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News July 10, 2017 Issue

High Court Will Review Protections for Whistleblowers Who Report Only Internally

Are whistleblowers protected from employer retaliation if they report wrongdoing to their employer but not to the SEC? The answer will depend on the U.S. Supreme Court, which this fall will review a lower-level court case dealing with that very question.

The high court on June 26 accepted a petition from Digital Realty Trust, a Maryland company. Digital Realty is challenging a ruling from the U.S. Court of Appeals for the Ninth Circuit upholding a lower court ruling that the company’s firing of a whistleblowing employee was subject to the provisions of the Dodd-Frank Act forbidding retaliation against whistleblowers. Digital Realty takes the position that the Dodd-Frank provisions should not apply, arguing that, as written, they apply only to whistleblowers who report to the SEC.

"This is a case that pits ‘plain English’ statutory interpretation against deference to administrative agency reading of statutes," said Georgetown University School of Law professor Donald Langevoort. "Here the SEC clearly includes internal whistleblowers in the realm of protection from retaliation, even though the statutory definition of whistleblower refers specifically to reporting to the SEC, not internally. So the case may be one of the first with the newly constituted Court to take up what has been a simmering issue for some time: how much power should agencies have to put their own meaning on a statutory provision?"

However the Supreme Court decides, its ruling is likely to impact investment advisers and others in the asset management industry. "Whistleblower protections apply to whistleblowers whose reporting leads to successful SEC enforcement actions either in administrative proceedings or enforcement actions in court," said University of North Carolina at Chapel Hill law professor Thomas Lee Hazen. "Thus, they would apply to advisory firms who end up as targets of SEC enforcement actions."

The Supreme Court will have differing appellate court rulings to consider. While the Ninth Circuit appellate court – as well as the U.S. Court of Appeals for the Second Circuit in another case – ruled that Dodd-Frank whistleblower protections apply not just to those employees who report directly to the SEC, but to those who just report internally, the Fifth Circuit U.S. Court of Appeals, in still another case, ruled the opposite way.

Tied into the question about the Dodd-Frank Act are two other pieces of legislation: the Sarbanes-Oxley Act, which has its own internal reporting provisions, and the Securities Exchange Act of 1934 and what they each require. So the Supreme Court will need to review what each law requires, whether and how Congressional intent applies, and the rulings from the three appellate courts.

"The problem is that the Exchange Act’s whistleblower protection does not explicitly address whether first making an internal report disqualifies the employee from the Act’s protections," said Hazen. "The Second and Ninth Circuits point to other provisions of the
securities laws that encourage internal reporting and the Fifth Circuit rule is inconsistent with that goal."

"I would like to see the Supreme Court uphold the Ninth Circuit’s view so as to encourage internal reporting as a first step," he said. "However, with the increasing number of literalist justices on the high court, there is a chance the Supreme Court may side with the Fifth Circuit."

"Ironically, even though the SEC supports extending Dodd-Frank anti-retaliation provisions to individuals who report internally only, the agency may receive more whistleblower complaints if the Supreme Court holds otherwise and reverses the Ninth Circuit decision," said Mayer Brown partner Matthew Rossi. "That’s because if Dodd-Frank protects only whistleblowers who report to the SEC and not those who report only internally, employees will have an incentive to make complaints directly to the SEC without first providing their employers with an opportunity to address them."

"This would undoubtedly harm internal compliance efforts," he said. "However, this result may be less pronounced than some fear because Sarbanes-Oxley already provides some protection for whistleblowers, although to a lesser extent than Dodd-Frank. Moreover, the SEC may attempt to take action against investment advisers that retaliate against internal whistleblowers on the grounds that retaliation violates the adviser’s compliance policies or code of ethics."

The case

Digital Realty employed Paul Somers as a vice president from 2010 to 2014, according to the Ninth Circuit appellate ruling. Somers made multiple reports to senior management in regard to possible securities law violations by the company, resulting in the Digital Realty terminating his employment, the Ninth Circuit said in recounting Somers’ complaint in the lower U.S. District Court.

Somers then sued his former employer, alleging violations of several state and federal laws, the Ninth Circuit appellate ruling said. Among those was the Exchange Act’s Section 21F, "Securities Whistleblower Incentives and Protection," which was added to the Exchange Act by the Dodd-Frank Act, and included anti-retaliation provisions.

"Digital Realty sought to dismiss the [Dodd-Frank Act] claim on the ground that, because Somers only reported the possible violations internally and not to the SEC, he was not a ‘whistleblower’ entitled to [the Dodd-Frank Act’s] protections," the Ninth Circuit appellate court said.

The U.S. District Court ruled in favor of Somers, according to the Ninth Circuit appellate decision. "The District Court deferred to the SEC’s interpretation that individuals who report internally only are nonetheless protected from retaliation under [the Dodd-Frank Act]."

"Digital Realty is glad that the Supreme Court has agreed to resolve the circuit split on this important legal issue that affects so many employers across America," said the attorney representing that company. An attorney representing Somers did not respond to an email or a voice mail seeking comment.

Other appellate court rulings

Here’s how two other appellate courts ruled in similar cases:

  • The Fifth Circuit. In Asadi v. G.E. Energy, the court in 2013 "strictly applied" the Dodd-Frank Act’s definition of what constitutes a whistleblower as someone who discloses information only to the SEC, the Ninth Circuit appellate court said. It then applied that definition against the Dodd-Frank Act’s anti-retaliation provision, and found that since the employee did not make his disclosures to the agency, the anti-retaliation provision did not apply.
  • The Second Circuit. In Berman v. Neo@Ogilvy, the court in 2015 interpreted the provision "to extend protections to all those who make disclosures of suspected violations, whether the disclosures are made internally or to the SEC," according to the Ninth Circuit appellate ruling.

The Ninth Circuit appellate ruling

The appellate court said that it agreed with the district court that "the regulation is consistent with Congress’s overall purpose to protect those who report violations internally as well as those who report to the government. This intent is reflected in the language of the specific statutory subdivision in question, which explicitly references internal reporting provisions of Sarbanes-Oxley and the Securities Exchange Act of 1934."

"In view of that language and the overall operation of the statute," the appellate court said, "we conclude that the SEC regulation correctly reflects Congressional intent to provide protection for those who make internal disclosures as well as to those who make disclosures to the SEC."