THE WHISTLE HAS BLOWN: Supreme Court Narrows Scope of Whistleblower Protection Under Dodd-Frank Act

Private: Gregory T. Laudadio

February 28, 2018 Download as PDF

As we reported in our November 13, 2017 Alert, Blowing The Whistle On Whistleblower Protection: Supreme Court To Review Scope Of Whistleblower Protection Under Dodd-Frank Act,[1] the United States Supreme Court was set to address a Circuit split on a narrow but important issue regarding the current scope of whistleblower protection: whether federal law protects whistleblowers who report securities violations internally to their employers without making a report directly to the United States Securities and Exchange Commission (“SEC”).  On February 21, 2018, the Supreme Court issued its opinion significantly limiting the scope of whistleblower protection.[2]

In response to the 2008 economic crisis, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act[3] (“DFA”) to ensure the stability of the financial industry and to provide increased consumer protection.  The DFA’s anti-retaliation provision prohibits employers from taking adverse employment action against employees who make a securities violation report to the SEC.[4]  However, the DFA is noticeably silent on whether this protection extends to employees who opt to report violations internally without also going to the SEC, because it defines “whistleblowers” only as persons who provide information “to the Commission.”[5]  This apparent restriction has divided several United States Circuit Courts of Appeal,[6] including the Second, Fifth, and Ninth Circuits, but has now been resolved by the Supreme Court in Digital Realty Trust, Inc. v. Somers.[7]

Paul Somers was an employee of Digital Realty Trust, Inc. (“Digital Realty”) from 2010 to 2014, working as a Vice President of Portfolio Management in both Europe and Singapore.  Before his termination in 2014, Somers reported his Singapore boss to senior management, but not the SEC, for potential violations of the Sarbanes-Oxley Act (“SOX”).[8]  Somers had accused his boss of “eliminat[ing] internal controls over certain corporate actions,” and other violations of SOX, including “hiding seven million dollars in cost overruns on a development in Hong Kong.”[9]  After being terminated, Somers brought a claim against Digital Realty in federal court for violating the anti-retaliation provisions of the DFA,[10] which states, in part, that employers may not take adverse employment action against employees who make “disclosures that are required or protected under the Sarbanes-Oxley Act.”[11]

At the trial court level, both parties argued over Somers’s qualification as a “whistleblower” under the DFA.  Somers claimed that he was wrongfully terminated in retaliation for internally reporting his boss’s alleged violations of SOX and that the DFA’s anti-retaliation provision provided him recourse.  Digital Realty moved to dismiss Somers’s claim, arguing that Somers had no standing to sue under the DFA because he never reported his allegations to the SEC and therefore did not qualify as a “whistleblower.”  The District Court for the Northern District of California ruled in favor of Somers, deferring to an SEC rule[12] interpreting the DFA’s anti-retaliation provision to include protections for whistleblowers who report only internally.[13]

Digital Realty appealed the District Court’s decision, arguing that the District Court erred in deferring to the SEC’s rule, which it alleged was misguided.  The United States Court of Appeals for the Ninth Circuit affirmed the District Court’s decision, however, stating that the SEC rule is “consistent with Congress’s overall purpose to protect those who report violations internally as well as those who report to the government,” and that Congress’s intent is “reflected in the language of the specific statutory subdivision [of the DFA], which explicitly references internal reporting provisions of Sarbanes-Oxley and the Securities Exchange Act of 1934.”[14]

The Supreme Court granted certiorari to Digital Realty and heard oral argument in November 2017.  Despite Somers’s success at both the trial and intermediate appellate levels, the Supreme Court ruled in favor of Digital Realty.  This outcome is particularly surprising because the District Court’s deference to the SEC’s interpretation of the DFA was based on a framework established in a landmark Supreme Court case, Chevron U.S.A., Inc. v. NRDC.[15]  In that case, the Supreme Court created an administrative law principle that requires courts to defer to an agency’s interpretation of an ambiguous statutory provision, as long as the interpretation is reasonable, meaning the interpretation is not “arbitrary, capricious, or manifestly contrary to the statute.”  The interpretation need not be the only or best interpretation, just reasonable – a low standard indeed.

The Supreme Court nonetheless narrowly interpreted the whistleblower provision.  “The definition first describes who is eligible for protection – namely, a whistleblower who provides pertinent information ‘to the Commission.’…[A]n individual who falls outside the protected category of ‘whistleblowers’ is ineligible to seek redress under the statute, regardless of the conduct in which that individual engages.”[16]  Furthermore, “[t]he ‘core objective’ of Dodd-Frank’s robust whistleblower program…is ‘to motivate people who know of securities violations to tell the SEC,’” as opposed to SOX’s “more far-reaching objective…to disturb the ‘corporate code of silence’ that ‘discourage[d] employees from reporting fraudulent behavior not only to the proper authorities, such as the FBI and SEC, but even internally.’”[17]

In construing the DFA narrowly, the Supreme Court made an important distinction regarding scope.  In response to Somers’s argument that a narrow reading would “vitiate” the DFA’s whistleblower protection clause, the Supreme Court explained that even a narrow reading leaves the clause with “substantial meaning.”[18]  “With the statutory definition incorporated, [the DFA] protects a whistleblower who reports misconduct both to the SEC and to another entity, but suffers retaliation because of the latter, non-SEC, disclosure.”[19]  Therefore, had Somers also reported his boss’s misconduct to the SEC, he would have been entitled to protection from his employer and would have had a valid claim following his termination.

The practical effect of the Supreme Court’s decision tends to contradict current practice, and to a degree public policy favoring enforcement of corporate accountability.  Internal whistleblowing is a valuable tool for all interested parties, but the Supreme Court’s ruling eliminates protections and incentives from the DFA’s whistleblower provision, albeit while reinforcing the SEC’s regulatory power in this arena.[20]  One commentator has noted, “It’s a bad day for whistleblowers…However, it’s also a bad day for corporate America, particularly for those who have created strong internal compliance systems, because now individuals who suspect a securities law violation would be well advised to report directly to the SEC, lest they forfeit fundamental anti-retaliation protections.”[21]

However, as put by another commentator, “The only gap that this will create is fewer claims by people who only posture as whistleblowers after the fact.  Anyone who’s genuinely a whistleblower is still covered by the Sarbanes-Oxley Act and if they complain to the SEC, as set forth in Dodd-Frank, then they’re covered by the Dodd-Frank protections as well.”[22]

Employers and employees in the financial industry need to be aware of the Supreme Court’s clarification on whistleblower protection: internal reporters will remain unprotected under the DFA unless they also report to the SEC.  At the same time, corporate compliance departments should alter their internal practices accordingly.

 

 

 

[1] http://www.rubinfortunato.com/article/blowing-whistle-whistleblower-protection-supreme-court-review-scope-whistleblower-protection-dodd-frank-act/

[2] Digital Realty Trust, Inc. v. Somers, (No. 16-1276).

[3] 124 Stat. 1376.

[4] See 15 U.S.C. § 78u-6, which was added as Section 21F to the Securities Exchange Act of 1934; see also 15 U.S.C. § 78u-6(h)(1)(A).

[5] 15 U.S.C. § 78u-6(a)(6).

[6] See, e.g., Somers v. Digital Realty Trust, Inc., 850 F.3d 1045 (9th Cir. 2017); Berman v. Neo@Ogilvy LLC, 801 F.3d 145 (2d Cir. 2015) (adopting SEC’s interpretation that whistleblowers who make disclosures internally are protected under DFA); Asadi v. G.E. Energy (USA), L.L.C., 720 F.3d 620 (5th Cir. 2013) (rejecting SEC interpretation that DFA was meant to protect whistleblowers who make disclosures internally or to the SEC).

[7] No. 16-1276.

[8] 116 Stat. 745.  SOX, enacted in response to major corporate scandals in 2002, is considered the predecessor to the DFA.  Like the DFA, it seeks to create stability in the financial industry by regulating corporate action and protecting consumers.

[9] Somers v. Digital Realty Trust, Inc., 119 F. Supp. 3d 1088, 1092 (N.D. Cal 2015).

[10] Somers brought several other claims as well, including discrimination and defamation.  Digital Realty moved to dismiss only the charges related to the DFA.

[11] 15 U.S.C. § 78u-6(h)(1)(A)(iii).

[12] 17 CFR 240.21F-2(b)(1)(ii); See also Securities Whistleblower Incentives and Protections (Adopting Release), 789 Fed. Reg. 34300, 3401-3404 (June 13, 2011).

[13] The SEC rule and its corresponding commentary, promulgated in 2011, provide clarity on “whistleblower” qualification under the DFA by analyzing the interplay between the DFA and SOX.  The rule’s commentary states that an individual qualifies as a whistleblower for the purpose of the DFA’s anti-retaliation protection, regardless of how the DFA itself defines “whistleblower,” if the individual makes a report in accordance with the DFA’s anti-retaliation provision.  Because the provision explicitly affords protection to individuals who report violations of SOX, and SOX provides protection to employees who make reports only internally, the DFA must also provide whistleblower protection for internal whistleblowers.  As such, the District Court ruled that Somers had standing to bring a wrongful termination claim under the DFA.

[14] Somers v. Digital Realty Trust, Inc., 850 F.3d 1045, 1047 (9th Cir. 2017).

[15] 467 U.S. 837 (1984).

[16] Digital Realty Trust, Inc. v. Somers, (No. 16-1276) at 10 (citing 15 U.S.C. § 78u-6(h)(1)(A)(i)-(iii)).

[17] Id. at 11-12 (citing S. Rep. No. 111-176, at 38; Lawson v. FMR LLC, 571 U.S. 429, ___ (2014) (slip op., at 4)).

[18] Id. at 14 (citing Brief for Respondent 35; Brief for Petitioner 32).

[19] Id. at 14.

[20] Prior to the decision, one commentator stated, “The results would be catastrophic, not only for the employees who lose their jobs trying to do the right thing, but also for investors who must rely upon the accuracy of numerous internal corporate disclosures when making investment decisions, and corporations which have created extensive compliance programs designed as an early reporting system protecting the company from fraud.”  Stephen Kohn, Digital Realty Trust v. Somers May Kill Corporate Compliance, Law360 (Sep. 21, 2017, 1:14 PM), https://www.law360.com/articles/964208/digital-realty-trust-v-somers-may-kill-corporate-compliance.

[21] Dunstan Prial, Companies May Find High Court Whistleblower Ruling Costly, Law 360 (Feb. 21, 2018, 7:03 PM), https://www.law360.com/employment/articles/1014744/companies-may-find-high-court-whistleblower-ruling-costly?nl_pk=b6ae1052-b7c1-4e1f-b4b5-8f05f23a249b&utm_source=newsletter&utm_medium=email&utm_campaign=employment.

[22] Id.

 
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