Enforcement News: SEC Settles Action Against Dual-Registered Investment Adviser/Broker-Dealer for Violating Whistleblower Protection Rule

• Posted on: Jan 17 2024

By: Jeffrey M. Haber

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), enacted on July 21, 2010, amended the Securities Exchange Act by adding Section 21F-17, “Whistleblower Incentives and Protection.” The purpose of these provisions was to encourage whistleblowers to report possible securities law violations by providing, among other things, financial incentives and confidentiality protections.

To achieve this Congressional purpose, the Securities and Exchange Commission (the SEC” or the “Commission”) adopted Rule 21F-17, which provides in relevant part: “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.” Since its adoption,¹ the SEC has vigorously enforced Rule 21F-17.

On January 16, 2024, the SEC announced (here) that it settled charges against J.P. Morgan Securities LLC (“JPMS”) for impeding hundreds of advisory clients and brokerage customers from reporting potential securities law violations to the SEC. JPMS agreed to pay an $18 million civil penalty to settle the charges.

According to the SEC, from 2020 through July 2023 (the “Relevant Period”), JPMS requested that certain clients sign a release (the “Release”) if the clients received a credit or settlement of over $1,000, regardless of whether JPMS admitted or denied any error or wrongdoing in connection with the credit or settlement. In addition, said the SEC, JPMS sometimes offered its clients an additional payment above and beyond the credit or payment calculated for the dispute. In at least one case, noted the SEC, this payment or credit was higher than the original credit or settlement. The SEC alleged that since 2020, at least 362 JPMS clients signed a release, receiving an amount ranging from approximately $1,000 to $165,000.

Pursuant to the Release, the client released JPMS from liability and “promise[d] not to sue or solicit others to institute any action or proceeding against [JPMS] arising out of events concerning the Account.” If the client breached the foregoing provision, said the SEC, then JPMS could “undertake whatever legal action [it] deem[ed] appropriate to address the breach(s), including, but not limited to, injunctive relief, and monetary damages not to exceed the settlement amount.”

According to the SEC, in a another section of the Release, the client agreed to keep the Release confidential and “not use or disclose (including but not limited to, media statements, social media, or otherwise) the allegations, facts, contentions, liability, damages, or other information relating in any way to the [client’s] Account, including but not limited to, the existence or terms of this Agreement.” Notwithstanding, noted the SEC, the client and the client’s attorneys were permitted to respond “to any inquiry about [the] settlement or its underlying facts by FINRA, the SEC, or any other government entity or self-regulatory organization, or as required by law.” Despite this statement, however, the Release prohibited clients from affirmatively reporting violations of the securities laws to the Commission, claimed the SEC.

To settle the action, JPMS agreed to pay a civil penalty of $18 million. In doing so, JPMS neither admitted nor denied the findings, except as to the Commission’s jurisdiction over JPMS and the subject matter of the proceedings, which were admitted. 

“Whether it’s in your employment contracts, settlement agreements or elsewhere, you simply cannot include provisions that prevent individuals from contacting the SEC with evidence of wrongdoing,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “But that’s exactly what we allege J.P. Morgan did here. For several years, it forced certain clients into the untenable position of choosing between receiving settlements or credits from the firm and reporting potential securities law violations to the SEC. This either-or proposition not only undermined critical investor protections and placed investors at risk, but was also illegal.”

“Investors, whether retail or otherwise, must be free to report complaints to the SEC without any interference,” said Corey Schuster, Co-Chief of the Enforcement Division’s Asset Management Unit. “Those drafting or using confidentiality agreements need to ensure that they do not include provisions that impede potential whistleblowers.”

A copy of the cease-and-desist order can be found here.

Footnote

1. 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.