Well, compliance officers all knew it would happen sooner or later.
For the last two years, the Securities and Exchange Commission has been doling out cash rewards to whistleblowers whose tips lead to an enforcement action. And all the while, SEC officials—most notably Sean McKessy, chief of the SEC Office of the Whistleblower—have warned that the next step would be to take action against companies that retaliate against those who report violations.
That day arrived last week, when the SEC took its first-ever enforcement action against a company for whistleblower retaliation. Whistleblower advocates praise the move, compliance professionals are poring over its details for clues about SEC enforcement, and some say it may actually be a missed opportunity.
The SEC charged Paradigm Capital Management, an Albany, N.Y.-based hedge fund advisory firm, and owner Candace King Weir with engaging in prohibited transactions and then seeking retribution against an employee who reported it. According to the SEC, Weir conducted transactions between Paradigm and a broker-dealer she also owns while trading on behalf of a hedge fund client. Advisers are required to disclose that they are participating on both sides of the trade and must obtain the client’s consent.
The firm, and Weir personally, agreed to pay $2.2 million to settle the charges and were ordered to retain an independent compliance consultant for at least two years.
Those securities laws violations are eclipsed, however, by the SEC’s focus on how the firm treated the head trader who reported the law-breaking trades. Paradigm engaged in a series of retaliatory actions that ultimately resulted in his resignation, including stripping him of his duties, changing his job from head trader to a full-time compliance assistant and, despite sanctioning the use of a personal e-mail account, threatening him with termination because a file sent to the firm’s chief compliance officer was labeled as stealing proprietary documents.
The whistleblower will be eligible to collect a bounty of 10 to 30 percent of the agreed-upon sanction. Settlements in excess of $1 million are drawn from an Investor Protection Fund, established by Congress, which has a current balance of more than $450 million.
The SEC’s decision to take action on retaliation was praised by Jordan Thomas, chair of the law firm Labaton Sucharow’s whistleblower representation practice, and the lawyer who represented the still-anonymous whistleblower.
“It’s not always easy or glamorous to be a corporate whistleblower, but the SEC has their back, and the ability to remain anonymous when reporting possible securities violations can make doing the right thing a lot easier,” says Thomas, a former SEC enforcement lawyer himself.
Patricia Harned, president of the Ethics Resource Center, is another fan of the SEC’s steps to enforce retaliation. ERC research shows that whistleblower retaliation remains widespread at companies, and as many as 20 percent of employees have witnessed it in action. “It’s good that the SEC has made companies aware that retaliation is such a big issue and a risk factor,” she says.
“This is the shot across the bow of Corporate America that you now need to have your securities lawyers in the room when you are talking about potential labor issues,” says Thomas Sporkin, a partner at the law firm BuckleySandler. “If you’re going to go after somebody and be aggressive with an employee, especially one whom you find out has not reported certain things internally, you need to bring your securities lawyers into the conversation if you don’t want this type of situation to happen.”
What Comes Next
Questions about the SEC action still abound. Why weren’t the financial penalties for the retaliation and the securities violations separate? Why didn’t the SEC demand improvements to Paradigm’s whistleblower program as part of the compliance review it ordered for the firm? Can the whistleblower get his job back if he wants it? And why was this yet another no-admit, no-deny settlement?
A press conference following the enforcement action shed little light on these questions.
“I can’t speculate as to why this is the first,” Andrew Ceresney, director of the SEC Enforcement Division, told reporters. He defended the choice not to break down the fine: “Our typical practice is, when there are multiple violations, we don’t break down the amount of the penalty to each action.”
“In every case, we consider a whole host of factors in determining whether to seek admissions,” Ceresney added. “In this case we determined that it wasn’t necessary to the case.”
Ceresney did clarify that the independent compliance review is not related to whistleblower protocols. “Obviously, if there were future retaliatory conduct, that would be subject to additional sanctions,” he said. “But the portion of the order dealing with compliance relates only to the transactional piece.”
One possible reason why no specific part of the fine was earmarked specifically for the retaliation is that the punitive penalty was probably quite low. Subtracting what was earmarked for disgorgements, the whistleblower fine (if indeed there was one) would be less than $300,000.
“We have yet another settlement where they are admitting nothing wrong,” laments Brian Dickerson, a partner at the law firm Roetzel. “You would think the SEC would have at least said, ‘All right, you don’t have to admit to the securities violation, but you have to admit you screwed up with the whistleblower.’”
Below is an excerpt from the Paradigm cease-and-desist order summarizing the facts of the whistleblower case.
On July 17, the day after he revealed himself as a whistleblower, Paradigm informed the Whistleblower that he would be removed from Paradigm’s trading desk and temporarily relieved him of his day-to-day trading and supervisory responsibilities. Paradigm informed him that, because he executed trades that were reported to the Commission, Paradigm needed to investigate his actions. Paradigm further directed the Whistleblower to work offsite at a different office building and instructed him to prepare a report that would detail all of the facts that supported the potential violations he reported to the Commission.
Between July 18 and July 20, Paradigm, on the advice of counsel, denied the Whistleblower access to certain Paradigm trading and account systems while he was at home. Paradigm also denied the Whistleblower access to his existing email account and redirected the Whistleblower’s trading and email accounts to its other trader so that he could continue receiving orders and making trades.
After it became apparent that Paradigm and the Whistleblower were unable to agree on severance terms that would result in the Whistleblower’s resignation or termination, the Whistleblower informed Paradigm that he was prepared to return to work, but only in continuation of his role as Paradigm’s head trader. Paradigm made it clear that the Whistleblower would not return to his position as head trader until Paradigm’s investigation was complete.
The Whistleblower returned to work as requested on Aug. 13. Upon his return, he was no longer located on the trading desk and was placed instead in an office on a different floor. Paradigm informed the Whistleblower that his first assignment and top priority was to identify any potential wrongdoing by the firm so that it could further investigate his allegations. As part of that assignment, the Whistleblower was asked to review more than 1,900 pages of hard-copy trading data, sorted by security.
On Aug. 15, in response to the Whistleblower’s allegations that the firm’s trading-related compliance policies were deficient, Paradigm tasked the Whistleblower with the additional task of consolidating multiple trading procedure manuals into one comprehensive document.
Approximately one month after Paradigm approved the Whistleblower’s use of his personal email address, the Whistleblower sent a confidential report from his personal email account to Paradigm’s CCO. This caused Paradigm to believe that the Whistleblower previously removed confidential documents using his personal email address...violating the terms of a confidentiality agreement.
The Whistleblower resigned on Aug. 17, 2012.
Source: Paradigm Cease-and-Desist Order.
Dickerson pans the lack of a specific fine, too. “There isn’t a blueprint here,” he says. “There is nothing there to show a client the risks. For compliance officers around the country who want to be able to go to the C-suite or HR department and say, ‘This is why we can’t treat a whistleblower like this,’ the headline makes that promise, but the actual meat on the bones isn’t there.”
Still, the enforcement action does pack some punch, Dickerson says. “What I’m telling clients is that the SEC is paying attention. Here again is a company in a highly regulated industry, and they obviously did not have the proper procedures and protocols for their compliance program to be implemented. If they did, the company would not have exposed itself and could have easily addressed the whistleblower’s concern.”
Gordon Schnell, a partner at the law firm Constantine Cannon, expects an even greater SEC focus on employment provisions and termination agreements that may discourage whistleblowers from coming forward. “Within the whistleblower legal bar, they have put out the word that they want examples of companies that have done it,” he says. “That will be the next step.”
Another lesson for companies is that termination isn’t all the SEC will look for in retaliation cases, says David Marshall, a partner with the law firm Katz, Marshall, and Banks. The job reassignments and other harassment in the Paradigm case showed a clear pattern. Companies also have to be wary of finding other ways to rid themselves of an unwanted whistleblower, such as applying overly strict application of company rules and hoping for a slip-up.
“I often hear from defense lawyers who just wish that supervisors, all the way up to CEOs, would talk to them first before … they fire a whistleblower without realizing that they are not only violating the law, but they are very likely to get caught because the whistleblower is going to take action,” he says.