It's Time (Really!) To Prepare For Increased Whistleblowing Activity

November 21, 2014 Advisory

Earlier this week, the Securities and Exchange Commission ("SEC") issued its 2014 Annual Report to Congress on the Dodd-Frank Whistleblower Program. While each of the SEC's prior Annual Reports have contained interesting and significant statistics about the number of tips received, where they came from and the types of allegations made by whistleblowers, this year's Report goes beyond mere numbers to deliver potent, eye-opening messages to companies in every industry, not just financial services, about how to appropriately respond to employee reports of wrongdoing.

All companies should respond to the SEC's suggestions. There is absolutely no indication that whistleblowing activity will decrease anytime soon – the SEC has a $437 million fund from which to pay whistleblower awards, and whistleblowing will only increase now that the SEC is handing out multimillion dollar awards. So, it is time for companies to do the following: (1) establish practices (or review existing practices) to properly handle whistleblower complaints, (2) establish (or review) anti-retaliation policies, and (3) examine employment agreements for compliance with SEC rules.

It's Time to Review Practices For Handling Employee Reports of Wrongdoing

The SEC's first message concerns the adequacy of a company's response to employee reports of potential wrongdoing. The SEC Whistleblower Program creates tremendous incentives for your employees to by-pass internal reporting mechanisms and report directly to the SEC. Successful whistleblowers stand to receive up to 30% of the total recovered by the SEC in an enforcement action where the penalties assessed exceed $1 million. To be eligible for that type of award, employees will want to be the first in to the SEC and provide the information that causes the SEC to open an investigation. And this year's SEC Report only adds to these incentives – the SEC reported that it issued its largest award to date, $30 million, to a whistleblower who "provided information of an ongoing fraud that otherwise would have been very difficult to detect." Indeed the SEC stated that it "hope[s] that awards like this one will incentivize company and industry insiders . . . both in the U.S. and abroad, to come forward and report their information promptly to the Commission."

Despite these incredibly strong incentives to go directly to the SEC, statistics show that most employees want to internally report first. In fact, according to the SEC, of the whistleblower award recipients who were current or former employees, over 80% raised their concerns internally to their supervisors or compliance personnel before reporting wrongdoing to the SEC. However, companies are failing to take advantage of their employees' willingness to keep matters in-house. Time after time, companies fail to act, or fail to act properly or appropriately, when they receive reports of wrongdoing. Companies fail to investigate; fail to keep the employee informed and, worse, retaliate against the employee for coming forward. As noted by the SEC, individuals generally turned to the government only after determining that the "the entity was not taking steps to address or remedy the violative conduct."

The result of a failed response to an employee report of wrongdoing is often an SEC (or other government) investigation that leads to a sizable recovery and a corresponding significant award to a whistleblower. The SEC's Report provides two such examples involving whistleblower awards made by the SEC in FY 2014. In one, "the whistleblower . . . worked aggressively internally to bring the securities law violations to the attention of appropriate company personnel. The whistleblower brought the information to the SEC only after the company failed to take corrective action." In another case, the SEC made an award to a "company employee with audit and compliance responsibilities who reported the securities violation internally and then reported the violation to the SEC after the company failed to take appropriate, timely action in response to the information."

Since the advent of the SEC Whistleblower Program, we have been encouraging companies to make sure that they have adequate policies and procedures in place regarding the proper handling of a whistleblower complaint. Companies are also well advised to ensure that the recipients of employee complaints understand their reporting and other obligations once the information is received. Given these recent developments, along with the SEC's Report, corporate eyes must clearly open to the importance of addressing this issue. According to the SEC, "companies not only need to have internal reporting mechanisms in place, but they must act upon credible allegations of potential wrongdoing when voiced by their employees." Now is the time, then, to establish practices – or review existing practices – to properly handle and respond to internal reports of misconduct.

It's Time to Review Retaliation Policies

A critical component of a corporate culture that encourages internal reporting is a policy against retaliation. Employees need to feel safe when they internally report; in fact, a significant reason why employees do not first internally report is their fear of retaliation. (Another reason is that they do not feel that their company will respond and take appropriate corrective action, see above.)

Now, companies have a new incentive to address this issue: the SEC is getting into the action. Federal securities law prohibits employers from retaliating against individuals in the terms and conditions of their employment when they engage in whistleblowing activities. In June, 2014, the SEC brought its first enforcement action under this anti-retaliation provision. As described in the SEC's report, after learning that its head trader had reported misconduct to the SEC, Paradigm Capital Management "engaged in a series of retaliatory actions, including changing the whistleblower's job function, stripping the whistleblower of supervisory responsibilities and otherwise marginalizing the whistleblower." The result: an order from the SEC for Paradigm to pay $2.2 million to settle retaliation and other charges.

In short, now is the time to heed the next message from the SEC to employers: "retaliation against whistleblowers in any form is unacceptable." Indeed, as the SEC states in its Report, unlawful retaliation means more than termination of employment; rather it includes "any retaliatory action, including demoting, suspending, threatening or harassing an employee for engaging in protected whistleblowing activity . . . ."

It's Time to Review Employment Agreements

The SEC reports also contains another important message for employers: the SEC is scrutinizing "employee confidentiality, severance and other kinds of agreements that may interfere with an employee's ability to report potential wrongdoing to the SEC," and "will continue to focus on agreements that attempt to silence employees from reporting securities violations to the Commission by threatening liability or other kinds of punishment." The SEC finds its authority for this in its whistleblower rules, which provide that "[n]o person may take any action to impede an individual from communicating directly with [the SEC] about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications."

As a result, what have become typical, standard confidentiality provisions in handbooks, offer letters, and employment agreements should be reviewed to ensure the appropriate exclusions are noted.

Being Proactive Is Crucial

The whistleblowing phenomenon is not going away. The SEC continues to get more and more tips each year (3,620 in FY 2014, up 10% from FY 2013), and the recent multi million dollar awards may open the floodgates. And not only are the tips coming from all 50 states, the District of Columbia and Puerto Rico, tips have also flowed in from individuals in 60 foreign countries (up from 55 countries in FY 2013), with the highest numbers coming from the United Kingdom, India, Canada, the People's Republic of China and Australia. On top of that, the SEC is carefully scrutinizing the way employers treat whistleblowers and employees who want to report wrongdoing.

Employees who want to report internally should be encouraged. With the right procedures and protections in place, many employees will indeed be more apt to report internally first. Don't miss the opportunity to properly handle that internal report – especially because what employees see as the company's response will either encourage or deter internal reports. This means companies must demonstrate that employees who report are safe from retaliation, and that appropriate investigations are conducted, while at the same time keeping the employee/whistleblower appropriately aware of what you are doing so that they know that their concerns are being addressed and appropriate corrective action is being taken. It may save your company tremendous potential exposure, not only from SEC enforcement actions but also from what is sure to be increased enforcement of the anti-retaliation provisions.

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