Risk Management and Crisis Response Blog

SEC Continues to Penalize Companies which Restrict Whistleblowing or Seek Waiver of Payment of Whistleblower Incentive Payments

Aug 24, 2016 4 MIN READ
Lawrence E. Ritchie

Partner, Disputes, Toronto

Andrew MacDougall

Partner, Corporate, Toronto

As whistleblower initiatives build steam in Canada, the United States and throughout the world, executives, and board members face evolving challenges that accompany them. Some of these relate to how firms need to deal with departing employees. In an order dated August 10, 2016 (the “BHI Order”), an administrative judge of the Securities Exchange Commission (“SEC”) imposed a USD $265,000 penalty on BlueLinx Holdings Inc.(“BHI”). BHI had used various versions of severance agreements that had the effect of prohibiting or discouraging its employees from reporting misconduct to the SEC, and in some cases, required its departing employees to waive their rights to receive whistleblower awards. A similar order dated August 16, 2016 (the “Health Net Order”) imposed a USD $340,000 penalty on Health Net, Inc. (“Health Net”) which expressly permitted departing employees to file a charge, provide information, or participate in any investigation or proceeding before any federal or state agency or governmental body, but required the employee to waive any right to individual monetary recovery based on any communication by the employee to the government agency or department. These orders send a strong message to market participants that the SEC is committed to ensuring potential whistleblowers are not in any way discouraged from coming forward with information regarding securities law misconduct.

SEC Finds that BHI and Health Net Breached Section 21F of  the Securities Exchange Act of 1933

The BHI Order stated that BHI was entering into severance agreements with departing employees that contained confidentiality provisions that prohibited and/or discouraged its employees from sharing confidential information concerning BHI that the employee had learned while employed by BHI. The BHI Order noted that some agreements required the employees either to provide written notice to the company or obtain written consent from the company’s legal department prior to providing confidential information.  Moreover, employees were only permitted to provide information if compelled to do so by law or legal process and there was no exemption to permit an employee to provide information voluntarily to the SEC or other regulatory or law enforcement agency.

The BHI Order also notes that BHI eventually amended its severance agreements to permit disclosures if applicable law required that the employee be permitted to do so, but the severance agreements also stated that the “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 with an administrative agency.”

The Order stated that by including such clauses in its severance agreements, BHI raised impediments to participation in the SEC’s whistleblower program. The Order noted that the “restrictions on the ability of [BHI] Employees to share confidential corporate information regarding possible securities law violations with the [SEC] and to accept financial awards for providing information to the [SEC], such as those contained in the [BHI] severance agreements, undermine the purpose of section 21F, which is to “encourage individuals to report to the [SEC]”

The Health Net Order considered a paragraph included in employee severance documents that stated “nothing in this Release precludes Employee from participating in any investigation or proceeding before any federal or state agency or government body… however, while Employee may file a charge and participate in any such proceeding, by signing this Release, Employee waives any right to bring a lawsuit against the Company, and waives any right to any individual monetary recovery in any such proceeding or lawsuit or in any proceeding brought based on any communication by Employee to any federal, state, or local government agency or department”  The Health Net Order stated that seeking to remove “the critically important financial incentives” to communicating with the SEC undermined the purpose of Section 21F, which is to encourage individuals to report to the SEC.

New Whistleblower Protections under the Ontario Securities Act

The Ontario Securities Commission (the “OSC”) established a new whistleblower program in July 2016. Like its American counterpart the OSC’s whistleblower program features monetary incentives for individuals who provide the OSC with information related to securities law misconduct, and also similarly emphasizes the need for whistleblower protections to encourage individuals to come forward with information. The OSC whistleblower protections in the Securities Act focus on anti-reprisal and anti-confidentiality provisions. As previously discussed on our blog, an important difference between the whistleblower regime in Ontario compared to the SEC program is that in Ontario, to the extent that contractual provisions prevent disclosure to securities regulators they are void, whereas in the United States it is a breach of securities law to impede such disclosure. This notwithstanding, how the American authorities deal with severance provisions and other dealings with departing employees, will be informative for articulating and administrating policies of Canadian firms.