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Whistleblowing in the Dodd-Frank Era: The Perfect Storm

February 2017

Renee Phillips

Orrick

(212) 506-5153

rphillips@orrick.com

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Whistleblowers

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• Massive statutory and regulatory changes in whistleblower protections and new monetary incentives

• More enforcement actions by prosecutors and regulators

• Dramatic changes in the interpretation of whistleblower protections encouraging more to come forward

• Invigorated Plaintiffs’ bar encouraging whistleblowers to come forward

The “Perfect Storm” of Whistleblower Activity

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• Sarbanes-Oxley enacted in 2002

• Dodd-Frank amended Sarbanes-Oxley in 2010

• Dodd-Frank also included new whistleblower provisions:

– Section 922: SEC whistleblower scheme

• Bounty provision

• Anti-retaliation provision

– Section 748: CFTC whistleblower scheme

• Bounty provision

• Anti-retaliation provision

– Section 1057: Consumer Financial Protection

• Anti-retaliation provision

The Legislative Front

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The “Centerpiece” of Dodd-Frank

Whistleblower Awards/Protections

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• Whistleblowers who provide the SEC with original information derived from “independent knowledge or analysis” about violations of securities laws will be awarded a share of between 10% and 30% of monetary sanctions ultimately imposed by the Commission that exceed $1 million.

Over$149,000,000

Whistleblower Awards

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Whistleblower Complaints Received By the SEC

2012 2013 2014 2015 2016

3,001 3,238 3,620 3,923 4,218

Source: U.S. Securities and Exchange Commission: Annual Report on the Dodd-Frank Whistleblower Program – Fiscal Year 2016(http://www.sec.gov/about/offices/owb/annual-report-2016.pdf)

40% since 2012

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Frequency of Whistleblower Tips in the United States

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Over 10% of SEC Tips Are From Outside of the U.S.

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*Source: 2016 Annual Report on the Dodd-Frank Whistleblower Program

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Profile of Whistleblower Award Recipients

• Almost 50% of award recipients were current and former employees

• Most claim to have reported internally first

• The rest: Company contractors or consultants, investors, professionals in same industry, personal relationships with targets

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Whistleblower Retaliation

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Whistleblower Retaliation (cont.)

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• Is internal reporting protected? Courts are split; SEC playing active role as amicus.

– See, e.g., Davies v. Broadcom Corp, 2015 WL 5545513 (C.D. Cal Sept 8, 2015)

• Former in-house counsel alleged terminated for reporting violations of FCPA internally

• Statute is clear in only covering “whistleblowers” who report to SEC

– Compare Asadi v. G.E. Energy (USA), LLC, 720 F.3d 620 (5th Cir. 2013) with Berman v. Neo@Ogilvy LLC, 810 F.3d 145 (2d Cir. 2015).

– Second Circuit and SEC view is that any reporting protected under SOX is protected under Dodd-Frank

Scope of Anti-Retaliation Protection Under Dodd-Frank

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• Protects employees from retaliation for reporting (internally or externally) what they reasonably believe to be

1. mail fraud;

2. wire fraud;

3. bank fraud;

4. securities fraud;

5. violation of rule or regulation of the SEC; or

6. violation of federal law relating to fraud against shareholders.

SOX Whistleblower Protection

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• Lawson v. FMR LLC, 134 S. Ct. 1158 (Mar. 4, 2014)

• Held: SOX’s protections apply to employees of contractors, and agents of public companies

– Temps, consultants, outsourced functions

– Includes “legions of [outside] accountants and lawyers” performing services for public companies

– Includes personal employees of “officers” or “employees” of public companies

– Housekeepers, gardeners, babysitters!

– Must reports have a nexus with work being done for the public company? Cases so far say yes.

Supreme Court Broadly Interprets SOX

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SEC Press Release

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• Rule 21F-17(a): Companies may not take “any action to impede an individual from communicating directly with the SEC about a potential securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement.”

• Sean McKessy, former Head of SEC’s OWB, repeatedly stated his office was actively looking for agreements (e.g., separation, confidentiality, etc.) that could have the effect of impeding reporting to the SEC, such as requirements that individuals first disclose complaints to employer prior to filing with SEC.

• “…if we find that kind of language, not only are we going to go after the companies, we are going to go after the lawyers who drafted it…[w]e have powers to eliminate the ability of lawyers to practice before the Commission.”

SEC Initiatives to “Unmuzzle” Employees From Reporting Externally

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• February 2015: SEC’s Office of the Whistleblower opens a broad “sweep” investigation, “In the Matter of Certain Non-Disclosure Agreements,” sending a broad document requests to a number of companies for all of their employment agreements, severance agreements and release of claim agreements, as well as all policies and handbooks relating to confidentiality, going back to August 2011 (effective date of DF regulations).

• SEC routinely reviewing company Form 8Ks for problematic provisions in executive agreements.

• Balance between having strong employment agreements and policies that protect legitimate confidentiality interests and not becoming a target.

SEC Makes Good on Its Enforcement Threats

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SEC Pushes the Envelope: BlueLinx and Health Net Actions

August 2016:  SEC brought cease and desist proceedings under Rule 21F‐17.

• BlueLinx Holdings Inc. (Aug. 10, 2016) and Health Net, Inc. (Aug. 16, 2016)

Companies simultaneously settled for $265K and $340K respectively.

BlueLinx bounty waiver language: 

• “Employee further acknowledges and agrees that nothing in this Agreement prevents Employee from filing a charge with…the Equal Employment Opportunity Commission, the National Labor Relations Board, the Occupational Safety and Health Administration, the Securities and Exchange Commission or any other administrative agency if applicable law requires that Employee be permitted to do so; however, Employee understands and agrees that Employee is waiving the right to any monetary recovery in connection with any such complaint or charge that Employee may file with an administrative agency. (Emphasis added.)”

First time that the SEC explicitly held bounty waiver unenforceable.

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BlueLinx: Other “Impeding” Provisions

“Employee has not and in the future will not use or disclose to any third party Confidential Information, unless compelled by law and after notice to BlueLinx.” 

“[The employee shall] hold in a fiduciary capacity for the benefit of the Company [ ] all Confidential Information….

For a period of two years, following the [employee’s] Termination Date, Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge Confidential Information.”

SEC Holds:  Needed to expressly exempt the Commission. Language “forced those employees to choose between identifying themselves to the company as whistleblowers or potentially losing their severance pay and benefits.”

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BlueLinx: SEC-Blessed Language

“Protected Rights. Employee understands that nothing contained in this Agreement limits Employee’s ability to file a charge or complaint with the Equal Employment Opportunity Commission, the National Labor Relations Board, the Occupational Safety and Health Administration, the Securities and Exchange Commission or any other federal, state or local governmental agency or commission (“Government Agencies”). 

Employee further understands that this Agreement does not limit Employee’s ability to communicate with any Government Agencies or otherwise participate in any investigation or proceeding that may be conducted by any Government Agency, including providing documents or other information, without notice to the Company. 

This Agreement does not limit Employee’s right to receive an award for information provided to any Government Agencies.”  (emphasis added)

Do companies need to go this far?

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Health Net

In 2011, added language to agreements requiring employees to waive “the right to file an application for award for original information submitted pursuant to Section 21F of the Securities Exchange Act of 1934.”  

• About 600 employees signed between 8/11 and 6/13.

In June 2013, updated agreements and removed this language and instead stated:

• “nothing in this Release precludes Employee from participating in any investigation or proceeding before any federal or state agency or governmental body . . .

• however, while Employee may file a charge, provide information, or participate in any investigation or proceeding, by signing this Release, Employee, to the maximum extent permitted by law . . . waives any right to any individual monetary recovery . . . in any proceeding brought based on any communication by Employee to any federal, state or local government agency or department.”

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Health Net (Cont’d)

SEC unaware of anyone actually impeded from communicating with the SEC

SEC unaware of company taking action to enforce provision

SEC holds:  Both the 2011 and 2013 agreements violated Rule 21F‐17 by “directly targeting the SEC’s whistleblower program by removing the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.”

Extremely expansive reading of the Rule: 

• No direct targeting of SEC program

• No removal of financial incentives unless permitted by law

Courts unlikely to agree with SEC, but issue not before the courts

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In re SandRidge Energy, Inc. (Dec. 20. 2016)

Separation agreements discovered through SEC filings provided that former employees could not:

• Voluntarily participate in government investigations;

• Use or disclose confidential information without Company consent (including to government agencies);

• Make statements or disparaging remarks regarding the Company, its officers, employees, etc., to any governmental entity or the media

Also found SandRidge retaliated against employee for reporting concerns in calculation of oil and gas reserves for SEC reports.

$1.4 million penalty

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• If companies want to avoid SEC scrutiny

– Critically review employee handbooks, codes of conduct, confidentiality agreements, offer letters, release agreements, etc.

– Need carve out language making clear communications with SEC and other regulators are not “chilled” in any way.

– To extent any provisions could be read otherwise, need to include or refer to carve out.

– This includes:

• Future monetary waivers

• Non-disclosure of confidential information

• Non-disparagement of company

• Failure to notify company of regulator inquiry

• Representation by employee that no charges or complaints are pending or if they are, will withdraw them

Key Takeaways

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