Although Dodd-Frank does not expressly grant the SEC enforcement authority over Dodd-Frank’s anti-retaliation provisions, the SEC explained when promulgating its whistleblower rules that it has such enforcement power and has repeated that assertion publicly. (The CFTC, in contrast, does not assert that virtually identical provisions of Dodd-Frank granted it the same enforcement power.) The SEC’s action leaves no doubt that the SEC will, as threatened, bring cases to enforce Dodd-Frank’s anti-retaliation provisions. The case also highlights the extreme caution that a company must take when a known whistleblower is in its midst.
The substantive violations at issue in the Paradigm matter were relatively simple. The SEC alleged that Paradigm engaged in principal transactions with an affiliated broker-dealer, C.L. King & Associates, without providing effective disclosure to a hedge fund client advised by Paradigm. Because Candance King Weir controlled both Paradigm and C.L. King, the SEC alleged that the transactions were principal transactions that required Paradigm (1) to provide the fund with written disclosure of the transactions prior to their completion and (2) to obtain the fund’s consent to engage in the transactions. Paradigm tried to satisfy these requirements with a “Conflicts Committee” that would review principal trades, but the SEC found that the committee was conflicted and inadequate.
In March 2012, Paradigm’s head trader made a whistleblower submission to the SEC revealing numerous alleged securities laws violations. On July 16, 2012, he notified Weir and C.L. King that he had made such a submission. Paradigm immediately retained outside counsel to provide advice regarding the situation. The following occurred over the next four weeks:
The SEC alleged that the actions taken against the whistleblower violated the anti-retaliation provisions of Section 21F(h) of the Exchange Act. In the SEC’s press release describing the action, Andrew J. Ceresney, director of the SEC’s Enforcement Division, said: “Those who might consider punishing whistleblowers should realize that such retaliation, in any form, is unacceptable.” Sean McKessy, chief of the SEC’s Office of the Whistleblower, added: “For whistleblowers to come forward, they must feel assured that they’re protected from retaliation and the law is on their side should it occur.”
The SEC’s action against Paradigm and its founder illustrates the no-win situation a company faces if it knows that a current employee has blown the whistle to the SEC. A company’s natural and understandable reaction is to try to figure out exactly what the whistleblower has disclosed. An equally understandable reaction is to limit the whistleblower from disclosing further potentially damaging information to the SEC. This enforcement action confirms that these goals may be unreachable in light of the SEC’s rules against taking any action against a whistleblower.
To its credit, Paradigm did not act rashly, but rather took the matter seriously and hired outside counsel to provide what was no doubt considered advice. The whistleblower also had counsel, and the lawyers tried repeatedly to devise a practical solution to the difficult employment situation presented. In its order, the SEC cited Paradigm’s changing the whistleblower’s job function and stripping him of supervisory responsibility. But leaving the whistleblower’s position and responsibilities unchanged would seem impracticable as Paradigm’s counsel conducted an internal investigation, no doubt leading to Paradigm’s conclusion that the employment relationship was “irreparably damaged.”
Recognizing the untenable situation, Paradigm and the whistleblower repeatedly tried to agree on a severance arrangement, but could not come to terms. This is not surprising given the incredible leverage that a whistleblower in this situation has over a company. But a severance agreement is fraught with danger as well because SEC Rule 21F-17 prohibits “any action to impede an individual from communicating directly with the Commission staff about a possible violation, including enforcing or threatening to enforce a confidentiality agreement.” SEC officials have stated repeatedly that they will review very carefully severance and separation agreements for any attempt to impede a whistleblower.
While this is the first enforcement action of its kind, it will not be the last. The SEC may soon bring additional enforcement actions under far different facts. For example, the SEC may bring a stand-alone enforcement action for violation of the anti-retaliation provision, including in cases in which the whistleblower incorrectly (but “reasonably”) thought there was a potential securities law violation. In addition, the SEC asserts that a whistleblower need not report to the SEC in order to be protected by the anti-retaliation provisions. Thus, the SEC’s enforcement of the anti-retaliation provisions could have far broader application in the future.
This case presents another reminder that companies must have a strong culture of compliance and a strong policy encouraging whistleblowers to report concerns internally if at all possible. Once the whistleblower has reported to the SEC, a company will be hamstrung to maintain status quo with respect to the whistleblower. The case also highlights the need to have plans in place to deal with whistleblowers promptly and effectively – while at all costs avoiding illegal retaliation. Training at all levels of an organization may be required to effectively educate employees to avoid taking actions that marginalize the whistleblower during an internal investigation.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and our colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:
Pam L. Johnston
Los Angeles, California
Bryan B. House