Key Takeaways From The SEC s 2015 Whistleblower Report

Transcription

1 Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY Phone: Fax: Key Takeaways From The SEC s 2015 Whistleblower Report Law360, New York (November 25, 2015, 10:38 AM ET) -- On Nov. 16, 2015, the Office of the Whistleblower (OWB) of the U.S.Securities and Exchange Commission, which is headed by Sean X. McKessy, released its annual report to Congress on the Dodd-Frank Whistleblower Program.[1] The report highlights the continuing growth and evolution of the program: since the inception of the program in late fiscal year 2011, $54 million has been paid to 22 whistleblowers, and the number of tips received is up 8 percent from last year, and 30 percent since inception.[2] Consistent with prior public statements by senior SEC officials, the reports stresses the SEC s efforts to protect whistleblowers from retaliation as well as its efforts to ensure that whistleblowers are able to communicate freely with the SEC. The report also highlights and discusses the several awards made to compliance personnel and officers. Finally, the report indicates that the OWB is tracking more than 700 matters that are based on whistleblower tips.[3] Fiscal Year 2015 and Cumulative Metrics According to the report, in fiscal year 2015, the SEC received 3,923 whistleblower tips. Although this is a significant increase from 2012, it is only a slight increase of about 8 percent from the 3,620 tips received in 2014.[4] This is somewhat surprising as some observers thought that the SEC s $30 million award at the very end of September 2014 would result in a much more significant increase in the number of tips. As in previous years, at least one whistleblower in every state provided a tip in 2015, with whistleblowers in California providing by far the greatest number of tips at 646, followed by New York with 261, and Florida and Texas with both 220.[5] The SEC also received tips from individuals in 61 foreign countries, with the greatest number of tips coming from individuals in the U.K., Canada, India and China.[6] As in prior years, the top three categories of tips were again corporate disclosures and financials (17.5 percent), offering fraud (15.6 percent) and manipulation (12.3 percent).[7] As we have noted previously, it is interesting that 24 percent of the tips made fail to identify any relevant securities law violation; this may indicate that many of these tips are facially meritless.[8] During fiscal year 2015, an additional 139 Notices of Covered Action ( NoCAs ) were posted (the same number as last year). These are notices identifying SEC enforcement actions that resulted in monetary sanctions over $1 million for which a whistleblower who provided original information that led to the success of that enforcement action may seek an award. Since the program s inception in August 2011, the SEC has posted 709 NoCAs to its website.[9] The SEC s Investor Protection Fund, established under the Dodd-Frank Act to provide funding for the whistleblower award program, had $437,795, available for awards at the beginning of fiscal year. However, because the $37,950, million has been paid out, the fund s balance at the end of the fiscal year is $400,693, million.[10]

2 OWB Efforts and Process Issues According to the report, in fiscal year 2015, the OWB received more than 120 whistleblower award claims, issued final or preliminary orders addressing over 150 award claims, and paid out more than $37 million to whistleblowers.[11] The OWB also returned over 2,800 phone calls from members of the public, and is currently tracking some 700 matters in which whistleblowers are involved.[12] The OWB has been criticized by some, especially in the last year, regarding the pace at which it is making awards. Indeed, there have been several blog posts and news articles that have chronicled the apparently slow pace of the awards process and the resulting backlog in award applications.[13] McKessy has previously said publicly that this criticism is unfair and fails to recognize the deliberative process involved in making these decisions and the degree to which the process had been clogged up with hundreds of meritless submissions by so-called serial submitters. [14] In the report, OWB describes two final orders one from 2014 and one from August 2015 in each case denying an individual s claims for awards in connection with multiple NoCAs and finding the claimant ineligible for an award in any other pending or future covered or related actions.[15] Profiles of Whistleblower Award Recipients Dodd-Frank prohibits the SEC from disclosing any information that reasonably could be expected to reveal the identity of a whistleblower, and OWB views protecting whistleblower confidentiality as integral to the whistleblower program. But the OWB has also in good faith endeavored, where possible, to provide some transparency by including in its reports certain aggregate information regarding whistleblowers who have received awards under the program. Last year s report for fiscal year 2014 provided quite significant details regarding the nature of the awardees and the kinds of cases involved (see last year s article, Key Takeaways From the SEC s Whistleblower Report ), and this year s report largely repeats this information. This year s report provides three new and important insights: First, the report indicates that [r]oughly one-half of the whistleblowers who have received awards under the program received awards for providing information that significantly contributed to an existing investigation as opposed to a new investigation.[16] The report does not elaborate on this somewhat surprising information, but one explanation might be that the SEC is ahead of the curve on some issues. Second, the report notes that, to date, almost half of the award recipients were current or former employees of the company on which they reported information of wrongdoing. [17] What is noteworthy here is that this means that more than half of all OWB award recipients have not been current or former employees of the relevant entity. This means that these whistleblowers were clients, customers, consultants, competitors, counterparties or some other person entirely. Finally, at a high level, the report discusses the factors that could increase or decrease the award percentage that a whistleblower receives. Most interesting here is the OWB s acknowledgment that a whistleblower s "unreasonabl[e] delay[] in reporting the violation to the Commission" is a significant factor that drives award percentages down. Indeed, according to the report, [a]pproximately 20% of the awards made to date were reduced because of an unreasonable reporting delay. [18]

3 Discussions and Descriptions of Major Awards Retaliation and Internal Whistleblower Protections The report highlights the now well-known Paradigm case the commission s first anti-retaliation case. The enforcement action itself concluded in 2014, and in fiscal year 2015, the commission awarded the maximum possible whistleblower payment of 30 percent of amounts collected, totaling over $600,000. The report emphasized, among other things, the unique hardships the whistleblower had experienced as a result of his/her reporting, including: the company s removing the whistleblower from his/her thencurrent position, assigning the whistleblower the task of investigating the very conduct he/she had reported to the commission, and changing the whistleblower s job function and stripping him/her of supervisory responsibilities.[19] Of course, the issue of protecting whistleblowers from retaliation is closely related to another priority of the OWB, which is preserving protections for whistleblowers who report concerns internally. The SEC has taken the position that the Whistleblower Rules adopted in 2011 extend employment retaliation protections not just to individuals who report potential securities law violations directly to the SEC, but also to individuals who report internally. This position was challenged in Asadi v. G.E. Energy (USA) LLC, 720 F.3d 620 (5th Cir. 2013), and the Fifth Circuit Court of Appeals rejected the SEC s position as unambiguously foreclosed by Dodd-Frank. However, as noted in the report, the Second Circuit recently held to the contrary that Dodd-Frank is sufficiently ambiguous on the question of whether internal whistleblowers are entitled to anti-retaliation protections to entitle the SEC s interpretation to socalled Chevron deference. See Berman v. Neo@Ogilvy LLC, No. 14-CV-4626, (2d Cir. Sept. 10, 2015). Asadi and Berman crystallized an already emerging federal court split, seemingly assuring review by the U.S. Supreme Court, but the Berman defendant recently withdrew its petition for certiorari to the Supreme Court, so the question of whether employment retaliation protections extend to internal whistleblowers will have to await another case and another term. It is clear that the SEC intends to continue pursuing retaliation cases and believes strongly that whistleblowers who report internally are protected from retaliation and may pursue the private right of action provided for in Dodd-Frank. Awards to Gatekeepers Among the cases profiled in the fiscal year 2015 report are two in which awards were made respectively to a compliance professional ($1-plus million award) and to a company officer ($500,000 award). These cases are significant because individuals whose principal duties involve compliance or internal audit responsibilities like officers, directors, trustees and partners who learn about misconduct through another employee s reporting generally are excluded from award eligibility unless an exception applies. As McKessy has previously declared publicly, the rules reflect a presumption that any employee who gets paid to keep the company from being on the other side of the SEC should not receive a whistleblower award.[20] See Rule 21F-4(b)(4)(iii)(A)-(B). There are, however, three exceptions to this general rule: First, if a person is engaged in conduct that interferes with an investigation, then another employee who notifies the SEC is eligible for reward. Rule 21F-4(b)(4)(v)(B). McKessy has previously indicated that there have not yet been any awards under this obstruction scenario.[21]

4 Second, if a person is aware that the company is engaged in, or intends to engage in, conduct that will cause significant, long-term damages to the company or shareholders, then a whistleblower can qualify for payout, even if he or she serves as a compliance officer, etc. McKessy has said that this exception in intended to prevent a $10 million problem from becoming a $100 million problem. Rule 21F-4(b)(4)(v)(A) (the substantial injury exception ). In April 2015, the commission relied on this exception to make an award to a compliance professional, noting in a press release that, [t]he award involves a compliance officer who had a reasonable basis to believe that disclosure to the SEC was necessary to prevent imminent misconduct from causing substantial financial harm to the company or investors. See There have been some suggestions that this award may have involved a company that had settled with the SEC and was about to embark on further perhaps related but unknown violative conduct. In any event, the fiscal year 2015 report notes that this award was the first time the Commission utilized the substantial injury exception, and we further understand that there is some reticence at the OWB that this exception not be applied frequently or generally, lest it swallow the rule.[22] Third, if misconduct is reported internally, and after 120 days, an individual officer, director or compliance professional believes that nothing has happened to correct the misconduct, that person can go forward to the SEC on the theory that the internal investigation has failed. Rule 21F- 4(b)(4)(v)(C). This exception formed the basis for the first award to a compliance officer in August 2014, and, as discussed in the fiscal year 2015 report, was the basis for the first award to a company officer in March See e.g. The fiscal year 2015 case is potentially more troubling, however. The SEC s press release quoted Director of Enforcement Andrew Ceresney as saying that the officer should be commended for stepping up to report a securities law violation when it became apparent that the company s internal compliance function was not performing well enough to address it. Unfortunately, none of the underlying award documents or press releases articulates or describes the circumstances giving rise to these awards. More troublingly, neither the press release nor the underlying order granting the officer s award articulate what exactly the underlying facts were that resulted in the SEC concluding that the company s internal compliance function was not performing well enough. [23] The upshot, however, is that, even though these are exceptional cases, the fact remains that, of the 22 awards made to date, two were to compliance personnel and one was to an officer. This suggests that companies should proceed very carefully here, and recognize that, after the four-month/120-day point of an internal investigation, the number of potential whistleblowers grows exponentially. That is, a compliance officer involved in the investigation may come to believe that the investigation is insufficient, in process, scope or substance, and decide to make a report to the SEC. Restrictive Agreements The report does not mince words: one area of focus for OWB in fiscal year 2015 was whether employers were using confidentiality, severance and other kinds of agreements to interfere with an individual s ability to report potential wrongdoing to the SEC.[24] Indeed, those who watch the SEC closely had been expecting that 2015 would be the year in which the SEC first brought a case under Rule 21F-17(a) for alleged efforts to muzzle whistleblowers. That case was KBR Inc. See

5 The case involved an agreement KBR allegedly required employees to sign in the context of internal investigations that, in the SEC s view, impermissibly impeded potential whistleblowers from communicating with the SEC by requiring employees to, among other things, seek permission from the legal department before disclosing anything (including underlying facts). As alleged, the agreement at issue in KBR appeared to be extremely restrictive and potentially intimidating to employees. The KBR matter caused great consternation in corporate America, both with respect to potential implications for the standard Upjohn warning and also with respect to SEC statements implying or suggesting that even standard confidentiality agreements may run afoul of Rule 21F-17(a). SEC Chair Mary Jo White sought to clarify these issues in her April 30, 2015, speech, The SEC as the Whistleblower s Advocate. [25] Importantly, White indicated that the agreement in the KBR matter had, in the SEC s view, impermissibly cover[ed] underlying facts and had required potential whistleblowers to seek preapproval from the legal department before reporting information to the SEC.[26] White went on to say that [c]ompanies conducting internal investigations can still give the standard Upjohn warnings that explain the scope of the attorney-client privilege in that setting, and that [c]ompanies may continue to protect their trade secrets or other confidential information through the use of properly drawn confidentiality and severance agreements. White declared that, although the SEC would not dictate particular language, companies must speak clearly in and about confidentiality provisions such that employees understand that it is always permissible to report possible securities laws violations to the Commission. Finally, White made clear her view that [c]ompanies would be well-served to review their own agreements and policies to ensure that they are consistent with Rule 21F-17 and all of the whistleblower rules. [27] Indeed, the report makes clear that the SEC will continue to focus on KBR issues, and there have been reports that an enforcement sweep and examination effort are underway on this score. The SEC is actively interested in any company documents, policies or statements that, in words or substance, suggest that an employee talks to the SEC at his or her own peril. Given the report s declaration that the OWB will continue to focus on agreements that have language that reasonably could have the effect of impeding whistleblowers from reporting securities violations to the Commission, [28] and White s admonition that companies should take a fresh look at their employment policies (including confidentiality agreements) to ensure that they are consistent with Rule 21F-17(a), we think companies would be wise to undertake some kind of prophylactic review of at least a sample of their confidentiality agreements and severance agreements. By Christian R. Bartholomew, Elliot S. Tarloff and Casey Yi, Jenner & Block LLP Christian Bartholomew is a member in Jenner & Block's Washington, D.C., office and a former trial lawyer for the U.S. Securities and Exchange Commission. Elliot Tarloff is an associate and Casey Yi is a paralegal in the firm's Washington office.

6 The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. [1] SEC, 2015 Annual Report to Congress on the Dodd-Frank Whistleblower Program (Nov. 16, 2015) ( Report ), available at [2] Id. at 1. [3] Id. [4] Id. at 21. [5] Id. at 29 (Appendix B). [6] Id. at 24. [7] Id. at 22. [8] Id. at 28 (Appendix A). [9] Id. at 12. [10] Id. at 27. [11] Id. at 10. [12] Id. at 8. [13] Bill Singer, SEC Whistleblower Program Is A Black Hole of Despair, Broke And Broker Blog (April 9, 2015), [14] Sean X. McKessy, Chief, Office of the Whistleblower, Remarks at Thomson Reuters Fourth Annual Corporate Whistleblowing Forum (Sept. 9, 2015) ( McKessy Remarks ). [15] Report at 14. [16] Id. at 16 (emphasis added). [17] Id. [18] Id. at 18. [19] Id. at [20] McKessy Remarks. [21] Id. [22] Report at 11.

7 [23] Press Release, Former Company Officer Earns Half-Million Dollar Whistleblower Award for Reporting Fraud Case to SEC, Release No (March 2, 2015), available at [24] Report at 6-7. [25] Mary Jo White, Chair, The SEC as the Whistleblower s Advocate, Speech Before Garrett Institute, Northwestern School of Law (April 30, 2015), available at [26] Id. (emphases added). [27] Id. [28] Report at 7. All Content , Portfolio Media, Inc.