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The SEC Makes Good on Its Promise to Crack Down on Agreements and Policies That Impede Whistleblowers From Reporting Securities Fraud

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  • Posted on: Aug 24 2016

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.  The Dodd-Frank Act contains whistleblower provisions that authorize the Securities and Exchange Commission (“SEC” or the “Commission”) 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.

The SEC Begins To Enforce Rule 21F-17

Since the rule’s adoption, whistleblowers and their counsel have complained that employers have used confidentiality and non-disclosure agreements to harass and intimidate employees and former employees from reporting a violation of the securities laws to the SEC. The problem from the whistleblower’s perspective was that following adoption, the SEC was not enforcing the rule.  That changed, however, in March 2014, when the SEC whistleblower office promised to police confidentiality agreements, and punish those companies that used such agreements to impede whistleblowing communications with the Commission.

A year later, in February 2015, the SEC laid the foundation to make good on that promise.  According to numerous media reports, the SEC 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. See, e.g., Rachel Louise Ensign, “SEC Probes Companies’ Treatment of Whistleblowers,” The Wall Street Journal, Feb. 25, 2015.

The KBR Administrative Action:

In April 2015, the SEC made good on its promise to crackdown on agreements and policies that restrict whistleblowing activities, when it issued a cease-and-desist order against KBR Inc. (“KBR”) for using confidentiality agreements that could chill the whistleblower process.

According to the SEC, KBR, a global technology and engineering firm based in Houston, required employees participating in internal investigations to sign confidentiality statements containing language warning that the employee could be disciplined and/or fired if he/she discussed the investigation and its subject matter with outside parties without the approval of KBR’s legal department.

The SEC acknowledged that it was “unaware of any instances in which (i) a KBR employee was in fact prevented from communicating” with the Commission, or “(ii) KBR took action to enforce the form confidentiality agreement or otherwise prevent such communications,” but nonetheless found that the agreement “impedes such communications.”

KBR agreed to pay a $130,000 penalty to settle the SEC’s charges and amend its confidentiality statement by adding language making it clear that employees could report securities law violations to the SEC and other federal agencies without KBR approval or fear of retaliation.

Commenting on the settlement, Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, underscored the vigor with which the SEC would pursue companies for violating Rule 21F-17:

By requiring its employees and former employees to sign confidentiality agreements imposing pre-notification requirements before contacting the SEC, KBR potentially discouraged employees from reporting securities violations to us. SEC rules prohibit employers from taking measures through confidentiality, employment, severance, or other type of agreements that may silence potential whistleblowers before they can reach out to the SEC.  We will vigorously enforce this provision.

The KBR order was the first reported enforcement action by the SEC that was based solely on the language of a confidentiality agreement.  There would be others, albeit more than a year later.

The BlueLinx Holdings Administrative Action:

On August 10, 2016, the SEC announced that BlueLinx Holdings Inc. (“BlueLinx”), a building products distributor based in Atlanta, agreed to pay $265,000 in settlement of charges that it violated Rule 21F-17 by using severance agreements that required outgoing employees to waive their rights to a monetary recovery if they filed a complaint with the SEC or other federal agencies.

According to the SEC, BlueLinx used several forms of severance agreements “that prohibited the employee from sharing with anyone confidential information concerning BlueLinx that the employee had learned while employed by the company, unless compelled to do so by law or legal process,” but which failed to exempt the employee from providing “information voluntarily to the Commission or other regulatory or law enforcement agencies.”

Even though BlueLinx’s severance agreements did not prohibit former employees from reporting violations to the SEC, the SEC nevertheless claimed that the company unlawfully restricted outgoing employees from participating in the SEC’s whistleblower program. According to the SEC, “by requiring its departing employees to forego any monetary recovery in connection with providing information to the Commission, BlueLinx removed the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.”

The SEC also objected to the requirement that outgoing employees notify the company’s legal department prior to disclosing information to third parties, because the agreement did not expressly exempt the SEC from the restriction. The SEC determined that “BlueLinx forced those employees to choose between identifying themselves to the company as whistleblowers or potentially losing their severance pay and benefits.”

Although the company did not admit or deny the findings, BlueLinx agreed: “(1) to amend its severance agreements to make clear that employees may report possible securities law violations to the SEC and other federal agencies without BlueLinx’s prior approval and without having to forfeit any resulting whistleblower award, and (2) to make reasonable efforts to contact former employees who had executed severance agreements after Aug. 12, 2011 to notify them that BlueLinx does not prohibit former employees from providing information to the SEC staff or from accepting SEC whistleblower awards.”

In the announcement of the settlement, the SEC made it clear that the Commission would continue to aggressively enforce Rule 21F-17.  Stephanie Avakian, Deputy Director of the SEC’s Enforcement Division underscored this point, stating “We’re continuing to stand up for whistleblowers and clear away impediments that may chill them from coming forward with information about potential securities law violations.” Jane Norberg, Acting Chief of the SEC’s Office of the Whistleblower, added, “Companies simply cannot undercut a key tenet of our whistleblower program by requiring employees to forego potential whistleblower awards in order to receive their severance payments.”

The Health Net Inc. Administrative Action:

On August 16, 2016, the SEC announced that Health Net Inc. (“Health Net”), a health insurance provider based in California, agreed to pay a $340,000 penalty for using severance agreements that required outgoing employees to waive their right to obtain monetary awards for blowing the whistle under the SEC’s whistleblower program.

Health Net provided a severance package pursuant to an agreement that outgoing employees signed when leaving the company. These agreements included a Waiver and Release of Claims that listed various potential claims against the company that an outgoing employee waived as a condition of receiving severance payments and other consideration from Health Net.

In August 2011, Health Net amended the Waiver and Release of Claims to specify that, while not prohibited from participating in a government investigation, the outgoing employee who executed the Waiver and Release of Claims was prohibited from filing an application for, or accepting, a monetary award from the SEC.

In June 2013, Health Net further amended the Waiver and Release of Claims by removing the language “expressly prohibiting employees from applying for whistleblower awards pursuant to Exchange Act Section 21F,” and added an exemption for “communicating directly with, cooperating with or providing information to any government regulator.” However, Health Net “retained restrictions in the Waiver and Release of Claims that removed the financial incentive for its former employees who executed that agreement to communicate with Commission staff concerning possible securities law violations at Health Net.”

On October 22, 2015, Health Net amended its severance agreements to remove the prohibition described above.

Notably, the SEC acknowledged that it found no evidence of any instances in which an outgoing Health Net employee who executed the severance agreements did not communicate directly with the SEC about potential securities law violations, nor did the SEC find any evidence that Health Net enforced the waiver provisions or otherwise prevented such communications.  Nonetheless, the SEC concluded that both the 2011 and the 2013 provisions violated Rule 21F-17 by removing the financial incentive to communicate with the SEC concerning possible securities law violations at Health Net.

In addition to paying the penalty, Health Net agreed to make reasonable efforts to contact former employees who signed the Waiver and Release of Claims, and provide those employees with a link to the SEC’s order and a statement that “Health Net does not prohibit former employees from seeking and obtaining a whistleblower award from the Securities and Exchange Commission pursuant to Section 21F of the Exchange Act.”

In the announcement of the settlement, the SEC continued to emphasize its effort to enforce Rule 21F-17.  In this regard, Antonia Chion, Associate Director of the SEC Enforcement Division, stated, “Financial incentives in the form of whistleblower awards, as Congress recognized, are integral to promoting whistleblowing to the Commission.  Health Net used its severance agreements with departing employees to strip away those financial incentives, directly targeting the Commission’s whistleblower program.”

Takeaway:

The foregoing administrative actions demonstrate the SEC’s intention to make good on its promise to crack down on agreements and policies that impede whistleblowers from reporting securities fraud to the Commission. Whistleblowers should take comfort knowing that the SEC is aggressively enforcing Rule21F-17 so that there are no contractual or policy impediments to blowing the whistle on securities fraud. Companies should review their severance agreements and policies to ensure that they are compliant with Rule 21F-17.  Even companies that have previously reviewed their severance agreements and company policies should undertake such a review in light of the SEC’s recent enforcement actions.

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