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Employers Beware; General Assertions of Alleged Fraud May be Enough to Trigger SOX Whistleblower Protection
Under Section 806 of the Sarbanes-Oxley Act (SOX), it is illegal for publicly traded companies to retaliate against employees who report suspected fraud. 18 U.S.C. § 1514A. Seemingly straightforward in many respects, this anti-retaliation provision has generated significant litigation since its passage by Congress. Among other things, for example, courts across the country have confronted questions concerning the scope of so-called protected activity; that is, examining the type of “whistleblowing” activity required of the employee to trigger the statute’s protection.
By statute, employees are protected if they engage in lawful acts to provide information regarding “any conduct which the employee reasonably believes constitutes a violation of section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders.” 18 U.S.C. § 1514A(a)(1). Employees must, generally speaking, blow the whistle on corporate fraud or, more to the point, what they reasonably believe to be corporate fraud.
Addressing this issue of protected activity, courts have struggled with defining the specificity required in the employee’s whistleblowing report to trigger protection. Companies often argue, understandably, that the whistleblowing must be specific as to the purported violation and must provide facts sufficient to establish each element of the alleged fraud. Conversely, whistleblowing employees suggest less specificity is required by statute.
The United States Court of Appeals for the Sixth Circuit recently weighed in on precisely this issue. In Rhinehimer v. US Bancorp Investments, Inc., a panel of the 6th Circuit unequivocally rejected the “definitively and specifically” standard proposed by the defendant publicly traded company (and previously adopted by the 2nd, 4th, and 5th Circuits). Instead, the Rhinehimer Court adopted the rule “that the employee’s reasonable belief is a simple factual question requiring no subset of findings that the employee had a justifiable belief as to each of the legally-defined elements of the suspected fraud.” As the court reasoned, “[t]he text and design of § 1514A does not suggest any heightened showing of a factual basis for the suspected fraud. . . . Indeed, at every juncture, the statute sweeps broadly, encompassing a wide swath of acts, limited only by their legality, to provide information or assistance to an investigation ‘regarding any conduct’ reasonably believed by the employee to constitute a violation of relevant law.”
In short, according to Rhinehimer, the employee whistleblower need not present a factual showing justifying the suspicion or reasonable belief in corporate fraud. Instead, “the complainant need only show that he or she ‘reasonably believes’ that the conduct complained of” violates one of the enumerated laws.
Employers, even those outside the jurisdiction of the 6th Circuit given legal trends, should be aware that a wider range of employee complaints may technically fall within the ambit of SOX protection. It remains important to promptly and seriously investigate and respond to those complaints. Doing so, as well as acting proactively, may significantly curtail potential liability exposure and legal expenses.
Rhinehimer v. U.S. Bancorp Investments, Inc., No. 13-6641 (6th Cir.) (May 28, 2015)
The Securities and Exchange Commission is serious about protecting corporate fraud whistleblowers. Since Congress passed Dodd-Frank in 2010, the SEC has continually attempted to bring more cases on behalf of and initiated by corporate fraud whistleblowers. Enforcement has been more vigorous over the years.
In February, the Wall Street Journal published an article discussing the SEC’s probe of companies’ treatment of whistleblowers. SEC Probe The SEC was reportedly looking into whether companies were attempting to stifle whistleblowing and muzzle whistleblowers through nondisclosure agreements, confidentiality agreements, employment agreements, severance agreements, and the like. Apparently, SEC officials were concerned about a corporate backlash against whistleblowers.
And now the SEC has announced its first settlement with a company accused of improperly restricting whistleblowers through restrictive employment agreements. KBR Settlement KBR, Inc. has agreed to pay $130,000 to settle claims asserted by the SEC that it required employees to sign a confidentiality agreement that could have kept them from reporting possible violations of securities laws to outside authorities. More specifically, the KBR confidentiality agreements purportedly included language warning employees that they could face discipline, including termination, if they discussed internal investigations with outside parties unless they first obtained approval from KBR’s legal department.
The pre-notification requirement in the KBR agreement, according to the SEC, is unlawful because it may have a chilling effect on employees, discouraging them from reporting securities violations to appropriate authorities. As a part of its settlement, KBR agreed to amend its confidentiality agreements to clarify that employees can report possible violations to the SEC and other federal agencies without prior KBR approval.
Along with its announcement of the KBR settlement, the SEC indicated that it has a number of other pending investigations involving companies silencing whistleblowers and that it will vigorously enforce these matters.
Although confidentiality agreements are oftentimes essential tools for companies to use in sensitive situations and in dealing with employees, those agreements must be carefully crafted so as not to run afoul of existing regulations. This is especially true in light of the SEC’s aggressive enforcement initiative.
In the matter of KBR Inc. (SEC File No. 3-16466)
Employers and employees alike are increasingly facing the prospect of being involved in issues relating to allegations of corporate fraud. Oftentimes the issue first arises when an employee-whistleblower voices a complaint internally to her employer. The employer’s response to an internal complaint – and treatment of the employee making the complaint – is critical to determining how the matter progresses. Under Section 806 of the Sarbanes-Oxley Act, of course, employers cannot retaliate against corporate fraud whistleblowers.
Providing guidance to employers and employees, the Department of Labor recently published a final rule addressing procedures and timing for claims of retaliation against corporate fraud whistleblowers. Under the rule, an employee who believes her employer retaliated against her for blowing the whistle on corporate fraud must file a complaint with OSHA within 180 days. In that complaint, which may be written or oral, the employee must show that her whistleblowing was a contributing factor in the adverse action taken by her employer. OSHA is then charged with investigating the complaint and, if it finds reasonable cause to believe the employer violated SOX, issuing a preliminary order providing appropriate relief to make the employee whole, which may include reinstatement.
During OSHA’s investigation, importantly, the employer will be advised of the allegations made and will have the opportunity to show by clear and convincing evidence that it would have taken the adverse action against the employee regardless of the whistleblowing. If the employer makes that showing, the investigation ends.
The Department of Labor’s final rule on SOX whistleblower retaliation – Procedures for the Handling of Retaliation Complaints Under Section 806 of the Corporate and Criminal Fraud Accountability Act of 2002 – was effective as of March 5, 2015. SOX Final Rule
In several contexts, an employee who blows the whistle on certain improprieties or unlawful conduct is afforded legal protection from retaliation. Under Sarbanes-Oxley, for example, a public company cannot retaliate against an employee who blows the whistle on corporate fraud. Similarly, Dodd-Frank protects employees who blow the whistle on securities fraud to the SEC from retaliation.
But with many reports being made anonymously, the situation can easily arise in which the company mistakenly believes a specific employee is the whistleblower when, in fact, she is not. If the company, based on that mistaken belief, takes adverse employment action against that employee, is it subject to liability for that “retaliation”?
The answer, at least in part, will necessarily depend on the jurisdiction. Although a strict application of the whistleblower laws in question may not entitle the employee to protection (e.g., an employee who makes no report cannot invoke Dodd-Frank), the employer may still be subject to liability under a common law cause of action. Indeed, an appellate court in California recently arrived at precisely that result.
In Diego v. Pilgrim United Church, an employee anonymously reported potential violations of state law pertaining to child day cares to the California Department of Social Services. Diego’s supervisor subsequently asked her questions and made comments demonstrating her belief that Diego was the whistleblower. She was not. Nonetheless, Diego was thereafter terminated. She filed suit alleging her termination was in retaliation for her supervisor’s belief that she blew the whistle.
The trial court dismissed the lawsuit, ruling that Diego had not demonstrated an important public policy was at issue in her termination because she never actually blew the whistle. The appellate court, however, reversed, reasoning that terminating perceived whistleblowers could discourage others from actually blowing the whistle.
From the employer’s perspective, it remains important to tread carefully when it becomes aware of a report. Terminating – or taking other adverse employment action – the whistleblower or perceived whistleblower is rarely the optimal response. And employees should remain cognizant that they may be able to invoke certain protection under whistleblower laws or, perhaps, by wrongful discharge litigation.
Diego v. Pilgrim United Church of Christ, 2014 WL 6602601 (Nov. 21, 2014)
Whistleblower Involvement Leads to Substantially Greater Penalties and Criminal Sentences, Study Finds
According to a recently-released academic study on the impact of whistleblowers on financial misrepresentation enforcement actions, the involvement of whistleblowers in securities enforcement actions has a significant impact on both the penalties imposed and jail time faced by company executives and employees. In particular, SEC and DOJ enforcement actions relating to financial misrepresentations to shareholders result in financial penalties for companies that are $90-$93 million greater, financial penalties for executives that average $50-$56 million more, and prison sentences for executives and employees that average 22-27 months longer when a whistleblower is involved.
Designed as an incentive to encourage employees to report wrongdoing, rewards for whistleblowers can be substantial. Under Dodd-Frank, for example, rewards may range from 10%-30% of monetary sanctions over $1 million from investigations and/or enforcements resulting from the employee’s report. The increasing trend toward greater financial rewards for whistleblowers and high-level government encouragement of their actions give rise to a corollary question whether whistleblower involvement in enforcement actions makes a meaningful difference.
Exploring that question, the study reviewed all SEC and DOJ enforcement actions associated with financial misrepresentation between 1978 and 2012, focusing on the effect of employee whistleblowers’ involvement on financial penalties assessed, sentences imposed, and duration of the enforcement actions. Over the study period, approximately $70 billion in penalties were assessed, and various industries were represented, including financial services, utilities, health care, and manufacturing. In the end, the study concluded “that whistleblower involvement in an SEC or DOJ investigation is associated with a significant increase in penalties.”
Whistleblowers would, therefore, seem to be a valuable source of information for regulators, both in terms of disclosing misconduct that might otherwise go undiscovered and in facilitating higher penalties. Companies across a wide range of industries and sectors would be wise to revisit their policies to ensure they have mechanisms in place to timely and properly address whistleblower complaints when they are voiced.
SEC Report Shows Increases in Securities Fraud Whistleblowing and Reveals Insight Into Continued Aggressive Enforcement
As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC created a whistleblower program to encourage people to submit information to help the SEC’s Division of Enforcement discover and prosecute violations of the federal securities laws. To entice whistleblowers, the program provides potentially substantial monetary rewards to whistleblowers, provides them legal protection from retaliation, and affords them confidentiality.
A couple days ago, on November 18th, SEC’s Office of the Whistleblower submitted its 2014 Annual Report to Congress on the Dodd-Frank Whistleblower Program. In it, the Office of the Whistleblower touted fiscal year 2014 as an historic year both in terms of the number and the size of whistleblower awards. And it sent a clear message that the Dodd-Frank-mandated whistleblower office will continue to grow and continue to emphasize prosecution of matters brought to its attention by whistleblowers.
The data shows a large increase both in complaints asserted and in the number of awards issued. Since August 2011, the whistleblower office has received 10,193 whistleblower tips, with 3,620 of those in fiscal year 2014 alone. Most of the tips have originated in California, Florida, New York, and Texas. And in that time, fourteen whistleblowers have received awards. In fiscal year 2014 alone, the whistleblower office authorized nine awards, including a record payment of more than $30 million to one whistleblower. More than 40% of the individuals who have received awards were current or former employees of the company involved in the related enforcement action. Of those current or former employees, more than 80% had raised their concerns internally before reporting the allegations to the SEC.
Indeed, the report suggests that whistleblowers who report alleged securities laws violations internally first may be in a better position to obtain awards from the SEC following a successful enforcement action. In one case, for example, an individual with internal audit responsibilities received an award of $300,000; although the general rule is that individuals with compliance or internal audit responsibilities are not eligible for awards, an exception exists where the person raises the issue internally at least 120 days before providing the information to the SEC. And another whistleblower was awarded $400,000 after aggressively working internally – to no avail – to obtain corrective action before reporting the issue to the SEC.
It is also important to note that the SEC is also serious about protecting employees or insiders who blow the whistle. In once case, for example, the SEC ordered a company to pay $2.2 million to settle retaliation and other charges relating to a company’s ill treatment of an employee who reported information to the SEC that the company had engaged in prohibited principal transactions. According to the Report, the SEC’s “action sends a strong message to employers that retaliation against whistleblowers in any form is unacceptable.”
As the Office of the Whistleblower articulated in its report when discussing the $30 million award to one whistleblower, “[w]e hope that awards like this one will incentivize company and industry insiders, or others who may have knowledge of possible federal securities law violations, both in the U.S. and abroad, to come forward and report their information promptly to the Commission.” Employers must take whistleblower allegations seriously; they can’t be disregarded or ignored. Instead, internal investigations and serious, diligent handling of whistleblower allegations must be a fact of life for public companies.
Another Federal Court Agrees that Securities Fraud Whistleblowers Must Blow the Whistle to the SEC for Dodd-Frank Protection
Several weeks ago, this blog discussed the Fifth Circuit’s determination in Asadi v. G.E. Energy, LLC that for an employee-whistleblower to be protected by the Dodd-Frank Act, she must “provide information relating to a violation of the securities laws to the SEC.” Internal complaints alone are not sufficient, at least in the Fifth Circuit, to invoke the statute’s whistleblower protection provision. Asadi
Consistent with the Fifth Circuit’s decision in Asadi, a federal court in the Eastern District of Wisconsin recently arrived at the same conclusion, ruling that the Dodd-Frank whistleblower protection provision does not protect an employee who only reports alleged securities law violations internally. Instead, the plain language of the statute, according to the court, requires that the alleged violation be reported to the SEC to be covered by Dodd-Frank’s whistleblower protection provision. “The statute is simple enough to understand. Reporting to the SEC is the precondition that triggers the anti-retaliation protections of the statute.”
Although there are pre-Asadi decisions suggesting statutory ambiguity permits claims to proceed without an actual report to the SEC, the wiser course for whistleblowers is to report alleged securities law violations to the SEC. And for employers, the lack of such a report may provide the basis for dismissing litigation.
Verfuerth v. Orion Energy Sys., Inc., No. 14-cv-352 (E.D. Wis.)
Congress enacted Dodd-Frank in the wake of the 2008 financial crisis. As one component of its comprehensive reform of the financial regulatory system, the statute’s whistleblower protection provision encourages individuals to provide information relating to a violation of securities laws to the SEC. That whistleblower-protection provision, codified at 15 U.S.C. § 78u-6, encourages whistleblowing by: (1) requiring the SEC to pay significant monetary awards to individuals who provide information to the SEC that leads to a successful enforcement action, and (2) creating a private cause of action for whistleblowers to sue employers who retaliate against them for engaging in protected actions.
Employers, naturally, must treat whistleblowing employees with caution. Under the “Protection of whistleblowers” provision of Dodd-Frank,
No employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower—
(i) in providing information to the Commission in accordance with this section;
(ii) in initiating, testifying in, or assisting in any investigation or judicial or administrative action of the Commission based upon or related to such information; or
(iii) in making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201 et seq.), the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.), including section 10A(m) of such Act (15 U.S.C. 78f(m)), section 1513(e) of Title 18, and any other law, rule, or regulation subject to the jurisdiction of the Commission.
15 U.S.C. § 78u-6(h)(1)(A).
While the SEC continues to administer the law’s bounty program and the federal courts continue to interpret the scope of the law, employers and employees alike face difficult challenges in addressing and resolving situations in which an employee believes an employer’s policies, programs and/or activities run afoul of securities laws. As always, it is important to scrutinize the latest administrative and judicial determinations to help navigate the statute’s requirements.
On July 21, 2010, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act. Along with the statute’s provisions reforming the financial sector, Congress included a whistleblower-protection provision, 15 U.S.C. 78u-6(h), which strengthened legal protections for employees who report violations of securities law. That is, the law encourages and protects securities law whistleblowers.
But to whom must a whistleblower blow the whistle to be protected under the Dodd-Frank Act? Is it enough to lodge an internal report with the company or must the employee directly notify the SEC? A number of courts have addressed this issue without delivering an agreed consensus. The Fifth Circuit, however, has concluded that to be a “whistleblower” under the Dodd-Frank Act, the employee must report the alleged securities law violation to the SEC; an internal report alone is insufficient.
According to the Fifth Circuit, “the plain language of the Dodd-Frank whistleblower-protection provision creates a private cause of action only for individuals who provide information relating to a violation of the securities laws to the SEC.” That determination stems from the statute’s definition of “whistleblower” as “any individual who provides, or 2 or more individuals acting jointly who provide, information relating to a violation of the securities laws to the Commission.” 15 U.S.C. 78u-6(a)(6).
While there remains disagreement among various federal courts as to this limitation on the Dodd-Frank Act’s whistleblower protection provision, for the time being employees in the Fifth Circuit are only protected if they blow the whistle on securities law violations to the SEC. An employee who makes an internal report of a potential securities law violation but who does not report it to the SEC is not a “whistleblower” under the Dodd-Frank Act.
Asadi v. G.E. Energy, LLC, Case No. 12-20522 (July 17, 2013)