SEC crackdown on whistleblower ‘pretaliation’ adds a new twist

A relatively small monetary sanction, settled between the Securities and Exchange Commission and a company most have never heard of, serves as warning to all public companies that craft policies for their workforce and exit agreements with departing employees.

On Aug. 10, the SEC reached a consent agreement with BlueLinx Holdings, an Atlanta-based building products distributor, over allegations it violated securities laws when using severance agreements that required outgoing employees to waive their right to monetary recovery if they filed a complaint with the Commission or other federal agencies. The company agreed to pay a $265,000 penalty.

According to the SEC’s order, BlueLinx added the monetary recovery prohibition to all of its severance agreements in mid-2013. The restrictive language forced employees leaving the company to waive possible whistleblower awards or risk losing their severance payments and other post-employment benefits.

BlueLinx consented to the SEC’s cease-and-desist order without admitting or denying the findings. It agreed to amend its severance agreements and notify former employees who executed severance agreements after Aug. 12, 2011, that the prohibition was invalid.

“This is the third enforcement action the SEC has taken against impediments to individuals participating in its [bounty] program. Taken together, the SEC has made a very strong statement to employers that they cannot impede individuals from communicating with it,” says David Marshall, a founding partner of the law firm Katz, Marshall & Banks. He represents individuals in whistleblower-reward programs and cites whistleblower retaliation cases as a focus of his work.

The whistleblower trifecta

In response to a post-Financial Crisis crackdown on perceived Wall Street shenanigans, the Dodd-Frank Act bolstered the SEC’s ability to draw out corporate whistleblowers. Most prominently, it authorized the creation of a bounty program to share a percentage of collected fines with the tipsters reporting securities law violations. Those rewards have ranged from tens of thousands of dollars to $30 million in 2014.

Dodd-Frank, through the SEC, also tackled retaliation against those who report. The Exchange Act’s Rule 21F-17, effective in 2011, demands that “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.”

“Most companies are not including express waivers of whistleblower bounties, but they may include language that more subtly deters employees, and that’s the rub.”
Steven Pearlman, Co-Head, Whistleblower and Retaliation Group, Proskauer

The message the SEC heard loud and clear: It can not only bring an enforcement action when there is retaliation, it also has the authority to act against “pretaliation,” typically in the various confidentiality and severance agreements many companies require both incoming and outgoing employees to sign.

In April 2015, the SEC announced its first enforcement action against a company for, in its words, “using improperly restrictive language in confidentiality agreements with the potential to stifle the whistleblowing process.”

According to the Commission, KBR Inc., a technology and engineering firm, required witnesses in certain internal investigations interviews to sign confidentiality statements. Those documents included a warning that employees could face termination if they discussed the matters with outside parties without the prior approval of KBR’s legal department.

Under the SEC’s settlement, KBR agreed to pay a $130,000 penalty and amended its confidentiality statement to clarify that employees are free to report possible violations to agencies without fear of retaliation.

In June, the SEC revisited pretaliation as part of a $415 million settlement with Merrill Lynch over allegations it misused customer cash that should have been deposited in a reserve account and failed to safeguard customer securities from the claims of its creditors.

In addition to Customer Protection Rule violations, the SEC also alleged that Merrill Lynch violated Exchange Act Rule 21F-17 by using language in severance agreements “that operated to impede employees from voluntarily providing information to the SEC.” Merrill Lynch agreed to revise those agreements and related policies and procedures. It will also launch a mandatory annual whistleblower-training program for all employees of Merrill Lynch and its parent corporation, Bank of America. Also, on an annual basis, employees will receive a summary of their rights and protections under the SEC’s Whistleblower Program.

In completing the enforcement trifecta, the BlueLinx case adds a fresh wrinkle. What caused its troubles wasn’t a prohibition on communicating government agencies, it was adding language to severance agreements that prohibited profiting from doing so.

Among the language used in documents that outgoing employees needed to sign to initiate severance pay:

“Employee further acknowledges and agrees that nothing in this Agreement prevents Employee from filing a charge with ... the Equal Employment Opportunity Commission, the National Labor Relations Board, the Occupational Safety and Health Administration, the Securities and Exchange Commission, or any other administrative agency if applicable law requires that Employee be permitted to do so; however, Employee understands and agrees that Employee is waiving the right to any monetary recovery in connection with any such complaint or charge that Employee may file with an administrative agency.”

“By requiring its departing employees to forgo 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 wrote.

Document disasters waiting to happen?

The action has a “huge significance for the whistleblower program, not only for the employees or former employees who participate in it, but for investors who are protected by the program,” Marshall says. “This latest action directly takes aim at a very insidious tactic employers have been using, which is attempting to undermine the ability of employees to benefit from incentives established by the program. By insisting that their employees or departing employees sign agreements that prohibit them from receiving a reward from the SEC for providing information about securities law violations, they undermine the most innovative part of the program.”

SEC ORDER

In the case of BlueLInx, the SEC ordered that:
A. Pursuant to Section 21C of the Exchange Act, Respondent BlueLinx cease and desist from committing or causing any violations and any future violations of Exchange Act Rule 21F - 17;
B. Respondent shall pay a civil money penalty in the amount of $ 2 6 5,000 to the Securities and Exchange Commission for transfer to the general fund of the United States Treasury in accordance with Exchange Act Section 21F(g)(3) pursuant to the terms of the payment schedule set forth in paragraph C below. Payment must be made in one of the following ways:
Respondent may transmit payment electronically to the Commission, which will provide detailed ACH transfer/Fedwire instructions upon request;
Respondent may make direct payment from a bank account via Pay.gov through the SEC website at http://www.sec.gov/about/offices/ofm.htm ; or
Respondent may pay by certified check, bank cashier’s check, or United States postal money order, made payable to the Securities and Exchange Commission and hand - delivered or mailed to:
Enterprise Services Center Accounts Receivable Branch HQ Bldg.
Room 181, AMZ - 341 6500 South MacArthur Boulevard
Oklahoma City, OK 73169
Payments by check or money order must be accompanied by a cover letter identifying BlueLinx as a Respondent in these proceedings, and the file number of these proceedings; a copy of the cover letter and check or money order must be sent to Antonia Chion, Associate Director, Division of Enforcement, Securities and Exchange Commission, 100 F Street, N.E., Washington, D.C. 20549.
C. BlueLinx shall pay the penalty due of $265,000 .00 in four installments to the Commission according to the following schedule:
$25,000 .00 within five (5) days of entry of this Order; 7
$60,000 .00 within ninety (90) days of entry of this Order;
$80,000 .00 within one hundred eighty (180) days of entry of this Order;
$100,000 .00 within two hundred seventy (270) days of entry of this Order.
Payments shall be deemed made on the date they are received by the Commission and shall be applied first to post order interest, which accrues pursuant to 31 U.S.C. § 3717 on any unpaid amounts due after twenty - one (21) day s of the entry of the Order. Prior to making the final payment set forth herein, BlueLinx shall contact the staff of the Commission for the amount due for the final payment. If BlueLinx fails to make any payment by the date agreed and/or in the amount agreed according to the schedule set forth above, all outstanding payments under this Order, including post - order interest, minus any payments made, shall become due and payable immediately at the discretion of the staff of the Commission without further application to the Commission.
D. Amounts ordered to be paid as civil money penalties pursuant to this Order shall be treated as penalties paid to the government for all purposes, including all tax purposes. To preserve the deterrent effect of the civil penalty, Respondent agrees that in any Related Investor Action, it shall not argue that it is entitled to, nor shall it benefit by, offset or reduction of any award of compensatory damages by the amount of any part of Respondent’s payment of a civil penalty in this action (“Penalty Offset”). If the court in any Related Investor Action grants such a Penalty Offset, Respondent agrees that it shall, within thirty (30) days after entry of a final order granting the Penalty Offset, notify the Commission’s counsel in this action and pay the amount of the Penalty Offset to the Securities and Exchange Commission. Such a payment shall not be deemed an additional civil penal ty and shall not be deemed to change the amount of the civil penalty imposed in this proceeding. For purposes of this paragraph, a “Related Investor Action” means a private damages action brought against Respondent by or on behalf of one or more investors based on substantially the same facts as alleged in the Order instituted by the Commission in this proceedings.
Source: SEC

Place yourself in the shoes of an outgoing employee at a company with similar language in severance agreements, Marshall suggests. Perhaps they have just lost a high-paying job and are stressed about how far their severance package will go toward supporting their family. Even if their lawyer suggests that a waiver of whistleblower awards will not hold up in court, “that may not be enough to convince them.”

This latest case is important and “serves as a strong message—as if there haven’t already been strong messages—to employers that now is the time to take a look at their existing agreements, handbooks, policies, and procedures and really do a deep-dive audit on their compliance program and all related employment documents,” says Gregory Keating, chair of the law firm Choate, Hall & Stewart’s whistleblower defense group. He serves as a management representative on the Whistleblower Protection Advisory Committee, a government task force, appointed to it by successive Labor Department secretaries.

The SEC, Keating says, makes no secret of its intent to include whistleblower retaliation and pretaliation in its enforcement agenda.

Here is how Sean McKessy, former head of the SEC's Office of the Whistleblower, addressed the issue when speaking to the Whistleblower Protection Advisory Committee in April: “KBR will not be the last case we bring under 21F 17(a). This is a space they were very actively investigating. Something that I spend a lot of my time when I'm educating our internal staff on is be aware that we have this authority and to ask for documents that individuals were asked to sign.”

“His remarks make it crystal clear that one of the things they are most ardently focused on is their view that the [Dodd-Frank Act] gives them independent jurisdiction to prosecute actions they view to be retaliatory,” Keating says. That focus will not just mean trouble for companies charged with an individual act of retaliation, there is also what he calls “systematic retaliation” that may rear its head, intentional or not, in various agreements, procedures, protocols, or handbook provisions.

“Most of the employers I work with have absolutely no intent to muzzle anybody or preclude anybody from walking up the steps of any government agency,” he says. “What’s noteworthy here is that the SEC doesn’t really care if there is insidious intent … It is quite clear that they view their jurisdiction as broad and they are going to be looking for any and all indications of employer conduct or policies or agreements that have in any way an effect of fostering retaliation or muzzling people. That is real, the water is deep, and this is not going away.”

The good news, Keating says, is that “the fix is relatively straightforward.”

“Employers will want to look at all their separation agreements, confidentiality and non-disclosure agreements, non-disparagement provisions, and even return of company property agreements —anything that regulates employee conduct —to make it clear that while there is a legitimate business interest in protecting proprietary information and getting documents back, nothing precludes you from communicating with any government agency.”

The settlement is also a “clear signal” from Jane Norburg, interim head of the SEC’s Office of the Whistleblower since McKessy’s July departure, that ensuring severance and settlement agreements don’t restrict whistleblowers will remain a priority, says Steven Pearlman, co-head of Proskauer’s whistleblowing and retaliation group.

“Most companies are not including express waivers of whistleblower bounties, but they may include language that more subtly deters employees, and that’s the rub,” he says.

While the attention the settlement received has focused on employees waiving their right to recover a reward, the order “also went further to take issue with the company’s confidentiality provisions,” Pearlman says. “That’s getting glossed over by everybody and, it shouldn’t, as it’s very important.”

The BlueLinx employee agreements instructed them that upon receiving an agency request for confidential information they should provide the company’s legal department with prompt written notice, giving it a chance to seek an appropriate protective order or similar legal maneuver prior to making that disclosure.

The SEC argued that the existing language violated the Dodd-Frank Act’s “do not impede” language.

“What is interesting is that the order didn’t include revised language for confidentiality provisions,” as it did for language pertaining to SEC bounties, Pearlman says. “That was curious and it is an issue because the language the SEC took issue with is a very commonly used clause.”

As for what the Commission did address, Pearlman agrees it is “a harbinger of greater scrutiny.”

“It is an absolute must that employers go back and revisit their severance and settlement agreements to make sure that not only do they not explicitly say something the SEC will take issue with, such as waiving the right to a bounty, but also more subtle deterrents, such as inartfully drafted non-disparagement clauses or overly broad confidentiality clauses,” he says. “Expect more activity on this front.”