This is not my usual April Fool’s Day Blog (although I wish it was). Today, the SEC announced its first enforcement action against a company for using improperly restrictive language in confidentiality agreements with the potential to stifle the whistleblowing process. The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010, amended the Exchange Act by adding Section 21F, “Whistleblower Incentives and Protection.” The congressional purpose underlying these provisions was “to encourage whistleblowers to report possible violations of the securities laws by providing financial incentives, prohibiting employment-related retaliation, and providing various confidentiality guarantees.” In 2011, the SEC adopted Rule 21F-17, which provides in relevant part:
- 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.
Rule 21F-17 became effective on August 12, 2011.
The SEC charged a Houston-based company with violating Rule 21F-17 by requiring witnesses in certain internal investigations interviews to sign confidentiality statements with language warning that they could face discipline and even be fired if they discussed the matters with outside parties without the prior approval of KBR’s legal department. Since these investigations included allegations of possible securities law violations, the SEC found that these terms violated Rule 21F-17. Without admitting or denying the charges, the company agreed to pay a $130,000 penalty to settle the SEC’s charges and the company voluntarily amended its confidentiality statement by adding language making clear that employees are free to report possible violations to the SEC and other federal agencies without company approval or fear of retaliation.
The language used by the company read:
I understand that in order to protect the integrity of this review, I am prohibited from discussing any particulars regarding this interview and the subject matter discussed during the interview, without the prior authorization of the Law Department. I understand that the unauthorized disclosure of information may be grounds for disciplinary action up to and including termination of employment.
The SEC demanded the addition of the following language:
Nothing in this Confidentiality Statement prohibits me from reporting possible violations of federal law or regulation to any governmental agency or entity, including but not limited to the Department of Justice, the Securities and Exchange Commission, the Congress, and any agency Inspector General, or making other disclosures that are protected under the whistleblower provisions of federal law or regulation. I do not need the prior authorization of the Law Department to make any such reports or disclosures and I am not required to notify the company that I have made such reports or disclosures.
So what does this have to do with executive compensation? Nearly every well-drafted employment, severance, change in control, and award agreement contains similar – although usually not as onerous – language.
So what is a company to do? Companies should review the language of all their agreement and consider changes, where necessary.