Unforced Errors: Staying on Serve with the SEC

Rafael Nadal and Roger Federer are almost certainly among the top five or six male tennis players of all time. Federer retired from tennis in 2022, and Nadal just announced he will retire at the end of this year. At their peaks, they were undisputedly the top two players in the world. And while few experts would confidently rank one ahead of the other – Nadal was dominant on clay courts, Federer on grass, and they were roughly even on hard courts – Nadal won 24 of the 40 matches they played against each other. The difference? It might have been that Nadal committed half the unforced errors as Federer in their head-to-head matches. See Peiris, et al., Analysis of Unforced Errors in Tennis, on the arXiv open-access archive, at https://arxiv.org/html/2407.19321v1#S4.

The lesson for firms in the securities industry? Keep your unforced error rate down. Update your policies and procedures regularly and make sure that you are not including things in severance agreements or client settlement agreements that the SEC has said are illegal. And if you receive a subpoena from the SEC – regardless of what the SEC is investigating – make sure to hire an attorney with substantial experience in defending SEC matters who can apprise you of all your risks before you respond.

One of the most obvious examples of an unforced error is when financial services firms repeatedly ignore the directive from the SEC that they cannot prohibit clients, employees, or anyone else from reporting securities laws violations to the SEC, state regulators, or self-regulatory organizations. Pursuant to Dodd-Frank Act’s whistleblower protections, the SEC prohibits registrants, brokerage firms, and investment advisors from including such “anti-whistleblowing” prohibitions in settlement agreements with disgruntled investors, as well as in employment agreements, separation agreements and settlement agreements with current or former employees. See https://www.sec.gov/enforcement-litigation/whistleblower-program/whistleblower-protections#anti-retaliation.  Specifically, pursuant to the Dodd-Frank Act, the SEC in 2011 adopted Securities Exchange Act Rule 21F-17(a), which provides:

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.

Despite this Rule and the SEC’s well-publicized cases enforcing the Rule, firms continue to punish employees for reporting securities violations to governmental authorities. See /blog/supreme-court-protects-whistleblowers/. See also https://www.sec.gov/files/litigation/admin/2023/33-11196.pdf (settlement with Gaia, Inc. and its CFO for violations of Rule 21F in May 2023, including firing whistleblower purportedly for making “unfounded complaints”); SEC v. GPB Capital Holdings, LLC et al., No. 21-cv-583 (E.D.N.Y. filed February 4, 2021), https://www.sec.gov/enforcement-litigation/litigation-releases/lr-25909 (complaint filed against investment advisor and several related entities and individuals for, inter alia, firing and taking other adverse action against whistleblower; court later appointed a receiver over the companies).

And it’s not just retaliating against employee-whistleblowers that can get companies in trouble. Some firms still include anti-whistleblowing provisions in employment agreements or separation agreements with prospective and former employees. On September 9, 2024, the SEC announced settlements with seven public companies for using agreements that violated the rule prohibiting firms from impeding potential whistleblowers from reporting potential misconduct to the SEC. https://www.sec.gov/newsroom/press-releases/2024-118. In this most recent instance, the firms required employees to waive their rights to disclose information or file a complaint with a governmental or regulatory body, and to waive their rights to any possible whistleblower monetary awards in hundreds of employment agreements, separation agreements, retention agreements, and settlement agreements. While the SEC did not allege that the companies had taken actions to enforce the waivers, the SEC takes the position that these waivers, while unenforceable in a court of law, still discourage employees and ex-employees from engaging in entirely legal conduct. In total, the seven companies agreed to pay more than $3 million combined in civil penalties. This is an expensive unforced error.

Just a couple of weeks later, the SEC announced that Florida advisory firm GQG Partners LLC agreed to a cease-and-desist order and to pay $500,000 in civil penalties for requiring one former and a dozen prospective employees over three years to agree to non-disclosure agreements limiting their ability to voluntarily report potential illegality to the SEC. See https://www.sec.gov/newsroom/press-releases/2024-150. The agreements these employees/prospective employees signed permitted them to respond to requests for information from the SEC but not affirmatively reach out and contact the SEC. That too is illegal. 

Similarly, firms continue to include these anti-whistleblowing/confidentiality provisions in arbitration settlement agreements to discourage or impede settling investors from reporting violations. See, e.g., In the Matter of Nationwide Planning Associates, Inc., NPA Asset Management, LLC, and Blue Point Strategic Wealth Management, LLC, File No. 3-22056 (Sept. 4, 2024), https://www.sec.gov/files/litigation/admin/2024/34-100908.pdf (settlement with broker-dealer and investment advisor for confidentiality provisions barring clients settling claims for investment losses from reporting conduct to regulators); SEC v. Sanchez, et al., No. 24-cv-00939 (S.D. Tex.) (filed Mar. 14, 2024), https://www.sec.gov/files/litigation/complaints/2024/comp-pr2024-35.pdf (SEC alleged defendant told investors he would help them recover their investment losses “if they took back everything they said to the SEC”).

Perhaps some firms believe that because these types of anti-whistleblowing provisions are unenforceable makes them harmless. See In re JDS Uniphase Corp. Sec. Litig., 238 F. Supp. 2d 1127, 1136 (N.D. Cal. 2002) (party cannot enforce agreement against former or current employees to prevent them from providing information about party’s allegedly illegal activities); FTC v. AMG Services, Inc., 2:12-cv -00536-GMN-VCF, 2013 U.S. Dist. LEXIS 206720, at *7 (D. Nev. Aug. 20, 2013) (collecting cases) (confidentiality agreements are unenforceable to prohibit former employees from willingly cooperating with government investigations); Woodson v. Runyon, Civ. Action No. 13-4098, 2013 U.S. Dist. LEXIS 96833, at *14 (D.N.J. July 11, 2013) (“While a confidentiality agreement can be used to safeguard such matters as trade secrets, the ‘whistleblower-type information about allegedly unlawful acts’ does not fall into that category”). That is far from true. The SEC has been clear that it will bring actions against firms for including these provisions in agreements, regardless of whether the provisions are enforceable. As a result, it makes sense for firms to review all templates that in-house and outside counsel are using for settlement agreements, employment agreements, and separation/severance agreements to eliminate any restriction on anyone reporting any potential violation of securities laws or rules to the SEC as well as to state securities regulators and self-regulatory organizations like FINRA.

In addition to the penalties that these firms paid to the SEC, it is likely that the firms incurred substantial attorney’s fees during the SEC’s investigations. These are unforced errors that a review of existing templates for agreements could eliminate.

If you are facing an SEC or other governmental agency investigation, it is essential that you talk to an attorney with substantial experience representing individuals and firms in securities investigations before responding to the government.