United States: For Whom The Whistle Tolls In 2014

Last Updated: February 3 2014
Article by Renee B. Phillips, Daniel J. Dunne and Paul F. Rugani

Momentum for the SEC's Dodd Frank whistleblower program is growing, and 2014 can be expected to bring continued expansion of the program and the number and types of whistleblower actions initiated by the SEC. The SEC's annual report to Congress reported that 3,238 whistleblower tips were received in 2013, up almost 10% from 2012, and awards to whistleblowers who provide information to the SEC are increasing as more substantive tips are received.

An investigation by the SEC into a whistleblower tip can take several years to culminate in an enforcement action, so the last year likely saw just the beginning of a wave of enforcement actions. Despite the fact that over 6,000 tips have been received through 2013, the SEC has issued only six separate awards to tipsters. Those awards have ranged from $125,000 to a record $14 million, representing 10 to 30 percent of the overall funds recovered by the SEC in these whistleblower cases.

These actions have included a successful investigation against a Texas Ponzi scheme operator, an enforcement action and related criminal charges against a hedge fund manager who misled investors about his qualifications and directed investor funds into a personal account, a settlement for violation of market access rules, and a settlement with a private equity fund that deceived investors about the funds' performance. The $14 million award was issued in an undisclosed enforcement action for a tip that allowed the SEC to halt a fraudulent scheme and recover at least $46.7 million in investor funds.

Major 2013 court developments will reverberate through 2014 and beyond, including a growing disagreement among federal courts over who qualifies for protection under Dodd-Frank's anti-retaliation provisions. The Supreme Court is also expected to resolve a debate among the courts and the Labor Department over who qualifies as a whistleblower under Sarbanes-Oxley's whistleblower protections. For an in-depth look at recent developments in whistleblower cases under Sarbanes-Oxley and Dodd-Frank, see here.

There is a growing split among federal courts over which whistleblowers are protected by Dodd-Frank's anti-retaliation provisions.

Federal courts have differed as to whether a whistleblower must report directly to the SEC, rather than internally within a company, to qualify for the whistleblower protections contained in Dodd-Frank. While Dodd-Frank section 922 defines "whistleblower" as one who provides information to the SEC, the Act protects, among other types of reports, those "required or protected" under Sarbanes-Oxley. The SEC's regulations promulgated under Dodd-Frank provide that those who submit tips internally may be eligible for "whistleblower" status and awards. The broader definition of whistleblower as covering those who make internal reports of violations was adopted in seven federal district court decisions in 2012 and 2013, including rulings from the Southern District of New York, the District of Massachusetts, the District of Connecticut, the District of Colorado, and the Middle District of Tennessee, all of which allowed retaliation claims by individuals who reported internally to go forward. However, in a victory for employers, the Fifth Circuit defined "whistleblower" narrowly in Asadi v. G.E. Energy (USA), L.L.C., 720 F.3d 620 (5th Cir. 2013), where it held that the anti-retaliation provisions in Dodd-Frank unambiguously protect employees who provide tips directly to the SEC, but do not protect internal reporters. The Fifth Circuit's Asadi decision was followed by the Northern District of California in Banko v. Apple Inc., Case No. 3:13-cv-02977-RS (N.D. Cal. Sept. 26, 2013), and by the District of Colorado in Wagner v. Bank of America Corp., Case No. 12-cv-00381 (D. Colo. July 19, 2013), in which judges dismissed Dodd-Frank retaliation claims by employees who only made complaints internally and did not report directly to the SEC before the alleged retaliation. These rulings counter the recent trend among federal courts to a more expansive interpretation of Dodd-Frank. The Fifth Circuit remains the only court of appeals to weigh in to date, but as other circuit courts weigh in, Supreme Court review becomes more likely.

The SEC will pursue anti-retaliation actions against employers in 2014.

Perhaps as a response to decisions limiting the protective scope of SEC anti-retaliation regulations, the SEC is also actively working on investigations into retaliatory conduct by registrants. According to SEC whistleblower chief Sean McKessy, who spoke at an event sponsored by the American Bar Association on January 22, 2014, potential actions by the SEC against employers who retaliate against whistleblowers could include a cease and desist order or monetary sanctions. The SEC's authority to pursue these actions and levy sanctions is an open question – neither Dodd-Frank nor its implementing regulations expressly provide the SEC with authority to police retaliatory conduct. The SEC's stated intent also conflicts with the views of at least one other federal agency. The CFTC, which also has a Dodd Frank whistleblower program, does not believe Congress has granted it the authority to pursue such actions.

The U.S. Supreme Court will clarify the scope of whistleblower protections under Sarbanes-Oxley.

In its first whistleblower case under Sarbanes-Oxley, Lawson v. FMR, Docket No. 12-3, the U.S. Supreme Court is expected to clarify the extent to which employees of contractors and subcontractors of publicly traded companies are covered by Sarbanes-Oxley's whistleblower protections . The case involves plaintiffs who worked for privately-held investment advisors for Fidelity mutual funds who claimed they were retaliated against for internal complaints about financial irregularities at Fidelity, who did not employ them directly. The district court held that the investment advisors were contractors of the public company, and that the plaintiffs were protected, but the First Circuit reversed, holding that Sarbanes-Oxley applies only to employees of covered companies. After the U.S. Dept. of Labor's Administrative Review board rejected the First Circuit's rationale in a subsequent case before the agency, Spinner v. Landau and Assoc., ARB Case. Nos. 10-111 and 10-115 (May 31, 2012), the petitioners requested further review from the Supreme Court.

At argument on November 12, 2013, some of the justices expressed skepticism that Sarbanes-Oxley was intended to cover every single contractor or subcontractor of a public company. Justice Breyer questioned whether a public company's gardener's employees would be protected under Sarbanes-Oxley. The government, as amicus, argued that Congress intended to cover contractors and subcontractors such as a accountants, lawyers and outside auditors, but there could nevertheless be limits imposed on who could qualify. However, members of the Court also questioned a narrow reading of the rule that would limit its application only to direct employees of public companies. A decision is expected in 2014.

2014 is likely to bring more clarity as to who can qualify as a whistleblower, what specific reports those individuals must make to be entitled to protection, and whether the SEC has been granted authority to protect whistleblowers within its purview. As the Dodd-Frank whistleblower program continues to gain momentum, more unresolved questions are likely to arise in their place. Public companies should continue to pay close attention to developments in whistleblower enforcement actions and maintain clear policies regarding internal reporting and compliance that are consistent with new developments as they occur.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Renee B. Phillips
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