No 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 communications.

The rule applies to the great majority of confidentiality and non-disclosure agreements that employers require of employees who are in a position to know about securities violations, and comes at a time when employers and their counsel have increasingly used such agreements to harass and intimidate whistleblowers.   This means that employees or former employees who are thinking about providing “tips” to the SEC under the whistleblower program can do so without fearing retaliation by their employers who might otherwise seek to hold them liable under state law for breaching confidentiality agreements.

The SEC rule trumping confidentiality agreements has no counterpart in the regulations governing the Internal Revenue Service’s whistleblower program or a qui tam relator’s communications with the government when bringing a lawsuit under the False Claims Act, although courts have refused to enforce confidentiality agreements in the FCA context and have found whistleblowing to the IRS to be protected activity under the Sarbanes-Oxley Act.  See Head v. The Kane Co., 668 F.Supp.2d 146, 152 (D.D.C. 2009)(finding contractual obligations to return all company documents and not to disparage employer void as against public policy where enforcement sought to prevent employee from providing evidence to government in qui tam lawsuit).  And see Vannoy v. Celanese Corporation, 2008-SOX-064, 2011 WL 4690624 (ARB Sept. 28, 2011) (whistleblower disclosures to the IRS are protected from retaliation by § 806 of the Sarbanes Oxley Act, 18 U.S.C. § 1514A).

It is also encouraging to see two recent rulings from U.S. Courts of Appeals for the Second and Ninth Circuits making it harder for employers and cooperating prosecutors to use federal criminal laws to intimidate and harass whistleblowers.  Both courts dismissed cases brought by the government against former employees who had been charged with theft of their employers’ proprietary information.  In the 2^nd Circuit, in the case of USA v. Aleynikov, the Court found that a district court jury erred when it convicted a former employee of violating the National Stolen Property Act (“NSPA”) and the Economic Espionage Act (“EEA”).  In the 9^th Circuit, in the case of USA v. David Nosal, the Court, sitting en banc, upheld the district court’s dismissal of a prosecution against a former employee under the Computer Fraud and Abuse Act (“CFAA”).

In both cases, the defendant employees took digital information from their previous employers either shortly before or shortly after after their employment ended.  The case in the 2^nd Circuit dealt with government charges against Sergey Aleynikov, a programmer who worked for two years at Goldman Sachs, becoming one of the highest-paid coders at the company.  On his last day at Goldman in 2009, Aleynikov downloaded the source code for the company’s high-frequency trading system and later shared that information with his new employer.  After Goldman discovered his action, Aleynikov was tried under the NSPA and EAA, found guilty, and sentenced to eight years in prison. The Second Circuit reversed, finding that while Aleynikov likely breached his confidentiality agreement with Goldman, he should never have faced criminal charges under these laws which prohibited the theft of secrets related to goods and products.

In the Ninth Circuit case, the government brought criminal charges under the CFAA against David Nosal, a former employee at the executive search company Korn/Ferry International.  The government accused Nosal of conspiring with other Korn/Ferry employees to access the company’s computers and obtain trade secrets he intended to use to form a competing company.  Although Congress passed the CFAA to combat large-scale hacking into computer systems, the government argued that Nosal should be found guilty under the law’s proscription against a user “exceed[ing] authorized access” to a computer system.

The Ninth Circuit disagreed.  “Basing criminal liability on violations of private computer use policies,” the court noted, “can transform whole categories of otherwise innocuous behavior into federal crimes simply because a computer is involved.”  The court pointed to chatting with friends, playing games, or watching sports highlights while at work as examples of “unauthorized access” that could lead to criminal liability under the government’s theory, and declined to expand the scope of the CFAA to such innocuous conduct on the job.

David J. Marshall, a whistleblower attorney at the D.C. law firm of Katz, Marshall & Banks, noted that the SEC decision and these recent court decisions mark significant victories for whistleblowers. Marshall said, “The law needs to recognize, as the SEC rule does, the difference between those employees who take employer information to benefit themselves and those who take information to share it with regulators and law enforcement in order to expose fraud on shareholders or the government, bribes of foreign officials and other such corporate misconduct.”  Marshall also observed the Second and Ninth Circuit decisions were an important brake on employers and prosecutors who would use criminal prosecutions to chill the rights of whistleblowers. “All too often companies hold out these criminal statutes as threats against employee whistleblowers who are using information to blow the whistle on illegal activity,” Marshall said.  “When employees can do the right thing without fear of criminal prosecution, the public reaps the benefit.”

McKessy and Martinez were both pleasantly surprised at the quantity and quality of whistleblower tips their organizations were receiving.  McKessy stated that while the OWB was warned “that [it] would be inundated with an avalanche of nonsense,” that has not happened thus far.  On the contrary, McKessy stated, the OWB is “very encouraged with the percentage of high quality information that comes in through the portal … we are seeing some very specific, timely, and credible tips coming through people who are participating in the program.”

Martinez echoed these sentiments.  He said that the CFTC Whistleblower Office has been “surprised by the quality of some tips.  Some tips are very detailed.  The whistleblower population at the CFTC has run the gamut from insiders to traders to market observers to victims of fraud themselves. Overall, it’s been a very encouraging development seeing the nature of some of the complaints that have come across my desk.”

McKessy also objected to the assumption that the existence of the bounty programs at the SEC and CFTC would subvert internal compliance programs established by companies.  McKessy stated that “The one observation I would make around that is—this is anecdotal, and I don’t have data behind it—a significant majority of individuals who have come to us and said that, I’m complaining about the company that I now work at or that I used to work at…report that they also reported internally before they came to us. They reported to their boss, they went to the audit committee in some instances, they called their anonymous hotlines.”

Finally, McKessy and Martinez both assured the public that whistleblowers like Harry Markopolos – the man who worked tirelessly to expose the massive Ponzi scheme conducted by Bernie Madoff, but did so independently as a non-employee – would still qualify for rewards under the whistleblower programs.  McKessy stated that “Harry Markopolos certainly didn’t work for Madoff, but put together some significant analyses around what he observed … we want to encourage people who have the ability to do that.”  Martinez added, “there are people out there … [who] may have the insight to bring something to our attention that, even though ostensibly out in the open, is not being put together either by the Commission or one of the [industry self-regulatory organizations], not only as a matter of obscurity, but even as a matter of bandwidth….We certainly encourage those types of complaints, and I hope to see a lot of them.”

Schapiro noted in her remarks that the new SEC whistleblower program is “already providing the agency with hundreds of higher-quality tips, helping us to avoid investigatory dead-ends and – at the same time – prodding companies to enhance their internal compliance programs.”   Although Mr. McKessy’s remarks were not available on the SEC website, the website Compliance Week reported that the whistleblower chief touted the fact that his staff has returned over 2,000 whistleblower hotline calls since the SEC established the hotline in May 2011.

Compliance Week also reported that McKessy discussed the SEC’s decision against requiring whistleblowers to first complain internally before pursuing a complaint with the SEC.  McKessy argued that not only do the rules still respect corporate compliance programs – for example, potentially increasing the percentage award a whistleblower receives if the whistleblower first reports internally – the “significant majority” of reports that he had personally reviewed did in fact report the wrongdoing internally before going to the SEC.

Debra S. Katz, a whistleblower attorney at the D.C. law firm of Katz, Marshall & Banks, found the attitude of the SEC officials to be a breath of fresh air.  “Having represented whistleblowers for as long as I have, it is extraordinary to finally work in a time where the laws and the officials responsible for enforcing those laws seem to finally recognize the value these brave individuals provide,” said Ms. Katz.

While transcripts of the talks were not available on the SEC website, AdviserOne quoted Plaze as telling CCOs during the conference that the newly created Asset Management Unit that is housed within the SEC’s Division of Enforcement “is dedicated to suing you.”  The website went on to quote Christopher Jackson, senior VP and general counsel for Calamos Advisors, who said that the “mass proliferation of regulations” coming from the SEC and Department of Labor, along with the new leadership at the SEC’s enforcement and examination divisions, the collaboration among SEC divisions, and the Whistleblower office, should be keeping CCOs up at night.

Mr. McKessy described a number of complaints related to advisory firms, including false and misleading representations, insider trading, persons holding themselves out to be advisors, and Foreign Corrupt Practices Act related tips.

Concerned that the hiring of this ‘female associate’ could be damaging to GE’s reputation and potentially violate the Foreign Corrupt Practice Act (“FCPA”), Mr. Asadi immediately objected to the hiring and raised this issue with his supervisor.  He then took the concern a step further by raising the issue with the Ombudsperson for G.E.

Mr. Asadi’s complaint alleges that in direct response to these actions, his immediate supervisor began pressuring him to step down from his position with G.E.  Shortly after his discussion with the Ombudsperson, GE issued an extremely negative performance review to Mr. Asadi.  While no significant employment issues were identified in the review, the company began aggressive negotiations for the Plaintiff’s departure from the company.  These negotiations continued until GE abruptly ended discussions and terminated the Plaintiff’s employment on June 24, 2011.

The legal question presented in GE’s motion to dismiss is as follows:

Dodd-Frank defines a whistleblower as an individual “who provides . . . information relating to a violation of the securities laws” to the Securities and Exchange Commission (“SEC”), yet the Complaint lacks any allegation that Asadi has ever provided any information to the SEC, much less that he had done so prior to his termination.  Should the Complaint be dismissed for failing to state a claim because it does not allege a material element that is necessary to obtain relief?

In his response to the motion to dismiss, however, Mr. Asadi cited Egan v. TradingScreen, Inc., No 10 Civ. 8202 (LBS), 2011 WL 16782066 (S.D.N.Y. May 4, 2011), arguing that in that case of first impression, District Judge Leonard Sand directly addressed the question of whether a plaintiff is required to report his allegations directly to the SEC in order to seek relief under the Anti-Whistleblower Retaliation provisions of Dodd-Frank.  Asadi quotes the following passage from Egan:

[T]he contradictory provisions of the Dodd-Frank Act are best harmonized by reading 15 U.S.C. § 78u-6(h)(A)(iii)’s protection of certain whistleblower disclosures not requiring reporting to the SEC as a narrow exception to 15 U.S.C. § 78u-6(a)(6)’s definition of a whistleblower as one who reports to the SEC. Therefore, [a] Plaintiff must either allege that his information was reported to the SEC, or that his disclosures fell under the four categories of disclosures delineated by 15 U.S.C. § 78u-6(h)(1)(A)(iii) that do not require such reporting: those under the Sarbanes-Oxley Act, the Securities Act, 18 U.S.C. § 1513(e), or other laws and regulations subject to the jurisdiction of the SEC.

Mr. Asadi argues that because his reports did fall under the four categories of protected disclosures articulated by the court in Egan, he qualifies as a whistleblower under Dodd-Frank.

“I expect this issue will ultimately be appealed no matter which direction the court comes down,” said whistleblower lawyer David J. Marshall of the law firm Katz, Marshall & Banks.  “Given that the overarching theme of the Dodd-Frank whistleblower protection language is to offer protection to individuals who speak out against illegal practices, we are optimistic that the court will come down on the side of Mr. Asadi.”

Insinga, however, is still waiting to receive anything from the IRS as a reward for his decision to blow the whistle five years ago.  His is not a unique case; government auditors and whistleblower advocates have long charged that the IRS hands out too few awards and takes too long to process claims.  The Post reports that in fiscal 2010, the last year for which the tax agency made data public, it collected $464.6 million from taxpayers under the whistleblower program but paid a relatively meager $18.7 million in total to 97 informants who helped break cases, according to an IRS report to Congress. An IRS spokesman said the awards for fiscal 2011 are too small to be reportable.

Stephen Whitlock, the director of the IRS’s whistleblower office, reminded the Post that the time frame for payouts in these cases is typically five to seven years, since the IRS waits for all outstanding taxes to be collected and appeals to be resolved before making an award determination.  But while IRS officials have said that they are still open to an award determination, an award was unlikely based on other sources of information the IRS received regarding Robobank’s dealings.  Insinga’s lawyers filed a lawsuit on February 21 with the United States Tax Court seeking compensation for the assistance their client provided to the IRS.

“We’ve created and amended multiple statutes over the past decade to provide compensation for those individuals brave enough to blow the whistle on fraudulent practices, and that’s good.  History has shown that financial incentives do work,” said whistleblower lawyer David J. Marshall, of the Washington, D.C. law firm of Katz, Marshall & Banks.  “But if the government fails to honor these new laws and instead looks to find a way out of rewarding whistleblowers, their effectiveness will diminish over time and the public will suffer the consequences.”

Katz, Marshall & Banks partner David J. Marshall, who represents whistleblowers before the SEC in tips pointing to a wide range of securities violations, Foreign Corrupt Practices Act violations and broker-dealer misconduct, said that passage of the Grimm bill would significantly hamper the SEC’s ability to root out wrongdoing in the financial markets.  Since the passage of the Sarbanes-Oxley Act and its corporate whistleblower protections in 2002, Marshall has represented dozens of corporate employees who have faced retaliation after reporting unlawful conduct to their employers.

“The great majority of whistleblowers already use internal compliance programs first,” Marshall said.  “They look to law enforcement only when their employers slam the door in their face.”  Marshall said Congress would be making a big mistake to require employees to first report internally. “It would be a very naïve farmer,” he said, “who would require his chickens to speak with the fox before telling the farmer about the theft of hens from the henhouse.  The chickens would just keep going missing, and the farmer’s investment would always be at risk. That’s the problem with requiring employees to report internally first.”  Marshall also pointed out that the SEC had established a number of important incentives to encourage employees to report their concerns to management first where practicable, including a provision in the program rules that gives the whistleblower credit for any violations the company discovers through its investigation.

Marshall added, however, that the Grimm bill stood little chance of passage.  He noted that Congress had rejected the idea of requiring whistleblowers to report internally when it passed the Dodd-Frank, and that the SEC had again considered and rejected the requirement in the comprehensive rule-making process for the new program, much to the disappointment of corporate interests who insisted that such a requirement was absolutely necessary for the survival of whistleblower hotlines and other internal-compliance programs.

According to the Post, the whistleblower works for a proxy solicitation firm, and says in his SEC submission that an employee of Institutional Investor Services, Inc. (“ISS”), a leading proxy advisory firm, has repeatedly provided such information to the whistleblower’s firm.  One example, the Post reports, is the leak of information regarding upcoming votes by Fidelity and Blackrock, two mutual-fund companies that control large blocks of voting shares of publicly traded companies.  When solicitation firms like ISS know how large shareholders plan to vote, they can help management spin its presentation to better address the shareholders’ concerns, effectively rigging the system of corporate governance.

While there is no way to know whether the whistleblower tip obtained by the Post will result in an enforcement action leading to a whistleblower award, the Post article demonstrates the wide range of misconduct that can be the subject of whistleblower tips submitted through the new SEC whistleblower program.