While the most common type of whistleblower may be a disgruntled employee, others can be whistleblowers, too. And as a recent SEC enforcement action highlights, interfering with these others’ attempts to communicate with the SEC can violate the agency’s whistleblower protection rules. In an amended complaint filed on November 4, 2019 in a pending SEC enforcement action, the agency alleges that the defendant company and one of its principals violated the SEC’s whistleblower rules by requiring the company’s investors to enter agreements in which the investors agreed not to contact the SEC or other regulatory enforcement authorities. The SEC alleges that these actions violated the agency’s whistleblower rules. A copy of the SEC’s November 4, 2019 press release about the amended complaint can be found here.
Background
The SEC first sued online auction portal Collector’s Coffee and CEO Mykalai Kontilai in the Southern District of New York in May 2019, as discussed here. The SEC alleged that the defendants had misappropriated over $6 million of investor funds in a $23 million offering fraud.
As described in the agency’s November 4 press release to which I linked above, on November 4, 2019 the agency filed an amended complaint in the enforcement action. Among other things, in the amended complaint, the SEC alleged that the defendants had “unlawfully sought to prohibit their investors from reporting misconduct to the SEC and other governmental agencies.”
Specifically, the agency alleged that the defendants had “attempted to resolve investor allegations of wrongdoing by conditioning the return of investor money on the investors signing agreements prohibiting them from reporting potential securities law violations to law enforcement, including the SEC.” The amended complaint further alleges that the defendants “went so far as to sue two investors that they believed breached one of the illegal agreements.”
The amended complaint alleges that the defendants’ actions in attempting to constrain the investors from contacting or communicating with the SEC violated SEC Rule Section 240.21F-17, which provides in pertinent part that “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.”
The SEC’s amended complaint charges Collectors Café and Kontilai with violations of the antifraud and whistleblower provisions of the federal securities laws, seeking preliminary and permanent injunctions, disgorgement plus prejudgment interest, and penalties.
The SEC’s press release includes a statement from the head of the agency’s Denver regional office as saying “”We allege that the defendants attempted to cover up their fraud by holding investors’ money hostage until the investors signed agreements preventing them from seeking law enforcement intervention.”
The press release also contains a statement from the head of the SEC’s Office of the Whistleblower as saying “The SEC’s whistleblower protections broadly protect not just employees, but anyone who seeks to report potential securities law violations to the Commission.”
Discussion
The SEC’s whistleblower rules, as is the case in many whistleblower programs, provide strong protections for those who come forward to report violations of the law. Underlying these protections is a fundamental notion that the law needs to protect those who come forward to report legal violations. Within these protections is an even more basic idea that there is a basic interest in having legal violations reported to the enforcement authorities.
The SEC’s actions against the defendants in this case, as well as the agency officials’ statements in the press release, highlight the fact that employees are not the only individuals that the SEC rules protect; the rules, as the SEC’s head of the Office of the Whistleblower put it, protects “anyone who seeks to report potential securities law violations to the Commission.”
For anyone who reads the newspaper these days, whistleblowing is a hot topic these days (a point I emphasized in a recent review of a current book about whistleblowing, here). The SEC’s amended complaint in this case is a reminder that whistleblower protection is a basic part of any whistleblower program, and underneath this fundamental need to protect whistleblowers is the basic need for those who witness wrongdoing to be encouraged to come forward and report legal violations. As the basic facts in this case show, those who committed the wrongdoing may take extraordinary steps to try to prevent those with knowledge of wrongdoing from coming forward. The agency’s amended complaint is a reminder that the law prohibits any effort to impeded those with knowledge of wrongdoing from reporting the legal violations.