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Feds Move Beyond Confidentiality Agreements to Target Companies That Try to Undercut Whistleblower Laws with Monetary Recovery Waivers

A defense contractor accused of using restrictive severance agreements that would “chill” whistleblowers has agreed to settle the accusations and pay $265,000 in penalties, the Securities and Exchange Commission announced.

The announcement marks the latest victory in the federal government’s ongoing campaign to encourage and reward whistleblowers, including employees who uncover fraud, waste and abuse in their workplaces. It’s also a sign that federal regulators’ crackdown on companies that use contracts restricting employee whistleblower activity have expanded their efforts beyond overzealous confidentiality agreements and are now focusing on the more subtle ways companies try to circumvent whistleblower-protection rules.

Problematic Confidentiality Clause

According to the SEC’s cease-and-desist order, around 160 departing employees of Atlanta-based BlueLinx Holdings Inc. had to sign severance agreements with a confidentiality clause obligating them to notify BlueLinx, in writing, before they could disclose confidential company information to “any person or entity not expressly authorized” by BlueLinx.

The confidentiality clause didn’t make an exemption for former employees filing whistleblower claims or other charges with government watchdog agencies. This effectively “forced those employees to choose between identifying themselves to the company as whistleblowers or potentially losing their severance pay and benefits,” according to the SEC.

The Next End-Run Around Whistleblower Laws: Monetary Recovery Waivers

According to the SEC, another clause of the severance agreement started innocuously enough, acknowledging that nothing in the agreement prevented a departing employee from filing a claim or charge with an administrative agency—i.e., blowing the whistle. But the clause then went on to state that the signing employee “understands and agrees that Employee is waiving the right to any monetary recovery in connection with any such complaint or charge.”

In so doing, “BlueLinx removed the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations,” the SEC said.

Ultimately, BlueLinx agreed to settle with the SEC without admitting or denying any of the allegations. In addition to paying the $265,000 penalty, the company agreed to amend the offending provisions and take reasonable steps to inform former employees of the changes.

Monetary Recovery ‘Critical’

Whistleblowers provide a valuable public service, especially in the world of defense contracting and healthcare fraud, where hundreds of billions of dollars are at stake and fraud, corruption and other malfeasance can jeopardize our men and women in uniform as well as seniors and people with disabilities who rely on federal healthcare programs. Indeed, the United States has a proud tradition of shielding and encouraging whistleblowers that dates back to the Revolutionary War. Today, strong state and federal laws are in place to protect whistleblowers from retaliation for their brave acts of disclosure.

But even strong anti-retaliation laws do not eliminate the financial and career risk whistleblowers take to expose corruption and wrongdoing. Acknowledging that these risks can deter even the best-intentioned employees from coming forward, Congress has chosen to incentivize disclosure by guaranteeing whistleblowers a reward if their claims succeed—a percentage of what the government recovers in the case. Under the False Claims Act, for example, the statute provides for whistleblowers to receive between 15 and 30 percent of the government’s recovery.

Indeed, in 2010 Congress recognized that “a critical component” of one federal whistleblower program was “the minimum payout that any individual could look towards in determining whether to take the enormous risk of blowing the whistle in calling attention to fraud.”

Going After Confidentiality Agreements: Wall Street Meets the Military-Industrial Complex

The BlueLinx settlement is a continuation of the SEC’s efforts to cultivate a strong whistleblower culture in publicly traded companies. Public companies have an outsize influence because they are the biggest players in all sectors of the U.S. economy. Moreover, millions of Americans depend on an honest stock market for their retirement, which makes stopping fraud on Wall Street even more important.

The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act added a whistleblower program to the Exchange Act, the federal law that governs publicly traded companies like BlueLinx and which is enforced by the SEC. In 2011 the SEC enacted Rule 21F-17, which states that “[n]o 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.”

In 2014, Congress passed a provision banning contractors or subcontractors from receiving federal funding if they use confidentiality agreements to prevent employees from reporting fraud, waste or abuse to government agencies or law enforcement. Accordingly, agencies like the Department of Veterans Affairs, the General Services Administration and the Environmental Protection Agency announced they would no longer contract with companies that restrict whistleblower activity through confidentiality agreements.

The biggest spender of all, the Department of Defense, now requires contract bidders to affirmatively state that they don’t make employees sign confidentiality agreements restricting whistleblower activity.

In April 2015 the SEC invoked 21F-17 when it fined public multinational contractor KBR $130,000 for using overbroad confidentiality agreements that—like BlueLinx’s—made no exception for employees filing whistleblower claims or other agency charges.

Focusing on Monetary Recovery

But BlueLinx’s agreement went further, attempting to defang whistleblower laws by taking away the monetary reward, which may sometimes be the only tangible positive offsetting the stress and risks of revealing that one’s employer is engaged in fraud.

“Companies simply cannot undercut a key tenet of our whistleblower program by requiring employees to forego potential whistleblower awards in order to receive their severance payments,” Jane Norberg, Acting Chief of the SEC’s Office of the Whistleblower, said in a statement.

Interestingly, the penalties the SEC extracted from BlueLinx were more than twice what it fined KBR a year ago. While BlueLinx is certainly a big fish—it reported $1.9 billion in net revenues for 2015—compared to KBR, which reported $5.1 billion in net revenues for the same period, BlueLinx is small fry. And in terms of defense contracting, KBR blows BlueLinx out of the water: BlueLinx had nearly $46 million in military contracts awarded to it between 2005 and 2010, but that pales in comparison to the hundreds of millions of dollars KBR has won and continues to win in defense bids at home and abroad.

Shortly after announcing the BlueLinx settlement, the SEC revealed that it had reached a $340,000 settlement over monetary recovery waivers with health insurance behemoth Health Net Inc., which in 2015 alone reported $628.5 million in government contract revenue and net revenues of $16.2 billion.

The increased fines suggest that the SEC and other federal agencies may be targeting their enforcement efforts on companies that don’t outright ban whistleblower activity—but which nevertheless try to get around the rules with sneaky provisions like monetary-recovery waivers.

“We’re continuing to stand up for whistleblowers and clear away impediments that may chill them from coming forward with information about potential securities law violations,” said Stephanie Avakian, Deputy Director of the SEC’s Enforcement Division.

Feds take strong action to protect whistleblowers from overzealous confidentiality agreements

Many companies require their employees to sign confidentiality agreements that prohibit the employees from disclosing non-public information about the company to outsiders. In general, these confidentiality agreements aim to protect a company’s proprietary information that gives it an advantage over its competitors; things like trade secrets, inventions, customer lists and strategic plans.

Recently, however, a growing number of companies have included language in their confidentiality agreements that prohibit employees from blowing the whistle on fraud or assisting government agencies investigating the misconduct. These newer agreements include things like non-disparagement provisions prohibiting employees from saying anything negative about the company and other provisions threatening disciplinary action if employees discuss any aspect of a company’s internal investigation of fraud and abuse.

Now, the federal government is fighting back, using its enforcement powers and its spending powers to protect employees who uncover fraud in the workplace.

Late in 2014, Congress passed and President Obama signed a spending bill for Fiscal Year 2015. This legislation, known as the Consolidated and Further Continuing Appropriations Act of 2015, included a provision that bans federal funding to contractors and subcontractors that use confidentiality agreements that prohibit employees from reporting fraud, waste or abuse to investigating government agencies or law enforcement officials. The same provision is included in the appropriations bill for Fiscal Year 2016.

To implement this provision, several federal agencies including the Department of Defense, the Environmental Protection Agency, the General Services Administration and the Department of Veterans Affairs, issued public notices that they cannot and will not contract with any company that restricts employees from reporting fraud, waste or abuse to investigative or law enforcement officials. The Defense Department went one step further. It now requires companies to affirmatively state in their bids that they do not require employees to sign such restrictive confidentiality agreements.

This is a very important addition by the Defense Department, as any company that falsely certifies to the department that it does not require these kinds of agreements could find itself on the wrong side of the False Claims Act. Under the False Claims Act, an individual with evidence that a private company knowingly submitted a false claim to the U.S. government can sue that company on behalf of the government. Those who violate the False Claims Act are on the hook for treble damages and penalties.  Courts have held that payments made by the federal government pursuant to a contract obtained through fraud can give rise to a claim under the False Claims Act.

The False Claims Act isn’t the only federal statute that encourages whistleblowers to come forward.

In response to the financial crises that brought on the Great Recession in 2008, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act regulated and imposed reforms on the financial infrastructure of the American economy — banks, investment banks, financial services companies, hedge funds, mortgage lenders, brokers, commodity traders, and public-traded companies.

The Securities and Exchange Commission is the federal agency charged with enforcing federal securities laws like Dodd-Frank. But the SEC cannot enforce the law unless it develops or obtains information that a person or company is violating the law. That’s where whistleblowers come in. 

And that’s why the Dodd-Frank Act created incentives for whistleblowers to come forward with information about financial wrongdoing and to protect whistleblowers from retaliation by those who had engaged in the illegal conduct or wanted to cover it up. To enforce those Dodd-Frank provisions, the SEC enacted Rule 21F-17, which states:

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.

Last April, the SEC flexed its regulatory muscles by pursuing an enforcement action against a publicly-traded company that required employees to sign such restrictive confidentiality agreements. Houston-based Kellogg, Brown & Root, a global technology and engineering firm, agreed to pay a $130,000 fine to the SEC and amend its confidentiality agreements to expressly state that employees are not prohibited from reporting possible violations of federal law to the SEC and other investigatory and law enforcement agencies.

The SEC enforced Rule 21F-17 against Kellogg, Brown & Root even when there was no evidence that the company had used the offending confidentiality agreements to discourage or discipline employees. KBR violated the rule simply by having its employees sign away their rights to cooperate with the government. The SEC was tipped off to the KBR confidentiality agreement by a pre-trial deposition (sworn testimony) in a False Claims Act case filed against the company.

The KBR case also highlights how interconnected these laws are; an order in a False Claims Act lawsuit created precedent to protected future whistleblowers working for companies governed by the Dodd-Frank Act and SEC enforcement rules.

Sixteen Attorneys General Stand Up Against Mandatory Arbitration

Including California, have asked the federal government to protect consumers from mandatory arbitration clauses in contracts covering financial services. The group co-signed a letter to the U.S. Consumer Financial Protection Bureau (CFPB) last month. These clauses are written into contracts by financial services companies for a wide range of financial products including credit cards, payday loans and checking account agreements.These clauses forbid consumers from taking disputes to court and/or making it prohibitively expensive to sue financial institutions by restricting consumers’ rights to bring a class-action lawsuit. Unlike court proceedings, arbitration cases are private alternate dispute resolution processes whereby decisions are kept confidential.

Decision makers are normally chosen by corporate defendants. The ability to obtain evidence can be restricted. Class claims are usually banned, and the party losing the case (normally the consumer) could be forced to pay the costs and, sometimes, attorneys’ fees of the winning party.These form agreements need to be agreed to before opening a checking account or getting a credit card, so consumers essentially have no bargaining power to negotiate or insist these provisions be removed from contracts. Financial institutions include the arbitration clauses into the fine print of contracts. Unless consumers study the contracts they may not be aware of, or understand, what they are agreeing to. Given how popular these clauses are, it may be impossible for consumers to find a financial services company not insisting their customers use arbitration. The Attorneys General asked CFPB Director Richard Cordray to protect consumers’ fundamental rights to assert their claims in court. “The need for regulations to protect the public interest has never been so great,” the Attorneys General wrote.

“Over the past decade, judicial decisions and business practices have diminished consumers’ rights and bargaining power with respect to contracts for financial services.”It was sent to the CFPB to be part of the agency’s investigation into the effects of mandatory arbitration clauses. The 2010 federal Dodd-Frank Wall Street Reform and Consumer Protection Act mandates the CFPB to conduct research before deciding if mandatory arbitration clauses harm consumers. Such research could impact regulations of the financial industry proposed by the agency.The letter was organized by Delaware Attorney General Beau Biden, Massachusetts Attorney General Martha Coakley and Kentucky Attorney General Jack Conway. Attorneys General from California, Connecticut, Hawaii, Illinois, Iowa, Maine, Maryland, New Mexico, New York, Oregon, Rhode Island, Vermont and Washington also signed the letter.

 

CFPB Launches Study Into Mandatory Arbitration, Bringing Discussion To Congress

The growing use of mandatory arbitration has become a hot topic among businesses and consumers, which has led the debate all the way to Congress, with billions of dollars potentially at stake. Like many issues brought to Congress, a government agency has been given the task to study arbitration, causing both financial institutions and consumer groups to lobby to influence the study’s design, reports the American Banker.The study is expected to widely influence implementation of the Dodd-Frank Act, which would give the Consumer Financial Protection Bureau the authority to regulate the use of arbitration. But lawmakers are waiting until the outcome of the study before enacting any changes.

The Consumer Financial Protection Bureau (“CFPB”) has been handed the task of studying the use of arbitration agreements by banks and other providers of consumer financial products, and everyone has something to say on how it should be conducted. The first insight into arbitration was released in late November by Pew Charitable Trusts, which found that “Consumers overwhelmingly want a choice between court and arbitration.” Sixty-eight percent of people surveyed believe that aggrieved consumers should get to choose between filing suit and going before an arbitrator, while 21 percent believe arbitration should be mandatory.The Pew study also revealed that slightly more than half of the nation’s 50 largest banks and credit unions have mandatory arbitration clauses in their checking account agreements.

Furthermore, the study found “strong opposition to certain aspects of arbitration clauses, such as the right of the financial institution to choose the arbitrator. Implicitly, the survey served as a rejoinder to a 2005 poll that has been cited by financial institutions as showing strong support for arbitration among consumers who have been through the arbitration process,” the American Banker reported. While the Pew study found that the overall attitude was that arbitration should come with stricter rules, Pew did not offer any recommendations. Banks assert that arbitration offers a cost efficient alternative to resolving disputes in a courtroom. They also contend that consumers typically fare better in arbitration. But, because of the financial institutions’ practice of weaving arbitration clauses into their contracts, consumers have a much harder time pursuing and winning a claim, consumer protection lawyers maintain.

Financial backers and lobbyists argue that the Pew survey is misleading and was designed in a way that misrepresented how the arbitration system works. But industry observers revealed that they have been relatively pleased at the CFPB’s current efforts and outcomes. The CFPB has not publicly revealed the scope and structure of its study, nor has it said when the study will be completed.

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