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News March 5, 2018 Issue

Supreme Court Whistleblower Definition Ruling May Hurt Advisory Firms

Don’t be so quick to applaud. The recent U.S. Supreme Court whistleblower anti-retaliation decision in favor of an employer may sound like good news to advisory firms, broker-dealers and companies everywhere – but may spur disgruntled employees to report suspected fraud or related actions directly to the SEC, rather than to upper management.

The Supreme Court on February 21 unanimously reversed a lower court decision in favor of California-based Digital Realty Trust, a real estate investment trust that owns, acquires and develops data centers. Under the Supreme Court’s ruling, Digital Realty Trust did not violate the Dodd-Frank Act’s anti-retaliatory provision when it terminated the employment of its vice president, Paul Somers, for reporting suspected securities law violations to senior management.

The reason, according to the Supreme Court, was that the definition of a whistleblower under Dodd-Frank explicitly states that reporting of suspected improper actions be reported to the Commission. In this way, it is unlike another federal law, the Sarbanes-Oxley Act, which contains an anti-retaliation provision covering employees who report fraud not only to the SEC, but to any other federal agency, Congress, or an internal supervisor, the Court said.

"The question presented: Does the anti-retaliation provision of Dodd-Frank extend to an individual who has not reported a violation of the securities laws to the SEC and therefore falls outside the Act’s definition of ‘whistleblower?’" asked Justice Ruth Bader Ginsberg, who wrote the majority opinion. "We answer that question ‘No’: To sue under Dodd-Frank’s anti-retaliation provision, a person must first ‘provid[e] . . . information relating to a violation of the securities laws to the Commission."

"The disposition of this case is therefore evident: Somers did not provide information ‘to the Commission’ before his termination . . . , so he did not qualify as a ‘whistleblower’ at the time of the alleged retaliation," the ruling continued. "He is therefore ineligible to seek relief under [that section of the law]."

"We welcome the Supreme Court’s decision on this important legal issue and the clarity it provides employers," said Digital Realty Trust senior vice president for investor relations John Stewart. "Congress drafted the Dodd-Frank whistleblower provision to require reporting directly to the SEC, and the Court’s decision respects the clear intent of the law." An attorney for Somers, when reached, chose not to comment.

One could almost hear the glasses being toasted in managerial offices in the wake of the ruling: Less need to look over our shoulders to see if any action we took against an employee who spoke up might get us in trouble, one less way that legal action may be taken against our firm.

But that might be celebrating a bit too soon.

Possibly an undesired result

"In ruling that the whistleblower protections require blowing the whistle to the SEC, the Supreme Court relied on the statute’s language," said University of North Carolina School of Law professor Thomas Lee Hazen. "Although the ruling may be correct under the current statute, I believe the result is unfortunate from a policy standpoint."

"For many years," he said, "the SEC has encouraged companies to clean their own house and self-report violations that may have occurred. The agency’s preference for self-reporting encouraged many companies to institute robust internal monitoring systems, in turn encouraging employees to report suspected problems internally. Limiting whistleblower protections to those who report to the SEC seems to run counter to encouraging companies to implement robust self-reporting within the company. The message from the current state of the law may well be to encourage reporting to the Commission rather than internal reporting within the company."

"This ruling is of importance to investment advisers, investment companies and others in the business – indeed, all employers," said Georgetown University School of Law professor Donald Langevoort. "This is a mixed win for employers at best. The scope of liability is indeed narrower, but now going forward, savvy whistleblowers have another reason to bypass internal reporting (which the business community rightly would prefer) in favor of going quickly to the SEC. But the Court was deciding this on textual, not policy grounds."

"Digital Realty won the battle but regulated entities and corporate America lost the war," said Buckley Sandler partner and former SEC Office of Market Intelligence chief Thomas Sporkin. "If an internal whistleblower at an investment adviser would previously have been inclined to report his or her observations solely through internal avenues, today that same whistleblower would be better served to report first to the SEC and then
report internally."

"Compliance and legal personnel at registered investment advisers and broker-dealers should consider reviewing their policies and procedures to ensure that they are striking the correct balance between motivating employees to report potential problems internally and not limiting an employee’s ability to report out," said Pasquarello Fink partner William Haddad. "This is especially true given the SEC’s focus (through enforcement actions) on entities that limit such reporting by requiring employees to sign restrictive confidentiality agreements that may have the effect of ‘chilling’ an employee’s desire to report out."

Sarbanes-Oxley and Dodd-Frank

One might ask why not bring such reports to internal upper management under Sarbanes-Oxley, which allows internal reporting? One answer is that, unlike Dodd-Frank, Sarbanes-Oxley requires that an administrative complaint be filed within 180 days, while Dodd-Frank permits a whistleblower to sue a current or former employer directly in federal district court within six years.

Further, Dodd-Frank allows a court to award a whistleblower double back pay with interest, while Sarbanes-Oxley limits recovered compensation to actual back pay with interest.

Both laws allow compensation for litigation costs, expert witness fees and reasonable attorney fees.

Gatekeepers

The Supreme Court, in its ruling, noted that "Somers and the Solicitor General express concern that our reading would jettison protection for auditors, attorneys and other employees subject to internal reporting requirements." If the whistleblower definition applies, the ruling said, there is a concern that such professionals will be left vulnerable to discharge or other retaliatory action for simply complying with their internal reporting obligations.

However, wrote Ginsberg, "our reading shields employees in these circumstances . . . as soon as they also provide relevant information to the Commission [emphasis Supreme Court]. True, such employees will remain ineligible for Dodd-Frank’s protection until they tell the SEC, but this result is consistent with Congress’ aim to encourage SEC disclosures."