The compliance side of the circuit split on whistleblower protections

A recent federal appeals court ruling further splits the circuit courts on the scope of whistleblower protections under the Dodd-Frank Act’s anti-retaliation provision, but any outcome is trivial to prudent compliance and legal teams.

In the case, Somers v. Digital Realty Trust, a divided panel of the 9th Circuit Court of Appeals in a 2-1 decision ruled in early March that anti-retaliation protections under the Dodd-Frank Act apply to whistleblowers even if they don’t file a report with the Securities and Exchange Commission.

“By broadening the definition of who qualifies as a whistleblower, the Somers decision may be an important catalyst for white-collar enforcement in the Ninth Circuit and elsewhere,” says Joseph Fazioli, a partner at law firm Dechert and former assistant U.S. Attorney for the Northern District of California. “Somers reflects the increasingly important role whistleblowers play in modern white-collar enforcement and highlights the need for companies to develop robust internal procedures regarding whistleblowers.

The case was filed by Paul Somers, a former employee of Digital Realty, who alleged he was wrongfully terminated after internally reporting to senior management several potential securities law violations. Following his termination, Somers filed a lawsuit against Digital Realty alleging violations of state and federal securities laws, including violations of the whistleblower protection provisions of Section 21F of the Dodd-Frank Act.

Digital Realty moved to dismiss the case on the ground that Somers was not a “whistleblower” under Dodd-Frank. The district court denied the motion, however, deferring to the SEC’s interpretation that the anti-retaliation provisions under Dodd-Frank extend to both external and internal reporters. The 9th Circuit affirmed, bringing the circuit in line with the 2nd Circuit Court of Appeals ruling in Berman v. Neo@Ogilvy.

In making their decision, both the majority in Somers and the 2nd Circuit in Berman relied, in part, on a 2015 U.S. Supreme Court ruling in King v. Burwell, to read the relevant statutes in favor of the government’s position. The relevant question addressed by the U.S. Supreme Court in King was whether a definition in one part of a statute should be applied to another part of the statute, even where it may not make sense.

“Somers reflects the increasingly important role whistleblowers play in modern white collar enforcement and highlights the need for companies to develop robust internal procedures regarding whistleblowers.”
Joseph Fazioli, Partner, Dechert

The majority in Somers, as with the majority in Berman, essentially found that the definition of “whistleblower” in Dodd-Frank (as employees who report “to the Commission”) should not necessarily apply to a later section of the statute pertaining to its anti-retaliation provision. “Reading the use of the word “whistleblower” in the anti-retaliation provision to incorporate the earlier, narrow definition would make little practical sense and undercut congressional intent,” the court wrote.

Prior to the Somers, there was already a split among the circuits. Thus, Somers widens the division of the courts of appeal and makes U.S. Supreme Court review even more likely, legal experts say.

In 2013, the 5th Circuit Court of Appeals in the case Asadi v. GE Energy ruled for strict construction of the Dodd-Frank, finding that the statute protects only those whistleblowers who report directly to the SEC. The practical concern with the 5th Circuit’s decision is the message that it sends to employees, which is that they better report to the SEC first, or they run the risk of not receiving legal protection.

That’s a “terrible message” to send to companies that are trying to build a robust internal compliance program and that are trying to encourage employees to report issues internally, says Bruce Ericson, a partner at law firm Pillsbury and co-leader of the firm’s securities and litigation enforcement team.

In a brief, one-sentence dissent in Somers, Judge John Owens agreed with the 5th Circuit, writing, “In my view, we should quarantine King and its potentially dangerous shape-shifting nature to the specific facts of that case to avoid jurisprudential disruption on a cellular level.”

From a legal standpoint, companies doing business in the 5th Circuit’s jurisdiction of Texas, Louisiana, and Mississippi face a different interpretation of the law and SEC rulemaking than on the 9th Circuit’s jurisdiction of Alaska, Arizona, California, and Hawaii, or in the 2nd Circuit’s jurisdiction of New York, Connecticut, and Vermont.

WHISTLEBLOWER DECISION

Below is an excerpt from the decision in Somers v. Digital Realty Trust.
The anti-retaliation provision in question in this case is found in a later subsection of Section 21F. It provides broad protections and states:
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, this chapter, including section 78j–1(m) of this title, section 1513(e), and any other law, rule, or regulation subject to the jurisdiction of the Commission.
15 U.S.C. § 78u-6(h)(1)(A). The issue in this case concerns subdivision (iii), which gives whistleblower protection to all those who make any required or protected disclosure under Sarbanes-Oxley and all other relevant laws.
Subdivision (iii) was added after the bill went through Committee. There is no legislative history explaining its purpose,but its language illuminates congressional intent. By broadly incorporating, through subdivision (iii), Sarbanes-Oxley’s disclosure requirements and protections, DFA necessarily bars retaliation against an employee of a public company who reports violations to the boss, i.e., one who “provide[s] information” regarding a securities law violation to “a person with supervisory authority over the employee.” 18U.S.C.§1514A(a). Provisions of Sarbanes-Oxley and the Exchange Act mandate internal reporting before external reporting. Auditors, for example, must “as soon as practicable, inform the appropriate level of management” of illegal acts,and only after such internal reporting may auditors bring their concerns to the SEC.
15 U.S.C.§78j-1(b). Leaving employees without protection for that required preliminary step would result in early retaliation before the information could reach the regulators. As the Second Circuit noted, “[I]f subdivision (iii) requires reporting to the [SEC], its express cross-reference to the provisions of Sarbanes-Oxley would afford an auditor almost no Dodd-Frank protection for retalition on because the auditor must await a company response to internal reporting before reporting to the Commission, and any retaliation would almost always precede Commission reporting.” Berman, 801F.3d at 151. Sarbanes-Oxley likewise requires lawyers to report internally, 15 U.S.C.§7245, and the SEC’s Standards of Professional Conduct setforthonlylimitedinstancesinwhichanattorneymayrevealclientconfidences to theSEC,17 C.F.R.§205.3(d)(2).The attorney would be left with little DFA protection.
That DFA’s definitional provision describes “whistleblowers” as employees who report “to the Commission” thus should not be dispositive of the scope of DFA’s later anti-retaliation provision.
Source: Somers v. Digital Realty Trust

Compliance lessons. From a compliance standpoint, the circuit split on the definition of whistleblower is trivial. Ethics, compliance, and legal teams should safely assume that both Dodd-Frank and Sarbanes-Oxley cover whistleblowers who report up, whether or not they report out. “That’s the prudent approach,” Ericson says. “To act otherwise is kind of reckless.”

As a starting point, policies and procedures should include language that not only prohibits retaliation, but also points employees in the direction of where and how to report concerns. One warning, however: “When designing their internal reporting programs, companies should avoid establishing policies that encourage internal reporting to the exclusion of external reporting,” Fazioli of Dechert says.

The SEC has signaled that it is closely scrutinizing policies for language that potentially discourages employees from reporting problems directly to the government. Several recent enforcement actions have resulted from confidentiality agreements that prohibit employees from disclosing externally information they already report internally, for example, or severance agreements that require outgoing employees waive their ability to obtain monetary rewards from the SEC’s Whistleblower Program.

Companies should also implement user-friendly whistleblower procedures—such as an anonymous hotline—and respond in a timely manner to reports. “Internal complaints brought forward should be handled carefully,” says Michael Delikat, a partner at Orrick and head of the firm’s Whistleblower Task Force that represents companies in responding to whistleblower complaints. Issues should be escalated up to the compliance or legal department, where they can be properly and thoroughly investigated, he says.

Response procedures for logging reports, as well as evaluating, investigating, and signing off on reports should be documented. “It’s important to document results even if the company ultimately determines that the complaint is unsubstantiated,” says Jennifer Mammen, counsel at law firm Bryan Cave. “You want to create a detailed and objective report explaining how and why a conclusion was reached.”

As courts continue to debate the issue of whistleblower protections, ethics and compliance officers should continue to foster a speak-up culture at home and abroad. Says Mammen, “You want to ensure that employees understand and have confidence in the fairness and effectiveness of your internal compliance procedures.”