In a decision with substantial implications for Securities and Exchange Commission ("SEC" or "Commission") enforcement, on February 21, 2018, the U.S. Supreme Court unanimously narrowed the scope of anti-retaliation protections for whistleblowers under the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), holding in Digital Realty Trust, Inc. v. Somers1 that employees must report alleged violations of securities laws to the SEC to trigger anti-retaliation protections under the statute. Reversing a prior Ninth Circuit decision,2 the Supreme Court ruled that employees who report alleged violations only internally are not protected whistleblowers under Dodd-Frank but are protected only if they have reported to the SEC.
The Dodd-Frank Act strengthened SEC enforcement by providing monetary awards and anti-retaliation protections to “whistleblowers” who report on securities law violations. The statute unambiguously provides monetary awards to people who report to the SEC. The issue in Digital Realty was the extent of anti-retaliation protections that restrict employers from firing, demoting, harassing or otherwise discriminating against a “whistleblower.”3
The Dodd-Frank Act defines a “whistleblower” as someone who provides “information relating to a violation of the securities laws to the Commission.”4 While that definition seemingly only protects those who report to the SEC, the statute separately provides protection for whistleblowers who make disclosures consistent with other federal laws that do not require disclosure to the SEC, including the Sarbanes-Oxley Act.5 The Ninth Circuit panel in Somers acknowledged the circuit split between the Second and Fifth Circuits on the definition of “whistleblower” under Dodd-Frank.6 While the Ninth and Second Circuits held that an individual who only discloses internally was protected by the Dodd-Frank provisions, the Fifth Circuit interpreted the term “whistleblower” more narrowly to include only those who report alleged violations to the SEC. This circuit split likely contributed to the Supreme Court deciding to resolve this topic.
Digital Realty involved the company’s former vice president, Somers, alleging that he was fired after making several internal reports to senior management regarding possible securities law violations at the company. Somers sued Digital Realty in the U.S. District Court for the Northern District of California, invoking the anti-retaliation protections of the Dodd-Frank Act. Digital Realty moved to dismiss on the grounds that Somers was required to report to the SEC under the statute. The district court denied the motion, finding that a whistleblower seeking protection from retaliation is not required to have reported to the SEC. A Ninth Circuit panel affirmed the district court on interlocutory appeal. The Supreme Court granted certiorari on June 26, 2017, heard oral arguments on November 28, 2017, and reversed on February 21, 2018.
The Supreme Court’s Decision
The Supreme Court ruled 9-0 in favor of Digital Realty. In the majority opinion authored by Justice Ginsburg, the Supreme Court held that an individual must report securities law violations to the SEC to be protected as a whistleblower under the Dodd-Frank Act. The Court found that the Dodd-Frank Act unambiguously defines a “whistleblower” as someone who provides information regarding securities law violations to the SEC. Because the statute’s definition limits those who are entitled to protection to those who report to the SEC, a person who reports only internally is not protected as a whistleblower regardless of the conduct they engage in, such as reporting misconduct.
The Court found that, by enacting the whistleblower provisions of Dodd-Frank, “Congress undertook to improve SEC enforcement and facilitate the Commission’s ‘recovery[y] [of] money for victims of financial fraud.’”7 The Court held that by requiring the provision of information to the SEC, the narrower whistleblower definition serves the goal of assisting SEC enforcement.
Expected Shifts in SEC Enforcement Dynamics
The Digital Realty decision represents a potentially significant shift in the dynamics between whistleblowers and companies. The decision narrows the scope of individuals entitled to Dodd-Frank whistleblower protection to exclude those who report only internally. As a result, whistleblowers now have a greatly heightened incentive to take their concerns directly to the SEC. This may lead to increased SEC reporting and provide uncertainty to companies with strong compliance and reporting regimes. Rather than being able to investigate and resolve securities-related issues internally, these companies will have to adapt to the reality that the SEC may be receiving information of alleged corporate misconduct before they are. In many or most instances, companies will not become aware of a whistleblower until after an SEC’s investigation has advanced.
The Digital Realty decision may also enhance the increasingly important role that whistleblowers play in government enforcement activity. Since Dodd-Frank established its new anti-retaliation protections and whistleblower “bounty” program in 2011 (a whistleblower can potentially receive between 10-30% of a monetary judgment from a successful enforcement action), the number of tips, complaints and referrals the SEC receives per year has increased significantly.8 Since launching the new program, the SEC has awarded 50 whistleblowers more than US$179 million.9 By requiring Dodd-Frank whistleblowers to report to the SEC, Digital Realty likely will increase the flow of tips to the government that catalyze enforcement activity.
The Digital Realty decision notwithstanding, companies still need to prioritize developing best internal practices to successfully address whistleblower complaints, create an incentive structure to encourage employees to report suspected wrongdoing internally, and foster a culture of compliance. Because Dodd-Frank’s whistleblower protections now protect only those who report to the SEC, companies must be even more careful than they have been to avoid any impairment to their employees’ rights to make reports to the SEC.10 Since 2015, the SEC has indicated it will focus attention on employment agreements (including non-disclosure, confidentiality and severance agreements) that could potentially discourage employees from reporting problems directly to the SEC in violation of Dodd-Frank. Several six-figure settlements have been announced with corporations that had such agreements in place—such as agreements prohibiting employees from externally disclosing information they had already reported internally or requiring that outgoing employees waive their ability to obtain SEC whistleblower rewards. In the wake of Digital Realty, companies must continue to perform a careful balancing act of establishing comprehensive programs that encourage internal reporting while at the same time not stifling whistleblower contacts with the government so as to raise SEC concerns.