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SEC Announces Settlement With Investment Advisory Firm For Allegedly Breaching Fiduciary Duties And Violating Whistleblower Protection Rule
01/22/2025On January 16, 2025, the Securities and Exchange Commission (“SEC”) filed a settled enforcement action against a pair of related investment advisers (the “Investment Adviser”) for allegedly breaching their fiduciary duties by failing to reasonably address known vulnerabilities in their investment models, and also for allegedly taking steps to impede employees from serving as whistleblowers in violation of SEC Rule 21F-17. Without admitting or denying the allegations, the Investment Adviser agreed to the imposition of a cease-and-desist order and a civil monetary penalty of $90 million. While the alleged fiduciary duty violations were a fairly typical application of the SEC’s rules and undoubtedly drove the penalty amount, the alleged 21F-17 violation was a noteworthy expansion of the types of provisions the SEC has previously criticized.
Rule 21F-17(a), adopted in 2011, prohibits impeding an individual from communicating with SEC staff about a potential violation of securities law. And given that the purpose of Rule 21F-17 is to encourage whistleblowers to report possible violations, prohibit employment-related retaliation, and provide guarantees of confidentiality, the SEC has consistently sought to interpret it broadly, ever since bringing its first enforcement action in 2015. For example, the SEC has criticized agreements with employees and departing employees that include direct prohibitions on communications with the SEC or other government agencies, non-disparagement clauses that implicitly preclude such communications, confidentiality agreements that implicitly preclude such communications, and requirements for notice in advance of making such communications, to name just a few examples.
In this case, the SEC went one step further to criticize a different type of provision in employee separation agreements. Specifically, the SEC took issue with a provision that had been utilized in severance agreements with almost 300 employees stating: “You represent that you have not filed against any [Investment Advisor Party] any charges, complaints or lawsuits regarding any acts or omissions occurring prior to your execution of this Agreement with any international, federal, state, city or local court, governmental agency or arbitration tribunal.” The separation agreements also had a carveout stating that nothing in the agreement prohibited departing employees from “making a good faith reporting of possible violations of law or regulation to any governmental agency or entity or making other disclosures that are protected under whistleblower laws or regulations.” Nevertheless, the SEC alleged that including this prospective carveout could not cure the potentially impeding effects of the backward-looking representation that no claims had been filed. The SEC claimed that requiring such a backward-looking representation as a condition of the separation agreements violated Rule 21F-17 because it required departing employees to disclose whether they had acted as a whistleblower, prevented departing employees who had filed such claims from receiving the post-separation payments and benefits that were offered in exchange for signing the separation agreement, and would have allowed the Investment Adviser to threaten arbitration for employees who may later be found to have withheld previous whistleblower activity.
During the course of the investigation, the Investment Adviser amended its agreements to state that “this representation does not apply to any charges, actions, or proceedings before, or engaging in communications with, the SEC … about possible fraud or other securities law violations occurring prior to the date you execute this agreement,” which the SEC described as remediating the prior violations.
It is unclear whether the SEC would have brought such a 21F-17 claim on a standalone basis, let alone whether it would survive a court challenge. Indeed, an argument could have been made that the backward-looking representation in the cited separation agreements did not include whistleblower submissions, and that in any event such a retrospective representation cannot “impede” prior whistleblowing. For these reasons, it is also unclear whether the SEC under future leadership will continue to expand upon its aggressive reading of Rule 21F-17. However, in the meantime, companies should consider reviewing their template separation agreements to make sure that any required representations do not run afoul of the SEC’s current understanding of what is and is not permitted.