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New Federal Law, SEC Scrutiny Triggers Clarification of Whistleblower Rights

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Existing privacy regulations and common sense have led investment advisors to vigorously protect confidential information from employee and contractor misappropriation. However, two recent developments raise concerns about how advisors restrict whistleblowers from disclosing confidential information to authorities. As a result, advisors should carefully review confidentiality agreements, severance agreements, employee manuals, policies and procedures, and potentially any other agreement that governs the use of confidential information.

The Defend Trade Secrets Act

The federal Defend Trade Secrets Act (DTSA) became effective on May 11. The DTSA’s primary function is to create a private cause of action for trade secret misappropriation under federal law.

Most critically for investment advisors, the DTSA provides immunity against criminal or civil liability to employees, consultants and contractors for violating trade secret laws if the disclosure is made solely for the purpose of reporting or investigating a suspected violation, or in a document filed under seal as part of a lawsuit or other proceeding.

Under the DTSA, advisors are required to give advance notice of such immunity in any agreement or other document with an employee, consultant or contractor that governs the use of trade secrets. To satisfy this requirement, advisors may simply include a cross reference in such an agreement to another policy document (e.g., policies and procedures manual).

Notably, this requirement only applies to contracts that are entered into or updated after May 11. Investment advisors should therefore amend any documents that govern the use or disclosure of trade secrets that are executed by or provided to employees, consultants and contractors to provide the advance notice of immunity to maximize recovery potential in misappropriation suits.

SEC Whistleblower Scrutiny

Under the SEC’s Whistleblower Incentives and Protection Program, which became effective Aug. 12, 2011, a person may generally be compensated by the SEC if he or she voluntarily provides “original information” that leads to a successful enforcement action resulting in sanctions exceeding $1 million. The whistleblower program also imposes extensive anti-retaliation protections.

To entice would-be whistleblowers, the agency regularly issues press releases extolling the amounts it awards — and sanctions — under the program. On Aug. 10, the SEC announced that an Atlanta-based building products distributor agreed to pay a $265,000 penalty to settle charges that it forced outgoing employees to waive whistleblower rights or risk losing their severance payments.

It was already clear that advisors may not overtly restrict whistleblowers from communicating with the SEC. However, recent examinations establish that advisors should also refrain from tacitly restricting whistleblower rights by incorporating broad restrictions against disclosing confidential information without specifically carving out whistleblower rights. Otherwise, advisors may find themselves on the wrong side of SEC scrutiny and potential enforcement.

For example, recent comments from SEC examiners referred to a severance agreement incorporating “sweeping prohibitions” against the outgoing employee raising claims against the firm. The examiner indicated that such prohibitions could also be read to restrict the outgoing employee’s ability to communicate with the SEC about securities law violations under the whistleblower program, which would constitute a violation of Rule 21F-17(a).

Accordingly, investment advisors should proactively amend all such agreements and their policies and procedures manual to make it abundantly clear that employees and contractors may communicate with the SEC about possible securities law violations at any time without repercussion.


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