ATTORNEY: AATIF IQBAL
POMERANTZ MONITOR MAY/JUNE 2017
Corporate employee-informants play an essential role in the enforcement of the federal securities laws. By reporting wrongdoing that might otherwise be very difficult for outside investors to detect, informants can make it easier to investigate and correct ongoing frauds, limiting the harm inflicted on investors as well as the broader public. In fact, according to a 2008 study by the Association of Certified Fraud Examiners, frauds are more likely to come to light through whistleblower tips than through internal controls, internal or external audits, or any other means.
Because confidential informants play such a vital role in disclosing and deterring securities fraud, the law recognizes the importance of protecting them from retaliation. The Sarbanes-Oxley Act of 2002 (“SOX”) requires companies to create robust internal compliance systems through which employees can anonymously report misconduct, and it protects such employees from any adverse employment consequences that might result. Significantly, SOX requires that certain employees first report violations internally, to allow the company to take corrective action before the SEC gets involved. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 further expands informants’ incentives by directing the SEC to pay a bounty to any “whistleblowers” who provide the SEC with information leading to a successful enforcement action.
Dodd-Frank includes an anti-retaliation provision that prohibits employers from retaliating against a “whistleblower” for acting lawfully within three categories of protected activity: (1) providing information to the SEC, (2) assisting in any SEC investigation or action related to such information, or (3) “making disclosures that are required or protected under” SOX or any securities law, rule, or regulation.
In recent years, some corporate defendants have argued that Dodd-Frank’s anti-retaliation provision does not protect employees who complain internally about wrongdoing if they do not report to the SEC before they suffer retaliation. They argue that the provision’s text only protects a “whistleblower,” which Dodd-Frank elsewhere defines as an individual “who provides information relating to a violation of the securities laws to the Commission.” So, if an employee reports a suspected violation to a supervisor or internal compliance officer and is then fired before he can report to the SEC, he is not a “whistleblower” as defined under Dodd-Frank’s anti-retaliation provision.
In March 2017, the Ninth Circuit rejected this argument in Somers v. Digital Realty Trust. The plaintiff had complained to senior management about “serious misconduct” by his supervisor, but was fired before he could report to the SEC. The district court denied the company’s motion to dismiss, holding that, because the plaintiff was fired for internally reporting a suspected violation—in other words, for “making disclosures that are required or protected under” SOX—he was protected under Dodd-Frank’s anti-retaliation provision.
The Ninth Circuit affirmed, holding that Dodd-Frank’s anti-retaliation provision “necessarily bars retaliation against an employee of a public company who reports violations to the boss.” In reaching its conclusion, the Ninth Circuit emphasized “the background of twenty-first century statutes to curb securities abuses,” noting that SOX did not just strongly encourage internal reporting; it prohibited certain employees, such as lawyers, from reporting to the SEC until they’d first reported internally. Dodd-Frank’s antiretaliation provision “would be narrowed to the point of absurdity” unless it protected employees who reported internally; otherwise, the law would require lawyers to report internally and then “do nothing to protect these employees from immediate retaliation in response to their initial internal report.” The Ninth Circuit thus agreed with the Second Circuit, which had reached the same conclusion in 2015 in Berman v. Neo@Ogilvy LLC.
Dodd-Frank’s promise of robust anti-retaliation protection is critical to deterring and correcting corporate fraud. By protecting whistleblowers whether they speak up internally or to law enforcement, the Ninth Circuit has helped ensure that both the external securities regulation system and the internal compliance system within each company can make use of these whistleblowers’ knowledge and insights in combating corporate fraud—and that wrongdoers cannot avoid the whistleblower protections entirely by firing any employee who reports misconduct internally, before he or she has the chance to inform the SEC.