Approximately a year ago, the Chief of the U.S. Securities and Exchange Commission’s (“SEC’s”) Office of the Whistleblower, Sean McKessy, publicly warned companies and their counsel against drafting contracts that attempt to dissuade would-be whistleblowers from reporting company wrongdoing to the SEC.1 McKessy stressed that his office was “actively looking for examples of confidentiality agreements, separation agreements, [and] employee agreements” that condition certain benefits on not reporting activities to regulators, including the SEC.
This month, the SEC held true to its word and announced a first-of-its-kind enforcement action against Houston-based technology and engineering firm, KBR, Inc. (“KBR”), in which KBR agreed to settle allegations that certain of its confidentiality agreements could be read to impede employees from reporting wrongdoing to the SEC.2
While neither admitting nor denying the findings, KBR agreed to pay a $130,000 penalty and to amend its confidentiality agreement language. Companies, including those with significant foreign operations that may implicate the FCPA, should take note of the KBR action and the SEC’s concern regarding how confidentiality provisions and other employment-related agreements might improperly impede whistleblower reporting.
The SEC’s order does not make clear whether the confidentiality agreement at issue was used only with U.S.-based employees or whether it was also used with non-U.S. employees. Regardless, because of the number of tips the SEC receives from outside the United States3 and the potential for SEC enforcement actions against even foreign-based U.S. issuers that violate the whistleblower anti-retaliation provisions of the Dodd-Frank Act, the action serves as a further caution to all U.S.-listed companies when drafting such agreements.
When it implemented the whistleblower provisions of Dodd-Frank, the SEC broadly interpreted the anti-retaliation protections of the Act through Exchange Act Rule 21F-17, which – among other protections – prohibits “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.”4 The KBR action is the first time the SEC has sought to enforce that provision.
The SEC order alleges that KBR regularly conducts internal investigations of potential wrongdoing at the company, and, as part of these investigations, typically interviews KBR employees. At the start of the interviews, internal investigators ask the employees to sign confidentiality statements regarding the interview and the information provided. Specifically, the SEC alleges, KBR witnesses had to agree to the following contractual provision:
I understand that . . . 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 unauthorized disclosure . . . may be grounds for disciplinary action up to and including termination of employment.5
According to the SEC, such language could discourage a witness-employee from bringing wrongdoing to the attention of the SEC without approval from KBR’s law department. Even though the SEC acknowledged that it knew of no instances when a KBR employee was, in fact, prevented from communicating with the SEC, or when KBR sought to enforce the confidentiality agreement or prevent such communications, the SEC found the potential for such interference sufficient to bring the action.
In light of the KBR action, companies publicly listed on U.S. exchanges should avoid broad confidentiality language in contracts with employees that do not contain an express carve out for reporting to governmental entities.6 This includes not only confidentiality agreements or statements like the one KBR used for internal investigations, but also employment agreements, Codes of Conduct, and – perhaps most significantly – separation agreements or settlements with departing employees, including those who have threatened or filed employment-related litigation.
The fact that the Second Circuit Court of Appeals has held that the Dodd-Frank anti-retaliation provisions do not apply extraterritorially should not provide comfort to companies that seek to use these agreements with foreign employees.7 That case was in the context of a foreign whistleblower plaintiff seeking to bring an anti-retaliation claim in U.S. court based on a statutory provision of Dodd-Frank with no clear extraterritorial reach. The potential liability at issue here concerns SEC enforcement of an SEC rule against issuers of securities registered with the SEC.8
Employers do not need to be concerned that all agreements to maintain confidentiality with employees may run afoul of SEC rules. In particular, provisions which seek to maintain confidentiality for the purpose of preserving the attorney-client privilege are permitted specifically by the SEC’s rules.9 For example, if during an internal investigation, an attorney conducts an interview of a company employee, the company may request that the employee treat confidential information discussed at the meeting to preserve the attorney-client privilege. While not explicitly required under the plain language of the SEC’s whistleblower rules, companies should consider whether to expressly inform the employee that reporting to the government any independent knowledge of wrongdoing (that is, information known apart from the privileged conversation) is always permitted. Until this area of the law develops more fully, this precautionary step appears to be the safest course to ensure that the SEC cannot allege any interference with wouldbe whistleblowers.
While the KBR action may be the first action brought under Rule 21F-17, it is unlikely to be the last. As widely reported in the media earlier this year, the SEC has sent inquiries to numerous companies requesting a wide range of non-disclosure, employment and other agreements, presumably to review whether these agreements contain overly broad provisions that may chill whistleblower reporting. We expect the SEC’s focus on whistleblower issues to continue and perhaps even intensify over the near term.10