Official Warns That SEC to Bring Actions On Whistle-Blower Retaliation, ‘Pretaliation'

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By Yin Wilczek

March 31 — The Securities and Exchange Commission will be bringing enforcement cases regarding whistle-blower retaliation and “pretaliation,” a senior official warned March 31.

“We’re going to be looking at staff to bring additional enforcement actions relative to retaliation and to bring our initial case” in 2015 related to the use of employer agreements to prevent employees from contacting the commission, said Sean McKessy, chief of the SEC's Whistleblower Office.

“It is critical that people be aware that we are looking at agreements and we’re looking at efforts by companies to stifle their employees from reporting to us,” McKessy continued. “I’ve gone on record saying that this is a priority that we will be enforcing these provisions, so pay attention to this space going forward.”

McKessy spoke at a Bloomberg BNA webcast. He said he voiced his own views, which did not necessarily reflect those of the SEC or other staff members.

Just a day after McKessy's comments, KBR Inc. agreed to settle a first-of-its-kind SEC administrative enforcement action that one of its confidentiality agreements infringed on federal whistle-blower protections.

Retaliation 

Under the SEC's bounty program, 1934 Securities Exchange Act Rule 21F(h)(1) bars employers from retaliating against employees when they engage in whistle-blowing activities. The SEC may enforce that provision in an action or proceeding.

The SEC brought its first anti-retaliation action in June 2014, alleging in a settled administrative action that hedge fund adviser Paradigm Capital Management Inc. retaliated against its head trader when it found out he tipped off the commission about the firm's improper principal transactions.

During the webcast, McKessy noted that the SEC has a “healthy inventory of investigations” regarding “what appear to be meritorious allegations of retaliation.” Five years from now, the Paradigm action probably will be viewed as the first of a series of retaliation cases brought by the SEC to send a message, he said. Should companies take an adverse employment action against a worker solely because he or she approached the commission, they do so at their own peril, he warned.

With regards to “pretaliation,” Rule 21F-17(a) states that employers may not “take any action to impede” their workers from contacting the SEC about possible securities violations, “including enforcing, or threatening to enforce, a confidentiality agreement” with respect to the worker's communication with the agency.

The SEC reportedly has sent requests to a number of companies seeking years of nondisclosure and other documents in its investigation of whether certain agreements may have crossed the line. 

Creative ‘Lawyering.'

At the webcast, McKessy said he is actively working with the enforcement staff to ensure they're not only attuned to the underlying securities violations, but also to any attempts by employers to prevent information from being brought to the SEC's attention. He observed that there is a “lot of lawyering going on” with respect to problematic employer pacts. While some of these agreements may not be enforceable because they violate public policy, companies and their attorneys should take a “longer-term and broader perspective” of the issue, he said.

Citing the experience of Enron, McKessy noted that should employees not report corporate wrongdoing, that may lead to a small problem becoming a $100 million problem and perhaps to the company's ultimate demise. “I would really encourage that creativity” to be channeled to more appropriate matters—not to stifle, but to encourage and support employees and allow them to report ongoing violations at the earliest time, he said.

Steven Pearlman, a Chicago-based partner at Proskauer Rose LLP, said that corporate America is coming to realize that to gain credibility with the SEC, they need a robust internal reporting program. “I have had greater and greater success in convincing” companies that they must have the right policies and procedures in place to encourage employees to report internally, he said.

In other comments, McKessy said it is too early to tell what impact the commission's $30 million bounty to a foreign whistle-blower—the SEC's largest reward to date—has had on the volume of tips and complaints it receives.

There was a spike in the volume of tips in the last quarter of fiscal year 2014 and in the first quarter of fiscal year 2015, McKessy said. “It remains to be seen if this is the new normal,” and whether the increased number is not an aberration, but can be sustained through the rest of 2015.

Divided Courts 

With regards to the split in the federal district courts as to whether the protections under the Dodd-Frank Wall Street Reform and Consumer Protection Act extend to whistle-blowers who did not contact the SEC, McKessy urged employers to be “mindful” that they don't miss the forest for the trees.

To date, the U.S. Court of Appeals for the Fifth Circuit is the only federal appeals court to rule on the issue. It concluded in July 2013 that a former G.E. Energy (USA) LLC employee couldn't sue his employer under Dodd-Frank's anti-retaliation provisions because he did not first approach the SEC with his suspicions.

Should the courts decide to follow the Fifth Circuit precedent, the commission may need to change its message, McKessy warned. “I may have to adjust my pitch” and inform tipsters that they must report to the SEC, perhaps to the exclusion of the employer, he said. The long-term detriment to corporate compliance functions from that result would outweigh any litigation victory for an employer over a single retaliation claim and “lead to counterproductive results” for corporate America, he said.

To contact the reporter on this story: Yin Wilczek in Washington at ywilczek@bna.com

To contact the editor responsible for this story: Ryan Tuck at rtuck@bna.com