According to a memo circulating amongst Republican-party leaders as of February 13th, Republicans in the House of Representatives are planning to propose a significant curtailment of the U.S. Securities and Exchange Commission’s (SEC) whistleblower program in legislation intended to rewrite Dodd-Frank. These revisions, which will be proposed as edits to Representative Jeb Hensarling’s Financial CHOICE Act, mainly pertain to rolling back financial regulations and provisions that would curb the power of the Consumer Financial Protection Bureau. The memo also indicates that House Republicans are considering editing the proposed legislation to prohibit “any SEC rulemaking by enforcement,” and further requiring the SEC to reevaluate its current enforcement program by establishing a committee that would notify individuals and firms of potential enforcement actions, and giving them an opportunity to respond in advance.
A significant change that stands to impact the SEC’s whistleblower program is a proposed prohibition on making whistleblower awards to “co-conspirators” for successful tips. The whistleblower program, in its current form, already prohibits the SEC from making awards to whistleblowers who were criminally convicted of the same or similar conduct underlying their tip(s), but it does allow the SEC to make awards to whistleblowers who were involved in wrongdoing but not criminally charged for it, even if he or she faced civil action for the conduct. Currently, it is unclear how many of the 39 whistleblowers who have received awards were involved in the misconduct that they reported, as the agency keeps the identity of whistleblowers extremely confidential, and publishes few details about cases and enforcement actions.
We will provide further updates as additional information about revisions to Dodd-Frank become available.
On February 10, 2017, a California jury awarded Sanford Wadler, the former general counsel of Bio-Rad Laboratories, Inc. (Bio-Rad), over $10 million in damages (including $5 million in punitive damages) on his claims under the Sarbanes-Oxley Act that the company fired him for investigating suspected Foreign Corrupt Practices Act (FCPA) violations by the company in China, and because he reported his concerns to the company’s Audit Committee.
This verdict came on the heels of a pre-trial ruling that, in effect, allows in-house counsel for corporations to proceed to trial on their whistleblower claims, even when proving such claims would require the presentation of privileged information obtained during his or her employment with and representation of the company. This ruling came in the face of California’s robust privilege laws, which are substantially more favorable to the privilege holder than to the attorney, and require that an attorney “maintain inviolate the confidence, and at every peril to himself or herself to preserve the secrets, of his or her client.” Despite the strictures of attorney-client privilege law in California, the district court in this case found that the federal Sarbanes-Oxley Act preempted California law to the extent that California’s disclosure rules were more protective of otherwise privileged information. The district court also found that, by vigorously and frequently referring to the subject matter of privileged communications in its defense of the case, among other things, Bio-Rad had effectively and broadly waived its claims of attorney-client privilege over those communications.
As this case illustrates, whistleblower retaliation claims, by in-house counsel, can be particularly difficult for a company to defend against, especially without using or referring to privileged communications. Therefore, companies facing potential whistleblower claims, by in-house counsel, should consistently and affirmatively assert their privilege as to such communications from the first hint of a dispute. Moreover, whether to assert any defenses, based on the advice of outside counsel, should be carefully considered early in the litigation process. In this case, one of the company’s main defenses was that it obtained advice from outside counsel that contradicted the former general counsel’s concerns about potential FCPA violations. In response to whistleblower retaliation claims from in-house counsel, companies should proactively consider whether defenses, based on the advice of outside counsel, can and should be asserted in the case in a manner that will preserve privilege - and if not - whether to waive privilege at all. Companies and their counsel should also consider whether even the fact that the company sought outside counsel’s advice about an in-house attorney’s concern should be introduced into the litigation.
The SEC recently announced that HomeStreet Inc., a Seattle-based financial services provider, agreed to pay the agency $500,000 as a penalty to settle charges that it conducted improper hedge accounting and later took steps to impede potential whistleblowers from reporting the violations. Darrell van Amen, HomeStreet’s treasurer, agreed to pay a separate $20,000 penalty to settle charges against him individually that he caused the accounting violations. According to the SEC, HomeStreet originated approximately 20 fixed rate commercial loans and entered into interest rate swaps to hedge the exposure. HomeStreet then designated the loans and the swaps in fair value hedging relationships, which can reduce income statement volatility that might exist absent hedge accounting treatment. Companies are required to periodically assess the hedging relationship, and to discontinue the use of hedge accounting if the effectiveness ratio falls outside a certain range. In certain instances from 2011 to 2014, van Amen implemented unsupported adjustments in HomeStreet’s hedge effectiveness testing to ensure that HomeStreet could continue using the favorable accounting treatment. The test results with altered inputs to influence the effectiveness ratio were provided to HomeStreet’s accounting department, which resulted in the creation of inaccurate accounting entries.
The SEC’s order further finds that after HomeStreet employees reported concerns about accounting errors to management, HomeStreet concluded the adjustments to its hedge effectiveness tests were incorrect. When the SEC contacted HomeStreet in April of 2015 seeking documents related to hedge accounting, HomeStreet presumed it was in response to a whistleblower complaint and began taking actions to figure out the identity of the purported whistleblower. One individual, who was considered to be a potential whistleblower, was told that the terms of their indemnification agreement could allow HomeStreet to deny payment for legal costs during the SEC’s investigation. HomeStreet also began requiring former employees to sign severance agreements waiving potential whistleblower awards, or the exiting employees would risk losing their severance payments and other post-employment benefits. Such waivers have been found to violate Rule 21F-17, which provides, inter alia, that “[n]o 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 ...”
The SEC ended 2016 with a trifecta of substantial whistleblower awards. On November 14th, the SEC issued an award in excess of $20 million to a whistleblower who provided the agency with information that enabled it quickly initiate an enforcement action before the perpetrators could squander investors’ funds. This award is the third-largest made since the SEC made its first whistleblower award in 2012.
Soon after, the SEC announced two awards totaling almost $4.5 million in one week on December 5th and December 9th to two separate whistleblowers. The December 5th award involved a single whistleblower who received $3.5 million for coming forward with information that led to an SEC enforcement action. The December 9th award was for $900,000, and made to a whistleblower whose tip enabled the SEC to bring multiple enforcement actions against wrongdoers. Neither announcement contained more specific details about the entities that were the subject of the SEC enforcement actions.
On January 17, 2017, the SEC announced that BlackRock Inc., a New York-based asset manager, had agreed to pay a $340,000 penalty to settle charges that it improperly used separation agreements to force exiting employees to waive their ability to obtain whistleblower awards. According to the SEC, more than 1,000 departing BlackRock employees signed separation agreements that included language that they “waive[d] any right to recovery of incentives for reporting of misconduct,” and did so in order to receive separation payments from the company. BlackRock added this language to its separation agreements in October of 2011, after the SEC adopted Rule 21F-17 which provides, inter alia, that “[n]o 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. . .” BlackRock did not remove the violating language in question from its separation agreements until March of 2016.
Ultimately, BlackRock consented to the SEC’s order without admitting or denying the SEC’s finding that it violated SEC Rule 21F-17. The SEC’s order further noted that BlackRock voluntarily revised its form separation agreement, and took several other remedial actions, including implementing annual trainings to summarize employee rights under the SEC’s whistleblower program.
The SEC announced on January 23, 2017 that it had awarded over $7 million, its sixth highest whistleblower award ever, to three whistleblowers who helped with the successful prosecution of an investment scheme. The SEC’s Office of the Whistleblower announced that three unidentified individuals would split the $7 million, with one of the whistleblowers receiving $4 million for providing the tip that started the SEC’s investigation. The other two whistleblowers will split the remainder of the award, as they provided the SEC with additional information that ended in a successful enforcement action.
In addition to not identifying the individual whistleblowers, or the entity that was the subject of the investigation and enforcement action, the SEC order also did not explain what percentage of the enforcement action’s sanctions were received by the whistleblowers as an award. Typically, SEC whistleblower awards range from 10 percent to 30 percent of the total sanctions imposed, which would mean that the enforcement action itself would have been between $23 million and $70 million. As of the date of that award, the SEC has awarded approximately $149 million through its whistleblower program. Enforcement actions using information provided by whistleblowers have reaped more than $935 million in payments to the SEC.
The whistleblower, John Verble, worked as a financial advisor for Morgan Stanley Smith Barney, LLC (Morgan Stanley LLC) from November 2006 until his termination in June of 2013. Verble alleged that he learned of illegal activity by Morgan Stanley LLC and certain of its clients, and that he also served as a confidential FBI informant in a separate investigation. Verble also initially alleged that he cooperated with the SEC, but did not provide any factual information about his cooperation with the SEC. Verble also claimed that he reported violations to other federal law-enforcement agencies, and internally to Morgan Stanley LLC. Neither Verble’s complaint, nor subsequent filings in the case, provided any factual information regarding his alleged reports to other law-enforcement agencies or internally to the company. Verble further alleged that “as a direct result of [his] involvement in assisting the FBI,” he “was retaliated against, discriminated against and illegally discharged from his position,” in violation of the False Claims Act, the Dodd-Frank Act, and Tennessee state law.
The defendants, Morgan Stanley, Inc., and Morgan Stanley LLC, filed a motion to dismiss Verble’s claims, arguing that Verble’s complaint should be dismissed because he failed to allege specific facts to support his claim alleging that he was fired in retaliation for being a whistleblower. Verble’s only argument in response to the defendants’ motion to dismiss was that he could provide additional facts in sealed pleadings to the district court, although he never ultimately did so. Verble also did not request leave to amend his complaint to allege additional facts in support of his retaliation claims. The district court ultimately dismissed Verble’s complaint in its entirety. Verble appealed this decision to the Sixth Circuit, which affirmed the district court’s dismissal of his complaint.
The Sixth Circuit affirmed the dismissal of both Verble’s False Claims Act retaliation claim and Dodd-Frank Act retaliation claim because Verble failed to allege sufficient, plausible facts to support that his termination was retaliatory in nature. Most notably, the Sixth Circuit did not reach or resolve the question (as other federal courts have done) of whether an individual like Verble, who never directly reported to the SEC, qualifies as a whistleblower under the provisions of the Dodd-Frank Act. That question has divided federal courts, as its answer depends on whether a court reads the text of the Dodd-Frank Act to be ambiguous enough to warrant deference to the SEC’s own interpretation of the statute. Specifically, the SEC issued a rule interpreting the Act’s anti-retaliation provision to protect individuals who report violations internally or to other law-enforcement agencies, in addition to the SEC.
In January 2017, the Occupational Safety and Health Administration (OSHA) published its Recommended Practices for Anti-Retaliation Programs, which provides valuable guidance to employers seeking to create “workplaces in which workers feel comfortable voicing their concerns without fear of retaliation.” OSHA’s recommendations apply to all public and private employers covered under the 22 whistleblower protection laws that OSHA enforces. OSHA’s publication identifies five characteristics that it believes make for an effective anti-retaliation program:
Management leadership, commitment, and accountability.
A system for listening to and resolving employees’ safety and compliance concerns.
A system for receiving and responding to reports of retaliation.
Anti-retaliation training for all employees and managers.
Anti-retaliation program oversight.
OSHA’s Recommended Practices for Anti-Retaliation Programs publication provides additional discussion as to its expectations for each of the five “key elements.” For example, as to the first element, “Management leadership, commitment, and accountability,” OSHA indicates this element can be achieved through leadership conferring with workers and worker representatives, if applicable, about creating and improving management’s awareness and implementation of anti-retaliation policies and practices, and requiring management-level anti-retaliation training. The fifth element can be achieved by requiring program audits to be performed by auditors who are independent of the process being audited.
Employers that are regulated under any of the 22 federal whistleblower protection laws that OSHA enforces should review this guidance and consider implementation strategies, as OSHA inspectors will likely begin to include issues identified in the agency’s Recommended Practices in their inspections.