SEC Releases FY 2019 Whistleblower Program Annual Report

On November 15, 2019, the SEC published its annual report to Congress covering the agency’s whistleblower program.

The report, which covers the period of October 1, 2018 through September 30, 2019, was prepared by the SEC’s Office of the Whistleblower (“OWB”) to summarize its whistleblower bounty program, report on recent statistical trends, and revisit key amendments to the SEC’s Dodd-Frank regulations that were first introduced in June 2018.

Whistleblower Bounty Program

The statistics provided in the SEC’s report suggest that the whistleblower program slightly contracted in FY 2019, compared to the previous year.  OWB received a total of 5,212 whistleblower tips in FY 2019, 70 fewer than were received in the record-setting FY 2018.  This total still represents an approximately 74% increase in tips received since the SEC started tracking statistics for the whistleblower bounty initiative in 2012.

The SEC reports that in FY 2019 approximately $60 million was distributed to 8 individuals whose initial tips and subsequent cooperation aided in the execution of successful enforcement actions.  The SEC’s March 2019 $50 million award to two whistleblowers included a $37 million bounty to one of the individuals – the SEC’s third largest single award since the program’s inception.

For FY 2019, the SEC reports that the most common activities reported by whistleblowers related to corporate disclosures and financials (21%), offering fraud (13%) and manipulation (10%).

Proposed Rule Amendments

The SEC proposed amendments to its regulations to cope with the volume of tips it receives on an annual basis.  Specifically, these amendments (the full text of which can be found here) seek to bar whistleblowers who repeatedly make frivolous claims and afford OWB additional discretion in making bounty determinations.  Moving into FY 2020, the SEC will continue to consider the public comments received on these proposed amendments, which were originally introduced in June 2018.  The SEC expects to adopt these proposed rules sometime in the coming year.

SEC Files Suit Against Company For Allegedly Impeding Investors From Blowing the Whistle

On November 4, 2019, the SEC announced that it had filed an amended complaint against online auction portal Collectors Café and CEO Mykalai Kontilai, alleging Kontilai tried to prevent investors from communicating with the SEC in violation of Rule 21F-17.  The SEC previously charged Collectors Café and Kontilai with fraudulently raising $23 million by making false statements to investors and instead misappropriating more than $6.1 million.

In the amended complaint, the SEC alleged that Collectors Café and Kontilai twice made attempts to stifle investors when those investors raised questions or concerns about the company’s conduct.  In particular, the amended complaint alleged that when an investor questioned Kontilai in 2015, Kontilai arranged for the investors’ shares to be repurchased in an agreement that required a promise that the investor would not contact government or administrative agencies for purposes of starting an investigation into the company.  The amended complaint further alleged that in 2017, two investors accused Kontilai of making material misrepresentations and omissions and brought a lawsuit to secure a return on their investment.  According to the complaint allegations, Collectors Café, Kontilai, and the two investors later entered into a settlement agreement that included an agreement not to communicate with any regulatory agencies, specifically identifying the SEC.  The SEC further alleged that once the investors spoke with the SEC, Collectors Café and Kontilai filed a lawsuit against them for violating the restriction in the settlement agreement.

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.  Unlike the rule in Dodd-Frank prohibiting whistleblower retaliation, this protection is not restricted to the employer-employee context, although it has been enforced against employers in the past.  The rule first became effective in 2011 and the SEC brought its first action under the rule in 2015 (we reported on that action here).  There has not been much activity around this rule in the last few years; a handful of enforcement actions were brought in 2016 and one was brought in early 2017.

This action appears to represent the SEC’s first public attempt to enforce Rule 21F-17 during the Trump administration.

ARB: SOX Whistleblower Provision Does Not Apply Extraterritorially

In a pair of recently issued decisions, the Department of Labor’s Administrative Review Board (ARB) held that Sarbanes Oxley’s anti-retaliation provision does not apply extraterritorially.  Hu v. PTC, Inc., ARB Case No. 2017-0068 (Sept. 18, 2019); Perez v. Citigroup, Inc., ARB Case No. 2017-0031 (Sept. 30, 2019).

Hu Decision

In Hu, the complainant worked entirely in China for a foreign subsidiary of a U.S. company.  He claimed that his employment was terminated in violation of SOX after he reported alleged misconduct relating to the U.S. parent company’s financial statements.  The sole issue before the ARB was whether SOX’s anti-retaliation provision (Section 806) covered the complainant’s claim of retaliatory discharge in China.  The ARB held that it did not, following the two-step framework for analyzing extraterritoriality set forth by the Supreme Court in Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010).

At the first step of the Morrison analysis—assessing whether the statute at issue extends beyond the U.S.—the ARB held that Section 806 is not extraterritorial, observing that there is no indication that Congress intended for it to apply extraterritorially.

At the second step of the Morrison analysis—evaluating the primary focus of the statute and where the activity comprising that focus occurred—the ARB held that Section 806’s primary focus is on retaliatory employment actions.  The ARB reasoned that Section 806’s focus on the terms and conditions of employment is distinct from the overarching purpose of SOX as a whole (to protect markets) and, therefore, the location of the employee’s principal workplace is the key factor to consider when deciding whether the employee is seeking to invoke Section 806 extraterritorially.  The ARB rejected the complainant’s argument that his Section 806 claim was domestic because his reports allegedly affected the U.S. securities market and because the termination decision may have been made in the U.S.  Ultimately, the Board affirmed the dismissal of the whistleblower claim because the complainant’s principal place of work was in China.

Perez Decision

In Perez, the complainant worked solely in Mexico for a subsidiary of a U.S. corporation.  He alleged that he was retaliated against for reporting concerns about activity in a U.S.-based account.  Relying heavily on its decision in Hu, the ARB again held that Section 806 did not apply extraterritorially and affirmed the ALJ’s dismissal of the whistleblower claim because the complainant exclusively worked in Mexico, and not the U.S.

Implications

Prior to the Hu and Perez decisions, the ARB in Blanchard v. Exelis Systems Corp./Vectrus Systems Corp., ARB Case No. 15-031 (August 29, 2017) (which we previously blogged about here) signaled in dicta that Section 806 could potentially apply extraterritorially.  The Hu and Perez decisions seemingly close that door and harmonize the Board’s position with numerous court decisions (see here and here) rejecting the extraterritorial application of SOX’s anti-retaliation provision.

U.S. Senate Introduces Bill to Extend Dodd-Frank Whistleblower Protections

On September 25, 2019, a bipartisan group of U.S. Senators introduced the Whistleblower Programs Improvement Act (the “Act”), which would extend anti-retaliation protections under the Dodd-Frank Act to internal complaints.  The Act mirrors a bill introduced in the House of Representatives earlier this year in direct response to the U.S. Supreme Court’s holding in Digital Realty Trust, Inc. v. Somers, 138 S. Ct. 767 (2018), in which the Court unanimously held that Dodd-Frank’s anti-retaliation provision only applied to individuals who provide information regarding a violation of securities law to the SEC (we reported on the House bill here).

The SEC reported that in 2018, the vast majority of employees or former employees who received awards pursuant to whistleblower protections initially raised their concerns internally with their employer.  Under the Supreme Court’s current definition of a whistleblower, employees are not protected from retaliation under Dodd-Frank unless they provide information to the SEC.  The Act would expand the anti-retaliation protections to include employees who report concerns about violations of securities laws internally to their employers before or instead of reporting to the SEC.  The Act also aims to improve how quickly successful whistleblowers could receive a monetary award.  If passed, the Act would require the SEC to decide within one year whether the whistleblower will receive a monetary award.

We will continue to monitor this legislation and keep our readers posted.

Second Circuit Holds Dodd-Frank Whistleblower Retaliation Claims are Arbitrable

On September 19, 2019, the Second Circuit affirmed a New York District Court’s order compelling arbitration of a whistleblower retaliation claim under the Dodd-Frank Act.  Daly v. Citigroup Inc., et al., No. 18-665.

Background

Plaintiff worked in the Private Bank Division of the bank.  She allegedly complained to bank attorneys and human resources employees that her supervisor repeatedly demanded that she disclose material non-public information so that he could pass that information along to his favored clients.  Plaintiff’s employment was subsequently terminated.

Following her termination, Plaintiff filed a complaint in the Southern District of New York alleging, inter alia, several whistleblower retaliation claims, including claims under SOX and Dodd-Frank.  The bank then filed a motion to compel arbitration and to dismiss Plaintiff’s claims.  The bank argued that with the exception of her SOX claim, her claims were all subject to an employment agreement Plaintiff had signed containing an arbitration provision.  The bank further contended that Plaintiff’s SOX claim should be dismissed because she had failed to exhaust her administrative remedies.  The district court granted the bank’s motion in its entirety and Plaintiff appealed to the Second Circuit.

Ruling

The Second Circuit affirmed the district court’s ruling.  It noted that while district courts in the Second Circuit had diverged on whether Dodd-Frank whistleblower retaliation claims are arbitrable, it would join the Third Circuit, the only federal circuit to have previously ruled on this issue, in holding that such claims are arbitrable.  See Khazin v. TD Ameritrade Holding Corp., 773 F.3d 488, 495 (3d Cir. 2014) (our post on that ruling is here).  The court first explained that in contrast to the SOX whistleblower retaliation provision, which contains an express anti-arbitration provision, nothing in Dodd-Frank’s text suggests that claims arising under that statute are non-arbitrable, which is a strong indication of Congress’s intent not to preclude Dodd-Frank whistleblower claims from arbitration.  The court also found it notable that the language of the SOX anti-arbitration provision restricted its applicability to disputes “arising under this section” (i.e., SOX).  The Dodd-Frank whistleblower retaliation provision, by contrast, is not located in the same section, or even the same title, of the federal code as SOX.  Finally, the court explained that even if the SOX anti-arbitration provision was ambiguous, it still could not infer that Congress intended to extend its application to Dodd-Frank because “[d]espite some surface similarities, the whistleblower retaliation  provisions of [SOX] and Dodd-Frank diverge significantly in their prohibited conduct, statute of limitations, and remedies.”  It concluded that “Plaintiff’s SOX whistleblower claim cannot save her otherwise arbitrable claims from their fate.”

Implications

This is a valuable win for employers facing Dodd-Frank whistleblower retaliation claims because the only federal appellate courts to address the issue have now both concluded that mandatory arbitration clauses are enforceable with respect to whistleblower retaliation claims arising under the Dodd-Frank Act.

SDNY Grants Motion to Dismiss SOX Retaliation Claim

On September 18, 2019, the U.S. District Court for the Southern District of New York granted a defendant-employer’s motion to dismiss a SOX whistleblower retaliation claim, finding that the plaintiff failed to adequately plead protected activity.  Tonra v. Kadmon Holdings, Inc., No. 18-cv-9028.

Background

The defendant-employer is a publicly traded biopharmaceutical company that develops and produces several drugs.  Around August 2011, Plaintiff was hired as the company’s Vice President of Preclinical Pharmacology.  About six years after his hiring, Plaintiff met with Defendant’s upper management to present preliminary animal testing results for a new drug that was designed to treat a rare kidney disease.  Plaintiff’s study allegedly showed that the drug had proven ineffective and potentially harmful.  Two months later, Plaintiff received the final test results for the drug, which allegedly confirmed the effects Plaintiff had forecasted.  Plaintiff allegedly proceeded to inform company representatives present at a regulatory compliance meeting that Defendant was required to report the negative test results to the U.S. Food and Drug Administration within the coming months.  Defendant terminated Plaintiff’s employment one day later.  Plaintiff filed suit in federal court claiming, inter alia, that he was retaliated against in violation of SOX for having drawn attention to Defendant’s alleged reporting obligations.

Ruling

Defendant moved to dismiss the SOX claim pursuant to Federal Rule of Civil Procedure 12(b)(6), arguing that the complaint failed to adequately plead protected activity.  The court granted the motion, finding the complaint did not plausibly allege facts that would support a reasonable belief that Defendant was at risk of violating any of the enumerated securities laws.  In particular, the court noted that Plaintiff’s allegations did not demonstrate a subjectively and objectively reasonable belief that the information at issue would be material to investors.  According to the court, for information to be “material,” it must “significantly alter the ‘total mix’ of information made available” to potential stockholders.  Additionally, the fact that Plaintiff recommended that the disclosures be made within multiple months after the information was first conveyed to management showed Plaintiff did not believe a securities violation to be imminent.

Implications

This decision favors defendant employers in cases where a plaintiff does not show that the complained-of violation would be material.

Ill. Federal Court Grants Summary Judgment on Whistleblower Retaliation Claims

On September 27, 2019, the U.S. District Court for the Northern District of Illinois granted a defendant-employer summary judgment on a whistleblower retaliation claim under the Illinois Whistleblower Act (“IWA”) and on a common law retaliatory discharge claim, holding that Plaintiff failed to establish that he suffered an adverse employment action under the IWA and that the retaliatory discharge claim failed as a matter of law because he could not show that his employment was terminated.  Arias v. Citgo Petroleum Corp., Case No. 17-cv-08897 (Wood, J.)

Background

Plaintiff worked as a Safety Coordinator for Citgo Petroleum Corporation (“Citgo”) at its refinery in Lemont, Illinois.  In 2011, Plaintiff alleged he became aware that Citgo was operating a Fluid Catalytic Cracking (“FCC”) unit with several reactor leaks, which periodically suffered emergency shutdowns due to the leaks.  He allegedly informed a government investigator of his safety concerns and asserted that he reasonably believed Citgo’s alleged failure to properly repair the FCC unit was a violation of certain OSHA standards.  Plaintiff also allegedly was temporarily re-assigned to a night shift position and issued a written warning for certain alleged policy violations following his report to the investigator.  Plaintiff allegedly resigned from his employment to avoid discipline for alleged misconduct at a company event and filed suit, asserting a claim under the IWA and a claim of common law retaliatory discharge.

Ruling

The court granted summary judgment in Citgo’s favor.  First, the court concluded that Plaintiff’s IWA retaliation claim failed as a matter of law because Plaintiff could not establish that he suffered an adverse employment action.  According to the court, Plaintiff failed to proffer admissible evidence to suggest temporary re-assignment to the night shift was punitive in nature, particularly because approximately half of its employees had been assigned to the night shift at that time due to business needs.  The court also ruled that the mere issuance of a warning letter for Plaintiff’s alleged policy violations was not the kind of materially adverse employment actions that a plaintiff is required to show to sustain an IWA retaliation claim.

Second, the Court held that Plaintiff’s common law retaliatory discharge claim failed as a matter of law because it was undisputed that Plaintiff had resigned from his employment with Citgo and the Illinois common law tort of retaliatory discharge requires a plaintiff to show that he or she was actually discharged by the employer.

Implications

This decision is a valuable win for employers faced with IWA and common law whistleblower retaliation claims that are vulnerable to summary judgement on grounds that the employee did not suffer an adverse employment action.

District of Rhode Island Dismisses In-House Attorney’s SOX Whistleblower Claim for Lack of Protected Activity

On July 19, 2019, the U.S. District Court for the District of Rhode Island granted an employer’s motion to dismiss a SOX whistleblower claim, holding that the Plaintiff—an in-house attorney—failed to allege sufficient facts to show he had an objectively reasonable belief that fraud had occurred.  Colesanti v. Dickinson, No. 18-491.

Background

Plaintiff was an in-house patent and trademark attorney, hired to advise the company regarding intellectual property rights.  Between 2013 and 2016, the company allegedly asked Plaintiff four times to review royalty payments to a French physician patent holder pursuant to a patent license and advise when those payments no longer needed to be made.  On April 16, 2014, in response to one of these requests, Plaintiff provided the expiration date of the patent, but did not calculate the date on which the company could cease making royalty payments.  On February 25, 2016, Plaintiff informed the company that the obligation to pay royalties ended when the royalty agreement expired on March 1, 2014.  Upon further review, the company allegedly discovered that this alleged oversight caused it to pay between $800,000 and $1,000,000 in overpayments.  The company ultimately decided to permit the physician to keep the overpayments.

Plaintiff alleged that he engaged in his first act of protected whistleblowing in February 2016, when he informed his superiors of the overpayment.  After discovering that these overpayments were made, the company hired an accounting firm to conduct an independent internal audit.  With respect to what Plaintiff alleged to be his second act of protected whistleblowing, Plaintiff subsequently emailed several members of the company’s senior management, including the general counsel, indicating that his original analysis of the royalty agreement was accurate and that the company had “misconstrued the termination date of the royalty payments.”  In these emails, Plaintiff also alleged that the company’s contract management system had “become a significant risk to the business” and contributed to the oversight.  For his third act of alleged whistleblowing, Plaintiff alleged that around late November 2016, he discussed the royalty overpayments with the company’s compliance officer, and when the compliance officer indicated that he was not aware of any issues relating to royalty overpayments, Plaintiff sent him a copy of the auditor’s draft report.  Plaintiff’s employment was terminated shortly thereafter.

Plaintiff filed suit alleging his employment was terminated in retaliation for the foregoing alleged whistleblowing in violation of SOX.  In support, he asserted that the company’s “failure to accurately and properly keep track of or pay royalties that were due and owing resulted in a material misrepresentation of such royalties to [the Company’s] shareholders and in any Securities and Exchange Commission filings.”

Ruling

The court dismissed Plaintiff’s complaint pursuant to Rule 12(b)(6).  At the outset, the court noted that the First Circuit has not yet addressed whether fraud allegations in a SOX whistleblower claim are subject to the heightened pleading standard under Federal Rule of Civil Procedure 9(b), but held that because SOX protects an employee’s “reasonable subjective belief of fraud, and does not require proof of actual fraud,” it would not apply the requirements of Rule 9(b).

The court then noted that courts routinely hold that activity is not protected by SOX “where it involves disclosure of conduct that is innocuous or trivial, or where it bears only a tenuous relationship to shareholder interests, even if the plaintiff reasonably believed the activity to be a violation of federal law dealing with fraud.”  The court also noted that claims grounded in securities fraud have been rejected where the alleged fraud “does not rise to the level that would be material to the shareholders.”

The court ultimately held that Plaintiff’s complaint fell short of satisfying the pleading requirements under Twombly and Iqbal because a “plaintiff’s particular educational background and sophistication [is] relevant to the subjective component” and the complaint contained no facts that established or permitted an inference “that a person with [Plaintiff’s] legal training and experience could reasonably believe that the conduct he disclosed to his superiors involved ‘deceit or misrepresentation’ that approximates or implicates fraud or that the conduct is otherwise tethered to wrongdoing connected to ‘the fraud-prevention purposes of SOX.’”

Implications

This decision reaffirms the principle that sophisticated employees like in-house attorneys will be held to a higher standard in alleging that they had an objectively reasonable belief that fraud had occurred in light of their training and experience.

ARB Affirms Dismissal of SOX Whistleblower Claim Against Non-Public Companies

The ARB recently affirmed the dismissal of a whistleblower retaliation claim under Section 806 of SOX, holding an employer is not a “contractor” covered by SOX simply because it was a party to a contract with a publicly traded company.  Griffo v. Book Dog Books, LLC, Robert William Holdings, LLC & Robert William Mgmt., LLC, ARB Case No. 2018-0029 (May 2, 2019).

Background

Respondents are private companies in the business of selling and renting text books.  They entered into contracts to sell and rent books through a publicly traded retailer.  They also entered into contracts to maintain accounts and a line of credit with a publicly traded financial institution.  Complainant was the CFO of Respondent Book Dogs Books.  He allegedly complained about financial and inventory inconsistencies at Book Dog Books and, shortly thereafter, his employment was terminated.  He filed a complaint with OSHA claiming his discharge constituted retaliation in violation of SOX’s whistleblower protection provision.  After OSHA dismissed his complaint, an ALJ granted Respondents’ motion for summary judgment, holding they were not covered employers under SOX because they were not publicly traded and Complainant did not provide any services to a public company.  Complainant appealed to the ARB.

Ruling

The ARB affirmed the ALJ’s decision, finding Respondents’ relationships with the two public companies were insufficient to render them covered “contractors” under SOX.  The ARB explained that, following the U.S. Supreme Court’s decision in Lawson v. FMR (2014) (discussed here)—which extended SOX’s whistleblower protection to employees of a publicly traded company’s contractors and subcontractors—courts considering the meaning of “contractor” under SOX have held that an employer is not a covered “contractor” simply because it has entered into a contract with a publicly traded company.  The ARB ruled that “at a minimum, a ‘contractor’ under [SOX’s whistleblower provision] must actually perform a service for a publicly traded company.”  The ARB concluded that since Respondents were only customers of the public companies, and did not provide any services to them, they were not covered by SOX.

Implications

This decision reflects the ARB’s recognition of basic and necessary limitations on the U.S. Supreme Court’s decision in Lawson.

Eastern District of Pennsylvania Grants Summary Judgment on SOX Claim

On July 18, 2019, the U.S. District Court for the Eastern District of Pennsylvania granted a defendant-employer’s motion for summary judgment on a SOX whistleblower retaliation claim, holding that the Plaintiff did not have an objectively reasonable belief that the defendant violated any SEC regulation.  Reilly v. Glaxosmithkline, LLC, No. 17-cv-2045.

Background

Plaintiff worked in the company’s Information Technology Department as a member of the team responsible for the AS/400 computer operating system, which hosts manufacturing and financial applications for portions of the company’s business.  In late 2011, Plaintiff noticed that the company’s computer servers were experiencing performance instability.  Plaintiff attributed the server instability to a co-worker’s decision to implement uncapped processors on the company’s AS/400 system (uncapping processors allows a server to use available computer capacity from another server, which can increase exposure to cyber threats).  From 2012 until 2015, Plaintiff repeatedly voiced concerns to his supervisor that security risks associated with the server’s performance problems could implicate a SOX audit.

Plaintiff ultimately escalated his complaints up the company’s entire chain of command, even lodging a complaint with the CEO.  In his complaints, Plaintiff expressed his belief that, among other things, the company’s 2013 report to the SEC omitted reference to any of the performance and security concerns he raised regarding server performance.  In response, the company launched an internal investigation which found Plaintiff’s complaints unsubstantiated.

In March 2014, the company announced that all but two of the AS/400 service team positions would be outsourced by September 2014.  Although the company invited Plaintiff to apply for one of the two positions, Plaintiff opted not to apply based on language in a memorandum he received during the internal investigation which stated that the company would “get back to [him] following the outcome of the investigation regarding [his] employment status.”  Thereafter, the effective date of termination was repeatedly postponed until Plaintiff received the last notice on April 8, 2015, notifying him that his position was being eliminated.  June 30, 2015, was the last day of Plaintiff’s employment.  Plaintiff filed suit shortly after his termination alleging that he was retaliated against in violation of SOX for reporting his concerns.

Ruling

Defendant moved for summary judgment arguing that: (i) the Plaintiff’s Complaint was untimely because it was not filed within 180 days from the date Plaintiff first received notice of his termination; and (ii) Plaintiff did not have an objectively reasonable belief that the company’s conduct violated the SEC rules covered by SOX.  Although Defendant argued that the statute of limitations began running from March 2014, the date that Plaintiff received his first notice that his position would be eliminated, the Court held that Plaintiff had cast doubt as to whether he received sufficient notice of his termination.  Specifically, the Court reasoned that the language in the memorandum Plaintiff received, in conjunction with the postponement of his termination several times, was sufficient to constitute “mixed official signals” regarding whether his termination would take effect.  Accordingly, because the statute of limitations did not begin to run until Plaintiff received his final, definitive notice on April 8, 2015, the statute of limitations did not bar the SOX claim.

However, the Court sided with Defendants on the question of whether Plaintiff had an objectively reasonable belief that the company violated SOX.  The Court, citing the company’s report to the SEC, held that the company sufficiently disclosed the risks associated with the poor performance its computer systems experienced.  The company’s report expressly noted, among other things, that the failure to “adequately protect critical and sensitive systems and information . . . could materially and adversely affect our financial results.”  Based on this, the Court held that no reasonable person in Plaintiff’s position, with his training and experience, could have believed that Defendant’s conduct violated SOX.

Implications

This decision stresses the need for a purported whistleblower to hold an objectively reasonable belief of a violation of one of the provisions enumerated in SOX and reiterates the ability of employers to escape liability based on the application of the “reasonable relief” standard.

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