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Questions Still Remain About the Protection of Whistleblowers

Bruce Carton | August 19, 2014

As the Securities and Exchange Commission’s Office of the Whistleblower continues to gain traction in its third full year in operation, two important questions about the ability to protect whistleblowers have surfaced: (1) the extent to which whistleblowers’ identities can actually be protected; and (2) the circumstances in which whistleblowers can claim they have been retaliated against.

Under the Dodd-Frank Act, retaliation is prohibited against whistleblowers who report possible wrongdoing based on a reasonable belief that a possible securities violation has occurred, is in progress, or is about to occur. Following the launch of the Office of the Whistleblower, the SEC repeatedly warned that it is looking to bring cases to emphasize its firm stance against whistleblower retaliation.

In June, the SEC filed its first anti-retaliation case against hedge fund Paradigm Capital Management and its owner. According to the SEC, Paradigm’s former head trader made a whistleblower submission to the SEC alleging the firm had engaged in prohibited transactions. The SEC claims that when Paradigm learned that the head trader had made a report to the SEC, it immediately “removed him from his head trader position, tasked him with investigating the very conduct he reported to the SEC, changed his job function from head trader to a full-time compliance assistant, stripped him of his supervisory responsibilities, and otherwise marginalized him.” Paradigm and its owner agreed to pay $2.2 million to settle the case.

Commenting on the case, SEC Director of Enforcement, Andrew Ceresney, warned that “those who might consider punishing whistleblowers should realize that such retaliation, in any form, is unacceptable.” Sean McKessy, chief of the SEC’s Office of the Whistleblower, added that the agency would continue to exercise its anti-retaliation authority in such cases to make sure whistleblowers “feel assured that they’re protected from retaliation and the law is on their side should it occur.”

The SEC will pursue anti-retaliation cases such as the one against Paradigm with vigor, given other recent developments that are likely causing whistleblowers to question whether they are, in fact, safe in coming forward with information.

Blown Cover

Despite the SEC’s commitment to keeping the identity of whistleblowers confidential, for example, such information can still become public in various ways. The identity of the whistleblower, for example, who received the SEC largest award to date ($14 million) was revealed in June. When the SEC announced the massive $14 million award back in late September 2013, it emphasized that the recipient of the award had requested anonymity. Accordingly, the SEC did not release the recipient’s name, nor did it identify the company involved, its industry, the amount of the penalty involved, the percentage of the penalty used to calculate the award, or the nature of the allegations.

Despite the SEC’s efforts, the identity of the whistleblower was disclosed when the recipient’s business partner filed a lawsuit against him seeking to share the award. The business partner who filed the case that revealed the identity of the recipient claimed that he had agreed to share the award as it resulted from their joint efforts and investigation. The award recipient has since persuaded the presiding judge to place the case under seal to prevent any further disclosure of his identity (already published by some media outlets, unfortunately) for his “personal safety and the safety of his family.”

The recent disclosures of whistleblowers’ identities, and ongoing legal challenges on the question of who qualifies as a protected whistleblower under Dodd-Frank, show that there are still plenty of reasons for prospective whistleblowers to be cautious.

Another recent instance illustrates that there are other legal limitations on the SEC’s ability to shield a whistleblower’s identity. As noted on the Office of the Whistleblower’s Website, the SEC may be required in an administrative or court proceeding to produce documents or other information that would reveal a tipster’s identity. In May just such a situation arose, when U.S. Magistrate Judge Henry Pitman of the Southern District of New York ordered the SEC to produce documents related to a whistleblower tip to Yorkville Advisors, a firm being sued by the SEC. The SEC had argued, unsuccessfully, that the documents were privileged. Although the documents did not disclose the whistleblower’s identity, they did identify the whistleblower’s attorney and could provide a useful roadmap for the defendants to conduct additional discovery that might reveal the whistleblower’s identity.

Yet another example of a compromised whistleblower’s identity—inadvertently—occurred in November 2010. According to the Wall Street Journal, while questioning an executive from a company being investigated, an SEC lawyer showed the executive a notebook that the agency had received from the whistleblower. The executive recognized the whistleblower’s handwriting, and reported the identity of the whistleblower back to the company.

Defining a Whistleblower

In addition to fears that their supposedly confidential identities may be disclosed, potential whistleblowers must also contend with a growing number of challenges concerning who is, in fact, a whistleblower entitled to protection by the SEC under the law. Last month, David Danon, a former lawyer at mutual fund Vanguard Group, asked the SEC to intervene in a dispute between Danon and Vanguard over Danon’s whistleblower activities.  In May 2013, just before he left Vanguard, Danon reportedly filed an SEC whistleblower claim alleging Vanguard had been operating an illegal tax shelter for several decades that had allowed it to avoid over $1 billion in federal and state income taxes. 

Vanguard’s lawyers claim that Danon took documents from the company in violation of state rules governing attorney conduct, including his duty of confidentiality to Vanguard, and demanded that he return the documents to the company. Danon asked the SEC to help him avoid retaliation by Vanguard. The SEC’s response will help shed light on how it views the role of in-house lawyers as whistleblowers, and whether they can be retaliated against, in light of their competing professional responsibilities to their employers as attorneys.

Another important issue still to be decided is whether the definition of a whistleblower protected under Dodd-Frank’s anti-retaliation provision includes someone who only reports the alleged misconduct internally (and not to the SEC). Although most federal courts have deferred to the SEC’s interpretation that the anti-retaliation provisions do apply to such whistleblowers, the sole appellate decision on this point to date (the Fifth Circuit case of Asadi v. G.E. Energy) held that one cannot be a Dodd-Frank whistleblower unless he or she actually reports information to the SEC.

A second appellate case on the definition of a Dodd-Frank whistleblower is now before the Second Circuit. In that case—Liu v. Siemens, A.G.—the SEC filed an amicus brief in February asking the Second Circuit to follow the SEC’s view on the issue rather than that of the Fifth Circuit. The SEC argued that the language of the Dodd-Frank statute “does not unambiguously demonstrate a Congressional intent to restrict employment anti-retaliation protection to only those individuals who provide the Commission with information relating to a violation of the securities laws.” Accordingly, the SEC urged the court to exercise judicial deference with respect to the SEC’s “reasonable interpretation” of the Dodd-Frank whistleblower definition. Ultimately, given the importance of this question and the current split in opinions, the definition of who is a Dodd-Frank whistleblower may be one that will be resolved by the U.S. Supreme Court.

The SEC has taken every opportunity to assure whistleblowers that the agency and the law are on their side and will protect them from retaliation. Nonetheless, the recent disclosures of whistleblowers’ identities, and ongoing legal challenges on the question of who qualifies as a protected whistleblower under Dodd-Frank, show that there are still plenty of reasons for prospective whistleblowers to be cautious.