Tag: Rule 21F-17

The One With The Silenced Investors

In response to Dodd-Frank, the SEC adopted Rule 21F-17 in August 2011, which provides:

(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.

I have mostly heard stories about violation of the rule as applied to employee severance agreements or employment agreements. You can’t prevent departing employees from being whistleblowers.

In a different approach to whistleblower protection, the Securities and Exchange Commission brought a case against a company for trying to limit the ability of its former investors from reported alleged wrongdoing to the SEC.

Mykalai Kontilai, wanted to build a website for the auction of collectibles, especially sports memorabilia. He grew that idea into plans for an affiliated social network, a physical coffee shop, and a television show. He managed to raise $23 million from 140 investors to implement his vision. Collectors Café was born.

According to the SEC complaint, Kontilai misappropriated more than $6.1 million of the money raised for personal use. He is also accused of misrepresenting the material facts about Collectors Café to those investors.

According to the SEC some of the investors alleged wrongdoing and wanted their money back. In at least two instances, Collectors Café and Kontilai attempted to resolve investor allegations of wrongdoing by conditioning the return of investor money on confidentiality clauses prohibiting the investors from communicating with law enforcement, including the SEC, about the alleged securities law violations.

In a stock purchase agreement to buy back the stock, there was this provision:

[Investors] … further warrant and affirm that. . . they will not, directly or indirectly, individually, collectively or otherwise, contact any third-party, including, but not limited to governmental or administrative agencies or enforcement bodies, for the purpose of commencing or otherwise prompting investigation or other action relative to [Collectors Café] or the subject matter herein.

In a settlement agreement with other investors, there was this provision:

“The Shareholders, for themselves and their counsel and advisors, confirm that they are not aware of, and have not had to date, and will not initiate on a going forward basis, any communications with any regulatory agencies such as the United States Securities and Exchange Commission or any other Federal, State, or Local governmental agency concerning the matters related to this Agreement.”

Collectors Café and Kontilai even went a step further and attempted to enforce the illegal confidentiality clause by filing a lawsuit claiming that the victims breached the confidentiality provision by communicating with SEC staff about possible securities law violations.

The SEC action is mostly filled with the alleged fraud at Collectors Café. This came after the SEC contacted the investors trying to find information about their complaint.

The two provisions contain the opposite of what should be in a settlement agreement. We know you can’t stop employees from acting as whistleblowers in severance agreements. It’s also clear that you can’t stop investors from talking to the SEC about securities fraud.

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The SEC Really Means It About Pretaliation Severance Agreements

In case you were not clear that the Securities and Exchange Commission is serious about enforcing Rule 21F-17, BlackRock is the latest to run the perp walk. The SEC accused the money management giant of improperly using separation agreements that forced employees to waive their ability to obtain whistleblower awards.

The SEC adopted Rule 21F-17, which provides in relevant part:

(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.

Rule 21F-17 became effective on August 12, 2011.

On October 14, 2011, BlackRock revised its form separation agreement. That agreement did not prohibit former employees from communicating directly with the SEC or any other governmental agency regarding potential violations of law. It did include language requiring a departing employee to waive recovery of incentives for reporting misconduct. Effectively, the agreement removed the financial incentive to be a whistleblower.

Paragraph 5 of BlackRock’s separation agreement in use from October 14, 2011 through March 31, 2016 stated in relevant part:

“To the fullest extent permitted by applicable law, you hereby release and forever discharge, BlackRock, as defined above, from all claims for, and you waive any right to recovery of, incentives for reporting of misconduct, including, without limitation, under the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Sarbanes-Oxley Act of 2002, relating to conduct occurring prior to the date of this Agreement.”

Over 1000 departing employees signed separation agreements with this language. BlackRock revised the agreement in March 2016 to remove that provision. BlackRock also produced a “Global Policy for Reporting Illegal or Unethical Conduct” that it distributed to employees and provides yearly training.

In the end, BlackRock a penalty of $340,000.

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Return of the Whistleblower

It’s been a busy week for whistleblower cases. The latest is a case against SandRidge Energy for using severance agreements that impeded employees from contacting the Securities and Exchange Commission.

In response to Dodd-Frank, the SEC adopted Rule 21F-17 in August 2011, which provides:

(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.

Sandridge’s severance agreements stated that the former employee could not

at any time in the future voluntarily contact or participate with any governmental agency in connection with any complaint or investigation pertaining to the Company, and [may] not be employed or otherwise act as an expert witness or consultant or in any similar paid capacity in any litigation, arbitration, regulatory or agency hearing or other adversarial or investigatory proceeding involving the Company.

A second provision had the former employee agree  “not to make any independent use of or disclose to any other person or organization, including any governmental agency, any of the Company’s confidential, proprietary information unless [the employee] obtain[ed] the Company’s prior written consent.”

A third provision required the former employee to “not at any time in the future defame, disparage or make statements or disparaging remarks which could embarrass or cause harm to SandRidge’s name and reputation or the names and reputation of any of its officers, directors, representatives, agents, employees or SandRidge’s current, former or prospective vendors, professional colleagues, professional organizations, associates or contractors, to any governmental or regulatory agency or to the press or media.”

Three bad provisions cost SandRidge $1.4 million.

Not really SandRidge. It’s in bankruptcy. It’s creditors are going to have add this unsecured claim in the bankruptcy proceedings.

SandRidge caught the attention of the SEC because it had included a severance agreement in an SEC filing. The SEC asked the company to change the agreements and it did so. But there were still a few hundred agreements out there.

Including for one employee that the SEC tried to interview to discuss his departure. He cited the severance agreement as a reason he was unable to speak with the SEC. The bad language turned from a technical violation into an actual impediment.

It turns out that the employee had serious concerns about how SandRidge was calculating oil and gas reserves. The company ended up firing him on April 1, 2015. While negotiating the severance agreement his lawyer asked for the unlawful provisions to be removed. This was two month after the KBR case on unlawful severance agreements.

SandRidge makes four cases over the past 18 months on severance agreements that violate Rule 21F-17.

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The SEC Strikes Back Again on Whistleblower Pretaliation

Compliance officers need to take a look at severance agreements. The Securities and Exchange has blown up another company for including provisions in its severance agreements that may have impeded employees from communicating information to the SEC.

NeuStar Inc. used severance agreements that contained a broad non-disparagement clause forbidding former employees from engaging “in any communication that disparages, denigrates, maligns or impugns” the company. Former employees could be compelled to forfeit all but $100 of their severance pay for breaching the clause.

In response to Dodd-Frank, the SEC adopted Rule 21F-17 in August 2011, which provides:

(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.

Among the investors, customers, competitors and other parties listed in the non-disparagement clause, NeuStar specifically included the Securities and Exchange Commission. That makes it a bad agreement and in violation of Rule 21F-17.  From August 2011 to May 21, 2015, NeuStar used the bad severance agreement for 246 employees. The SEC order indicates that at least one ex-employee wanted to talk to the SEC, but was impeded by the agreement.

This is the third pretaliation case from the  SEC, following up on KBR and BlueLinx.

In each case, the offending company was required to reach out to the ex-employees and let them know that the company was not preventing them from talking to the SEC. It seems clear that the compliance officers may want to spend some time this holiday season looking through their severance agreements to see if they could be construed as limiting the employees from talking to the SEC. If so, you may want to send a holiday card granting those employees a holiday wish to talk to the SEC.

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Whistleblowers Power Up

Two whistleblower stories caught my attention. Both are follow-ups to previous stories.

Close-up Of Metal Sport Whistle On American Flag

The Securities and Exchange Commission previously announced that it thought poorly of severance agreements that restricted the former employees from being whistleblowers. Last year, the SEC brought an action against KBR for restrictive employee agreements that stifled whistleblowing. That was in the context of confidentiality statements used as part of internal investigations. The SEC’s expressed distaste left few practitioners thinking that the distaste was limited to this kind of application.

BlueLinx didn’t get the law firm memos on this issue and continued to use severance agreements that stifled whistleblowers. When Rule 21F-17 was passed by the SEC, BlueLinx revised its severance agreements to allow terminated employees to be whistleblowers, but waive any right to monetary recovery in connection with it.

Further, by requiring its departing employees to forgo any monetary recovery in connection with providing information to the Commission, BlueLinx removed the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.

The SEC wants whistleblowers. That has given rise to the professional whistleblower. It took six years since the passage of Dodd-Frank, but in January 2016, the SEC announced the first-ever whistleblower award to an outsider.  I think that was the first professional whistleblower. (Other than those whistleblowers who profited indirectly through books and speaking engagements.)

The Wall Street Journal reported that the rumor that Harry Markopolis’s firm was behind the State Street Bank and BNY Melon FX whistleblowers seems to be true. According to the story Mr. Markopolos became intrigued about the possibility that trust banks were overcharging clients in currency markets after reading a book by Yale University’s chief investment officer that pointed to unpredictable “foreign exchange translations.” Mr. Markopolos searched for bank employees to prove his case. He found a trio. The group organized Delaware partnerships to keep their identities out of public view. Mr. Markopolos served as a litigation consultant to the lawyers.

The resulting awards could exceed a combined $100 million. That will attract a lot of attention for those who think professional whistleblowing might be lucrative. It has taken years to get to the settlement and it’s not clear how much the whistleblower award will be or how much of a cut Markopolis will take from the award. It certainly seems like it could be millions or even tens of millions.

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SEC Action for Stifling Whistleblowers in Confidentiality Agreements

whistleblower-info-promo

A story surfaced a few weeks ago that the Securities and Exchange Commission was taking a close look at employment agreements that limited the actions of whistleblowers. The story behind the story came out. The SEC brought an action against KBR, Inc. for violating whistleblower protection Rule 21F-17 enacted under the Dodd-Frank Act.

KBR required witnesses in certain internal investigations interviews to sign confidentiality statements with language warning that they could face discipline if they discussed the matters with outside parties without the prior approval of KBR’s legal department.  Since these investigations could have included allegations of possible securities law violations, the SEC found that these terms violated Rule 21F-17, which prohibits companies from taking any action to impede whistleblowers from reporting possible securities violations to the SEC.

The 2010 Dodd-Frank financial-reform bill granted a financial incentive for whistleblowers. A tipster can get between 10% and 30% of the penalty collected if their information leads to an SEC action. The whistleblower program handed out an award for more than $30 million last year that caught the attention of many.

The Dodd-Frank whistleblower regulations prohibit companies from interfering with employees reporting potential securities-law violations to the SEC. Rule 21F-17 provides in relevant part:

(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.

The form confidentiality statement that KBR has used before and since the SEC adopted Rule 21F-17 requires witnesses to agree to the following provisions:

I understand that in order to protect the integrity of this review, I am prohibited from discussing any particulars regarding this interview and the subject matter discussed during the interview, without the prior authorization of the Law Department. I understand that the unauthorized disclosure of information may be grounds for disciplinary action up to and including termination of employment.

I bet many companies have a similar confidentiality provision.

The SEC brought the action even though it was not aware of any instances in which an employee was prevented from communicating the SEC about a potential securities law violation. Beyond that, the SEC was not aware of any instances in which KBR even tried to enforce the confidentiality provision.

KBR agreed to pay a $130,000 penalty to settle the SEC’s charges. The company voluntarily amended its confidentiality statement by adding the following language:

Nothing in this Confidentiality Statement prohibits me from reporting possible violations of federal law or regulation to any governmental agency or entity, including but not limited to the Department of Justice, the Securities and Exchange Commission, the Congress, and any agency Inspector General, or making other disclosures that are protected under the whistleblower provisions of federal law or regulation. I do not need the prior authorization of the Law Department to make any such reports or disclosures and I am not required to notify the company that I have made such reports or disclosures.

KBR also agreed to reach out to KBR employees subject to that confidentiality after August 21, 2011 (the date the rule was in effect) to say that the agreement does not prevent them from reaching out to the government to report possible violations.

KBR was the sacrifice to alert others to this potential problem. It seems harsh for KBR considering there is no statement of an incident where harm was done. I would assume that the confidentiality provision surfaced as part of some other government investigation of KBR.

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