On October 30, 2013, the SEC announced another whistleblower bounty award under the Dodd-Frank whistleblower program. Although the size of this latest award ($150,000) is relatively modest compared to the recent $14 million award (about which refer here), the most recent award does suggest that awards under the whistleblower program are gaining momentum.
I have long been concerned that as awards under the whistleblower bounty program start to accumulate that even more whistleblowers will be encouraged to come forward and make reports to the SEC. Among my concerns about this possibility is not only that increased numbers of whistleblower reports would result in more enforcement actions, but that the increase in the number of reports would also lead to a rise in civil litigation following in the wake of and based upon the whistleblower reports.
Anyone who wants to see what a follow-on civil action of this type might look like will want to take a look at the securities class action complaint filed on November 1, 2013 in the Middle District of Tennessee against Unilife Corporation and three of its directors and officers. A copy of the complaint can be found here. The plaintiff’s lawyers November 1, 2013 press release about the lawsuit can be found here.
Unilife is a medical device manufacturer that produces retractable medical syringes. The complaint alleges that the company misled investors by failing to disclose that
(1) the Company’s Unifill syringes failed to comply with the FDA’s validation processes; (2) the Company’s Quality Management System failed to comply with FDA regulations; (3) the Company purposefully increased its purchase of Unifill component parts to make suppliers believe that Unilife was producing at increased volumes despite the fact that there was no customer demand or manufacturing capacity to support such purchases; and (4) as a result of the foregoing, the Company’s statements were materially false and misleading at all relevant times.
In support of these allegations, the securities class action plaintiff’s complaint expressly references and quotes extensively from the complaint filed on August 30, 2013 by Talbot Smith, a former employee of the company who alleges that he was fired in retaliation for reporting the company’s regulatory violations to governmental authorities. In his retaliation complaint (a copy of which can be found here), Smith expressly alleges (in paragraph 16) that his employment was terminated in August 2012, “after he made whistleblowing complaints about violations of the law that had occurred or were about to occur, and after he provided information relating to a violation of the securities laws to the Securities and Exchange Commission.”
In his retaliation lawsuit, Smith alleges that his whistleblowing reports are protected under both Sarbanes-Oxley and the Dodd-Frank Act. Smith is suing Unilife and two of its officers for lost wages, lost benefits and the lost value on restricted stock arising from his alleged wrongful termination
The recently filed securities class action complaint quotes extensively from Smith’s retaliation complaint (see paragraph 43 of the securities complaint) as well as from a September 9, 2013 Forbes magazine article about Smith’s complaint (here). The complaint also quotes extensively from a September 3, 2013 Forbes magazine article about the company (here).
With respect to Smith’s retaliation complaint, the securities class action complaint states:
Smith alleges that the Company purposefully ran fake production at the Company’s facilities in order to lead visiting investors to believe that demand for the Company’s products was high. Moreover, according to Smith, the Company purposefully suppressed internal reports demonstrating that the cost of developing the Company’s syringes was higher than the price the Company was able to sell to customers. In addition, the complaint alleged that the Company failed to comply with the Food and Drug Administration’s required validation process.
In the Forbes article about Smith’s retaliation complaint, the company is quoted as having said that Smith is a disgruntled former employee who was released for poor performance not for his whistleblowing activities and that Smith only first raised his whistleblowing allegations after he learned that he was losing his job. A company spokesman also apparently suggested to Forbes that Smith was shorting the company’s stock and was financially motivated to try to lower the company’s share price.
From the Forbes magazine articles and from the allegations in the two complaints, about the only thing that is clear is that this is a very messy situation. The securities complaint has only just been filed and so there is no way of knowing whether or not it ultimately will succeed. However, there is no doubt that the plaintiff is trying to use Smith’s whistleblower allegations to bolster the allegations in the securities class action complaint.
The presence of the whistleblower’s allegations and the use made of the allegation in the securities class action complaint are consistent with what I have feared from whistleblowing – that is, that whistleblower reports will lead to follow-on civil litigation. My larger concern is that increased whistleblowing activity, encouraged by the availability of whistleblower bounties, could lead to an increase not only in SEC enforcement activity but also to an increase in follow-on civil litigation, including in particular securities class action litigation activity.
I make no predictions but it would not surprise me one bit if in the coming months we were to see a rash of complaints like the recently filed Unilife securities class action lawsuit complaint in which whistleblower allegations are featured prominently and used to try to bolster allegations of securities law violations.
Understanding the New Business Structures: I know that many of this site’s readers visit the site and the read the various posts in order to try to stay up to date on developments affecting the D&O liability insurance arena and environment. For the benefit of those readers who aim to stay on top of things, I commend an article that appeared in last week’s issue of The Economist magazine.
The October 26, 2013 article entitled “The New American Corporation: The Rise of the Distorpation” (here) reports and comments on the “shift in the way businesses structure themselves” that is “changing the way American capitalism works.” These essence of these changes is a move toward types of firms –such as master limited partnerships, business development corporations and real estate investment trusts – that “retain very little of their earnings” and pass them through to investors. And “crucially, so long as they distribute their earnings, such set-ups can largely avoid corporate tax.”
As the article puts it, “the corporation is becoming the distorporation.” These kinds of business forms have a valuation on the American markets in excess of $1 trillion. Though they represent only 9 percent of listed companies, these business took in 28% of all capital raised in 2012. The increasing prevalence of these kinds of structures has important implications for the ways that capital is raised and deployed and the ways that companies are doing business. And though there may be a variety of concerns about the rise in the number of businesses using these business forms, the likelihood is that the use of these structures will continue to grow.
Among other things, the rise in these business forms has important implications for the way that D&O insurance is structured and underwritten.
The Week Ahead: Next week I will be in Orlando attending the annual PLUS International Conference. On Tuesday November 5, 2013, I will be moderating a Conference panel entitled “Derivative Actions Grow Up – Are They the D&O Exposure to Watch?” The panel has a stellar line-up of participants, including Tower Snow of the Cooley law firm: Gay Parks Rainville of the Pepper Hamilton law firm; Steve Boughal of The Hartford; and George Aguilar of the Robbins Arroyo law firm. It should be an excellent session. Information about the Conference can be found here.
I look forward to seeing many of you in Orlando. I hope that if you are a reader and you see me at the conference that you will make a point of saying hello, particularly if we have not met before.
Due to my travel commitments over the next two weeks, there may be interruptions in my usual publishing schedule on this site.