SEC Releases FY 2021 Whistleblower Program Annual Report

On November 15, 2021, the SEC published its annual report to Congress covering the period from October 1, 2020 to September 30, 2021.  The report was prepared by the SEC’s Office of the Whistleblower to summarize its whistleblower bounty program, report on the program’s recent dramatic growth, and highlight key amendments to the SEC’s whistleblower program rules.

Record-Breaking Awards for Whistleblower Bounty Program

The report reveals that in FY 2021, the whistleblower program experienced the largest number of submissions to the program and the largest number of award recipients.  The SEC paid out more in whistleblower awards this fiscal year than in all previous years combined.

The SEC received more than 12,200 whistleblower tips; an increase of 76% from FY 2020.  The tips were received from 99 different countries and all 50 states.  The most common violations reported included: Manipulation (25%), Corporate Disclosures and Financials (16%), Offering Fraud (16%), Trading and Pricing (6%), and Initial Coin Offerings and Cryptocurrencies (6%).

Overall, the SEC awarded approximately $564 million to 108 individuals in FY 2021, including the two largest single award payouts to date—$114 million in October 2020 and $110 million in September 2021—which brought the total amount the SEC has awarded to whistleblowers since the program’s inception to $1.1 billion.  

Amendments to Whistleblower Program Rules

The SEC adopted several changes to its whistleblower program effective as of December 2020, including to its award-setting procedures and to the definition of a “whistleblower” (see our post on those changes here).  According to the report, these amendments “increased efficiencies around the review and processing of whistleblower award claims.”

Under the new rules, the SEC issued two permanent bar orders against serial submitters who were responsible for hundreds of frivolous award applications.

The report also noted that in August 2020, the new SEC Chair, Gary Gensler, directed staff to consider revisions to two amendments that could have discouraged tips by allowing the SEC to limit the size of some of the largest awards and to unilaterally deny “related action” awards where there is another applicable whistleblower award program.

CA District Court: Dodd Frank Whistleblower Provision Does Not Apply Extraterritorially

On June 28, 2021, the United States District Court for the Northern District of California granted the Company’s Rule 12(b)(6) motion to dismiss after an executive claimed he was discharged in violation of the Dodd-Frank Act’s (DFA) whistleblower protection provision for alerting the Company and authorities about possible tax fraud.  Airton Amorim De Almeida v. Western Digital Corp., No. 3:20-cv-04735.  According to the court, the DFA whistleblower provision did not apply because the relevant events occurred in Brazil.

Background

Plaintiff, a citizen and resident of Brazil, brought suit against the company and a Brazilian entity that is wholly owned and operated by the Company.  While working in Brazil for the Company, Plaintiff allegedly became concerned with potentially fraudulent conduct.  He notified the SEC and the DOJ, and allegedly submitted an anonymous email to company executives alerting them of his concerns.  This resulted in both an SEC investigation and an internal investigation.

About a year after lodging his complaints, Plaintiff allegedly was “duped into” participating in a phishing scam that cost the Company $2 million.  As a result, the Company relieved Plaintiff of some of his responsibilities, and in 2017, his employment with the Company ended.  There was some disagreement with respect to whether Plaintiff was terminated or whether there was mutual agreement to end his employment.  Over two years after Plaintiff’s separation, he brought suit against the Company and its wholly owned Brazilian subsidiary, alleging whistleblower retaliation in violation of the DFA.  Both entities sought to dismiss Plaintiff’s claims.

Ruling

The court held that because Plaintiff relied on the DFA anti-retaliation provision and that provision does not apply to alleged retaliatory conduct that takes place overseas, Plaintiff failed to state a claim.  Plaintiff was a resident of a foreign country, was employed by a foreign company, and the allegedly corrupt activities took place in a foreign country.  Further, any potential adverse employment action took place in Brazil.

In addition, even though the court refused to allow such extraterritorial application of the provisions under the DFA, it could rely on the following to conclude that Plaintiff failed to allege sufficient facts to give rise to a plausible inference that he suffered adverse employment actions in retaliation for whistleblowing:  Plaintiff fell prey to a phishing scam, costing the Company $2 million, and the fact that over a year had elapsed between the alleged whistleblowing behavior and Plaintiff’s eventual separation.

Implications

This decision confirms that the DFA whistleblower protection provision does not extend extraterritorially.

New York’s Whistleblower Protection Law Is Dramatically Expanded

On October 28, 2021, New York Governor Kathy Hochul signed into law a bill dramatically expanding New York’s whistleblower statute, New York Labor Law § 740, which is scheduled to take effect on January 26, 2022.  S4394A/A.5144A.

The Previous Whistleblower Law

New York Labor Law § 740, which was enacted in 1984, was designed to protect employees who report a violation of the law that either “creates and presents a substantial and specific danger to the public health or safety, or…constitutes health care fraud.”  N.Y.L.L. § 740(2).  In 2002, a parallel whistleblower statute was enacted to provide health care employees with additional protections.  N.Y.L.L. § 741.

The protection for employees who do not work in health care under the previous statute was focused on alleged harm to the public at large.  The whistleblower employee had to demonstrate that there was an “actual violation” of a safety statute or regulation creating a substantial and specific danger to the public health or safety, and that the harm that resulted from the violation affected the public-at-large, as opposed to an individual plaintiff or group.  The statute formerly contained a broad election of remedies provision, but it was eliminated in 2019 and replaced with new language stating that “Nothing in this section shall be deemed to diminish the rights, privileges, or remedies of any employee under any other law or regulation or under any collective bargaining agreement or employment contract.”  N.Y.L.L. § 740(7).

The statute of limitations for a § 740 claim was one year and employees who successfully proved that they were retaliated against were entitled to recover back pay, but not compensatory or punitive damages.  They also were not entitled to a jury trial.

As we previously reported, attempts were made in previous years to expand § 740, but, other than the 2019 amendment, none of the proposed bills were signed into law.

The New Expanded Whistleblower Law

The new expanded law significantly bolsters protections for private-sector employees alleging retaliation, and exposes employers to significant additional liability.

Expanded Definition of “Employee”

The amended law adds “former employees” and “independent contractors” to those “employees” permitted to bring whistleblower claims.

Change to Reasonable Belief Standard

The amended law removes the previous requirement that there be an actual violation of the law.  Employees are now protected if they “reasonably believe” an employer’s activity or conduct is (i) in violation of a “law, rule or regulation,” including executive orders and judicial or administrative decisions, rulings, and orders; or (ii) “poses a substantial and specific danger to the public health or safety.”

Expansion of Protected Activity

The prior law required that employees first report violations to their employers before disclosing violations to a public body, thereby providing a reasonable opportunity to correct the alleged violation.  The amended law now requires employees to make a “good faith effort” to notify their employer.  Employer notification is not necessary if (i) there is imminent and serious danger to public health; (ii) the employee reasonably believes reporting of the violation to the employer would result in the destruction of evidence, concealment, or harm to the employee; or (iii) the employee reasonably believe that their supervisor is already aware of the violation and will not correct it.

Expansion of Prohibited Retaliatory Conduct

The amended law expands the definition of prohibited “retaliatory actions” to include (i) adverse employment actions against current employees, such as discharge, suspension, or demotion; (ii) actions or threats that would adversely impact a former employee’s current or future employment; or (iii) contacting or threatening to contact immigration authorities on an employee or their family member.

Additional Remedies, Longer Statute of Limitations, and Right to Jury Trial

The amended law expands the remedies potentially available to whistleblowers to include: front pay, civil penalties not to exceed $10,000, and punitive damages (in addition to back pay).  The statute of limitations is extended from one year to two years, and whistleblowers now have a right to a jury trial.

Notification

Employers must notify employees of their rights under the whistleblower law by posting a notice in a conspicuous place.

Implications

New York’s expanded whistleblower law exposes New York employers to a dramatically altered regulatory environment.  Internal compliance mechanisms as well as whistleblower policies and procedures are thus of even greater importance than before.

SEC Awards $40 Million to Two Whistleblowers

On October 15, 2021, the SEC’s Office of the Whistleblower announced multi-million dollar awards to two whistleblowers who provided the SEC with information that assisted the agency in bringing a successful enforcement action.  (The order granting the awards can be accessed here.)  The larger of the two awards, $32 million, was awarded to the whistleblower whose information caused the opening of the investigation and exposed difficult-to-detect violations.  The second award of $8 million was given to a second whistleblower who submitted important additional information after the investigation was already underway.

Emily Pasquinelli, Acting Chief of the SEC’s Office of the Whistleblower, said in a press release that “[t]hese whistleblowers reported critical information that aided the Commission’s investigation and provided extensive, ongoing cooperation that helped the Commission to stop the wrongdoing and protect the capital markets.”

Since the inception of the whistleblower program in 2011, the SEC has awarded approximately $1.1 billion to 218 individuals.

SEC Announces $36 Million Award to Whistleblower

On September 24, 2021, the SEC announced an approximately $36 million award to a whistleblower who provided critical information to the SEC that contributed to a successful enforcement action.  (The order granting the award can be accessed here.)

Emily Pasquinelli, Acting Chief of the SEC’s Office of the Whistleblower noted that “[w]histleblowers can act as a springboard for an investigation or, like here, they can propel forward an already existing investigation.”

Since issuing its first whistleblower award in 2012, the SEC has awarded approximately $1.1 billion to 214 individuals.

Over $1 Billion Whistleblower Awards Paid to Date by the SEC

On September 15, 2021, the SEC announced accumulated awards of over $1 billion paid to 207 whistleblowers since its first award in 2012.  Over $500 million was awarded in fiscal year 2021 alone.

The SEC crossed the billion-dollar milestone with awards of $110 million and $4 million to two whistleblowers on September 15, 2021.  The $110 million award marks the second-highest award to date and consists of $40 million stemming from an SEC case and $70 million for related actions by another agency.

An examination of the $110 million award order provides important insights into the SEC’s evaluation of whistleblower assistance.  According to the SEC, the information provided by the award recipient was valuable because it was based on the whistleblower’s own examination, evaluation, and independent analysis, and it contributed significant independent “original information” that bridged the gap between certain publicly available information and the possible securities violations that the Commission and the Other Agency were investigating.  For example:

  • The whistleblower used publicly available information to provide the Commission with important insights into the extent of the alleged misconduct.
  • The whistleblower also provided information derived from multiple sources not readily identifiable or accessible by members of the public without specialized knowledge, unusual effort, or substantial cost.
  • The whistleblower’s sources collectively raised a strong inference of securities law violations not otherwise reasonably inferable from any individual source.

The SEC noted that, as a result of this analysis, the whistleblower provided the agency with a detailed suggested witness list and other supporting documentation, thereby saving the SEC significant time and resources.  The whistleblower also provided substantial, ongoing assistance to the staff, including multiple written submissions, communications, and in-person meetings.  The SEC also disclosed that the whistleblower suffered personal and professional hardships as a result of the whistleblower activities (while not providing any details regarding such hardships).

The SEC acknowledged, however, that the whistleblower submitted information after the Commission had already opened an investigation of the potential misconduct, and it assisted with only some of the misconduct the staff was investigating – suggesting even a higher possible award where these circumstances are not present.

The award amount can range from 10-30% of the money collected when the monetary sanctions exceed $1 million.  Rule 21F-5(b).  But, the award is at the discretion of the SEC, and the same order which provided for the $110 million award to a whistleblower denied an award to another whistleblower in an unrelated award claim.

An award can also be provided for an action that results in a non-prosecution agreement (NPA) or deferred prosecution agreement (DPA), based on the amendments to the SEC whistleblower program rules in December 2020.  As such, in February 2021, a whistleblower who had already received an award for an SEC enforcement action received another award for a successful NPA or DPA resolution by the Department of Justice on a related action.

Stay tuned for our ongoing review of the monthly notices of Covered Actions.  See our previous posts on the June 2021 Covered Actions here and July 2021 Covered Actions here.

July 2021 Update of the SEC’s Covered Actions for Potential Whistleblower Claims

On July 30, 2021, the SEC posted 14 Notices of Covered Actions, after which individuals have 90 calendar days to apply for a whistleblower award.  As discussed in our prior post, the SEC publishes these Notices for cases in which the final judgment or order, either by itself or together with other prior judgments or orders in the same action issued after July 21, 2010, results in monetary sanctions exceeding $1 million.

In this post, we briefly survey the 14 Notices of Covered Actions from July 2021.  (See our previous post on the SEC’s Notices of Covered Actions from June 2021.)  Several of the alleged misconducts in the 14 Covered Actions also resulted in parallel criminal actions.

2021-062: In the Matter of Gateway One Lending & Finance, LLC

On June 24, 2021, the SEC entered an order with Gateway One Lending & Finance, LLC based on an Offer of Settlement and findings of false and misleading statements regarding loan performance under Section 17 of the Securities Act of 1933.  According to the order, Gateway, an auto loan originator, securitizer, and servicer, understated the historic losses of its auto loans and overstated the projected future performance for six auto loan-backed securitizations between July 2014 and December 2016 by excluding important liquidation expenses. Without admitting or denying the findings in the SEC’s order, Gateway agreed to pay $6.5 million for disgorgement, prejudgment interest, and civil penalties.

2021-063: SEC v. The Legacy Group, Inc.; Colorado Ventures I, LLC; Radiant Holdings, LLC; Randy R. King; Matthew B. King; and Andrea S. Trout

On June 11, 2021, final judgments were entered against Colorado and Florida residents Randy R. King, Matthew B. King, and Andrea S. Trout and three entities they operated, The Legacy Group, Inc., Colorado Ventures I, LLC, and Radiant Holdings, LLC, stemming from alleged violations of Section 17(a) and Section 5 of the Securities Act and Section 10(b) of the Securities Exchange Act of 1934.  The SEC’s charges asserted the defendants conducted fraudulent, unregistered securities offerings related to investment opportunities in “fix-and-flip” residential real estate properties in high-end markets.  The SEC alleged the defendants misused investor funds, made material misrepresentations about the value of certain properties and the amount of equity and liabilities tied to certain properties, and materially misstated the risks of certain investments.  The defendants also allegedly took undisclosed compensation, contrary to the business plan presented to the investors.  The defendants, without admitting or denying the allegations, consented to judgments and injunctions, which, among other things, resulted in orders of disgorgement, prejudgment interest, and civil penalties totaling more than $1.2 million.

2021-064: SEC v. Sethi Petroleum, LLC and Sameer P. Sethi

On June 24, 2021, a final judgment was entered against defendant Sethi Petroleum, LLC, ordering it to pay disgorgement and prejudgment interest of $3.2 million for violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act.  The case stemmed from an emergency civil action filed by the SEC on May 14, 2015, against Sethi Petroleum and its president, Sameer P. Sethi, for offering fraudulent oil and gas investments.  The SEC alleged that the defendants used the proceeds of joint venture securities offerings on undisclosed and unapproved expenditures, contrary to the stated purpose in the offering materials and diverted funds to defendants and other individuals.  The SEC also alleged that defendants made other misrepresentations (including false claims of partnering directly with large public oil and gas companies) misled investors about the company’s assets and expected returns, and failed to adequately disclose prior enforcement actions against the company and its affiliates (including the prior criminal conviction and incarceration of Sameer Sethi).  In response to these allegations, the U.S. District Court for the Eastern District of Texas found Mr. Sethi had violated the federal securities laws and ordered disgorgement, prejudgment and civil penalties of more than $4.5 million, less any amounts returned to investors.  Mr. Sethi’s appeal was denied and the district court’s judgment was affirmed by the Fifth Circuit, which resulted in this final judgment being entered.

2021-065: SEC v. Emil Botvinnik

On May 20, 2021, a final judgment was entered by the United States District Court for the Southern District of New York ordering Emil Botvinnik to pay $1.5 million for disgorgement, prejudgment interest, and civil penalties.  The SEC’s 2018 complaint alleged Botvinnik engaged in a fraud involving frequent, short-term trades for his customers with costly commissions and fees that made almost certain that his customers would lose money.  Botvinnik also engaged in unauthorized trading and concealment of material information from his customers regarding transaction costs.  The SEC charged Botvinnik with violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

2021-066: SEC v. The Owings Group, LLC, Owings-1, LLC, Owings Capital Group, LLG, Owings Capital Funds, LLC, Mark Johnson, Kevin Drost, Brian Koslow, David Waltzer

On May 12, 2021, the United States District Court for the District of Maryland issued a memorandum opinion and corresponding final judgments against Mark Johnson, Kevin Drost, Brian Koslow, David Waltzer, and their associated entities.  The SEC’s July 2018 complaint charged the defendants with multiple violations, including Section 10(b) of the Exchange Act, Sections 5 and 17(a) of the Securities Act, and Section 206(4) of the Investment Advisers Act of 1940.  These violations were based on an alleged fraudulent scheme surrounding an untested, and ultimately unsuccessful, method devised by the defendants to take a company public.  The defendants allegedly used various fraudulent methods to attract investors, including making fake escrow accounts and shell companies, and issuing false and misleading statements.  According to the SEC, the defendants lost all investor funds except for payments made to early investors using new investors’ money.  The court ordered varying judgment amounts against the defendants, each ranging from $172,774 to $1,480,648, some of which include jointly and severally liable amounts.  Most of the individual defendants had consented to judgments in 2019, but in June 2021, one individual defendant (Mark Johnson) filed an appeal to the Fourth Circuit regarding the amount of disgorgement and penalty ordered against him, which remains pending.

2021-067: In the Matter of Loci, Inc. and John Wise

On June 22, 2021, the SEC settled charges with Loci Inc. and its CEO John Wise for making materially false and misleading statements relating to an unregistered offer and sale of digital asset securities.  The order found that the digital tokens, called “LOCIcoins,” constituted securities and that defendants made numerous materially false statements in connection with the tokens relating to the company’s revenues, number of employees, and user base of its software platform.  Without admitting or denying the findings of the SEC’s order, the defendants consented to a civil money penalty of $7.6 million, disgorgement of $38,163 and prejudgment interest of $6,209.

2021-068: SEC. Eric Pulier

On May 20, 2021, the United States District Court for the Central District of California issued a final judgment against Eric Pulier, who, without admitting or denying the allegations, consented to a judgment of $4.8 million.  According to the SEC’s complaint filed in September 2017, Pulier, a former executive at Computer Sciences Corporation (“CSC”) and co-founder of ServiceMesh, Inc., defrauded CSC out of over $98 million in connection with its November 2013 acquisition of ServiceMesh.  He allegedly paid approximately $2.5 million in bribes to third parties to assist with his scheme, made material misrepresentations to CSC and its auditors, and circumvented CSC’s internal accounting controls.

A parallel criminal case, no. 17-CR-00599, was filed in September 2017 but was dismissed in December 2018 upon the U.S. Government’s ex parte application to dismiss the indictment in the case with prejudice.

 2021-069: In the Matter of Centaurus Financial, Inc.

On June 2, 2021, the SEC settled charges with Centaurus Financial, Inc., a dually-registered investment adviser and broker-dealer, regarding breaches of fiduciary duty in connection with its receipt of third-party compensation from client investments without fully and fairly disclosing its conflicts of interest.  The order found violations of Sections 206(2) and 206(4) of the Advisers Act.  The SEC also alleged Centaurus had breached its duty to seek best execution despite a more favorable value present at the time of the investment transactions, and that it had failed to adopt and implement written compliance policies and procedures reasonably designed to prevent these violations.  Without admitting or denying the findings of the SEC’s order, Centaurus consented to pay $1.3 million.

2021-070: In the Matter of Crown Capital Securities, L.P. 

On June 24, 2021, the SEC settled charges of violations of Sections 206(2) and 206(4) of the Advisers Act with Crown Capital Securities, L.P., a dually-registered investment adviser and broker-dealer, regarding disclosure failures concerning investment advice on mutual funds and cash sweep money market funds.  The SEC’s order found Crown Capital had breached its fiduciary duties in connection with its receipt of third-party compensation from client investments without fully and fairly disclosing its conflicts of interest, its failure to seek best execution despite a more favorable value present at the time of the investment transactions, and its failure to adopt and implement written compliance policies and procedures reasonably designed to prevent these violations.  Without admitting or denying the findings of the SEC’s order, Crown Capital consented to pay $1.6 million.

 2021-071: SEC v. Savraj Gata-Aura (a/k/a Samuel Aura a/k/a Sam Aura) and Core Agents, Ltd. (d/b/a Core Agents International, Ltd.)

On June 22, 2021, the United States District Court for the Southern District of New York issued a final judgment against Savraj Gata-Aura and Core Agents, Ltd. for $3.7 million, which is to be offset by an amount equal to the order of restitution and the forfeiture amount set forth in the parallel criminal case.  In that proceeding, Aura had pleaded guilty to one count of conspiracy to commit wire fraud under 18 U.S.C. § 1349.  The SEC’s allegations and Aura’s admissions in the criminal case set forth that Aura recruited a network of sales agents to sell fraudulent investments in co-working spaces Bar Works, Inc. and Bar Works 7th Avenue, Inc., using false and misleading offering materials, including false statements regarding the identity and background of Bar Works’ purported CEO, “Jonathan Black,” a pseudonym for a defendant in a related case, Renwick Haddow.

In July 2020, Aura was sentenced to 48 months in prison, supervised release for 3 years, and forfeiture of $3.0 million.  In December 2020, an order of restitution was entered against Aura for $40.0 million, for which he is jointly and severally liable with any other defendant in that matter, defendants in related matters, as well as any defendants who have not yet been charged.

 2021-072: SEC v. Joseph Andrew Paul, John D. Ellis, Jr., James S. Quay, a/k/a “Stephen Jameson,” and Donald H. Ellison

On May 27, 2021, the United States District Court for the Eastern District of Pennsylvania issued a final judgment as to John D. Ellis, Jr. for payment of $1.3 million, which is to deemed satisfied by the entry of a restitution order in a parallel criminal case.

In April 2016, the SEC alleged Josepha Andrew Paul and John D. Ellis, Jr. created fraudulent marketing materials about the historical performance of their investment advisory firm, Paul Ellis Investment Associates.  According to the SEC, Paul and Ellis recruited James S. Quay and Donald H. Ellison to find and mislead potential investors.  Quay, who was previously convicted of tax fraud in 2005 and found liable for securities fraud in 2012, allegedly used an alias to conceal his true identity.  A final judgment against Ellison, including an amount of $83,118 for disgorgement, prejudgment interest and civil penalties, was entered in October 2017 with Ellison’s consent.

In 2017, defendants Paul, Ellis, and Quay were charged in the parallel criminal action, in which all three individuals pled guilty.  Paul was sentenced to 34 months imprisonment, 5 years supervised release, and payment of $1.5 million in restitution.  Quay was sentenced to 125 months imprisonment, 3 years supervised release, and payment of $1.3 million in restitution.  Ellis was again charged with fraud in a separate case, filed in April 2021.  Sentencing in both cases against Ellis is set for October 2021.

2021-073: In the Matter of Maxwell Drever

On May 5, 2021, the SEC settled charges of violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act with Maxwell Drever, a real-estate developer.  According to the SEC’s order, Drever raised approximately $53 million to purchase and redevelop a commercial building in Texas but failed to disclose his receipt of $10.2 million in fees charged to investors in connection with the purchase and redevelopment. Drever also invested $9 million of the undisclosed fees he received to take an equity stake in the project for himself and falsely told certain investors that the investment had come from his own funds.  Without admitting or denying the findings of the SEC’s order, Drever consented to pay $1.6 million for disgorgement, prejudgment interest and civil penalties, and cancel the equity stake in the project he received in exchange for the $9 million investment.

 2021-074: In the Matter of Gurprit Chandhoke and VII Peaks Capital, LLC

On June 4, 2021, the SEC settled charges against investment adviser VII Peaks Capital, LLC and its co-owner, co-principal, and managing member, Gurprit Chandhoke, for breaches of fiduciary duty.  The SEC found that from late 2015 through 2017, VII Peaks and Chandhoke engaged in transactions that were not disclosed to or approved by the board of directors of the client, VII Peaks Co-Optivist Income BDC II, Inc.  These transactions included over $700,000 in due diligence fees collected by VII Peaks for loans made by the BDC to portfolio companies, an undisclosed $400,000 payment by a portfolio company for technology services to a company which Chandhoke partially owned and served as CEO, and an undisclosed $250,000 personal loan to Chandhoke from a company owned and controlled by a portfolio company’s CEO.  The SEC also alleged that the transactions with Chandhoke violated the Investment Company Act for failure to obtain approval from the Commission for the affiliated person transactions, and that VII Peaks failed to implement its own valuation policies and procedures in valuing two portfolio companies of the BDC in 2018.  Without admitting or denying the findings of the SEC’s order, VII Peaks agreed to pay $1.0 million for disgorgement, prejudgment interest and civil penalties, and Chanhoke agreed to a payment of $194,357 as well as an association suspension, investment company prohibition, and penny stock suspension, all for 12 months.

A related settlement was entered into with Michelle E. MacDonald, the CFO of the BDC, for causing VII Peaks’ violations under Section 206(2) of the Advisers Act and for a $20,000 penalty.

 2021-075: SEC v. Hemp, Inc.; Bruce J. Perlowin; Barry K. Epling; Jed M. Perlowin; Ferris Holdings, Inc.; Hobbes Equities Inc.; Diversified Investments LLC; and Quantum Economic Protocols LLC

On May 31, 2021, the United States District Court for the District of Nevada issued final judgment as to defendants Hemp, Inc., Bruce J. Perlowin, Barry K. Epling, Ferris Holding, Inc., and Hobbes Equities Inc., on consent from each defendant.

In its June 2016 complaint, the SEC charged Hemp, Inc., its CEO Bruce Perlowin, Perlowin’s friend Barry Epling, Perlowin’s brother Jed Perlowin, and private companies owned by Epling or Jed Perlowin with violations of Section 5 of the Securities Act and Section 10(b) of the Exchange Act for engaging in a long-running fraudulent scheme to evade registration requirements.  The defendants allegedly sold hundreds of millions of unregistered and purportedly unrestricted Hemp shares to public investors through the use of, among other things, purported gifts and consulting agreements, nominee companies, and fraudulent statements made to registered broker-dealers.

The final judgments entered on May 31 ordered, among other things, civil penalties of $300,000 from Hemp Inc., $1.7 million from Bruce Perlowin, and $8 million from Epling, respectively.  On August 23, 2021, the remaining defendants also submitted stipulations and consents for entry of final judgments, proposing, among other things, a civil penalty of $150,000 for Jed Perlowin.

SEC Alleges Employer’s Compliance Manual Violates Rule 21F-17

On June 23, 2021, the SEC announced that Guggenheim Securities, LLC (“Company”) agreed to settle charges that it violated Rule 21F-17 by including language in its compliance manual and training materials that allegedly prohibited employees from contacting regulators without prior Company approval.  Without admitting or denying the findings in the SEC’s order, the Company consented to a cease-and-desist order, a censure, and a civil penalty of $208,912.

Rule 21F-17, which was adopted by the SEC after the passage of the Dodd-Frank Act in 2010, prohibits actions that impede individuals from reporting a possible securities law violation to the SEC.

The SEC alleged that from 2016-2020, the Company’s compliance manual stated that:

Employees are also strictly prohibited from initiating contact with any Regulator without prior approval from the Legal or Compliance Department.  This prohibition applies to any subject matter that might be discussed with a Regulator, including an individual’s registration status with FINRA.  Any employee that violates this policy may be subject to disciplinary action by the Firm.

According to the order, the compliance manual was updated annually and employees were required to sign an acknowledgement that they would adhere to its policies.  The SEC further alleged that in 2018 and 2019, the Company provided annual compliance trainings that included similar language.

Notably, the SEC stated that it was unaware of any instances in which an employee was prevented from communicating with SEC staff about potential violations or in which the Company took action to enforce the compliance manual’s restriction or prevent communications.  After being contacted by the SEC, the Company removed the language quoted above and added a provision notifying employees of their right to report violations and to participate, assist, or testify in any investigation by a governmental agency.

As we previously reported (see here and here), the SEC brought multiple actions to enforce Rule 21F-17 during the Obama administration, focusing primarily on allegedly restrictive language in severance agreements, but only one such action during the Trump administration (see here and here).  This recent action may signal renewed scrutiny by the SEC under the Biden administration of companies’ compliance with Rule 21F-17.

CA Federal Court Dismisses Whistleblower Claims After Bench Trial

On July 26, 2021, the United States District Court for the Northern District of California held, after a bench trial, that Plaintiff Botta failed to prove that Defendant PricewaterhouseCoopers LLP (“PwC”) terminated his employment in retaliation for his filing of a complaint with the SEC, and dismissed his whistleblower claims brought under SOX and California law.  Botta v. PricewaterhouseCoopers LLP, No. 18-cv-02615.

Background

Plaintiff was an auditor at PwC for nearly two decades.  In 2016, he filed a whistleblower complaint with the SEC, alleging that PwC supervisors willingly overlooked accounting errors and internal-control deficiencies in order to retain business.  The SEC investigated, but chose not to take action against PwC.

In August 2017, PwC terminated Plaintiff’s employment.  Plaintiff claimed the termination, as well as certain other employment actions, were taken in retaliation for his complaint to the SEC.  Plaintiff subsequently sued PwC, alleging violations of SOX, supplemental whistleblower claims under California law, and breach of his employment contract.  The court held a bench trial using Zoom.

Ruling

In its Findings of Fact and Conclusions of Law, the court ruled that PwC was justified in terminating Plaintiff’s employment, and that Plaintiff had not established that PwC retaliated against him.  Although Plaintiff focused on the timing of his termination (four months after the SEC opened an investigation into his whistleblower complaint), the court held that the temporal proximity “wasn’t bolstered by other evidence,” and PwC had “offered a different, persuasive side of the story.”  PwC asserted at trial that Plaintiff’s employment had been terminated because he “fabricated an internal control or lied about doing so,” which was a violation of PwC internal standards.  The court ultimately found that “[Plaintiff], in the end, simply didn’t put forward enough evidence to prove that his SEC complaint contributed to PwC’s decision to fire him.  The temporal proximity between his complaint and his termination generated suspicion, but at trial that suspicion wasn’t confirmed.”  PwC representatives also testified persuasively that they had not even known Plaintiff had filed a whistleblower complaint.

The court also found that Plaintiff was removed from other client engagements for legitimate reasons, including his “lack of rapport,” “bedside manner,” and lack of “sensitivity.”  Therefore, the court held that Plaintiff had not proven that his protected activity was a “contributing factor” to the adverse actions taken against him.  For the same reasons, Plaintiff had not established a causal link between his protected activity and any adverse employment action as required under California law.

Implications

This case demonstrates that temporal proximity between a whistleblower complaint and an adverse employment action likely will not, standing alone, establish retaliation.  Instead, the factfinder considers all of the evidence and makes a context-specific determination regarding whether an adverse employment action was motivated by retaliatory animus.

SDNY: SOX Whistleblower Protections Extend to Investors

On July 21, 2021, the U.S. District Court for the Southern District of New York held that the whistleblower protections established in SOX are not restricted to employee whistleblowers, but also extend to shareholders.  SEC v. Collector’s Coffee Inc., No. 19-cv-4355.

Background

As we previously reported, in 2019 the SEC sued online auction portal Collectors Coffee and its CEO, alleging in an amended complaint that the CEO attempted to prevent investors from communicating with the SEC in violation of Rule 21F-17.  Rule 21F-17, which was adopted by the SEC after the passage of the Dodd-Frank Act, prohibits company actions that impede individuals from reporting a possible securities law violation to the SEC.  Although the Obama-era SEC brought multiple enforcement actions to enforce Rule 21F-17, this action was notable as it was the SEC’s first public attempt to enforce Rule 21F-17 during the Trump administration.

The SEC alleged in its lawsuit that the CEO and Collectors Coffee attempted to enforce a settlement agreement they had reached with two investors who had accused the CEO of making material misrepresentations and omissions, which contained a provision prohibiting communications with regulatory agencies like the SEC.

On June 26, 2020, Defendants filed a motion to dismiss, and on May 17, 2021, Magistrate Judge Gabriel Gorenstein issued a Report & Recommendation recommending that the District Court deny their motion because SOX is not restricted to employee whistleblowers.  Collectors Coffee and the CEO objected to the Magistrate Judge’s Report, arguing that the SEC exceeded its rulemaking authority in promulgating Rule 21F-17, and that the Rule violates the First Amendment of the United States Constitution.

Ruling

District Judge Victor Marrero adopted the Magistrate Judge’s Report and Recommendation in its entirety.  Defendants argued that Rule 21F-17 exceeded the SEC’s rulemaking authority because Rule 21F-17 applies to any “person,” while Section 21F of the Exchange Act applies only to whistleblower-employees.  The court rejected this argument, holding that the broad definition of the term “whistleblower” in Section 21F—which includes “any individual who provides … information relating to a violation of the securities laws to the [SEC]”—is not restricted to the employer-employee context.  The court also relied on the Congressional intent behind Section 21F, which was to encourage whistleblowing activity and protect whistleblowers generally.

The court also rejected Defendants’ First Amendment argument, holding that because the contractual provisions they sought to enforce would be illegal and unenforceable under Rule 21F-17, no First Amendment right was abridged.

Implications

This decision provides for a broad reach of Rule 21F-17.  Companies should ensure that their internal investigation protocols and settlement agreements include language making clear that whistleblowers may report concerns to the SEC.

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