Third Circuit Allows Enforcement of Arbitration Agreement Against SEC Whistleblower

Closeup of gavel placed on block with judge reading papers at desk

The Dodd-Frank Act prohibits the enforcement of predispute arbitration agreements for SOX and CFTC whistleblowers. However, whistleblowers to the Securities and Exchange Commission must arbitrate their retaliation claims instead, according to the Third Circuit in Khazin v. TD Ameritrade Holding Corp., No. 14-1689 (3rd. Cir. Dec. 08, 2014).

The plaintiff, Boris Khazin, signed an employment agreement to arbitrate all disputes arising out of his employment. Subsequently, he brought to the attention of his supervisor a mispriced financial product and recommended a correction that would cost the company more than $1 million in lost revenue. He was told to ignore the issue. Following termination because of a purported billing irregularity, he eventually filed a Dodd-Frank retaliation lawsuit in Federal Court in New Jersey. He appealed the decision to the Third Circuit.

The lower court required him to arbitrate his claim. It held that Dodd-Frank did not alter the enforcement of arbitration agreements signed prior to Dodd-Frank’s adoption by the U.S. Government. It concluded that the presumption against retroactivity did not warrant altering existing contractual rights agreed to prior to the law. On appeal, the Third Circuit affirmed the decision on a different line of reasoning.

The Third Circuit found that the text of the Dodd-Frank Act did not bar employers from requiring SEC whistleblowers to arbitrate there claims. The prohibitions on predispute arbitration agreements in Dodd-Frank applied only to whistleblower protection lawsuits filed under the Sarbanes-Oxley Act and the Commodity Exchange Act.

The SEC was confronted with this omission in the text of the law prior to issuing its final rules for implementing the whistleblower program. However, the securities regulator concluded that no rule was necessary. In Release No. 34-64545, the SEC declared that Section 29(a) of the Exchange Act prohibited employees from limiting their right to file anti-retaliation litigation under Section 21F in an appropriate District Court.

The Third Circuit disagreed. In footnote 5, it dismissed the SEC’s argument that Section 29(a) prohibits enforcement of the arbitration agreement. The Supreme Court has unequivocally held that “Congress did not intend for § 29(a) to bar enforcement of all predispute arbitration agreements.” Khazin, slip op. at *14n.5 (quoting Shearson/American Express Inc. v. McMahon, 482 U.S. 220, 238 (1987)).

The Third Circuit opinion leaves no room for the SEC to issue rules in this area to bar arbitration of retaliation disputes, either. It declares it unambiguously clear that Congress intended for arbitration of retaliation claims brought by SEC whistleblowers under the rules of statutory construction. By explicitly barring predispute arbitration contracts for the CFTC and SOX whistleblowers, the court concluded that Congress deemed arbitration permissible for SEC claims.

The conclusion that Congress wanted to allow arbitration of SEC claims while prohibiting enforcement for CFTC retaliation claims seems odd. The opinion offers no policy justification for this distinction and I am struggling to come up with one.

The SEC has routinely declared that protecting whistleblowers from retaliation is crucial to a successful incentive program. Concerns about arbitrator bias, low awards and the desire for whistleblower lawsuits to be litigated in a public forum all weigh against arbitrating retaliation claims.

The Third Circuit is the first appellate court to weigh in on this important question regarding the SEC program. While there is still the potential for another Circuit to answer the question against arbitration, it is a disappointing initial loss for whistleblowers. We will be revising our section on arbitration of retaliation claims soon to account for this decision.  In the meantime, please contact one of our SEC whistleblower lawyers for additional information about the state of the law.