SEC Enforces First-Ever Dodd-Frank Whistleblower Retaliation Claim

by Stinson Leonard Street
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The U.S. Securities and Exchange Commission recently entered into a $2.2 million settlement agreement with Paradigm Capital Management Inc. and its owner Candace King Weir, in its first-ever action enforcing whistleblower anti-retaliation laws under Dodd-Frank. The Paradigm case reinforces the need for companies to have effective compliance programs and to manage potential whistleblowers carefully. This Insight highlights key elements of the case, and implications for corporate compliance programs.

The action accused the capital management firm and its owner of engaging in illegal principal transactions; and of subsequently retaliating against the whistleblower who revealed the violations to the SEC. In signing the agreement, the firm did not admit or deny the SEC findings.

Background

Paradigm is a New York corporation managing $1.7 billion in total assets. Weir owns 73% of Paradigm, which gives her primary decision-making power over the firm. In order to reduce the tax liabilities of investors of a Paradigm-managed fund, the firm generally crossed a large block of securities back and forth between that fund and the account of C.L. King & Associates, Inc., a New York corporation of which Weir also owned 73%.

Prohibited Principal Transactions

Since Weir controlled both Paradigm and C.L. King & Associates during the time these transactions occurred, the SEC charged Paradigm with violation of Section 206(3) of the Advisers Act (15 U.S.C. § 80b-6), which prohibits an investment adviser, while acting as a principal for her own account, from trading with the client's account without first disclosing the conflict and obtaining the client's consent to such transactions.

The SEC also charged that Paradigm failed to disclose material information on how the firm manages conflicted transactions, making its filings materially misleading in violation of the Advisers Act.

Whistleblower Retaliation

According to the SEC, a Paradigm head trader blew the whistle and voluntarily submitted information on these violations to the SEC. The whistleblower also informed Paradigm of his submission, which led the firm to gradually relieve him from his day-to-day trading and supervisory responsibilities. Paradigm’s actions allegedly included redirecting whistleblower’s emails to another trader; forcing him to work from home; denying him access to files and reports; and finally depriving him of any meaningful work commensurate with his position as a head trader. The whistleblower resigned one month later.

The SEC charged Paradigm with being in violation of Section 21F(h) of the Securities Exchange Act of 1934, which protects whistleblowers by prohibiting an employer, among other things, from discharging, demoting, suspending, threatening, harassing and discriminating against an employee for providing information to the SEC. Under Dodd-Frank, a whistleblower who voluntarily provides the SEC with original information relating to a violation can be awarded between 10% and 30% of monetary sanctions, if the information ultimately leads to an administrative or judicial action resulting in sanctions of $1M or more.

In the settlement with the SEC, Paradigm agreed to disgorge $1,700,000 plus $181,771 in interest to investors in the fund affected by the illegal transactions. The civil penalty amounted to $300,000—but has not been disclosed is what percentage related to the principal violations or to the whistleblower retaliation claim.

As part of the settlement, Paradigm also had to hire an independent compliance consultant, who will produce a report with reviews and recommendations concerning the firm’s supervisory structure and compliance policies and procedures. Paradigm must adopt all recommendations contained in the report.

This is the first action the SEC has filed under its authority to enforce anti-retaliation provisions. Andrew J. Ceresney, director of the SEC Enforcement Division stated that “[t]hose who might consider punishing whistleblowers should realize that such retaliation, in any form, is unacceptable.” Similarly, Sean McKessy, chief of the SEC’s Office of the Whistleblower assured the public that the “[SEC] will continue to exercise [its] anti-retaliation authority in these and other types of situations where a whistleblower is wrongfully targeted for doing the right thing and reporting a possible securities law violation.”

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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