SEC Brings Enforcement Actions to Remedy Improper Contractual Limitations on Whistleblower Activities

The U.S. Securities and Exchange Commission (“SEC” or “Commission”) in recent months has settled a number of actions targeting employment agreements used by companies—both public and private—which include language implicating Rule 21F-17 of the Securities Exchange Act of 1934. This Rule, adopted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”), affords broad “whistleblower” protections to individuals who report potential securities law violations. As a result of these investigations, the SEC announced settlements with companies whose employment-related agreements were found by the Commission to include language that may impede an employee’s communication with the SEC in the context of reporting a potential securities law violation. The settlements included substantial fines and remediation measures, with the SEC considering a company’s willingness to cooperate with the agency as a key factor in structuring the settlement terms.

A Review of Rule 21F-1

Enacted to encourage reporting of potential securities law violations, Rule 21F-17 provides individual whistleblowers with financial incentives, confidentiality guarantees, and protection from retaliation. In promulgating Section 21F of the Exchange Act, Congress viewed these whistleblower protections as critical components in encouraging whistleblower activity – in effect, both guarding against and rewarding the risk taken by an individual in reporting suspected fraudulent activity and participating in investigative proceedings. As adopted by the SEC on August 12, 2011, Rule 21F-17(a) provides:

a.) 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.

In its settlement orders, the SEC focused largely on the confidentiality language utilized by companies in employment and separation agreements. In each case, the Commission concluded that such language impedes potential whistleblower activity, resulting in a combination of cash fines, time-consuming internal compliance audits, and cease and desist orders requiring the targeted companies to both revise non-compliant documents and implement necessary changes to administrative protocols, as more fully described below.

Recently Settled Actions

Recently settled actions provide helpful context to companies evaluating their own employment agreements, whether those agreements concern separations, confidentiality obligations, or internal policies.

In the Matter of Monolith Resources, LLC

On September 8, 2023, the SEC settled charges with Monolith Resources, LLC (“Monolith”), a privately held clean technology company employing approximately 236 employees. Monolith historically entered into separation agreements with certain terminating employees, exchanging separation pay for a general release of claims by the employee. Although the separation agreements used by Monolith recognized the rights of these employees to engage in certain protected whistleblower activities, they also included a provision requiring terminating employees to waive their rights to recover monetary awards in connection with the filing of fraud claims or participation in related governmental investigations. More specifically, the SEC took issue with the following language, which had the effect, the Commission concluded, of impeding protected whistleblower activity under Section 21F and Rule 21F-17 of the Exchange Act:

These [governmental] agencies have the authority to carry out their own statutory duties by investigating charges or claims, issuing determinations, filing lawsuits in their own name or taking other action authorized by statute. You retain the right to participate in any such action, but not the right to recover money damages or other individual legal or equitable relief awarded by any such governmental agency.

The SEC concluded that the waiver of money damages or other equitable relief required under Monolith’s separation agreement “raised impediments to participation in the Commission’s whistleblower program by having the employees forego the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.” Of note, although twenty-two former Monolith employees signed separation agreements containing the above language, the SEC was not made aware of any instance in which a former employee who was a party to such an agreement either refrained from communicating with the SEC or was prevented from doing so by Monolith’s enforcement of the confidentiality provision.

In settling the enforcement action, Monolith (1) revised its separation agreement to remove the language limiting a terminating employee’s right to participate in financial incentives that may be afforded under Rule 21F-17 of the Exchange Act, (2) notified former employees who had signed the prior separation agreements that they were not restricted from participating in such financial incentives, and (3) agreed to pay a civil penalty in the amount of $225,000.

In the Matter of a Real Estate Firm

On September 19, 2023, the SEC settled with a commercial real estate services and investment firm. Like Monolith, the firm historically entered into separation agreements with certain terminating employees, by which the employee would receive an amount of separation pay in exchange for a general release of claims in favor of the company. The firm's separation agreement included the following employee representation:

Employee represents and acknowledges [t]hat Employee has not filed any complaint or charges against the firm, or any of its respective subsidiaries, affiliates, divisions, predecessors, successors, officers, directors, shareholders, employees, representatives or agents…with any state or federal court or local, state or federal agency, based on the events occurring prior to the date on which [the separation agreement] is executed by Employee.

The SEC concluded that this language, when read in combination with a general statement in the separation agreement that the terminating employee may not execute the separation agreement prior to the employee’s termination date, effectively impeded potential whistleblowers from taking protected (and encouraged) action under Section 21F and Rule 21F-17 of the Exchange Act by requiring the terminating employee to represent, on the execution date, that the employee had not filed a complaint or charges based on events occurring at any time before termination through the execution date. The firm subsequently added the following carve-out language to its separation agreement:

Nothing in this Agreement shall be construed to prohibit Employee from filing a charge with or participating in any investigation or proceeding conducted by the Equal Employment Opportunity Commission, National Labor Relations Board, the Securities and Exchange Commission, the Department of Justice, or a comparable federal, state, or local agency.

The SEC, however, concluded that this carve-out applied only prospectively (i.e., to post-termination activity) and, thus, did not cure the impeding effect of the employee representation.

In settling the enforcement action, the firm (1) revised its separation agreement to comply with Rule 21F-17 of the Exchange Act and undertook a global audit of similar agreements, (2) notified former employees who signed the prior separation agreements of the protections afforded them by Rule 21F-17, (3) reviewed and initiated necessary changes to internal compliance protocols, and (4) agreed to pay a civil penalty in the amount of $375,000.

In the Matter of D.E. Shaw & Co., L.P.

On September 29, 2023, the SEC settled its enforcement action against D.E. Shaw & Co., L.P. (“D.E. Shaw”), a Delaware limited partnership registered with the Commission as an investment adviser which, together with its affiliates, provides financial advisory services to various investment funds. D.E. Shaw employs more than 750 people. During an approximately 8-year period beginning in August 2011, D.E. Shaw required new employees to sign employment agreements that prohibited the individuals from disclosing “confidential information” about the company. Confidential information was broadly defined to include, among other business information, “information gained in the course of the Employee’s employment with [D.E. Shaw] that could reasonably be expected to be deleterious to [D.E. Shaw or its affiliates] if disclosed to third parties.”

In addition to these employment agreements, D.E. Shaw also entered into separation agreements and general releases of claims with certain terminating employees, whereby the terminating employees would receive separation-related payments in exchange for waiving their rights to bring federal, state, and local claims against D.E. Shaw. Among other things, the release required terminating employees to make the following representation:

The Employee represents and warrants to the Company that the Employee has not made, filed or lodged any complaints, charges, or lawsuits or otherwise directly or indirectly commenced any proceeding against any member of [D.E. Shaw, its affiliates, or certain other covered persons and entities] with any governmental agency, department, or official; any regulatory authority; or any court, or other tribunal, or other dispute resolution body.

For certain other of its employees, D.E. Shaw appended the release (including the above language) to existing employment agreements or required execution of a separate termination agreement including the release language and required execution of the same in order to receive post-termination payments. The release language made clear that it was intended to survive the employee’s termination from employment with the company.

The SEC concluded that the above-described language in the employment agreements and termination agreements raised impediments to participation in protected whistleblower activities (namely, impeding communications with the SEC about potential securities law violations) by employees and terminating employees of D.E. Shaw, resulting in violations of Section 21F and Rule 21F-17 of the Exchange Act.

In settling the enforcement action, D.E. Shaw initially communicated to its employees an acknowledgment of their rights to communicate with the SEC (or other government agencies or regulators) regarding possible legal violations without advance authorization from the company. It also made certain administrative changes, including revisions to the company’s Internal Reporting Policy, Code of Ethics, and Employee Handbook. D.E. Shaw revised its employment agreements more than two years after the Commission’s investigation ended and its separation agreement and release language more than four years later, in each case to bring its template documents into compliance with Rule 21F-17 of the Exchange Act. As part of its settlement, D.E. Shaw was both censured and assessed a civil penalty in the amount of $10,000,000.

Conclusion

The SEC’s recent focus on Rule 21F-17 in the context of employment-related agreements signals the agency’s continued interest in investigating matters adjacent to more common securities transactions. Companies should assess whether a review of their internal agreements is appropriate, with an eye towards ensuring that the terms of those agreements comply with applicable whistleblower protections. Companies should also consider consulting with counsel when drafting or revising terms that implicate whistleblower activity given the SEC’s recently articulated view of the scope of prohibitions embedded within Rule 21F-17.