Whistleblower Developments is a periodic report covering significant cases, decisions, proposals, and legislation related to whistleblower statutes and how they may impact your business. Recent developments include:

• Company Directors are Not Liable for SOX Whistleblower Claims According to S.D.N.Y.
• SEC’s Fiscal Year 2019 Whistleblower Program Annual Report Reflects Another Strong Year for the Program
• CFTC’s Fiscal Year 2019 Annual Report Emphasizes Commitment to Public Outreach
• SEC Awards $260,000 to Three Whistleblowers
• SEC Steps Out of the Box to Extend Protections to Investor Whistleblowers
• Second Circuit Turns Down Deutsche Bank Whistleblowers’ Award
• Second Circuit Affirms Trial Court’s Decision to Compel Dodd-Frank Whistleblower Retaliation Claims to Arbitration

Company Directors are Not Liable for SOX Whistleblower Claims According to S.D.N.Y.

On December 9, 2019, the U.S. District Court for the Southern District of New York ruled that company directors cannot be held liable under the whistleblower retaliation prohibitions contained in the Sarbanes-Oxley Act (SOX).

The plaintiff in this case is the former president and CEO of the defendant companies, all of which were commonly owned by a parent company. The company-defendants purchased and operated their owner’s energy plants. In 2015, the plaintiff claimed he became concerned that the company-defendant’s owner was publicly overstating its liquidity, then reported his concerns to the parent company’s CEO and CFO, and to certain members of the parent company’s board of directors. The plaintiff ultimately claimed that after he reported these concerns, he was removed from his position as president and CEO of the defendant companies and was replaced by a person who diverted funds to the parent company in an effort to cover up its misrepresentations about its available liquidity.

The directors, whom the plaintiff named as defendants in the ensuing case, asked the court to dismiss the claims against them, arguing that they cannot be liable under SOX due to actions alleged that they took solely in their positions as company directors. The court agreed and concluded the relevant SOX provision (Section 1514A(a)) does not provide for director liability. That provision states, in relevant part, “[n]o company…or any officer, employee, contractor, subcontractor, or agent of such company” may retaliate against an employee for reporting suspected securities law violations. In light of the fact that Congress specifically provided for director liability in other provisions of the law, the court ruled Congress’s omission of director liability in Section 1514A(a) to be especially noteworthy. Based only on the clear statutory language, the court ruled the director defendants could not be liable under SOX in their capacity as company directors.

The court further noted that in a 2015 case, Wadler v. Bio-Rad Labs., Inc., the Northern District of California came to the opposite conclusion because it decided the word “agent” in Section 1514A(a) was sufficiently broad to include directors. However, the court disagreed in this case and noted that elsewhere in SOX the words “agents” and “directors” had been used to define different categories of people, thus precluding the court from applying a definition of “agent” broad enough to include directors.

The case is Zornoza v. Terraform Global, Inc. et al., No. 18-cv-11617, in the U.S. District Court for the Southern District of New York (Dec. 9, 2019).

SEC’s Fiscal Year 2019 Whistleblower Program Annual Report Reflects Another Strong Year for the Program

On November 15, 2019, the SEC published its annual report to Congress for its whistleblower program (which covers from October 1, 2018 through September 30, 2019).

Compared to fiscal year 2018, the volume of whistleblower tips slowed down slightly in fiscal year 2019. The whistleblower program received a total of 5,212 whistleblower tips in fiscal year 2019 (70 fewer tips than in fiscal year 2018). Nevertheless, this total represents about a 74% increase in tips received since the SEC started tracking statistics for the whistleblower program in 2012. In fiscal year 2019, the whistleblower program distributed approximately $60 million to eight individuals whose initial tips and subsequent cooperation aided in the execution of successful enforcement actions. The SEC further reported that, for fiscal year 2019, the most common activities reported by whistleblowers related to corporate disclosures and financials (21%), offering fraud (13%), and manipulation (10%).

In its annual report, the SEC highlighted proposed rule amendments to its regulations, to help the whistleblower program better handle the volume of tips it receives annually. These amendments seek to bar whistleblowers who are found to have repeatedly made baseless claims and also would allow the whistleblower program additional discretion in making whistleblower bounty determinations. As we proceed into 2020, the SEC will continue to consider public comments received on these proposed rule amendments, originally solicited in June 2018. According to the annual report, the SEC expects to adopt these proposed new rules sometime in 2020.

CFTC’s Fiscal Year 2019 Annual Report Emphasizes Commitment to Public Outreach

The Commodity Futures Trading Commission (CFTC) recently released its 2019 Annual Report, which covers the fiscal year ending September 30, 2019. Like the SEC whistleblower program’s report, the CFTC’s report outlines the whistleblower tips it received and the awards it granted over the course of the fiscal year.

In fiscal year 2019, the CFTC’s whistleblower program received 455 tips from whistleblowers, which is fewer than the 760 tips received in fiscal year 2018. The CFTC’s whistleblower program noted that the higher number of tips in fiscal year 2018 may have been attributable to heightened consumer interest in virtual currencies and CFTC news alerts increasing awareness of the program. Overall, the number of tips the program receives has increased every year from the 58 tips received in 2012, which was the first year of the program. During fiscal year 2019, the CFTC’s whistleblower program also received 102 non-whistleblower tips and 35 referrals from the SEC, which it forwarded to the CFTC’s Division of Enforcement for evaluation and disposition. These tips involved matters alleging money laundering, false reporting, foreign bribery, insider trading, and retaliation against employees.

The CFTC also granted five whistleblower awards in fiscal year 2019 and denied awards to 129 applicants (primarily because those applications did not relate to a qualifying sanction obtained by the CFTC or other regulatory agency). These awards ranged from approximately $1.5 million to approximately $7 million. For context, since 2012 the CFTC has issued 14 whistleblower awards, totaling approximately $100 million. The five awards made in fiscal year 2019 totaled more than $15 million. Overall, the CFTC has recovered over $800 million in sanctions resulting from whistleblower tips.

By way of its annual report, the CFTC emphasized that it remains focused on outreach efforts to educate industry stakeholders about its whistleblower program. Its outreach efforts include presentations and attendance at seminars, conferences, and other professional gatherings.

SEC Awards $260,000 to Three Whistleblowers

On November 15, 2019, the same day it released its whistleblower program’s annual report, the SEC awarded $260,000 to three whistleblowers who helped reveal a scheme to defraud retail investors. Although it customarily does not provide details regarding specific violations or the parties involved, in its press release the SEC pointed out that the fraudulent scheme was “operated by recidivist violators.” The SEC further noted the whistleblowers themselves were victims of the fraud, and their contributions led to a successful enforcement action.

With this award, the SEC whistleblower program has now awarded $387 million to 70 whistleblowers since the launch of its whistleblower program in 2012.

SEC Steps Out of the Box to Extend Protections to Investor Whistleblowers

Recently, the SEC applied Rule 21F-17 of the Securities Exchange Act of 1934 outside the usual employer-employee relationship that normally gives rise to such claims. By way of background, Rule 21F-17 provides penalties for anyone who interferes with an individual’s ability to communicate with the SEC about potential securities violations. Rule 21F-17 was first enacted in August 2011, and since then the SEC has only enforced this rule in the context of employer-employee relationships (i.e., where an employer allegedly interfered with an employee’s ability to communicate with the SEC, often through the use of restrictive contract terms).

In November 2019, the SEC ended this pattern when it charged Collector’s Coffee, Inc. (which operates as Collector’s Café) with violating Rule 21F-17 by allegedly interference with investors’ ability to communicate with the SEC about possible misconduct at the company. Specifically, since the SEC first sued Collector’s Café and its owner in May 2019, the SEC claims the defendants have purposely misled their investors about the SEC’s allegations in an attempt to prevent those investors from communicating with the agency. The SEC also claims it has uncovered evidence of past behavior showing attempts to inhibit potential whistleblowers from coming forward, including lawsuits against two investors the company believed breached one of the allegedly violative agreements.

While the main thrust of the SEC’s amended complaint involved allegations of the company’s misappropriation of investor funds, its Rule 21F-17 claim alleges that Collector’s Café offered to repurchase the shares of certain investors who had raised concerns about their investments to the company. In the course of the repurchase transactions, the company and the particular investors allegedly executed a stock purchase agreement that included a representation that the investors “have not, and will not, contact any third-party for the purpose of commencing or otherwise promoting investigation or other action,” including any governmental or administrative agencies. The SEC concluded that this language alone violated Rule 21F-7.

Accordingly, legal and compliance departments or consultants to investment advisors and broker dealers should consider including investor communications and investor agreements in their annual Rule 21F-17 compliance reviews. Legal and compliance consultants should especially consider whether any current or earlier investor agreements or investor communications include or allow for any or all of the following:

• Prohibition on disclosures of confidential information unless the investor is legally required to do so;
• Requiring notification, or consent, prior to disclosing any confidential information, without making a specific exception for communications with the SEC; and
• Limitations or disclaimers on investors’ ability to collect whistleblower awards from the SEC.

Because the SEC does not need to demonstrate that a company threatened to, or actually did, interfere with an investor’s ability to communicate with the SEC, identifying this kind of potentially problematic language is a good first step toward ensuring Rule 21F-17 compliance, now and in the future.

Second Circuit Turns Down Deutsche Bank Whistleblowers’ Award

On November 8, 2019, the Second Circuit declined to overturn the SEC’s denials of several whistleblower claims for awards based on civil penalties paid by Deutsche Bank to the SEC in 2015. In doing so, the Second Circuit ruled, in part, that the SEC may deny an award to a whistleblower who submits useful information first but packages it in an impenetrable or unusable format. The Second Circuit said that requiring the SEC to award whistleblowers based on the value of information contained in their submissions, regardless of whether those submissions themselves contribute to the success of an enforcement action, could lead to unintended consequences and “disincentivize whistleblowers from curating their submissions.” By focusing on the value of the overall submission, the SEC’s interpretation of its whistleblower program statute “strikes a sensible balance between care and timeliness, one that is more consistent with the whistleblower program’s purpose,” the Second Circuit ruled.

The three petitioners at issue in this decision were among several claimants who applied for whistleblower awards after Deutsche Bank AG paid $55 million in civil penalties to the SEC in 2015. The fine was part of a settlement resolving a five-year SEC investigation into allegations that the bank hid up to $3.3 billion in paper losses on derivatives contracts during the financial crisis. The SEC ultimately approved only two whistleblower award applications in 2017, awarding the whistleblowers about $8 million each. The agency rejected all of the other claimants. It rejected the first two applicants because they did not qualify as original sources of information that ultimately led to the success of the enforcement action. It rejected the last applicant because the information he originally offered to the SEC was not in a useful or usable format, although he technically was the first to submit the information.

The cases are Colin Kilgour, et al. v. U.S. Securities and Exchange Commission, Case No. 18-1124, and John Doe v. U.S. Securities and Exchange Commission, Case No. 18-1127, which were both before the U.S. Court of Appeals for the Second Circuit.

Second Circuit Affirms Trial Court’s Decision to Compel Dodd-Frank Whistleblower Retaliation Claims to Arbitration

On September 19, 2019, the Second Circuit Court of Appeals affirmed a New York district court’s decision that a whistleblower retaliation claim brought under the Dodd-Frank Act must be arbitrated.

In this case, the plaintiff worked in the defendant bank’s private bank division, and she allegedly complained to the bank’s attorneys and human resources department that her supervisor had repeatedly demanded that she disclose material non-public information to him so that he could pass that information along to his clients. The plaintiff alleged that, after she reported that behavior, she was fired. The plaintiff next filed a lawsuit in the U.S. District Court for the Southern District of New York asserting, among other claims, several whistleblower retaliation claims, including claims under SOX and Dodd-Frank. The bank defendant filed a motion to compel arbitration and to dismiss the plaintiff’s claims. The bank based its arguments in favor of arbitration on the plaintiff’s employment agreement, which contained an arbitration provision. The trial court agreed, and the plaintiff appealed its decision to the Second Circuit.

The Second Circuit affirmed the trial court’s ruling, noting that federal trial courts within the Second Circuit had split on whether Dodd-Frank whistleblower retaliation claims could be arbitrated. After acknowledging that split, the Second Circuit joined the Third Circuit (the only other federal appellate court that has ruled on this issue) in holding that Dodd-Frank whistleblower retaliation claims are subject to arbitration. In its opinion, the Second Circuit explained that in contrast to the SOX whistleblower retaliation provision (which contains anti-arbitration language), nothing in Dodd-Frank suggests that claims under it are not arbitrable. The Second Circuit also noted that, although SOX contained language prohibiting claims under it from being arbitrated, that language was restricted to disputes “arising under [SOX].” Therefore, the applicability of that prohibition could not be extended to Dodd-Frank, which is not located in the same statutory section as SOX. The Second Circuit further decided that, even if the anti-arbitration language in SOX is ambiguous, the court could not infer from SOX that Congress intended to extend that prohibition to Dodd-Frank because “[d]espite some surface similarities, the whistleblower retaliation provisions of [SOX] and Dodd-Frank diverge significantly in their prohibited conduct, statute of limitations, and remedies.”

The case is Daly v. Citigroup, Inc., et al., No. 18-665, decided by the U.S. Court of Appeals for the Second Circuit (Sept. 19, 2019).

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