Made for the U.S.A Only: Second Circuit Holds That the Dodd-Frank Act’s Antiretaliation Provision Applies Only Domestically

According to the SEC, in fiscal year 2013, foreign whistleblowers accounted for 404 of the 3,238 whistleblower reports received by the SEC (nearly 12%). Recently, the Second Circuit Court of Appeals may have significantly undermined incentives for foreign tipsters to report potential violations to the SEC.

On August 14, 2014, the Second Circuit held that the Dodd-Frank Act’s whistleblower antiretaliation provision (15 U.S.C. § 78u-6(h)(1)) does not apply “extraterritorially” and thus did not cover a foreign tipster’s allegation that he had been terminated for reporting potential Foreign Corrupt Practices Act (FCPA) violations to his employer. Liu v. Siemens AG, Docket No. 13-cv-4385 (2d Cir. Aug. 14, 2014). The antiretaliation provision of the Dodd-Frank Act, which gives employees easy access to U.S. district courts, prohibits employers from retaliating against whistleblowers employees who make certain protected disclosures. The provision incentivizes reporting and facilitates the SEC’s enforcement of securities law violations.

The plaintiff Liu, a citizen and resident of Taiwan, alleged that he was fired from a Siemens Chinese subsidiary after he reported potential FCPA violations and other misconduct to his superiors. None of the alleged events related to Liu’s firing occurred in the United States. Nevertheless, Liu filed suit in the United States District Court of the Southern District of New York claiming that Siemens had violated the antiretaliation provision of the Dodd-Frank Act.

The Second Circuit affirmed the District Court’s order dismissing the complaint with prejudice and held that the Dodd-Frank Act’s whistleblower antiretaliation provision does not apply “extraterritorially.” The Second Circuit reasoned that the Dodd-Frank Act, like any statute, is presumed, in the “absence of clear congressional intent to the contrary, to apply only domestically.” Id., slip op. at 2. And the Second Circuit found “absolutely nothing in the text of the [antiretaliation] provision … or in the legislative history of the Dodd-Frank Act, that suggests that Congress intended the antiretaliation provision to regulate relationships between foreign employers and their foreign employees working outside the United States.” Id. at 12.

Because the antiretaliation provision did not extent extraterritorially, the court found that it did not cover Liu’s allegations since all events related to his termination¾the alleged misconduct, Liu’s discovery of the misconduct, and Liu’s termination¾occurred outside the United States. As such, the District Court correctly dismissed Liu’s complaint. The Second Circuit’s decision will likely impact the willingness of potential whistleblowers outside the United States to report misconduct to the SEC. Moreover, the lack of protection afforded to foreign-based whistleblower may adversely effect on the SEC’s FCPA investigations which usually involve misconduct that occurs outside of the United States. There is nothing in the Second Circuit’s decision, however, to indicate that foreign-based whistleblowers are prohibited from receiving payment under the Dodd-Frank bounty program.

While the ruling clarifies the Dodd-Frank Act’s geographical reach, it did not resolve another outstanding issue, namely whether or not Dodd-Frank applies to reports made internally, as opposed to reports made directly to the SEC.

SEC Gives Insider Trader a $30,000 Slap On The Wrist

On April 23, 2014, the SEC agreed to settle insider trading charges against Chris Choi, a former accounting manager at Nvidia Corporation who allegedly set into motion a trading scheme that reaped nearly $16.5 million in illicit profits and avoided losses. Given the amount of the purported loss, the fact that Choi was the original “tipper,” and the fact that nearly every other member of the scheme has been indicted, the Choi settlement seems like nothing more than a slap on the wrist: a $30,000 penalty without admitting to the insider trading allegations. The Choi settlement also represents a notable departure from the SEC’s recent insider trading fines and penalties against “tippers.”

According to the SEC’s complaint, on at least three occasions during 2009 and 2010, Choi tipped material nonpublic information about Nvidia’s quarterly earnings to his friend Hyung Lim. SEC v. Choi, No. 14-cv-2879 (S.D.N.Y. Apr. 23, 2014). Lim passed the information along to Danny Kuo, a hedge fund manager at Whittier Trust Company, who passed the information to his boss and to a group of managers at three other hedge funds.

Kuo and the other tippee-hedge fund managers used Choi’s information to trade in advance of Nvidia earnings announcements and reaped trading gains and/or avoided losses of approximately $16.5 million.

The SEC alleged that Choi was liable for this trading because he “indirectly caused trades in Nvidia securities that were executed” by the hedge funds and “did so with the expectation of receiving a benefit and/or to confer a financial benefit on Lim.” The SEC charged him with violations of Section 10(b) of the Exchange Act (and Rule 10b-5) and Section 17(a) of the Securities Act.

Choi, without admitting or denying the SEC’s allegations, agreed to settle the matter and to the entry of an order: (1) permanently enjoining him from violations of Section 10(b), Rule 10b-5, and Section 17(a); (2) barring him from serving as an officer or director of certain issuers of securities for five years; and (3) ordering him to pay a $30,000 penalty.

Not only is Choi’s settlement a significant departure from the resolutions obtained by his “downstream” tippees, a number of whom were convicted on criminal charges of insider trading, it is a departure from recent SEC “tipper” settlements. For example:

•   A former executive at a Silicon Valley technology company, who allegedly tipped convicted hedge fund manager Raj Rajaratnam with nonpublic information that allowed the Galleon hedge fund to make nearly $1 million profit, agreed to pay more than $1.75m to settle the SEC’s insider trading charges. See SEC Charges Silicon Valley Executive for Role in Galleon Insider Trading Scheme.

•   A physician who served as the chairman of the safety monitoring committee overseeing a clinical trial for an Alzheimer’s drug being jointly developed by two pharmaceutical companies, who allegedly tipped a hedge fund manager with safety data and eventually data about negative results in the trial approximately two weeks before they became public, which allowed the hedge fund to make nearly $276 million in gains, agreed to pay more than $234,000 in disgorgement and prejudgment interest to settle the SEC’s insider trading charges. The physician’s penalty may have been mitigated by the fact that he cooperated with and received a non-prosecution agreement from the U.S. Attorney’s Office in a parallel criminal action. See SEC Charges Hedge Fund Firm CR Intrinsic and Two Others in $276 Million Insider Trading Scheme Involving Alzheimer’s Drug.

•   A former executive director of business development at a pharmaceutical company located in New Jersey, who allegedly tipped a hedge fund manager (a friend and former business school classmate) with material nonpublic information regarding the company’s anticipated acquisition that allowed the manager to make nearly $14 million in gains, escaped criminal prosecution and agreed to pay a $50,000 penalty to settle the SEC’s insider trading charges. See SEC Charges Pharmaceutical Company Insider and Former Hedge Fund Manager for Insider Trading, Resulting in Approximately $14 Million in Profits.

There are a few reasons the SEC may have settled with Choi for such a small civil penalty. First, the SEC recently settled with Lim, the second chain in the insider trading scheme. Lim tentatively agreed to disgorgement or to pay a penalty once he has completed his cooperation with the U.S. Attorney’s Office for the Southern District of New York and has been sentenced in its pending, parallel criminal action¾i.e., United States v. Lim, 12-cr-121 (S.D.N.Y.). It also could be Choi’s limited financial means. We likely will never know the reason for the SEC’s agreed-upon resolution, but the fact of the resolution may have some value to other defendants.