Risk & Compliance

Whistleblower Showdown Heads to Supreme Court

The case turns on whether Dodd-Frank protections should apply when a whistleblower reports activity only to a company's compliance function and not...
Eric HavianSeptember 29, 2015
Whistleblower Showdown Heads to Supreme Court

A recent decision by the Second Circuit Court of Appeals in New York has staged a showdown for the Supreme Court to decide what protections whistleblowers should receive when they report illegal activity internally and an employer retaliates as a result. However the Supreme Court decides, corporate officers should take a deep breath and think about the impact of the positions they are taking on the issue.

Eric Havian

Eric Havian

The landmark Dodd-Frank Act gives special protections to corporate employees who expose securities law violations. If an employer retaliates, the employee can sue for double damages and has a longer statute of limitations than under other laws (such as Sarbanes-Oxley). Dodd-Frank also allows the employee to sue immediately in federal court, without the need first to go through lengthy and often pointless administrative proceedings.

The suit in question, Berman v. [email protected], was brought by Daniel Berman, a financial director at a major advertising firm, after he was allegedly fired for reporting accounting fraud internally. Berman then reported his findings to the Securities and Exchange Commission (SEC) six months later.

The Berman court addressed the question of who is eligible for this expanded whistleblower protection — whether the law protects an employee who merely reports illegal conduct internally, or only those employees who report to the SEC. The New York court ruled that reporting to the SEC is not required, rejecting an earlier decision by an appellate court in the Fifth Circuit (in the Asadi v. GE Energy case), which had ruled that employees who only reported internally were not eligible for Dodd-Frank’s anti-retaliation protections.

The conflicting rulings are particularly tricky for corporate officers (including CFOs and compliance officers) who learn about violations through the compliance process. Those officers may be whistleblowers but, absent imminent harm or company efforts to impede an investigation, they must wait 120 days after any internal report before going to the SEC. In New York, those officers would have Dodd-Frank protection during the 120-day window, while officers in Texas would not. This conflict is what the Supreme Court will need to resolve.

Some companies might perceive an advantage in denying Dodd-Frank protection to employees who report only internally. But before companies decide to press the courts to adopt the more limited view of the law announced in Asadi, they should think twice. Limiting whistleblower protections to employees who go to the SEC may be short-sighted in the long run.

The Dodd-Frank legislation not only created protections for whistleblowers, it also set up a whistleblower rewards regime. Those who report securities violations to the SEC are entitled to an award of 10% to 30% of the amount the SEC collects as a result of the whistleblower report.

When Dodd-Frank and its regulations were being drafted, corporate lobbyists besieged the SEC and Congress with predictions that whistleblower rewards would cause employees to circumvent corporate compliance programs that had been diligently implemented by companies in an effort to police themselves. The lobbyists asked why an employee would bother to report internally when they could get a reward by racing to the SEC.

In response, the SEC set up a series of regulatory provisions designed to remove the disincentive to report internally. The SEC (1) provided an increased award for those who report the fraud to internal compliance programs; (2) passed a rule that preserved the reward even for employees who first report internally, and only later report to the SEC; and (3) created a rule that made the date of the internal report the effective date for determining when the whistleblower first reported to the SEC. The net effect of these carefully crafted rules was to remove any financial disincentive that an employee would have for reporting violations to internal corporate compliance programs.

So it was at least anomalous that after the statute and regulations were in place, the same companies that had argued so strenuously to preserve the incentives to use compliance programs adopted a position that inevitably leads to the opposite result.

Take the case of corporate giant General Electric. In the Asadi case, GE, which had vigorously lobbied against Dodd-Frank, successfully persuaded the court that no Dodd-Frank protection existed for employees who reported violations solely to corporate compliance programs. In numerous lower courts, corporations have adopted similar positions on the requirement for SEC reporting, although these companies have lost most of those lower-court cases.

It takes no great imagination to see the incentives that an SEC reporting requirement creates. Under such a regime, any employee who wants full protection from retaliation must first report violations directly to the SEC. If he or she reports first to internal compliance, and is immediately retaliated against, no Dodd-Frank remedy will exist. Reporting to internal compliance will inevitably decline.

As for the Berman case, the Second Circuit may well have saved corporate America from itself, or at least from its legal representatives. The prudent course would be to accept that outcome and breathe a sigh of relief. Is the short-term avoidance of the claim of a single whistleblower really worth sacrificing the structural benefits of a robust corporate compliance program? Some companies and their lawyers apparently think so, but for their sake we should hope they are wrong.

Eric Havian is a former Assistant U.S. Attorney (criminal) and has represented whistleblowers in False Claims Act cases for the past 20 years. He is a partner and co-founder of the San Francisco office at Constantine Cannon LLP.