Enforcement Highlights

SEC Uses Its Powers under the Dodd-Frank Whistleblower Provisions to Warn Employers Against Attempting to Restrict Employees’ Ability to Report Potential Violations

On April 1, 2015, the SEC announced a settled enforcement proceeding against KBR, Inc., a publicly traded, Houston-based technology and engineering company, for including “restrictive language” in confidentiality agreements used in the course of internal investigations. This is the first time the SEC has used its enforcement powers under Rule 21F-17 of the Whistleblower provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Rule 21F-17 provides that “[n]o person may take 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 … with respect to such communication.”

The language to which the SEC took exception appeared in confidentiality agreements KBR used in connection with internal investigations. The statement, which investigators required employees to sign before the interview, was included in the Company’s Code of Business Conduct Investigations Procedures manual. The statement read:

I understand that in order to protect the integrity of this review, I am prohibited from discussing any particulars regarding this interview and the subject matter discussed during this interview, without the prior authorization of the Law Department. I understand that the unauthorized disclosure of information may be the grounds for disciplinary action up to and including termination of employment.

It does not appear that the policy specifically referenced reporting to the SEC or any governmental authority. Moreover, it seems likely that the Company’s intent was to prevent employees from discussing the matter with each other. The SEC admitted that it had no evidence KBR ever prevented an employee from communication with the SEC staff or that KBR took any action to enforce the confidentiality provision. Nevertheless, the SEC posited that the language undermined the purpose of Section 21F and Rule 21F-17(a), which is to “encourage individuals to report to the” SEC.

The SEC indicated its approval of KBR’s amended policy by quoting it in the Order. The new policy provides:

Nothing in this Confidentiality Statement prohibits me from reporting possible violations of federal law or regulation to any governmental agency or entity, including but not limited to the Department of Justice, the Securities and Exchange Commission, the Congress, and any agency Inspector General, or making other disclosures that are protected under the whistleblower provisions of federal law or regulation. I do not need the prior authorization of the Law Department to make any such reports or disclosures and I am not required to notify the company that I have made such reports or disclosures.

While the Order imposes a modest civil penalty of $130,000, KBR is also required to contact KBR employees who signed confidentiality statements from August 21, 2011, to the present and to provide them with a copy of the Order and a statement that they do not need permission from KBR to communicate with any governmental entity.

This case of first impression underscores the SEC’s commitment to the Whistleblower program and its intent to punish employers that, intentionally or not, restrict an employee’s ability to report potential violations to the SEC. There has been much press about such restrictive language in employment agreements, not just related to the SEC, but also related to the National Labor Relations Board and other federal agencies. It is clear the SEC will consider such restrictive language wherever it may be found. By virtue of this Order, companies will have to manage protecting the integrity of internal investigations and avoiding accusations that it discouraged employees from going to the SEC. It also remains to be seen whether the SEC will take the position that companies are required to affirmatively inform employees of their ability to make reports to the SEC or other governmental bodies or whether employees must merely refrain from discouraging such activity. Because the Whistleblower provisions apply to both private and public companies, it seems a prudent course of action for all employers to review employment and confidentiality agreements.

Whistleblower Award Update

There was not much activity from the SEC Office of the Whistleblower (OWB) in the months since it announced the highest whistleblower award to date in September 2014, but that changed in February when it issued a number of denials. The following is a summary of what’s happened since our last whistleblower award update:

Awards:

In the Matter of the Claim for Award, Exchange Act Rel. No. 72947. On August 29, 2014, the SEC issued its first award under the Dodd-Frank Act to an employee who performed audit and compliance functions. The employee, who had compliance responsibilities, received an award of $300,000. Generally, information provided to an individual with compliance responsibilities is not considered “original.” Such an employee is entitled to an award, however, if they first report the misconduct to the company and it subsequently fails to take action within 120 days. See 17 C.F.R. §§ 240.21F-4(b)(4)(iii)(B),v(v). This exception applied to the claimant because he reported the conduct to his supervisor 120 days prior to submitting it to the Commission.

In the Matter of the Claim for Award, Exchange Act Rel. No. 73174. In September 2014, the SEC announced a record-breaking whistleblower award of $30 million. The significance of this award was discussed in a previous blog post. See SEC Announces Highest Whistleblower Award to Date.

In the Matter of the Claim for Award, Exchange Act Rel. No. 74404. The SEC did not announce its next whistleblower award until March 2015. This award was the first ever to a former corporate officer who learned of a violation as a result of another employee reporting misconduct through corporate and compliance channels. Typically, officers who learn about fraud through another employee or through a compliance process are not eligible for an award under the whistleblower program. See 17 C.F.R. § 240.21F-4(b)(4)(iii)(A). However, the SEC’s bounty rules provide an exception that makes an officer eligible for an award if he or she provides the information to the SEC more than 120 days after other responsible personnel possessed the information and failed to adequately act on it. See 17 C.F.R. § 240.21F-4(b)(4)(v)(C). The former corporate officer fell within that exception and the SEC awarded the officer between $475,000 and $575,000 for reporting original, high-quality information regarding misconduct under the Dodd-Frank Act.

Denials:

In the Matter of Pipeline Trading Systems LLC, Notice of Covered Action 2011-194. Pipeline Trading Systems LLC (“Pipeline”) and two of its top executives agreed to pay $1 million for the company’s failure to disclose to customers that a majority of orders placed on its “dark pool” trading platform were filled by a trading operation affiliated with Pipeline. The SEC denied the claimant an award because he did not meet the definition of a “whistleblower” under the Exchange Act. (Denial Order Aug. 15, 2014).

In the Matter of the Claim for Award, Exchange Act Rel. No. 72947. On August 29, 2014, the SEC denied an award to a second claimant because the information provided did not lead to the successful enforcement of the covered action and did not contribute to the ongoing investigation.

SEC v. James Roland Dial, Case No. 4.12-CV-01654 (S.D. Tex. 2012), Notice of Covered Action 2012-66. The defendants caused Grifco International Inc. to issue more than 13 million unrestricted securities to themselves and then sold the securities shortly after into a rising artificial market (caused by their dissemination of false and misleading information). The defendants were ordered to pay disgorgement and prejudgment interest. The SEC denied the claimant an award because (1) claimant did not provide “original information” within the meaning of Section 21F(a)(1) of the Exchange Act and Rule 21F-4(b)(1)(iv), (2) the information provided by claimant did not lead to successful enforcement of a covered judicial or administrative action within the meaning of Section 21F(b)(1) of the Exchange Act and Rules 21F-3(a) and 21F-4(c), and (3) claimant was not a “whistleblower” within the meaning of Section 21F(a)(6) of the Exchange Act and Rule 21F-2 because he did not provide information relating to a possible violation of the federal securities laws in accordance with the procedures set forth in Rule 21F-9(a) under the Exchange Act. (Denial Order Feb. 13, 2015).

SEC v. Harbert Management Corporation, HMC-New York, Inc. and HMC Investors, LLC, 12-cv-5029 (S.D.N.Y. 2012), Notice of Covered Action 2012-89. Here, the SEC denied the claimant an award because (1) he did not provide information that led to the successful enforcement within the meaning of Section 21F(b)(1) of the Exchange Act and Rules 21F-3(a)(3) and 21F-4(c), and (2) he failed to submit information in the form and manner that is required under Rules 21F-2(a)(2), 21F-8(a) and 21F-9(a) & (b) of the Exchange Act. (Denial Order Feb. 13, 2015).

SEC v. Kenneth Ira Starr, 10 civ 4270 (S.D.N.Y. 2010), Notice of Covered Action 2012-129. On March 3, 2011, Starr was sentenced to 90 months in prison, ordered to pay more than $30 million in restitution, and ordered to forfeit more than $29 million in connection with his misappropriation of investor funds in connection to a series of cases filed against him by the government, which included charges of money laundering, wire fraud, fraud by an investment advisor, and misappropriation of client funds. This specific action arose from Starr’s misappropriation of at least $8.7 million of his clients’ money. The SEC denied the claimant an award because he or she did not provide information that led to the successful enforcement within the meaning of Section 21F(b)(1) of the Exchange Act and Rules 21F-3(a)(3) and 21F-4(c). (Denial Order Feb. 13, 2015).

SEC v. George Wesley Harris, No. 3:09-cv-01809-M (N.D. Tex. 2009), Notice of Covered Action 2011-206. The Northern District of Texas entered a $4.8 million judgment against Harris and his co-defendants for operating a fraud scheme that promised returns for investing in oil drilling projects in Texas and New Mexico. The SEC denied the award because (1) claimant did not provide information that led to the successful enforcement within the meaning of Section 21F(b)(1) of the Exchange Act and Rules 21F-3(a) and 21F-4(c), and (2) claimant also did not provide the Commission with original information within the meaning for Section 21F(b)(1) of the Exchange Act because Claimant’s submission was not derived from claimant’s independent knowledge or independent analysis. The SEC further noted that the claimant made a false statement on the Form WB-APP, which was signed under penalty of perjury, by stating he or she was “the 44th President of the United States.” (Denial Order Feb. 13, 2015).

The OWB denied two other claims, one on February 13, 2015, and one on February 16, 2015, in orders that make it impossible to tell the name or nature of the underlying action. Both claims were denied, however, because the information provided by the whistleblowers did not provide information that led to the successful enforcement of an action within the meaning of Section 21F(b)(1) of the Exchange Act and Rules 21F-3(a)(3) and 21F-4(c). Specifically, the information did not (1) cause the Commission to (i) commence an examination, (ii) open or reopen an investigation, or (iii) inquire into different conduct as part of a current Commission examination or investigation under Rule 21F-4(c)(1) of the Exchange Act; or (2) significantly contribute to the success of a Commission judicial or administrative enforcement action under Rule 21F-4(c)(2) of the Exchange Act.

Finally, the Second Circuit upheld the SEC’s denial of an award to a whistleblower who provided information to the SEC before the enactment of the Dodd-Frank Act in July 2010. Styker v. S.E.C., No. 13-4404-ag, 2015 U.S. App. LEXIS 3765 (2d Cir. Mar. 11, 2015). The whistleblower submitted information from 2004-2009 to the SEC, which eventually led to a $24 million settlement with Advanced Technologies Group. The Second Circuit rejected the whistleblower’s argument that the SEC went beyond its congressionally mandated authority, and it deferred to the SEC’s interpretation of the law that information submitted prior to July 2010 does not qualify for an award. Id. at *8-9.

SEC “Claws Back” Bonuses and Stock Sale Profits From CFOs of Public Company Charged With Accounting Fraud

On February 10, 2015, the SEC announced settlements with two former chief financial officers of Saba Software, a Silicon Valley software company, that require the CFOs to repay Saba more than $500,000 in bonuses and profits from stock sales earned subsequent to Saba’s false filings. Notably, the SEC did not allege that either former officer violated the federal securities laws in any fashion, nor was there evidence of either officer’s knowledge of, or complicity in, the underlying conduct that prompted the company to settle accounting fraud charges lodged against it by the SEC in September 2014. See Press Release, SEC Announces Half-Million Dollar Clawback from CFOs of Silicon Valley Company that Committed Accounting Fraud (Feb. 10, 2015).

The first CFO, William Slater, a former accountant who served as CFO from November 2011 through February 2013, and the second, Peter E. Williams III, a California attorney who served as CFO from March 2004 through July 2007 and again on an interim basis from October 2011 through January 2012, agreed to reimburse the company approximately $337,000 and $142,000, respectively, pursuant to Sarbanes-Oxley Section 304(a).

Section 304(a) provides that in the event an “issuer,” as defined under the Securities and Exchange Act of 1934, is required to issue a restatement of its accounting records as a result of misconduct under the securities laws, the issuer’s CEO and CFO “shall reimburse the issuer” for any bonus, “incentive-based,” or “equity-based” compensation, or for the profits from the officers’ personal sale of any of the issuer’s securities during the 12-month period following the first issuance of each allegedly violative financial statement. See 15 U.S.C. § 7243(a).

In September 2014, the SEC charged Saba with accounting fraud, and the company agreed to a settlement. The company was required to restate its financial records for the years 2008–2011 and for parts of 2012. In connection with the settlement with Saba, the SEC alleged that two Saba vice presidents had overseen a practice of misstating the hourly work of international consultants, both pre-booking and underbooking time statements, in order to adhere to prearranged time estimates. The practice violated GAAP and allegedly led to an overstatement of Saba’s revenues by approximately $70 million. The vice presidents responsible for the misconduct agreed to a collective disgorgement of approximately $55,000 and a collective penalty of $100,000, while the company agreed to pay a $1.75 million fine. At the time of the settlement, Saba’s CEO agreed to reimburse the company for more than $2.5 million in bonus, incentive, and equity-based pay that he received during the 12-month periods following the original issuance of the financial statements containing the alleged fraud. See Press Release, SEC Charges Software Company in Silicon Valley and Two Former Executives Behind Fraudulent Accounting Scheme (Sept. 24, 2014).

The SEC claims that “Section 304 does not require that a chief financial officer [or chief executive officer] engage in misconduct to trigger the reimbursement requirements.” William Slater, CPA and Peter E. Williams, III, Securities & Exchange Act of 1934 Release No. 74240, File No. 3-16381 (Feb. 10, 2015) at 5. Indeed, despite no evidence of fault or liability, Mr. Williams, who served as interim CFO for only four months between 2011 and 2012, was forced to reimburse the company for more than $140,000 in compensation he had received as a result of the allegedly violative financial statements.

This draconian clawback provision went into effect in 2002, although the SEC declined to actively enforce it until 2009. That year, the enforcement division settled accounting fraud charges with CSK Auto and four of its former executives, but in that case, it did not stop there. As former SEC Director of Enforcement Robert Khuzami announced in a December 8, 2009 speech, the SEC sought “to clawback more than $4 million in bonuses and stock sale profits from the former CEO, despite the fact that he was not alleged to have personally participated in the underlying financial wrongdoing.” Khuzami noted that, going forward, the SEC would use this “powerful enforcement tool” in “appropriate circumstances” in order to prevent CEOs and CFOs from “personally profit[ting] from misstated financial filings” and to incentivize these officers “to ensure the accuracy of [their] compan[ies’] financials.” Robert Khuzami, Remarks at AICPA National Conference on Current SEC and PCAOB Developments (Dec. 8, 2009).

Though Khuzami touted the new priority of the enforcement of this provision in another speech, see Robert Khuzami, Remarks at AICPA National Conference on Current SEC and PCAOB Developments (Aug. 5, 2009) (“This is the first Section 304 action seeking to clawback compensation from an officer that was not alleged to have personally participated in the underlying financial wrongdoing.”), it is unclear when and why the staff will deem officers “appropriate” targets for clawbacks. In fact, because the provision requires no proof of culpability on the part of the corporate officers, the employment of this enforcement tool is particularly difficult to forecast.

Looking ahead, because Section 304(a) does not provide for a private right of action that would allow shareholders to seek reimbursement from CEOs and CFOs, see Cohen v. Viray, 622 F.3d 188, 193-194 (2d Cir. 2010), the SEC remains the exclusive enforcement entity of this powerful provision. There is some indication that we may see an expansion of requirements related to companies’ internal clawback policies through the implementation of Dodd-Frank, see Kara M. Stein, Remarks at the “SEC Speaks” Conference (Feb. 21, 2014) (“We also need to finalize rules about executive compensation, including provisions requiring issuers to have policies in place to claw back compensation.”), but in the meantime, enforcement will remain at the SEC’s whim.

Third Circuit Clarifies Extraterritorial Reach of Federal Securities Laws

The Third Circuit recently clarified the extraterritorial limits of the federal securities laws, as the U.S. Supreme Court defined in Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010). See United States v. Georgiou, Nos. 10-4774, 11-4587, 12-2077, __ F.3d __, 2015 WL 241438 (3d Cir. Jan. 20, 2015). George Georgiou and his co-conspirators made zero-sum trades between brokerage accounts in Canada, the Bahamas, and Turks and Caicos to artificially inflate the value of four “target stocks” that were available for trade in the U.S. through two interdealer quotation systems, the OTC Bulletin Board (“OTCBB”) and the Pink Sheets. Id. at *1. Georgiou used the fraudulently inflated value of his ownership interest in the target stocks as collateral to obtain loans that he would never repay, ultimately costing his creditors and the other stockholders of the target stocks millions of dollars. Id. On appeal, Georgiou argued that his convictions could not stand because they were based on the extraterritorial application of the federal securities laws. Id.

In Morrison, the Supreme Court limited Rule 10(b)’s application to two types of transactions: “(1) transactions involving ‘the purchase or sale of a security listed on an American stock exchange,’ and (2) transactions involving ‘the purchase or sale of any other security in the United States.’” Georgiou, 2015 WL 241438, at *4 (quoting Morrison, 561 U.S. at 273). The Third Circuit determined that Georgiou’s transactions were not of the first type, even though some of the purchases were executed by market makers operating within the United States, because the SEC does not consider the OTCBB and the Pink Sheets to be securities exchanges. Id. at *4–5.

The Third Circuit held, however, that Georgiou’s transactions were of the second type because they involved “the purchase or sale of any other security in the United States.” Id. at *4. Whether a transaction is domestic, the court observed, does not depend on “‘the place where the deception originated, but [the place where] purchases and sales of securities’ occurred.” Id. at *5 (quoting Morrison, 561 U.S. at 266). A purchase or sale of securities occurs “when the parties incur irrevocable liability to carry out the transaction,” such as “the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money.” Id. at *5–6 (citations omitted) (internal quotation marks omitted). The Third Circuit held that at least one transaction in each of the target stocks involved the purchase or sale of a security in the United States because “all of the manipulative trades were ‘facilitate[d]’ by U.S.-based market makers, i.e., an American market maker bought the stock from the seller and sold it to the buyer.” Id. at *6. Accordingly, the court affirmed Georgiou’s conviction under Section 10(b).

The take away: would-be fraudsters who think they can escape federal securities laws by setting up shop outside the U.S. to manipulate domestic securities should think again.

UPDATE: Third Circuit Affirms Arbitrability of Dodd-Frank Retaliation Claim in Khazin v. TD Ameritrade Holding Corp., _ F.3d _, No. 14-1689, 2014 WL 6871393 (3d Cir. Dec. 8, 2014).

In March, we wrote about a ruling out of the District of New Jersey enforcing an arbitration provision contained in an employment agreement that pre-dated Dodd-Frank. The court reasoned that to disregard a pre-Dodd-Frank arbitration provision “would fundamentally interfere with the parties’ contractual rights and would impair the predictability and stability of their earlier agreement.” Khazin v. TD Ameritrade Holding Corp., Civil Action No. 13-4149 (SDW)(MCA), 2014 U.S. Dist. LEXIS 31142 (D.N.J. Mar. 11, 2014). The court also emphasized the “strong federal policy in favor of the resolution of disputes through arbitration” and cited a number of other federal courts that have reached a similar result. Id.

The Third Circuit, though, declined to reach this issue. Instead, it determined that Khazin’s claim, which was brought under Dodd-Frank, was not subject to the Anti-Arbitration Provision at all. 2014 WL 6871393, at *2. Dodd-Frank’s Anti-Retaliation Provision states: “Predispute Arbitration Agreements.—No predispute arbitration agreement shall be valid or enforceable, if the agreement requires arbitration of a dispute arising under this section.” Although the Anti-Arbitration Provision was included in Dodd-Frank, it followed language that said, “Section 1514A(a) of title 18, United States Code [Sarbanes-Oxley], is amended ….” The Dodd-Frank retaliation cause of action, on the other hand, was added to the Securities Exchange Act of 1934 located at 15 U.S.C. § 78a et seq. The court explained, “[i]t would be nonsensical for the word ‘section’ in the Anti-Arbitration Provision to refer to Section 922 of the Act [the whistleblower protection section of Dodd-Frank] when Section 922 expressly places its constituent parts in separate “sections” of the Code.” 2014 WL 6871393, at *3 n.3.

In light of this interpretation, the court did not express any opinion on whether the district court properly determined that Dodd-Frank’s Anti-Arbitration Provision did not invalidate the arbitration clause in his pre-Dodd-Frank employment agreement.

SEC Releases 2014 Annual Report to Congress on the Dodd-Frank Whistleblower Program

By all accounts, 2014 was a year of tremendous success for the SEC’s Dodd-Frank Whistleblower Program. According to its 2014 Annual Report to Congress on the Dodd-Frank Whistleblower Program, the SEC paid nine whistleblower awards, including a record $30 million award to a single whistleblower. SEC’s 2014 Annual Report to Congress on the Dodd-Frank Whistleblower Program. Sean X. McKessy, the Chief of the Office of the Whistleblower, told Congress that these awards exceeded the number of awards made “in all previous years combined.” In addition, the SEC brought its first enforcement action under the anti-retaliation provisions of the Dodd-Frank Act.

The Annual Report offers more than just numbers, however. Without disclosing whistleblower identities, the Annual Report provides a “profile” of award recipients. Notably, more than 40% of the individuals who received awards were current or former employees of the company about which they reported. In addition, 80% of the individuals had raised issues internally prior to submitting information to the SEC, but the company failed to “take steps or remedy” the misconduct. Other award recipients included the actual victims of the fraud, individuals who had a “personal relationship” with the perpetrator, and contractors and consultants that worked with the company about which the report was made.

The Annual Report also reflects an increase in the number of whistleblower complaints in general. Complaints related to “Corporate Disclosures and Financials (16.9%), Offering Fraud (16%), and Manipulation (15.5%)” were the most common categories; complaints relating to municipal securities and public pensions were the least common categories. Moreover, the Office of the Whistleblower received 3,620 tips in 2014 (almost 400 more than last year) and returned more than 2,731 phone calls—recall that in May 2011 a whistleblower hotline was established and Whistleblower Office attorneys aimed to return messages within 24 hours.

Two important observations come from our review of the Annual Report. First, growing public awareness of the Whistleblower Program and the increase in the number and amount of whistleblower awards will only lead more individuals to bring alleged violations to the SEC’s attention. Second, given the fact that 80% of whistleblowers had raised their concerns first internally and the fact that nearly one-fifth of all tips, complaints, and referrals relate to accounting issues, it is extremely important for companies to implement adequate policies and procedures to respond to internal reports and to provide training to supervisors on how to handle internal complaints.

Commissioner’s Concerns About Civil Penalties Temper SEC’s Release of FY14 Enforcement Results

On October 16, the SEC publicized its preliminary enforcement results for fiscal year 2014. In what it described as a “successful enforcement year,” the Commission brought a record 755 actions and obtained $4.16 billion in penalties and disgorgement. These 2014 figures translate to an average of $5.5 million per action, which is 11% higher than the penalties and disgorgement obtained per action in fiscal year 2013 and a whopping 30% upsurge from just two fiscal years ago. It is not a coincidence that these developments correspond neatly with the appointment of Mary Jo White as SEC Chair in 2013. In fact, Chair White has been candid from the outset of her tenure about the Commission’s intention, under her direction, to “make aggressive use of our existing penalty authority, recognizing that meaningful monetary penalties—whether against companies or individuals—play a very important role in a strong enforcement program.”

It would appear, however, that at least one high-ranking SEC official has become uneasy during this era of heightened civil penalties. Speaking at the Securities Enforcement Forum in Washington, D.C., just two days before these results were released, Commissioner Michael S. Piwowar openly questioned whether the manner in which the SEC now administers penalties might be encroaching upon due process protections. As Commissioner Piwower explained:

In recent months, I have become concerned by the increasing number of staff recommendations that have not been accompanied by analysis of the principal factors described in the 2006 penalty statement. If we were a publicly-traded company, then we would likely be subject to an investigation if we knowingly permitted a misleading statement to remain outstanding without corrective disclosure. More importantly, we will have not accorded appropriate due process if we fail to follow our own publicly-announced framework for monetary penalties.

. . .

Thus, for purposes of transparency, clarity, and, most importantly, due process, the Commission should be forthcoming as to the appropriate analytical framework for corporate penalties.

The “2006 penalty statement” referenced in Commissioner Piwowar’s speech represents the Commission’s most recent effort to provide the investing public with “the maximum possible degree of clarity, consistency, and predictability in explaining the way that its corporate penalty will be exercised.” While this pronouncement set forth nine factors that may be weighed, the appropriateness of a penalty reportedly hinges on two principal considerations: – (1) whether the company received a direct benefit as a result of the violation and (2) whether the penalty will recompense or further harm the injured shareholders. This latter consideration, in particular, is inherently controversial. As the SEC acknowledged in the 2006 Statement, the penalties it imposes on public companies are costs frequently endured by innocent shareholders who already have been harmed by the company’s purported misconduct. Hence, SEC penalties should not be perceived as adding further insult to the financially injured.

Based on Commissioner Piwowar’s comments, the SEC may be drifting away from these factors, even though it has published no further guidance explaining which factors might now be disfavored or what other considerations could apply. If so, these recent developments cast a renewed spotlight on comments that Chair White made regarding the SEC’s 2006 Statement during a September 2013 speech to the Council of Institutional Investors. Most notably, Chair White stated:

While it is not a binding policy, the 2006 press release in my view sets forth a useful, non-exclusive list of factors that may guide a Commissioner’s consideration of corporate penalties, such as the egregiousness of the misconduct, how widespread it was, and whether the company cooperated and had a strong compliance program. The enforcement staff still references these factors as well as other inputs when analyzing and proposing their own recommendations to the Commission.

Ultimately, however, each Commissioner has the discretion, within the limits of the Commission’s statutory authority, to reach his or her own judgment on whether a corporate penalty is appropriate and how high it should be.

Interestingly, Commissioner Piwowar’s comments seem to reflect a general apprehension, at least on his part, to exercising discretion that is limited only by statutory constraints when the factors and “other inputs” used to determine the appropriateness of such penalties have not been disclosed publicly. To remedy this perceived problem, Commissioner Piwowar advocated that any revision to the 2006 Statement should be made through an interpretative release that would be subject to a notice-and-comment process. In his view, “This approach will satisfy any due process concerns, allow all interested persons to express their comments on the proposed framework, and provide a stronger defense of our approach should it be challenged in the future.”

Absent such an administrative undertaking or an unexpected reversal of policy, it likely will be left to the judiciary whether to impose any additional limitations on future SEC penalties. If the United States Court of Appeals for the District of Columbia’s decision in Collins v. SEC, No. 12-1241 (D.C. Cir. Nov. 26, 2013), provides any foresight, courts may be receptive to tethering future penalties so that they reasonably align with prior outcomes under similar circumstances. In Collins, the appellant challenged the SEC’s imposition of a penalty on grounds that it was arbitrary and capricious and violated the Excessive Fines Clause under the Eighth Amendment. Id. at *6. While the penalty was upheld, the appellate court made clear that the Commission cannot be “oblivious to history and precedent” and that a penalty could be deemed “arbitrary and capricious” if “the sanction is out of line with the agency’s decisions in other cases.” Id. at *8 (quoting Friedman v. Sebelius, 686 F.3d 813, 827-28 (D.C. Cir. 2012)). It remains to be seen, of course, what circumstances could trigger such a decision, although additional appeals – and judicial insights – seem likely in fiscal year 2015, particularly if the financial stakes continue to rise. In the meantime, the SEC appears more focused on making history and precedent, in part through the imposition of larger civil penalties, than being closely guided by it.

SEC Announces Highest Whistleblower Award to Date

The SEC recently announced a record-breaking whistleblower award of $30-35 million, which shattered the previous high award of $14 million. See SEC Awards More Than $14 Million to Whistleblower. Not only is this award noteworthy for its size, but also because it was made to a foreign resident and it could have been even higher if the whistleblower did not unreasonably delay in reporting the violations.

This was not the first award made to foreign residents, but it was the first award made to a foreign resident since the Court of Appeals for the Second Circuit found that the anti-retaliation protections of Section 21F(h) of the Dodd-Frank Act do not apply to foreign whistleblowers who experience retaliation overseas from foreign employers. Liu v. Siemens, __ F.3d __, 2014 WL 3953672 (2d Cir. Aug. 14, 2014); see also Made for the U.S.A. Only: Second Circuit Holds That the Dodd-Frank Act’s Antiretaliation Provision Applies Only Domestically. In making this award, the SEC reiterated that any extraterritorial aspects of tips, such as a whistleblower’s foreign residency or alleged misconduct that occurs abroad, do not matter when there is a “sufficient U.S. territorial nexus”—i.e., “whenever a claimant’s information leads to a successful enforcement of a covered action brought in the United States, concerning violations of the U.S. securities laws, by the Commission, the U.S. regulatory agency with enforcement authority for such violations.” Order Determining Whistleblower Award Claim, Whistleblower Award Proceeding, File No. 2014-10 (Sept. 22, 2014). It found that the Second Court’s holding in Liu v. Siemens, __ F.3d __, 2014 WL 3953672 (2d Cir. Aug. 14, 2014), was not controlling and that “the whistleblower award provisions have a different Congressional focus than the anti-retaliation provisions, which are generally focused on preventing retaliatory employment actions and protecting the employment relationship.”

In announcing the award Sean McKessy, Chief of the Office of the Whistleblower, underscored the extraterritorial reach of the program: “This award of more than $30 million shows the international breadth of our whistleblower program as we effectively utilize valuable tips from anyone, anywhere to bring wrongdoers to justice. Whistleblowers from all over the world should feel similarly incentivized to come forward with credible information about potential violations of the U.S. securities laws.” See SEC Press Release: “SEC Announces Largest-Ever Whistleblower Award.”

Further, this already staggering award amount had the potential to be even higher if the whistleblower did not unreasonably delay in reporting to the SEC. The whistleblower delayed for an undisclosed period of time after first learning of the violations, which the SEC said caused investors to suffer significant losses that might have been avoided. The SEC found that the whistlblower’s delay was unreasonable under the circumstances and reduced the award from the maximum percentage allowed under the statute. It rejected the whistleblower’s argument that the percentage awarded was below the average percentage awarded to other whistleblowers as irrelevant. The SEC, however, did not apply the unreasonable delay consideration as severely as it otherwise might have done because a period of the delay occurred before the implementation of the whistleblower program established by the Dodd-Frank Act.

This latest award shows the SEC’s willingness to make awards to whistleblowers across the globe.