Employment Agreements Under the Bright Light of the SEC’s Enforcement Efforts

Back in April 2015, we told you about a new player in the world of employee whistleblower enforcement: the Securities and Exchange Commission (SEC). The SEC grabbed everyone’s attention in 2015 by issuing its first administrative order finding that a public company violated SEC rules based solely on language in an employment agreement.

The company had a provision in its employee confidentiality agreement that subjected an employee to termination for disclosing certain confidential information. The agreement didn’t expressly prevent employees from reporting alleged malfeasance to the SEC or any other government agency. But, the SEC found that such language had a stifling effect on employees, discouraging them from reporting potential violations to the SEC. The company was fined $130,000 and had to revise its employee confidentiality provisions.

The SEC’s enforcement efforts in this area have considerably ramped up since then. In its 2016 Annual Report to Congress on the Dodd-Frank Whistleblower Program, the SEC specifically stated that “protecting whistleblowers’ rights to report possible securities law violations . . . will continue to be a priority in the coming fiscal year.”

You may be asking: How can the SEC do this? It’s not a labor and employment agency like the Equal Employment Opportunity Commission, the Department of Labor, or the National Labor Relations Board. The answer is: The Dodd-Frank Wall Street Reform Act.

Enacted on July 21, 2010, this legislation amended the Securities Exchange Act of 1934 and among its key changes were provisions to encourage and protect whistleblowers reporting suspected violations of U.S. securities laws. Accordingly, after passage of the Dodd-Frank Act, the SEC adopted Rule 21F-17 (codified at 17 C.F.R. § 240.21F-17) on August 12, 2011 that prevents a company from “imped[ing] an individual from communicating directly with the [SEC’s] staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.” The SEC has used this language as a basis to target companies’ use of restrictive language in employment and severance agreements. More recent examples have included bigger fines and continued proof of aggressive enforcement by the SEC.

In August 2016, the SEC fined a Georgia-based company $265,000 for violating Rule 21F-17. In that case, some of the company’s severance, separation, and settlement agreements with former employees included language providing that the employee would not disclose any of the company’s confidential information to third parties unless compelled to do so by law and after notice to the company. This is a very common provision in such agreements used widely by companies around the country. The SEC, however, found that this language unlawfully prevented or discouraged former employees from reporting possible securities laws violations to the SEC.

A truly notable aspect of this case was that the company had actually revised its severance agreements around June 2013 to include the following language:

[N]othing in this Agreement prevents Employee from filing a charge with . . . the Securities and Exchange Commission . . . however, Employee understands and agrees that Employee is waiving the right to any monetary recovery in connection with any such complaint or charge that Employee may file.

The SEC held that this language was unlawful because it removed “the critically important financial incentives that are intended to encourage” persons to report suspected violations. The SEC determined that this undermined the purpose of Rule 21F-17.

In another August 2016 Order, the SEC fined a California-based company $340,000 for similar violations. The SEC found that the company’s severance agreements with former employees forced employees to waive their right to monetary recovery that they may be otherwise entitled to from being whistleblowers to the SEC. This was despite the SEC’s concession that it had no evidence of any instances in which the provisions actually dissuaded employees from reporting suspected violations, or that the company had ever sought to enforce the provisions at issue.

The clear takeaway: publicly-traded companies should closely examine all of their employment agreements to ensure compliance with Rule 21F-17. As these cases demonstrate, failure to do so could result in significant monetary penalties.