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Christmas Coal For Two Companies That Used Separation Agreements To Impede The Ability Of Departing Employees To Report Violations Of The Securities Laws

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  • Posted on: Dec 22 2016

The Securities and Exchange Commission (“SEC” or “Commission”) has put a lump of coal in the Christmas stockings of two companies this week for using separation agreements that impede the ability of whistleblowers to report violations of the securities laws to the Commission. The announcements by the SEC (here and here) came within a day of each other and evidence a continued resolve by the Commission to crackdown on companies that use severance agreements and other types of employment contracts to silence and discourage employees from reporting wrongdoing to the Commission.

The settlements announced on December 19 and 20 follow a string of cases (four of which were discussed by this Blog here and here) brought by the SEC against companies within the past 24 months that have used severance agreements to impede departing employees from communicating with the SEC about possible securities law violations—agreements that, among other things, impose financial forfeiture on the employee or expose the employee to litigation.

In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”) to combat illegal and fraudulent conduct on Wall Street and promote compliance with the federal securities laws.  The Dodd-Frank Act contains whistleblower provisions that authorize the SEC to pay substantial cash rewards to whistleblowers that voluntarily provide the SEC with information about violations of the securities laws. The Act further empowers whistleblowers to report corporate fraud or illegal conduct by prohibiting retaliation against individuals who blow the whistle under the SEC whistleblower program.

In 2011, the SEC adopted Rule 21F-17 to implement the whistleblower-protection provisions of the Act.  The rule provides 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 … with respect to such communications.” Rule 21F-17 applies to any policy or procedure, or agreement, such as confidentiality, severance, and non-disclosure agreements, that may impede an employee or former employee from providing information to the SEC about a securities law violation.

In February 2015, the SEC began policing confidentiality agreements and punishing those companies that used such agreements to impede whistleblowing communications with the Commission. The enforcement division asked dozens of public companies for nondisclosure agreements, employment contracts, severance agreements, and other similar documents as part of an investigation into whether there were efforts to suppress lawful whistleblowing activities. By April of that year, the SEC brought its first action.

In addition to initiating enforcement actions, the staff of the Office of Compliance Inspections and Examinations has warned companies that it is reviewing compliance with the Commission’s rules and “encouraged” the companies to “to evaluate whether their compliance manuals, codes of ethics, employment agreements, severance agreements, and other documents contain language that may be inconsistent with Rule 21F-17.” See October 24, 2016 “Risk Alert”.

The Latest Settlements:

NeuStar, Inc.:

On December 19, 2016, the SEC announced that NeuStar, Inc., a Virginia-based technology company, agreed to pay a $180,000 penalty “to settle charges involving its severance agreements,” which the SEC charged “impeded at least one former employee from communicating information” to the Commission.

The SEC found that NeuStar violated Rule 21F-17 “by routinely entering into severance agreements that contained a broad non-disparagement clause forbidding former employees from engaging with the SEC and other regulators ‘in any communication that disparages, denigrates, maligns or impugns’ the company.”  Violation of the provision could result in the forfeiture of all but $100 of the employee’s severance pay. According to the SEC, these severance agreements were used with at least 246 departing employees from August 12, 2011 to May 21, 2015.

NeuStar voluntarily revised its severance agreements after the SEC began its investigation and consented to the SEC’s cease-and-desist order without admitting or denying the findings. In addition, NeuStar agreed to make reasonable efforts to inform those who signed the severance agreements that the company does not prohibit former employees from communicating any concerns about potential violations of law or regulation to the SEC.

SandRidge Energy Inc.:

On December 20, 2016, the SEC announced that an Oklahoma City-based oil-and-gas company, SandRidge Energy Inc., “agreed to settle charges that it used illegal separation agreements” and illegally “retaliated against a whistleblower who expressed concerns internally about how [the company’s] reserves were being calculated.”

The SEC found that although SandRidge conducted multiple reviews of its separation agreements after Rule 21F-17 became effective in August 2011, it nevertheless “continued to regularly use restrictive language that prohibited outgoing employees from participating in any government investigation or disclosing information potentially harmful or embarrassing to the company.” Such restrictive language, charged the SEC, violated the very rule the company “regularly” reviewed.

The SEC further found that SandRidge fired a whistleblower who repeatedly raised concerns internally about the process used by SandRidge to calculate its publicly reported oil and gas reserves.  That employee, who had been offered a promotion, but turned it down, was fired months later after senior management concluded the employee was disruptive and could be replaced with someone “‘who could do the work without creating all the internal strife.’” The company had conducted no substantial investigation of the whistleblower’s concerns and initiated an internal audit that was never completed. This was the first time the SEC has charged a company “for retaliating against an internal whistleblower,” said Jane Norberg, Chief of the SEC’s Office of the Whistleblower. The employee’s separation agreement also contained the company’s prohibitive language that violated the whistleblower protection rule.

SandRidge agreed to pay a penalty of $1.4 million, subject to the company’s bankruptcy plan, without admitting or denying the SEC’s findings. David A Kimmel, director of communications for SandRidge, said in an email statement that under the company’s bankruptcy reorganization plan, SandRidge will satisfy the fine by a payment of about $100,000.

Takeaway:

In commenting on the NeuStar settlement, Jane Norberg stated that the SEC’s action demonstrated its “continued” enforcement of Rule 21F-17, and “underscore[d]” the Commission’s “ongoing commitment to ensuring that potential whistleblowers can freely communicate with the SEC about possible securities law violations.” It fair to say that “strong enforcement” of the rule will remain a priority of the Commission during 2017.

In light of this “continued” enforcement effort, companies should review their severance, confidentiality and employment agreements to ensure compliance with Rule 21F-17. To be sure such agreements and documents are important tools for companies to protect their sensitive information.  But, they should not be used as a shield to thwart the disclosure of wrongdoing. Therefore, agreements that are vague and ambiguous about the ability of departing employees to report wrongdoing to the SEC should be revised to make it clear that communications with the SEC are not prohibited.

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