SEC, CFTC Directors Speak on Whistleblower Programs


The Chief of the SEC’s Office of the Whistleblower, Jane Norberg, and the Director of the CFTC Whistleblower Office, Christopher Ehrman, spoke recently at the Practicing Law Institute’s program on June 28, 2017, titled Corporate Whistleblowing in 2017. Their comments covered a wide range of hot topics in the field of whistleblower law and were relayed in a recent JDSupra article, so we thought them appropriate to briefly detail here for current and potential Dodd-Frank whistleblowers.

Both Norberg and Ehrman emphasized that the programs are open for business and going well. Norberg said that the United States has recovered over $1 billion as a result of enforcement actions and related actions arising from whistleblower tips. Ehrman emphasized that the CFTC Whistleblower Office is growing, seeing an increase in staffing, tips, and high quality tips. Ehrman expected 2017 to be a strong year for the CFTC Whistleblower program.

About the SEC Whistleblower program, Norberg spoke significantly on whistleblower protection. Protecting whistleblowers from retaliation and efforts to chill their reports are a top priority according to Norberg. Norberg believes that that the SEC’s interpretation of the Dodd-Frank anti-retaliation provision to protect whistleblowers who report internally is the only one consistent with the incentives to encourage internal reporting put in place by the SEC. Norberg also discussed Rule 21F-17, but did not definitely state whether the Rule also covers non-US employment agreements. Instead, she said that it would depend on the facts and circumstances of the case.

About the CFTC Whistleblower program, Ehrman spoke specifically on the changes to the CFTC whistleblower program that will go into effect on July 31, 2017. As he explained, the changes are intended to enhance whistleblower protections and revise the claims review process to mirror the SEC program. Ehrman did not provide a definitive answer to the question of whether the changes would apply retroactively. He said that they are considering it and would let everyone know when they have reached a definitive answer.

We will continue to post information here that provides insight as to any changes in the program during the Trump Administration.

Supreme Court to Review SEC Internal Whistleblower Retaliation Protections


The Supreme Court will next term review a whistleblower retaliation lawsuit, Somers v. Digital Realty Trust, Inc., to determine whether the anti-retaliation protections of the Dodd-Frank Act protects employees who report misconduct internally. The Ninth Circuit, in a split decision, determined that the Dodd-Frank Act protected the employee from retaliation as a whistleblower in spite of the fact that he did not file a Form TCR with the U.S. Securities and Exchange Commission.

We were pleased to see the Ninth Circuit’s decision in March upholding the SEC interpretation of the anti-retaliation provisions and hope that the Supreme Court settles this issue once and for all in favor of protecting whistleblowers. It agreed with the Second Circuit, which has previously reversed a contrary district court decision in Berman v. Neo@Ogilvy, LLC, concluding that Dodd-Frank was ambiguous on the definition of whistleblower and that the SEC’s resolution of that ambiguity was entitled to deference under Chevron.

Internal reporting has been a controversial area of the whistleblower law since Congress passed Dodd-Frank. Companies initially petitioned the SEC to require all whistleblowers report internally first before filing a Form TCR. They argued that providing a monetary incentive for SEC whistleblowers without requiring internal reporting would undermine their compliance processes. The SEC nevertheless decided to allow most whistleblowers the option to file a Form TCR without internal reporting.

The SEC then issued a regulation defining the term whistleblower with respect to the retaliation provisions of the Dodd-Frank Act. Rule 21F-2 adopts a different definition of whistleblower for the anti-retaliation section than Congress specified in the definition section of the bill.

The SEC has justified this position in numerous court filings as necessary because the bill’s definition of whistleblower otherwise makes meaningless the anti-retaliation provision set forth by Congress. The SEC filed an amicus brief with the SEC in Somers defending its position and supporting its position that the anti-retaliation protections of Dodd-Frank apply to internal whistleblower.

The Fifth Circuit was the first court of appeals to take up this question in Asadi v. G.E. Energy (USA) L.L.C., and it sided with the company. This decision setup the circuit split which will be resolved by the Supreme Court next year.

No to CHOICE Act on SEC whistleblower culpability


The U.S. House of Representatives on Thursday approved banking reforms in the Financial CHOICE Act of 2017 that would, if adopted, “gut many of the key banking reforms implemented after the financial crisis” according to a CNBC article. Apart from the overall impact on the Dodd-Frank Act, the law makes an important change to the SEC whistleblower program which would impact employees reporting violations of the federal securities laws.

The CHOICE Act would require the SEC to deny awards to culpable whistleblowers despite the fact that they have not been convicted of a crime and made the decision to report the behavior to the Securities and Exchange Commission. The SEC program already denies award to “any whistleblower who is convicted of a criminal violation related to the judicial or administrative action[.]”

The new law, if passed in its present form, specifically defines the denied as a person who:

(A) procures, induces, or causes another person to commit the offense;
(B) aids or abets another person in committing the offense; or
(C) having a duty to prevent the violation, fails to make an effort the person is required to make.

The change will, in all likelihood, weaken a program that has helped recover more than $500 million for the U.S. Government since 2010.

Senator Jacob Howard, the chief sponsor of the False Claims Act in 1863, described what has become the nation’s leading law fighting fraud as “setting a rogue to catch a rogue[.]” In rejecting this position, the U.S. House reaches beyond convicted criminals (already barred by the present law) to relatively innocent people required to make difficult decisions with their career and income on the line.

With the proposed change, the U.S. Government will make a strong statement that it does not want the help of anyone that has had any involvement in the violation of the federal securities law. However, in some cases these are the people who are most likely to have the evidence necessary to put a stop to the financial fraud.

The complete denial of a reward for this behavior would be the first of its kind. The IRS whistleblower program currently provides for the reduction of an award if the whistleblower “planned and initiated” the actions.

In reality, the devil is probably in the details. If the SEC takes a broad reading of the “aids or abets” section and the failure to act section, then it could have a chilling effect which ultimately results in fewer people reporting wrongdoing. The real problem is that it inserts a substantial amount of uncertainty it what was supposed to be a mandatory award.

Let’s not reverse course now.  The SEC has worked hard to establish a successful program and protect the whistleblower. This would impact people who are mostly innocent (i.e., ordered to do so by their employer under threat of termination or simply trained by their employer to do such tasks without any discussion of the legality) and are trying to do the right thing.  The current standard (criminal conviction) is the best one.

SEC Warns About Fake News on Stocks


Last month, the SEC warned investors about companies using fake news to drive up stock prices. In conjunction with this warning, the SEC charged 27 public companies, firms and writers with fraud for failing to disclose paid promotion, using multiple pseudonyms for publications about the same stock and/or using fake credentials. Just over half (17) reached settlements of up to $3 million.

The fraud at issue resulted not from the accuracy or the inaccuracy of the facts presented in the story. Instead, the SEC was targeting potentially biased news coverage and analysis which appeared as unbiased analysis on an investing website with no disclosure of interest by the author. The complaint against Lidingo Holdings for example describes it as a stock promotion firm generating articles on investment websites about publicly-traded companies that appeared to be objective and independent, when in fact it was a paid promotion.

This reminds me of the lawsuits brought by the Federal Trade Commission about a decade ago to require disclosures by affiliate marketers about product endorsements. It also resembles a bit the pump and dump scams that used to happen with penny stocks trading over-the-counter on the pink sheets.

This is not the first time that investors have had run-ins with fake news online. Two years ago, there was a fake news story that Twitter was going to be acquired by Google for $31 billion. The fake story sent Twitter stock up 8 percent because the website containing it looked identical to Bloomberg News.

Individuals at the publicly traded companies, the marketing promotion companies, the writing agencies and the online stock websites could be potential whistleblowers. The question in these types of cases is whether there will be more than $1 million in civil penalties and disgorgement. If it is a sufficiently large scheme to pull in multiple players and publicly traded companies, then it becomes more likely that the fines will get to a point where the whistleblower can qualify for a Dodd-Frank award.

Tax Day Debate at Supreme Court Over Time for SEC Disgorgement


The Securities and Exchange Commission defended its ability to disgorge illegal profits from wrongdoers before the Supreme Court yesterday in Kokesh v. SEC. It was Justice Neil Gorsuch’s second day of oral arguments.  An opinion is expected by the end of the term in July.

The case is now focused on the question of how long the SEC can seek to recover funds through disgorgement. Disgorgement is one of the primary sources of funds recovered for violations of the federal securities laws. Civil penalties are limited both by the five year statute of limitations, according to the 2013 Supreme Court ruling in Gabelli v. SEC, as well as the Congressional limits. The SEC claims disgorgement is not limited by the five-year statute of limitations in 28 U.S.C. § 2462.

In the case at issue, the lower court ordered Kokesh to pay a civil penalty of $2.4 million, disgorgement of $34.9 million, and prejudgment interest of $18.1 million. Kokesh appealed and argued that the 11 year period for disgorgement used in the case was inappropriate.

The SEC argued that there is no statute of limitations because disgorgement is remedial. It is neither a penalty or a forfeiture under Section 2462 according to statutory construction. Moreover, adoption of the defendant’s position would reduce the likelihood that victims are compensated through the distribution of disgorged funds.

The case implicates possible payouts for SEC whistleblowers. If the Court cuts off disgorgement at five years, Kokesh would only pay $7.4 million in disgorgement and penalties (rather than $37.3 million), as well as a correspondingly smaller amount of prejudgment interest. A projected whistleblower award of between $5 million and $16 million under the current system will be valued under the defendant’s system at between $1 and $3 million.

9th Circuit: Internal SEC Whistleblowers Can Sue Under Dodd-Frank Anti-Retaliation Provision


On a 2-1 decision, the Ninth Circuit has affirmed the right of internal whistleblowers to sue under the Dodd-Frank Act after they are retaliated against for informing their company of suspected violations of federal securities laws. The circuit split on anti-retaliation protections for internal SEC whistleblowers now consists of the Second and Ninth Circuits in favor and the Fifth Circuit against.

In the Ninth Circuit case, the employee reported several possible securities law violations to senior management and was terminated shortly thereafter. The Ninth Circuit opinion said that he was not able to report his concerns to the SEC before he was fired. After suing for retaliation, the defendant sought to dismiss, arguing that he did not meet the definition of “whistleblower” under the Dodd-Frank Act.

The opinion in Somers v. Digital Realty Trust Inc., Case No. 15-17352, 2017 WL 908245 (9th Cir. March 8, 2017) sides with the Second Circuit in Berman v. Neo@Ogilvy LLC, 801 F.3d 145 (2015) and disagrees with the Fifth Circuit in Asadi v. G.E. Energy (USA), L.L.C., 720 F.3d 620 (5th Cir. 2013).

The majority opinion in Somers notes the ambiguity in the statute on the definition of whistleblower as well the limited scope of protections provided by a strict interpretation of the text which would contravene the Congressional intent. Moreover, it notes that the explicit reference to internal reporting provisions of the Sarbanes-Oxley Act meant that Congress could not have been applying the previous definition of whistleblower to this subsection. It then defers to the SEC regulation as a reasonable agency interpretation of the ambiguity pursuant to the Chevron doctrine.

Since Asadi, the SEC has waged war against companies arguing that internal whistleblowers are not protected under Dodd-Frank. It has submitted amicus briefs in support of its position in several cases, including Berman and Somers. It looked close for a while there as a few courts sided with the defendants following Asadi. Now, it has hopefully been firmly resolved in favor of protecting internal whistleblowers.

Review of SEC Rule 21F-17 (Impeding Whistleblowers)


Brandon Lauria will speak on SEC enforcement of Rule 21F-17 at a Knowledge Group live webcast on March 9, 2017.  Rule 21F-17 prohibits confidentiality agreements and other measures which restrict access to the SEC whistleblower program.  The one hour webcast at noon (EST) will cover the rule protecting whistleblower communications with the SEC and recent civil enforcement actions brought by the SEC against corporations for impeding communications with whistleblowers.

Over the last year, the SEC has included violations of Rule 21F-17 in eight enforcement actions.  This makes it a crucial area for whistleblower, employment and corporate attorneys to understand.

The rule states:

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 (other than agreements dealing with information covered by § 240.21F-4(b)(4)(i) and § 240.21F-4(b)(4)(ii) of this chapter related to the legal representation of a client) with respect to such communications.

The rule went into effect in 2011.  From April 2015 until January 2017, the SEC brought nine enforcement actions pursuant to the rule.  These nine actions can be grouped by type:

  • Confidentiality: Anheuser-Busch
  • Pre-Approval of Communications: KBR, Merrill
  • Information Limits on Communications: Merrill, Neustar, SandRidge
  • Prohibited Investigation Participation: SandRidge
  • Prohibited Filing Reward Claims: Health Net
  • Reward Waivers: Health Net, BlueLinx, Blackrock, HomeStreet
  • Attempted Identification/Threats: HomeStreet

Here is a brief summary of the enforcement actions by the SEC under Rule 21F-17 so far:

KBR, Inc. (April 2015)
KBR required witnesses in internal investigations to sign confidentiality statements indicating that they could be fired if they discussed the matters without approval from KBR legal dept. There were no specific instances of impeding communications. KBR settled with the SEC for $130,000.

Health Net, Inc. (August 2016)
From 2011-2013, the company specifically prohibited filing claims for an SEC whistleblower reward.  After revisions, the company still created severance agreements requiring waiver of the right to a whistleblower reward until 2015.  The parties settled for $340,000.

BlueLinx Holdings Inc. (August 2016)
In 2013, the company added language to severance agreements requiring waiver of possible whistleblower awards.  The SEC and BlueLinx settled for $265,000.

Merrill Lynch (August 2016)
Merrill severance agreements prohibited disclosure of confidential information unless pursuant to formal legal process or written approval by Merrill. In 2014, Merrill clarified the agreement to provide that employees could initiate communications with the SEC but limited the types of information that could be provided. No specific employees were impeded.

Anheuser-Busch InBev (Sept. 2016)
A 2012 separation agreement for a whistleblower required secrecy and confidentiality of material. As a result, the Whistleblower stopped communicating with SEC. In 2015, the company amended its separation agreements to allow whistleblowing.

Neustar (Dec. 2016)
From 2011 until 2015, the company had a broad non-disparagement clause in its severance agreements. This clause impeded communications between a specific former employee and the SEC. The company and the government settled the case for $180,000.

SandRidge Energy (Dec. 2016)
SandRidge separation agreements prohibited participation in government investigations or disclosing harmful/embarrassing information.  The overall case, which included civil enforcement based on anti-retaliation protections, settled for $1.4 million.

BlackRock (Jan. 2017)
From 2011 until 2016, BlackRock separation agreements required waiver of the right to recover financial incentives for reporting misconduct. The company settled with the SEC for $340,000

HomeStreet (Jan. 2017)
The company suspected a whistleblower and attempted to identify him or her. To one individual, it threatened to deny reimbursement for legal counsel. Their severance agreements also required waiver of rewards from whistleblowing.

Hacking and Insider Trading Continue to Mix


It was more than a year ago that the U.S. Securities and Exchange Commission cracked down on a group of hackers and traders who obtained confidential, non-public information about publicly traded companies by hacking websites for press releases. A recently released report by a cybersecurity company suggests that such insider trading continues, although this time with data obtained through phishing from personnel at publicly traded companies who typically file reports to investors with the SEC.

The FireEye report details a scheme in February to obtain confidential corporate information by spoofing an email purportedly from the SEC’s EDGAR filing service. When the email recipient clicked on instructions inside the attached Microsoft Word file, they unwittingly granted access to the internal corporate networks of the company. Because the scam appeared to come from a legitimate email address, FireEye indicates several corporate executives were fooled.

Law firms have also been targets for cybercriminals looking to trade on inside information. In December, the Government brought charges against three Chinese citizens that hacked top U.S. mergers and acquisitions lawyers to obtain information about deals and profit from buying shares.

This is prime territory for the SEC whistleblower program. A person at a hacked company that turns over critical information about the scam to the SEC which allows them to stop the illicit trading could be entitled to a reward. Individuals that work for the companies trading based on the confidential and illegally obtained information could also put together the evidence to report the trades to the SEC.

In the 2015 case, one of the participants settled with the SEC for $30 million. With rewards of between 10 and 30 percent of the recovery, this enforcement action alone could have brought a whistleblower $3 to $9 million.

The potential disruption of the market by participants trading on hacked information is tremendous. It poses a definite threat to the integrity of the market and therefore we expect such information to be taken seriously by the SEC when received from a credible whistleblower. Indeed, the SEC has recognized this problem and made cybersecurity compliance a top priority for its compliance examinations of broker-dealers and other market participants. It is unlikely to take a different approach in its pursuit of enforcement actions.

Congress Considers Co-Conspirator Eligibility for SEC Whistleblower Rewards


A memo circulated in early February regarding the Financial Choice Act produced by House Financial Services Chairman Jeb Hensarling (R-Texas) has proposed the elimination of SEC whistleblower rewards for co-conspirators.

The SEC whistleblower program established by the Dodd-Frank Act currently prohibits the SEC from taking into account any monetary sanctions “based on conduct that the whistleblower directed, planned, or initiated.” If a whistleblower is nevertheless eligible for a reward, there is no reward percentage based on monetary sanctions paid for such conduct.  There is also no reward if a whistleblower is convicted of a criminal violation related to the judicial or administrative action.

This is a fairly common standard in the U.S. whistleblower laws. The IRS whistleblower program allows the reduction of awards if the whistleblower planned and initiated the tax underpayment. It also forbids awards to whistleblowers that are criminally convicted for their role in planning and initiating the action.

The False Claims Act, the nation’s leading law against fraud, bars the pursuit of a False Claims Act lawsuit by a person convicted of criminal conduct arising from his or her role. Awards can be reduced if the relator planned and initiated the fraud. In the legislative history of the False Claims Act, the theory behind this was espoused that sometimes the best way to stop fraud is by “setting a rogue to catch a rogue.”

Ultimately, the scope of the change to the SEC whistleblower program if the law passes will depend on the definition of co-conspirator. A broad definition of the term could put rewards for people who were not entirely innocent in jeopardy. For example, if an individual was ordered to engage in misconduct by their boss and they complied, they could potentially be ineligible for a reward under the proposed law.

The emergence of an employee that has participated in the fraud as a whistleblower has been a cornerstone of many False Claims Act cases. An individual that is a true insider to a fraudulent scheme often has great evidence of the fraud and a comprehensive understanding of the players and scheme.

This is not to say that they would necessarily fall into every meaning of the term co-conspirator. Often, they are employees who were instructed to perform certain tasks by their employer and followed those instructions because they did not fully appreciate the consequences. If these so-called participants were covered by the term co-conspirator it would eliminate a large segment of potential whistleblowers.

Commentary has already suggested that the proposed bill is unlikely to make it through the Senate in its current form. It would likely run squarely up against the advocacy of Senator Grassley if it were to go there and truly weaken the provisions. We will nevertheless keep an eye on the upcoming bill for these and other changes to the Dodd-Frank Act.

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Court Rules on Confidentiality Agreements for SEC Whistleblowers


A U.S. District Court in the Southern District of California has recently ruled on the validity of a SEC whistleblower’s defense to the enforcement of a company’s confidentiality agreement.  In the decision, the Court accepts the validity of a public policy defense to a limited whistleblower disclosure of confidential information concerning securities fraud.

The case arose after a whistleblower sued the company for retaliation.  The company brought counterclaims against the whistleblower-plaintiff for breach of the confidentiality clause of its employment agreement.  The whistleblower then asserted the public policy in favor of whistleblowing as a defense.

These issues have been more frequently litigated in the context of the False Claims Act, where whistleblowers (known as relators) are required to bring a qui tam lawsuit through the judicial system.  This litigation process permits companies to bring counterclaims, unlike standard submissions to the SEC whistleblower program where the whistleblower is not involved in the government’s enforcement action.

To briefly summarize the important areas of the decision for securities whistleblowers:

  • The public policy exception allowing breach of a confidentiality agreement by a whistleblower applies to SEC whistleblowers providing information to the U.S. Government.
  • The whistleblower has a public policy defense at least allowing a limited removal of documents from the company in order to demonstrate the fraud and protect against document destruction.
  • A SEC whistleblower retaliation complaint can rely on confidential information that is reasonably necessary to demonstrate the retaliation.
  • The whistleblower defense allowed does not offer protections for breach of the confidentiality agreement when a whistleblower provides confidential information to the press.

The ruling strengthens the protections for SEC Whistleblowers.  The SEC has independently pursued civil enforcement actions against companies recently both for retaliation against whistleblowers as well as impeding communications from SEC whistleblowers through a variety of tactics.

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