Congress, whistleblower lawyers urge SEC to police ‘de facto gag clauses’

October 29, 2014

You certainly can’t accuse Sean McKessy, who heads the whistleblower office at the Securities and Exchange Commission, of ignoring employers’ attempts to silence would-be whistleblowers. McKessy has repeatedly warned corporations – most recently in an interview with Stephanie Russell-Kraft at Law360 – that if they try to stop employees from coming to the SEC with claims of wrongdoing or if they retaliate against those who have spoken out, the agency can bring an enforcement action against them for violating the Dodd-Frank Financial Reform Act.

To prove that’s not an idle threat, the SEC included retaliation allegations in a $2.2 million settlement in June with the hedge fund advisory firm Paradigm Capital Management. The Paradigm case had been initiated by a trader who was forced out of the company after Paradigm found out he’d gone to the SEC. In announcing the settlement, SEC Enforcement Director Andrew Ceresney said, “Those who might consider punishing whistleblowers should realize that such retaliation, in any form, is unacceptable.”

But on Monday, eight Democratic members of the House of Representatives said in a letter to the SEC that one enforcement action and a lot of tough talk is not enough to reassure whistleblowers, especially in the face of mounting evidence that employers are requiring tipsters to sign supposedly coercive employment and severance agreements. The letter’s lead signers were Maxine Waters of California, the ranking Democrat on the House Committee on Financial Services, and Elijah Cummings of Maryland, the top Democrat on the Oversight and Government Reform Committee. They and the other six representatives told the SEC that its Dodd-Frank whistleblower program – which generated more than 6,000 tips and led to 139 enforcement judgments in the last fiscal year – will dry up “if corporate actions that chill the environment for whistleblowers are not promptly and adequately addressed.”

Why did the House Democrats send the letter now? A congressional committee aide told me by email that the letter’s signers began tracking the issue of whistleblower retaliation even before the June 2014 Washington Post investigation cited in their letter. Since then, the aide said, study by law professor Richard Moberly of the University of Nebraska and whistleblower lawyers Jordan Thomas of Labaton Sucharow and Jason Mark Zuckerman of Zuckerman Law – “De Facto Gag Clauses: The Legality of Employment Agreements that Undermine Dodd-Frank Whistleblower Programs” – documented the tactics that employers are using to prevent employees from reporting allegations of corporate misconduct to the SEC, including severance agreements that require employees to forfeit their right to bounty payments from the SEC. With the SEC’s Oct. 16 announcement of its enforcement actions over the last year – and no anti-retaliation case in sight since Paradigm – Waters and the other Democrats, the aide said, wanted to make sure the agency is still committed to protecting whistleblowers.

Whistleblower lawyers, meanwhile, have petitioned the SEC to conduct public hearings and eventually issue formal rules on employment and severance agreements that limit employees’ rights as SEC whistleblowers. Labaton partner Thomas – one of the authors of the gag clauses study and counsel to the whistleblower in the Paradigm case – is also among the leaders of the rulemaking petition drive. He told me he has no doubt that the SEC is serious about protecting tipsters but that the agency has to clarify limits on the restrictions employers can impose. Otherwise, he said, whistleblowers simply won’t come forward.

The petition for SEC rulemaking cites some examples of agreements that seem intended to discourage whistleblowers from airing complaints outside of their companies. The military contractor KBR, for instance, allegedly required employees being interviewed in an internal investigation to sign agreements barring them from discussing the inquiry with anyone outside of the company, including government officials. (The Washington Post has reported that the SEC is investigating KBR’s anti-disclosure tactic.) And several banks, the petition said, require employees to sign codes of conduct that either require them to report suspected wrongdoing internally before they go to government regulators; require them to inform managers if they’re involved in a government investigation; or bar employees from disclosing any corporate information without management’s authorization.

The SEC’s McKessy has said explicitly that contracts prohibiting employees from reporting wrongdoing to the SEC are a violation of the SEC’s Dodd-Frank anti-retaliation regulation. He has also said that in-house lawyers who draft such provisions could be barred from practicing before the commission. Clients have heeded that warning, said employment lawyer Jill Rosenberg of Orrick, Herrington & Sutcliffe. “To the extent the SEC has spoken, it has said that agreements that require individuals to keep information confidential are forbidden under Dodd-Frank,” she said. “We’re telling clients: Don’t do it.”

But there’s still uncertainty about other corporate tactics, such as provisions in severance agreements that bar employees from reaping the bounty for blowing the whistle to the SEC and employment agreements mandating internal reporting before tipsters can go to the government. Corporate documents are also a leverage device for employers: The gag clauses study asserts that whistleblowers increasingly face threats that employers will sue them for breaching general confidentiality provisions in employment contracts if they try to use internal documents; and the petition for SEC rulemaking says that some companies attempt to prohibit employees from sharing documents with private lawyers, which, in turn, precludes them from reporting tips anonymously to the SEC. (Under the rules of the SEC program, tipsters can only remain anonymous if they supply information through their lawyer.)

Whistleblower lawyer Mark Labaton of Isaacs Friedberg & Labaton told me about a raft of recent cases in which corporations have accused whistleblowers of misappropriating documents or violating provisions requiring them to report suspected misconduct internally, including J-M Manufacturing v. Phillips & Cohen in state court in New Jersey, Walsh v. Amerisource Bergen in federal court in Philadelphia, and Wildhirt v. AARS Forever in Chicago federal court. Forbes even ran a blog post in June advising healthcare employers how to take advantage of precedent in such suits. These cases involved False Claims Act whistleblowers, not SEC tipsters, but Labaton said defendants also threaten counterclaims when whistleblowers go to the SEC. “This is an increasing trend,” he said. “Corporations try to create these really ugly sideshows in order to intimidate whistleblowers.”

All five of the whistleblower and employment lawyers I reached out to – Thomas, Labaton, Rebecca Katz of Motley Rice, Erika Kelton of Phillips & Cohen, and Jonathan Ben-Asher of Ritz Clark & Ben-Asher – said they have clients who have been coerced into signing agreements that discourage them from reporting to the SEC, despite SEC whistleblower lawyer McKessy’s constant warnings that corporations will be subject to enforcement actions if they violate the Dodd-Frank prohibition on impeding whistleblowers from tipping the agency. “It’s a vague rule,” said Nebraska professor Moberly, co-author of the gag clauses study. “What we’d really like would be for the SEC to give some examples and say these are the types of provisions that would impede whistleblowers.”

It’s unlikely that Monday’s letter from Democratic House members will have a tangible impact. The Republican majority controls the agenda of the Financial Services and Oversight committees, and Republican chairs don’t seem to be rushing to convene hearings on retaliation against SEC whistleblowers. (The Financial Services Committee is more concerned with whistleblowers who allege discrimination and retaliation by the Consumer Financial Protection Bureau.) Nevertheless, whistleblower lawyers told me the letter can’t hurt. “Congressional interest will hopefully reinforce the SEC’s commitment to protect whistleblowers,” Thomas said.

Even Rosenberg, the Orrick lawyer who advises employers, said her clients would appreciate formal guidance from the SEC. There are often legitimate reasons why corporations encourage internal reporting and discourage employees from disclosing documents, she pointed out. Clients need to know where the line is. “Sean McKessy goes out and says something, but that doesn’t have the effect of law,” she said. “That’s dangerous. Clarity might not be such a bad thing, given that there’s a lot of noise out there.”

An SEC representative did not respond to my email requesting comment on the congressional letter.

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