In September 2024, the Securities and Exchange Commission (“SEC” or “the Commission”) resolved three separate actions against corporate entities for reaching agreements with employees, potential employees, and clients that, according to the SEC, impeded an individual’s ability to report violations of the securities laws to the Commission in violation of Rule 21F-17(a) (the “Rule”). This trio of resolutions is the latest in a series of actions focused on protecting whistleblowers and follows the SEC’s first-ever application of the Rule in January 2024 to an agreement reached with a customer or client,[1] rather than an employee, and the first-ever enforcement action by the Commodities Futures Trading Commission (“CFTC”) for alleged violations of its similar whistleblower rules. SeeCFTC Resolves First Action for Impeding Whistleblowers Over Objections of Two Commissioners.
September 24, 2024 SEC Action Against Investment Advisor
In its most recent action, the SEC fined a Florida-based investment advisor $500,000 for using nondisclosure agreements that allegedly impeded whistleblowers from reporting to the SEC in violation of Rule 21F-17(a), which prohibits an issuer from taking “any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement[.]”
According to the SEC, the investment advisor requested that applicants for employment sign a non-disclosure agreement (“NDA”) that required the potential employee to keep the company’s information confidential and specifically prohibited disclosure “to any person (including any governmental agency, authority or official or any third party) the fact that Confidential Information has been made available” to the potential employee. “Confidential Information” included all documents and information received by the candidate relating to the Company. A candidate was permitted to disclose Confidential Information in response to a subpoena or other legal process, but the SEC noted that the applicant was required by the NDA to promptly notify and consult with the investment advisor about resisting or narrowing the request and potentially assist the investment advisor in seeking a protective order. Another provision allegedly included in the NDAs required candidates to certify their compliance with the terms of the NDA when requested by the company. The SEC alleged that the investment advisor entered into such NDAs with 12 potential employees.
The SEC alleged further that if an individual was offered employment by the investment advisor the individual subsequently signed a separate confidentiality agreement that included appropriate carveouts permitting employees to report possible securities law violations to the Commission. The SEC noted the conflict between the pre-employment agreements and the post-employment agreements, and also the investment advisor’s Whistleblower Policy, contained in its compliance manual, which included carveouts for SEC reporting. The SEC alleged that these conflicting materials created confusion and “raised an impediment to whistleblowing.”
In the same September 24 order, the SEC also criticized a severance agreement the investment advisor entered into with an employee who filed an internal complaint and threatened to report to the SEC. The severance agreement included a carveout allowing the employee to seek a whistleblower award from the SEC; however, the agreements required the employee to represent that he had not reported allegations to the SEC and was unaware of any factual basis to report an alleged violation of law to the SEC. The SEC claimed that it violated Rule 21F-17(a) to require the employee to disclaim his allegations as part of the settlement agreement.
Additional September 2024 Actions Involving Rule 21F-17(a)
On September 9, 2024, the Commission announced resolutions with seven public companies who utilized employment agreements that the Commission alleged similarly impeded reporting by whistleblowers. The agreements cited by the SEC all allegedly prohibited employees from receiving monetary benefits as a result of whistleblowing activity. Two of the agreements cited in this resolution, originating from a software company and a credit reporting agency, were consulting agreements that required consultants to keep company information confidential unless disclosure was “required by law,” but only if the consultant first notified the company of the intended disclosure.
Finally, on September 4, 2024, the SEC settled allegations with a broker dealer and two affiliated investment advisers for violating the Rule, resulting in the three entities agreeing to pay combined civil penalties of $240,000. In this action, the SEC alleged the agreements contained provisions that “created the reasonable impression that signing clients were prohibited from affirmatively reporting potential securities law violations to the Commission.” Despite containing confidentiality carveouts, the Commission still found these agreements to be in violation as they “expressly contravened Rule 21F-17(a)” by requiring clients to attest that they had not reported the underlying matter to any self-regulatory securities commission or authority “and shall forever refrain from doing so…”
The volume of enforcement activity by the SEC this year related to alleged violations of Rule 21F-17(a), coupled with the similar action by the CFTC noted above and the announcement by the Department of Justice of its new whistleblower incentive program, make clear that companies may incur risk in executing even a relatively small number of confidentiality agreements with applicants for employment, employees, clients, customers, and the like. A proactive review of such agreements and standard NDAs is likely prudent in this enforcement environment.
[1] SEC, J.P. Morgan to Pay $18 Million for Violating Whistleblower Protection Rule (Jan. 16, 2024), https://www.sec.gov/news/press-release/2024-7.
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