The SEC’s New Whistleblower Action: Is It Counterproductive?
The SEC brought its first enforcement action centered on corporate restrictions which could impact employee whistleblowers, deterring them from reporting to the agency. Specifically, the Commission alleged that a policy at KBR, Inc. which precluded the disclosure of information by an employee about that person’s interview in an internal investigation, or the subject matter of the interview, without the permission of the law department undermined Exchange Act Section 21F and Rule 21F-17 thereunder. In the Matter of KBR, Inc., Adm. Proc. File No. 3-16466 (April 1, 2015).
The factual background to KBR is straight forward. Prior to the passage of the Dodd-Frank Act in 2010 which added whistleblower provisions to the Exchange Act, KBR adopted a form confidentiality statement for use in its internal investigations. It stated in part: “I understand that in order to protect the integrity of this review[internal investigation], 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 the unauthorized disclosure of information may be grounds for disciplinary action . . .”
Use of the form was not required by KBR. It was, however, included as an enclosure to the KBR Code of Business Conduct Investigation Procedures manual. KBR, as part of its compliance efforts, conducted internal investigations regarding complaints and allegations from its employees of potential illegal or unethical conduct by the firm or its employees. As part of those inquiries typically employees were interviewed. KBR investigators “have had witnesses sign” the statement at the start of an interview, according to the Order.
The SEC is “unaware of any instances in which (i) a KBR employee was in fact prevented from communicating directly with Commission Staff about potential securities laws violations, or (ii) KBR took action to enforce the form confidentiality agreement or otherwise prevent such communications . . .” Nevertheless, the statement “undermines” the purpose of Rule 21F-17(a), according to the Order. That Rule, enacted under Exchange Act Section 21F, provides in part that: “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 . . . a confidentiality agreement . . .” This provision is designed to encourage reports to the Commission.
KBR resolved the proceeding. As part of its remedial steps the firm amended its statement to provide in part that “Nothing in this Confidentiality Statement prohibits me from reporting possible violations of federal law or regulations to any governmental agency . . . I do not need prior authorization of the Law Department . . .” to make such disclosures. The firm also agreed to make reasonable efforts to contact employees in the U.S. who has signed such a statement on and provide them with a copy of the Commission’s Order and the amended policy and to certify compliance in writing. In addition, the firm consented to the entry of a cease and desist order based on the Section and Rule cited in the Order and agreed to pay a civil penalty of $130,000.
KBR appears to have a robust compliance program designed to root out wrongful conduct by the firm and its employees. As part of that program the company conducts internal investigations after receiving a report of wrongful or unethical conduct by the company or its employees, according to the SEC. Indeed, the firm developed policies and procedures to guide the process. This is consistent with the SEC’s goal of encouraging the development of effective compliance programs and the whistleblower program.
When the Commission drafted its whistleblower rules there was significant discussion about whether those rules should require the employee to first report to the company. Ultimately the SEC elected not to include such a provision in its rules. At the same time the Commission stated that its rules were designed to encourage employees to report to the company. Thus, the Commission’s current website states: “The final rules do not require that employee whistleblowers report violations internally in order to qualify for an award. However, the rules strengthen incentives that had been proposed and add certain additional incentives intended to encourage employees to utilize their own company’s internal compliance programs when appropriate to do so.” Many companies supplemented or developed robust compliance programs in the wake of the SEC’s whistleblower rules to facilitate internal reports.
The Order in KBR should not be used to discourage or undercut these efforts – but it could. It seems clear that the KBR confidentiality policy was not used in every instance and there was no indication it had actually been enforced against or even discouraged a potential whistleblower. In view of these facts it is debatable as to whether a civil penalty or even a cease and desist order rather than a Report of Investigation was the appropriate resolution of this matter. This is particularly true in view of the firm’s remedial efforts which eliminated the prospect of any future issues. Indeed, if the point was to convey the SEC’s views while assuring issuers that they should continue to have robust compliance systems that encourage employees to report unethical and wrongful conduct to the firm, a Report was the vehicle of choice. In contrast, the selection of an enforcement action to convey the SEC’s message, particularly coupled with the imposition of a needless financial penalty, may well send the wrong message regarding such compliance efforts. That would be counterproductive for the SEC.