complaints were made and that lead to only 8 awards. Of those 8, seven reported the problems internally before going to the SEC. That should eb a warning to ignoring internal whistleblowers.

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The One With The Silenced Investors

In response to Dodd-Frank, the SEC adopted Rule 21F-17 in August 2011, which 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.

I have mostly heard stories about violation of the rule as applied to employee severance agreements or employment agreements. You can’t prevent departing employees from being whistleblowers.

In a different approach to whistleblower protection, the Securities and Exchange Commission brought a case against a company for trying to limit the ability of its former investors from reported alleged wrongdoing to the SEC.

Mykalai Kontilai, wanted to build a website for the auction of collectibles, especially sports memorabilia. He grew that idea into plans for an affiliated social network, a physical coffee shop, and a television show. He managed to raise $23 million from 140 investors to implement his vision. Collectors Café was born.

According to the SEC complaint, Kontilai misappropriated more than $6.1 million of the money raised for personal use. He is also accused of misrepresenting the material facts about Collectors Café to those investors.

According to the SEC some of the investors alleged wrongdoing and wanted their money back. In at least two instances, Collectors Café and Kontilai attempted to resolve investor allegations of wrongdoing by conditioning the return of investor money on confidentiality clauses prohibiting the investors from communicating with law enforcement, including the SEC, about the alleged securities law violations.

In a stock purchase agreement to buy back the stock, there was this provision:

[Investors] … further warrant and affirm that. . . they will not, directly or indirectly, individually, collectively or otherwise, contact any third-party, including, but not limited to governmental or administrative agencies or enforcement bodies, for the purpose of commencing or otherwise prompting investigation or other action relative to [Collectors Café] or the subject matter herein.

In a settlement agreement with other investors, there was this provision:

“The Shareholders, for themselves and their counsel and advisors, confirm that they are not aware of, and have not had to date, and will not initiate on a going forward basis, any communications with any regulatory agencies such as the United States Securities and Exchange Commission or any other Federal, State, or Local governmental agency concerning the matters related to this Agreement.”

Collectors Café and Kontilai even went a step further and attempted to enforce the illegal confidentiality clause by filing a lawsuit claiming that the victims breached the confidentiality provision by communicating with SEC staff about possible securities law violations.

The SEC action is mostly filled with the alleged fraud at Collectors Café. This came after the SEC contacted the investors trying to find information about their complaint.

The two provisions contain the opposite of what should be in a settlement agreement. We know you can’t stop employees from acting as whistleblowers in severance agreements. It’s also clear that you can’t stop investors from talking to the SEC about securities fraud.

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The Continued Rise of Professional Whistleblowing

The Securities and Exchange Commission announced awards totalling $50 million to whistleblowers who brought high-quality information to the SEC and assisted in bringing a successful enforcement action.

As with all whistleblower awards, the order is heavily redacted as to the company involved, what happened, and when it happened. I’m not sure I can identify which case the awards tie to.

Two things caught my attention about the awards.

One, the order discusses approval or rejection of awards for Claimant #1, Claimant #2, Claimant #4, and Claimant #7. I take it that at least seven people submitted tips to the SEC for the bad acts involved in the case. That is a lot of people sending information to the SEC. I’m not if it’s because a lot of people knew about the problem or a lot of people knew they could make money by reporting the problem.

Second, the two successful claimant had attorneys involved in the whistleblowing process.

Claimant #1 had his or her attorney approach the SEC first before formally submitting the tip. That ended up hurting the award because the SEC found the delay unreasonable and investors were continuing to be harmed. Somehow, Claimant #1 “passively financially benefited” from the misconduct during the delay.

Claimant #2 met with the SEC with his or her attorney. According to the order, Claimant #2 had the “smoking gun” evidence that indisputably showed the problem.

Claimant #2 also received a whistleblower award from another agency in connection with the action. I would guess it was this CFTC award.

Putting those two things together, lots of whistleblowing and lots of lawyers, whistleblowing is becoming a new industry and there is growing population of professional whistleblowers and their service providers.

Matt Kelly pointed out the slick graphic the SEC now seems to be appending to whistleblower award press releases. I have to be a bit snarky and point out the shortcomings of the fancy map showing the quantity of tips by state.

In my snarkiness, I’m going to point out that that the map also shows the most populous states. More people=>more companies=>more tips.

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The Continuing Rise of the Professional Whistleblower

In 2016, the Securities and Exchange Commission opened its doors to the professional whistleblower when it first granted a whistleblower award to a company outsider. It’s becoming more lucrative.

Last week the Commodity Futures Trading Commission announced an award of approximately $30 million to a whistleblower who voluntarily provided key original information that led to a successful enforcement action. Previously, the highest award amount paid to a CFTC whistleblower was in March 2016 of more than $10 million (see CFTC Press Release 7351-16 CFTC Announces Whistleblower Award of More Than $10 Million.)

The SEC has preliminarily approved a $48 million payout in the same matter.

Unlike many whistleblowers, the recipient of those award came forward. Edward Siedle is a former lawyer for the Securities and Exchange Commission who has turned forensic investigator.

The award comes from a $267 million settlement between JPMorgan and the SEC. In a parallel action, JPMorgan Chase Bank agreed to pay an additional $40 million penalty to the U.S. Commodity Futures Trading Commission. The bank was investigated for steering high-net-worth clients toward its own proprietary investment funds that could cost more rather than those managed by other institutions. OF course, that could have been (maybe) addressed in a disclosure to clients.

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Changes to the SEC’s Whistleblower Program

Seven years ago the Securities and Exchange Commission opened its Office of the Whistleblower under the authorization of the Dodd-Frank Act. Since then the SEC has received over 22,000 whistleblower tips, obtained over $1.4 billion in financial remedies related to those tips, and ordered over $266 million in whistleblower awards to 55 individuals. Now, the SEC wants to tweak the program and offered up a series of regulatory revisions.

More Settlements Would Eligible

The first change is to expand the scope of actions that are subject to whistleblower awards. The current SEC whistleblower rules do not address whether the SEC can pay an award when the information that leads to a Deferred Prosecution Agreement or Non-Prosecution Agreement entered into by DOJ or a state attorney general in a criminal proceeding. The SEC is also looking for the discretion to award whistleblower claims based on public information using independent evaluation and analysis.

More for Smaller Settlements

The second change is to push for a higher award in smaller cases. According to the SEC, 60% of the whistleblower awards have been less than $2 million. The SEC is trying to set a $2 million floor, subject to the Section 922 cap of 30% of the award. The purpose of the change is to reward meritorious whistleblowers and incentivize future whistleblowers who might otherwise be concerned about the low dollar amount of a potential award.

Less for Bigger Settlements

The third change is related to the remaining 40% of funds paid out in claims. That 40% represents just three awards. For big cases, the SEC wants to be able to cap the award at $30 million, subject to the Section 922 floor of 10% of the award.

Digital Realty Fix

In the Digital Realty case decided by the Supreme Court earlier this year, the Court held that the whistleblower provisions of the Exchange Act require a person to report a possible securities law violation to the SEC in order to qualify for protection against employment retaliation.  For purposes of retaliation protection, an individual would be required to report information about possible securities laws violations to the Commission “in writing”.

Others

Besides these four big changes, there are several other smaller changes to increase the efficiency and effectiveness of the whistleblower program.

My Take

I think it’s great that the current SEC is willing re-evaluate its rules and fix them to make them work better. I bet most o fus could point to many parts of the SEC rules that need fixing. I hope they continue this process for other rules.

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The Limit of Whistleblowers

The Supreme Court just decided a case that limits the whistleblower anti-retaliation provisions in Dodd-Frank. The Court handed down its decision in Digital Realty Trust v. Somers.

Dodd-Frank defines “whistleblower” as a person who provides “information relating to a violation of the securities laws to the Securities and Commission.” 15 U. S. C. §78u–6(a)(6). A whistleblower is then eligible for an award if original information provided leads to a successful enforcement action. Under Rule 21F, a whistleblower has to go through particular steps to be able to claim an award, but the anti-retaliation protections apply whether or not the requirements, procedures and conditions to qualify for an award are satisfied.

Mr. Somers reported suspected securities-law violations to senior management of Digital Realty Trust. He was fired. He did not alert the SEC prior to his termination. He didn’t file an administrative complaint within 180 days that is required under the Sarbanes-Oxley whistleblower protections. Nonetheless, he brought suit against the company with a claim of whistleblower retaliation.

The Supreme Court stuck with the clear definition in Dodd-Frank. A whistleblower for securities law violations must report the violation to the SEC to have protection from retaliation.

The Supreme Court pointed out that there is a different definition of whistleblower under the CFPB part of Dodd-Frank. Under 12 U.S.C. §5567(a)(1), a “covered employee” who provides information to the company, the FBI, or any other State, local, or Federal, government authority or law enforcement agency relating to a violation of a law subject to the CFPB’s jurisdiction gets whistleblower protection.

Mr. Somers argued that the limiting whistleblower definition should only apply to eligibility for awards. The Court completely disagreed with that argument and relied on the plain language of the statue. There were two concurring opinions, but they only took different approaches to whether the Court should take into consideration legislative history as part of statutory interpretation. The two concurring opinions agreed with the result, leaving Mr. Somers as a non-whistleblower. The ruling settled a split between the Ninth and Fifth Circuits, reversing the Ninth Circuit’s decision.

There is an obvious impact on compliance programs. As much as we might hope that employees who think there is a problem would tell someone internally first, there is much more incentive to go directly to the SEC.

It’s all confusing in application. A tip left with the SEC is kept anonymous, so a company would not know the identity of the whistleblower. A company could fire an employee who left a tip without knowing that the employee did so. Without a requirement that the employee also tell the company, the company is in the dark and may not even be aware of the problem.

The other piece missing in the arguments is whether there even was an actual securities law problem at Digital Realty Trust.

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The SEC Strikes Back Again on Whistleblower Pretaliation

Compliance officers need to take a look at severance agreements. The Securities and Exchange has blown up another company for including provisions in its severance agreements that may have impeded employees from communicating information to the SEC.

NeuStar Inc. used severance agreements that contained a broad non-disparagement clause forbidding former employees from engaging “in any communication that disparages, denigrates, maligns or impugns” the company. Former employees could be compelled to forfeit all but $100 of their severance pay for breaching the clause.

In response to Dodd-Frank, the SEC adopted Rule 21F-17 in August 2011, which 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.

Among the investors, customers, competitors and other parties listed in the non-disparagement clause, NeuStar specifically included the Securities and Exchange Commission. That makes it a bad agreement and in violation of Rule 21F-17.  From August 2011 to May 21, 2015, NeuStar used the bad severance agreement for 246 employees. The SEC order indicates that at least one ex-employee wanted to talk to the SEC, but was impeded by the agreement.

This is the third pretaliation case from the  SEC, following up on KBR and BlueLinx.

In each case, the offending company was required to reach out to the ex-employees and let them know that the company was not preventing them from talking to the SEC. It seems clear that the compliance officers may want to spend some time this holiday season looking through their severance agreements to see if they could be construed as limiting the employees from talking to the SEC. If so, you may want to send a holiday card granting those employees a holiday wish to talk to the SEC.

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Whistleblowers Power Up

Two whistleblower stories caught my attention. Both are follow-ups to previous stories.

Close-up Of Metal Sport Whistle On American Flag

The Securities and Exchange Commission previously announced that it thought poorly of severance agreements that restricted the former employees from being whistleblowers. Last year, the SEC brought an action against KBR for restrictive employee agreements that stifled whistleblowing. That was in the context of confidentiality statements used as part of internal investigations. The SEC’s expressed distaste left few practitioners thinking that the distaste was limited to this kind of application.

BlueLinx didn’t get the law firm memos on this issue and continued to use severance agreements that stifled whistleblowers. When Rule 21F-17 was passed by the SEC, BlueLinx revised its severance agreements to allow terminated employees to be whistleblowers, but waive any right to monetary recovery in connection with it.

Further, by requiring its departing employees to forgo any monetary recovery in connection with providing information to the Commission, BlueLinx removed the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.

The SEC wants whistleblowers. That has given rise to the professional whistleblower. It took six years since the passage of Dodd-Frank, but in January 2016, the SEC announced the first-ever whistleblower award to an outsider.  I think that was the first professional whistleblower. (Other than those whistleblowers who profited indirectly through books and speaking engagements.)

The Wall Street Journal reported that the rumor that Harry Markopolis’s firm was behind the State Street Bank and BNY Melon FX whistleblowers seems to be true. According to the story Mr. Markopolos became intrigued about the possibility that trust banks were overcharging clients in currency markets after reading a book by Yale University’s chief investment officer that pointed to unpredictable “foreign exchange translations.” Mr. Markopolos searched for bank employees to prove his case. He found a trio. The group organized Delaware partnerships to keep their identities out of public view. Mr. Markopolos served as a litigation consultant to the lawyers.

The resulting awards could exceed a combined $100 million. That will attract a lot of attention for those who think professional whistleblowing might be lucrative. It has taken years to get to the settlement and it’s not clear how much the whistleblower award will be or how much of a cut Markopolis will take from the award. It certainly seems like it could be millions or even tens of millions.

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