Enforcement News: SEC Charges Investment Advisor With Violating Whistleblower Protection Rule

• Posted on: Oct 2 2023

By: Jeffrey M. Haber

We have often written about the SEC’s whistleblower program and, in particular, the success of the program with respect to detecting and preventing violations of the federal securities laws. The success of the program depends, in large part, on the ability of would-be whistleblowers to have the freedom to report wrongdoing without fear of reprisal. Taking steps to impede an employee or former employee from sharing information with the SEC impairs this free flow of information to the Commission. To ensure the freedom to communicate, the SEC has cracked down on companies that use severance agreements and other types of employment contracts to silence and discourage employees from reporting wrongdoing to the Commission.¹ 

In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) to combat illegal and fraudulent conduct on Wall Street and promote compliance with the federal securities and commodities laws.  The Dodd-Frank Act contains whistleblower provisions that authorize the Commission to pay substantial cash rewards to whistleblowers that voluntarily provide the SEC with information about securities fraud and other violations of the securities laws, including the Foreign Corrupt Practices Act. 

To fulfill the purpose of the Dodd-Frank Act, the Commission adopted Rule 21F-17,² which provides in relevant part:

(a) No 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. 

Despite being effective for more than 12 years, many companies have ignored the mandate of Rule 21F-17. In this regard, they have used severance agreements and other types of employment contracts to silence and discourage employees from reporting violations of the securities laws to the Commission. That was the case in the Matter of D. E. Shaw & Co, L.P., Securities Exchange Act of 1934, Release No. 98641 (Sept. 29, 2023).

Matter of D. E. Shaw & Co, L.P.

On September 29, 2023, the SEC announced (here) that it settled charges against New York-based registered investment adviser D. E. Shaw & Co., L.P. (“DESCO”) for impeding whistleblowing by requiring employees to sign agreements prohibiting the disclosure of confidential corporate information to third parties, without an exception for potential SEC whistleblowers, and by requiring departing employees to sign releases affirming that they had not filed any complaints with any government agency in order for the employees to receive deferred compensation. DESCO agreed to pay $10 million to settle the SEC’s charges.

The SEC found (here) that, from at least 2011 through 2019, DESCO required new employees to sign agreements that prohibited them from disclosing confidential information to anyone outside the company unless authorized by DESCO or required by law or court order. Confidential information was broadly defined to include any information gained in the course of employment that could reasonably be expected to be damaging to DESCO if disclosed to third parties. In addition, according to the SEC, from at least 2011 through 2023, DESCO required approximately 400 of its departing employees to sign releases affirming that they had not filed any complaints with any governmental agency, department, or official in order for them to receive deferred compensation and other benefits sometimes worth millions of dollars. According to the SEC, in 2017, DESCO circulated a firm-wide email notifying employees that they were not prohibited from communicating with regulators regarding possible violations of law and that notice to DESCO was not required. However, said the SEC, DESCO did not include similar whistleblower protection language in its employment agreements until 2019 and in its releases until 2023—after the SEC’s investigation commenced.

“Entities employing confidentiality, separation, employment and other related agreements should take careful notice of today’s enforcement action,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “The Commission takes seriously the enforcement of whistleblower protections and those drafting or using these types of agreements should take equally serious their obligations to ensure that they don’t impede whistleblowers from contacting the Commission.”

“Protected by federal law, whistleblowers play a significant role in uncovering fraud and other illegality in the securities markets, particularly with respect to registered entities regulated by the Commission,” said Sheldon L. Pollock, Associate Director of the SEC’s New York Regional Office. “The SEC remains committed to ensuring their unfettered ability to provide information to further our investigations.”

In its cease-and-desist order (here), the SEC found that DESCO violated Rule 21F-17(a) of the Securities Exchange Act of 1934. Without admitting or denying the SEC’s findings, DESCO agreed to be censured, cease and desist from violating the whistleblower protection rule, and pay a $10 million civil penalty.

Footnotes

1. In April 2015, the SEC brought the first enforcement action for a violation of the whistleblower protection rule based on a company’s use of a restrictive confidentiality agreement. See In the Matter of KBR, Inc., Exchange Act Release No. 74619 (Apr. 1, 2015). This Blog wrote about that enforcement action here. Since 2015, the SEC has instituted nearly 20 additional enforcement actions charging violations of the rule. This Blog has examined some of those enforcement actions here, here, here, here, and here.
2. Rule 21F-17 became effective on August 12, 2011.

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.