SEC Files First Whistleblower Retaliation Case

by Brooks Pierce
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Well, you can’t say Sean McKessy didn’t warn you.  The chief of the SEC’s whistleblower office has been warning for months at least that his group was looking to bring a stand-alone case enforcing the anti-retaliation provisions of the Dodd-Frank whistleblower rules.

On Monday, the Commission filed a settled administrative action in which Albany, New York-based investment adviser Paradigm Capital Management, Inc. was charged with prohibited principal transactions and then retaliating against the employee who reported the trading activity to the SEC.  As the Second Circuit has recently told us, “Trials are primarily about the truth.  Consent decrees are primarily about pragmatism.”  So the all of the “facts” that follow derive from the SEC’s claims in the settled order, and may or may not actually be true.

The Principal Transactions

Briefly, Paradigm engaged in principal transactions with C.L. King & Associates, Inc. (“C.L. King”), an affiliated broker-dealer, without providing effective disclosure to, or obtaining effective consent from, a hedge fund client (the “Fund”) advised by Paradigm.  As part of a tax reduction strategy from 2009 through 2011, Paradigm owner Candace King Weir directed Paradigm’s traders to sell selected securities at prevailing market prices from the Fund to a proprietary trading account controlled at C.L. King.  Because Weir controlled both Paradigm and C.L. King, the transactions between the two entities were principal transactions that required effective written disclosure to, and consent from, the Fund.  But Paradigm did not provide that disclosure to the Fund and did not get that consent.  Paradigm did establish a review committee to approve the pricing of the trades, but the committee was conflicted.  As a result, the SEC found that Paradigm violated, and Weir caused violations of, Section 206(3) of the Advisers Act.  In addition, Paradigm’s Form ADV omitted to state material facts concerning Paradigm’s process for obtaining consent to the principal transactions.

This part of the case is interesting by itself, and is a relatively sophisticated one for the SEC’s Asset Management Unit to bring.  But for now, I’m more interested in the retaliation piece, and especially what didn’t happen there.

An Insider Blows the Whistle, and Suffers for It

In March 2012, Paradigm’s then-head trader made a whistleblower submission to the SEC that revealed these principal transactions.  On July 16, 2012, the whistleblower notified Weir and C.L. King’s Chief Operating Officer that he had reported potential securities law violations to the Commission.  That day, the whistleblower was questioned about his allegations and then returned to the trading desk.  Paradigm also retained outside counsel to advise the firm.

At the end of the next day, Paradigm informed the whistleblower that he would be removed from the trading desk and temporarily relieved of his trading and supervisory duties.  Paradigm explained that because he executed trades that were reported to the SEC, the firm needed to investigate his actions.  Paradigm further directed the whistleblower to work offsite at a different office building and to prepare a report that would detail all of the facts that supported the potential violations.

On July 17, the whistleblower’s counsel proposed that he be permitted to prepare his report from home rather than come into the office.  Paradigm and the whistleblower’s counsel also discussed the idea of his leaving the firm in exchange for a severance payment.  Between July 18 and July 20, Paradigm denied the whistleblower access to certain Paradigm trading and account systems and his work email while he was at home.  He submitted the requested report on July 20 and told Paradigm he was planning to return to work on Monday, July 23.  On July 21, though, Paradigm told him not to bother coming in.  Three days later, the firm told the whistleblower’s lawyer that the employment relationship had been “irreparably damaged” and that Paradigm wanted him to leave employment with “as little difficulty or acrimony as possible.”

After the two sides could not agree on severance terms, the whistleblower informed the firm that he was prepared to return to work, but only as Paradigm’s head trader.  Paradigm said he could come back on August 13, and that his compensation structure would remain the same.  But he would not return as head trader; Paradigm merely noted that his duties would be “meaningful” to the firm.  His first assignment was to identify any potential wrongdoing by the firm so it could further investigate his allegations.  As part of that assignment, the whistleblower was asked to review more than 1,900 pages of hard-copy trading data.  Paradigm denied his requests for access to electronic reports that might make this review more efficient.  On August 15, Paradigm also directed the whistleblower to consolidate multiple trading procedure manuals into one comprehensive document and propose revisions to that document.

Also, while the whistleblower was working from home, he received Paradigm’s consent to use his personal email address in preparing the report detailing the basis for his claims.  A month later, the whistleblower sent a confidential report from that address to Paradigm’s CCO. This caused Paradigm to believe that the whistleblower previously removed confidential documents using his personal email address.  On August 16, Paradigm accused him of violating Paradigm’s policies and his terms of employment by removing confidential business records from Paradigm’s information network.  The whistleblower resigned the next day.  The SEC found that in forcing the whistleblower to this point, Paradigm violated Section 21F(h) of the Exchange Act, which prohibits an employer from discharging, demoting, suspending, threatening, harassing, directly or indirectly, or in any other manner discriminating against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower in, among other things, providing information to the Commission.

My Take

I think this case is quite important, mostly because of what it doesn’t include.  The whistleblower wasn’t fired.  His salary wasn’t cut.  But he was marginalized and apparently given make-work the SEC thought was designed to encourage his departure.  It’s a fairly bold decision for the SEC to make this its first whistleblower retaliation case.  Granted, it’s a settled administrative order, not subject to a federal court’s approval.  But employers subject to the SEC’s jurisdiction should take careful note, and calibrate its reactions to legitimate claims of securities violations to be sure it doesn’t punish a whistleblower for being a whistleblower.

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.

© Brooks Pierce | Attorney Advertising

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