Brokerage Ops the June 2014 issue

Fresh Air for Whistleblowers

The Supreme Court has vastly expanded whistleblower protections.
By Priya Huskins Posted on May 29, 2014

Congress reacted to the last two rounds of large corporate accounting scandals (WorldCom-Enron and the financial crisis of 2007-08) by passing laws intended to encourage potential whistleblowers to come forward.

In 2002, the Sarbanes-Oxley law provided strict anti-retaliation protections for whistleblowers seeking to shed light on violations of the federal securities laws. By 2010, the Dodd-Frank law took things further by establishing the Office of the Whistleblower to administer a new whistleblower incentive program. Under the program, individuals who provide high-quality information can retain 10% to 30% of the monetary sanctions collected through the Securities and Exchange Commission (if the sanction exceeds $1 million).

It’s been four years since Dodd-Frank, and we’ve seen just a handful of awards. Only one was in the millions and was definitely noteworthy. The SEC took only six months after being contacted to recover investor funds. The whistleblower payment? $14 million.

Everybody Jump In

As of March, we learned the group of folks who are potentially protected from retaliation is much larger than previously understood. Until recently, most corporate attorneys would have said the anti-retaliation provisions of Sarbanes-Oxley apply only to public companies and their employees. In March, however, the Supreme Court ruled the Sarbanes-Oxley anti-retaliation protection for whistleblowers also applies to employees of companies that contract with public companies. One reason the court took this broader stance is because the statute’s purpose is to “safeguard investors in public companies and restore trust in the financial markets.” 

It appears we are primed for a rising cacophony of whistleblowing. A company’s primary defense against false whistleblower activity is, of course, creating and reinforcing an ethical culture. It’s critical for senior executives to commit to the company’s code of ethics and swiftly correct any deviations.

The group potentially protected from retaliation is much larger than previously understood.

Private companies working with public companies will want to consider implementing whistleblower training similar to what public companies already use. It’s important to provide employees with a clear process that allows them to raise concerns (including anonymously), to address those concerns and to demonstrate the company’s commitment to ethical behavior.

Your clients should also review how they advertise their whistleblower hotline. If the only way to access the hotline is through a company’s restricted-access intranet, you’ve just guaranteed any employees of contractors who want to report possible wrongdoing will go directly to the SEC. Make the whistleblower hotline easily accessible to both employees and contracting company employees.

We should expect the number of whistleblower complaints to rise. And, to be sure, some of them will end up suing their employers for retaliation. Some complaints will lead to lawsuits against directors, officers and their companies.
Consider the following key insurance issues:

  • EMPLOYMENT PRACTICES LAWSUITS. Employees who believe they were retaliated against will consider bringing employment-related lawsuits. Companies that historically have not purchased employment practices liability insurance need to revisit this decision.
  • INVESTIGATIONS OF CORPORATE ENTITES vs. INDIVIDUALS. When the SEC first investigates a whistleblower complaint, it is likely to ask the corporate entity to voluntarily cooperate. Unfortunately, modern D&O insurance policies tend not to cover compliance expenses for a government agency investigation of the corporate entity. Brokers should attempt to expand coverage for their client companies (and individuals) for SEC investigations—whether formal or informal. Limit decisions should include the potential cost of a whistleblower-related investigation. Consider placing a stand-alone policy for government investigations of the corporate entity.
  • INSURED EXCLUSIONS. If a D&O policy still has the insured versus insured (“I v I”) exclusion in it, brokers should attempt to carve back coverage for suits involving whistleblowers, even if they are directors or officers. Also, be as broadly expansive as possible as to the definition of whistleblower.If possible, consider migrating clients to a carrier, that is willing to move away from the I v I to the more policyholder-friendly “entity versus insured” exclusion. The entity versus insured exclusion will be triggered if the company itself brings or supports the claim against an insured under the policy. It’s important to negotiate into this exclusion a broad carve-back for derivative suits involving whistleblowers.
  • FRAUD EXCLUSION. Although difficult to obtain, brokers should attempt to negotiate the D&O policy’s fraud exclusion so that it can be triggered only by a final adjudication of wrongdoing in “the underlying action.” Without the underlying action clarification, the insurance carrier may argue a finding of wrongdoing by the SEC is effectively an adjudication of wrongdoing applicable to any other litigation that may have accompanied or resulted from the SEC’s actions. By inserting “the underlying action” language, an insured can be more certain legal fees will be paid until a final adjudication of the particular matter is at hand.

Is this a disaster for corporate America? Of course not. Most directors and senior executives want to know about possible wrongdoing so that they can stop it. But it’s a good idea for your clients to address concerns that will naturally arise now that a lot more people may be encouraged to blow the whistle. 

It will likely take some time to see this trend fully develop. Private and public companies have a chance to examine their internal whistleblower reporting processes so they can respond to complaints in a timely and thorough manner.

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