Tuesday, May 10, 2011

Federal Court Rules that Private Invocation of Dodd-Frank Anti-Retaliation Whistleblower Section Requires Providing Information to SEC

In a case of first impression, a federal court ruled that the anti-retaliation whistleblower protection provisions of the Dodd-Frank Act require a prospective whistleblower to show that he either provided the information to the SEC, or that his disclosures fell specific categories listed in the whistleblower provisions. Further, even if the prospective whistleblower did not provide the information directly to the SEC, he could still be covered by Section 922 of Dodd-Frank if he gave information to outside counsel hired by the company’s independent directors to investigate the allegation and who he alleges reported it to the SEC. (Egan v. TradingScreen, Inc. et al., (SD NY), 10 Civ 8202 (LBS), May 4, 2011).

The prospective whistleblower alleged that the company CEO was diverting corporate assets to another company which he solely owned. The employee reported this behavior to the company president, but not the SEC, who passed the information to the independent directors who, in turn, hired outside counsel to conduct an internal investigation, which resulted in a report confirming the allegations. After being told to resign, the CEO gained control of the board and thereby prevented the independent directors from forcing his resignation. He then fired the prospective whistleblower and denied him the company’s standard severance package. The prospective whistleblower brought suit in federal court under the anti-retaliation provisions of Section 922 of Dodd-Frank, which grants a private right of action.

Section 922’s anti-retaliation provisions explicitly prohibit retaliation against whistleblowers who provide information and testimony to the SEC, noted the court, evincing a legislative intent to encourage whistleblowers reporting such violations to report to the SEC. However, there are narrow exceptions to the SEC reporting condition for disclosures protected by Section 806 of Sarbanes-Oxley, for disclosures that are required or protected under any other law, rule, or regulation subject to SEC jurisdiction, and a federal criminal code provision prohibiting interference with the lawful employment or livelihood of any person who provides truthful information to a law enforcement officer relating to the commission of federal offenses.

In this case, said the court, the whistleblower could not fit into any of the exceptions to the rule that information must be reported to the SEC. The disclosures by the prospective whistleblower could not be protected by Section 806 of Sarbanes-Oxley because the whistleblower provisions of Section 806 apply only to publicly traded companies and his was a private company. The court also rejected the claim that the prospective whistleblower’s reporting of FINRA rule violations entitled him to protection under the exception for disclosures that are required or protected under any other law, rule, or regulation subject to SEC jurisdiction. While the Dodd-Frank Act protects whistleblowers who fulfill an existing duty to disclose, noted the court, it does not protect those who report violations of SEC laws or regulations that do not impose such a duty. The two FINRA rules cited by the employee did not impose a duty to disclose. Rule 2010 contains only a general obligation to observe high standards of commercial honor and just and equitable principles of trade, and Rule 3270 only requires an employee of a FINRA member firm receiving employment or compensation from any business activity outside the scope of the relationship with his or her member firm to provide prior written notice to the member firm.

Since the prospective whistleblower could not avail himself of an exception to the SEC reporting condition, he would have had to report the information to the SEC either directly or jointly. And the court found that he adequately alleged that he acted jointly with the outside counsel hired by the independent directors in an effort to provide information to the SEC regarding the CEO’s alleged misconduct. But this finding did not assume that he had adequately pleaded the allegation that counsel provided and the SEC actually received this information. Thus, the court gave him a chance to amend his pleadings to support his knowledge, heretofore on information and belief, that the conduct was reported to the SEC, with such amendment being effective only if it supports knowledge of actual transmission to the SEC.

The court examined the SEC’s proposed regulations implementing Section 922 and found that the Commission has proposed no interpretation of the statute requiring deference from the court in this case. The SEC’s definition of the term “whistleblower” does not clarify the question of whether direct personal reporting is required. Other portions of the proposed regulations assume that a whistleblower has reported directly to the SEC, noted the court, but these are not relevant here because they interpret the bounty award provisions of Section 922, not the separate anti-retaliation provisions at issue in this case.

Obviously, a whistleblower must directly report to the SEC to receive a bounty award from the SEC, said the court, but the agency has not extended this prerequisite to the private right of action in the anti-retaliation provisions. On the contrary, the SEC explicitly excludes the anti-retaliation provisions from the proposals and seeks comment on whether it should promulgate rules implementing the anti-retaliation provisions.

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