The SEC Takes Aim At Agreements That Stifle Whistleblowers
Securities Litigation Law Alert 04/08/15 Jonathan W. Hackbarth
On April 1, 2015, the SEC issued a cease and desist order against KBR, Inc., a technology and engineering corporation based out of Houston. In this first of its kind order, the SEC imposed a $130,000 penalty against KBR for entering into confidentiality agreements with certain employees that had the potential to thwart those employees from reporting securities violations to the SEC in violation of the Dodd Frank Act. The KBR matter is part of the SEC’s broader effort to promote whistleblowing by imposing sanctions against the use of agreements between employers and employees that have the potential to stifle employees from reporting securities violations to the SEC. The SEC has confirmed that it is currently conducting a number of similar investigations, and is expected to increase the number of these investigations in the coming months. According to the SEC, now is the time for employers to review their contracts with employees to ensure that they are compliant with the Dodd Frank Act.
Prior to the enactment of the Dodd Frank Act in 2010, the SEC came under criticism for failing to pursue a number of tips concerning Bernie Madoff’s investment company. In response to these criticisms, the Dodd Frank Act established a whistleblower program whereby individuals who reported legitimate securities violations in excess of $1 million are eligible to receive between 10 percent and 30 percent of any resulting penalties collected by the SEC. To encourage this type of reporting, SEC rules prohibit employers from entering into any type of agreement with employees that has the potential to deter whistleblowing.
What is remarkable about the KBR matter is that the SEC was unaware of any instance in which KBR prevented any of its employees from reporting potential securities violations to the SEC. The KBR matter thus had little in common with prior orders against employers who were alleged to have actively prevented employee whistleblowing. To the contrary, the entire basis for the SEC’s unprecedented penalty against KBR was a single provision in one of KBR’s employee confidentiality statements, which the corporation had implemented long before the passage of the Dodd Frank Act. The pertinent provision stated:
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.
The SEC found that this provision prohibited employees from discussing the substance of their interview without clearance from KBR’s law department under penalty of disciplinary action. It therefore impeded employees from reporting potential securities violations to the SEC in violation of the SEC’s rules.
In addition to the $130,000 penalty, KBR also agreed to inform certain of its employees who signed the confidentiality statements that they are not required to seek permission from KBR before communicating with the SEC, or any other governmental agency, regarding possible securities violations or other legal violations. KBR also agreed to amend its employee confidentiality statement to make clear that its current and former employees will not have to fear termination or retribution or seek approval from company lawyers in the following manner;:
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.
The takeaways from the SEC’s Order against KBR are clear. First, the SEC is and will continue to actively investigate employer-employee agreements and other arrangements that have even the potential to stifle the reporting of securities law violations. Second, if the SEC uncovers any such arrangement, it will likely be the subject of substantial penalties, even, as in the case of KBR, in the absence of bad intent where an employer was simply relying on a confidentiality statement enacted long before the passage of the Dodd Frank Act. Employers should therefore review all of their contracts with employees, agents, and other representatives, including, without limitation, confidentiality, compensation, employment, settlement, and severance agreements, to ensure that those agreements do not stifle the reporting of potential securities violations to the SEC. Although pre-notification, pre-screening, and prohibitions of this type of whistleblowing will almost certainly be found to violate SEC rules, the SEC will look critically on any arrangement, no matter how creative, that could even potentially stifle whistleblowing.
For any questions, please contact Jonathan W. Hackbarth at (414) 277-5603 / [email protected], or your local Quarles & Brady attorney.