WHISTLEBLOWER INCENTIVES AND PROTECTIONS:

The Great Recession of 2007-2009 shook America’s, and the world’s, capital markets. In response to the economic turmoil, the U.S. Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) on July 21, 2010. That omnibus legislation implemented many changes to the way U.S. capital markets operate, including the addition of Section 21F-17 as an amendment to the Securities Exchange Act of 1934 (the “1934 Act”). This amendment addressed “Whistleblower Incentives and Protection” in the hope that this provision would “encourage whistleblowers to report possible securities law violations by providing, among other things, financial incentives and confidentiality protection” in the words of the Jan. 16, 2024, Order Instituting Administrative and Cease-And-Desist Proceedings (the “Order”) issued by the U.S. Securities and Exchange Commission (“SEC”). As required by Dodd-Frank, the SEC then adopted Rule 21F-17, effective on Aug. 12, 2011. Part A. of the rule reads as follows:

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.

This rule has typically caused concern with respect to employment agreements with persons working in the financial industry. The expectation was that some such employees could be induced to “blow the whistle” on their employers, especially when offered financial incentives and protection against employer retaliation. The notion was that those inducements, on top of feeling good about “doing the right thing,” would tip the equation in favor of contacting the SEC. The SEC, as part of its periodic examinations of registered capital market participants, issued warnings concerning the risk of Rule 21F-17 violations, and in 2015 began instituting enforcement actions, in each case due to restrictions in employment-related agreements that could “impede” an employee from contacting the Commission. Through2023, the SEC had brought at least 9 cases for Rule 21F-17 violations.

I wrote about the history of SEC’s sanctions for violative employment-related agreements in my blog “Armored to the Brink,” In the case of Brinks, the armored car company, sanctions resulted in both a $400,000 civil penalty and extensive operational changes at the company. As I also noted in that blog, Commissioner Peirce, while supporting the enforcement, expressed concern that the company had been led to adopt protective language in the revised employment-related agreements allowing unrestricted ability to contact ANY law enforcement or governmental entity. That is considerably more extensive than the scope of Rule 21F-17.

TROUBLES IN THE HOUSE OF MORGAN

According to the Order, JPMorgan Chase & Co. (“JPM”) is “a global financial services firm incorporated in Delaware and headquartered in New York, New York.” It is also one of the most iconic American financial institutions, whose history is intertwined with the history of the United States and that of New York City. It traces its origins to 1799 and the formation of The Manhattan Company, whose stated purpose was “to supply ‘pure and wholesome’ drinking water to the city’s” residents. At that time only the Bank of New York had received a charter from the State of New York, and it was licensed in 1784. Alexander Hamilton was one of the main organizers for the Bank of New York, and his nemesis, Aaron Burr, was among The Manhattan Company’s founders. Although The Manhattan Company was primarily chartered to operate a reservoir and water pipe system serving the City, Burr managed to get the New York Legislature to include a provision in its origin document that allowed the Company to use its surplus capital for the business of banking, thereby breaking the existing monopoly held by The Bank of New York.

On April 17, 1837, Junius Spenser Morgan, a London banker, and his wife, Juliet Pierpont, had a baby boy, John Pierpont Morgan (“J. Pierpont Morgan”), who, although a weak infant, grew to become the leading financier in American history. In 1857, Junius and his family came to New York to take charge of a growing bank, leading in 1864 to a restyling of the enterprise as J.S. Morgan & Co. The bank played a major role in the U.S. economy; for example, it assisted Thomas A. Edison with the foundation of and sale of securities in General Electric in 1892.

In the face of the Financial Panic of 1893, J. Pierpont Morgan led the rescue effort that culminated in 1895 with the private sale of U.S. Government bonds to European buyers to “replenish America’s gold supply.” In 1901, Morgan & Co. organized the purchase of Andrew Carnegie’s steel company, which became U.S. Steel Co. Then in 1904, the bank helped finance the Panama Canal construction. In response to The Panic of 1907, when the stock market crashed, Morgan personally organized the rescue of the U.S. financial system. He summoned the heads of the major New York banks and refused to let them leave until they had agreed on a plan, including the purchase of some $30 million of New York City bonds to inject liquidity into the capital market system. In 1940 J.P. Morgan & Co. (“JPM”) went public.

In 2000, JPM merged with Chase Manhattan Bank and in 2004, with Bank One of Columbus, Ohio. By 2020, JPM had become America’s largest bank, with a family of affiliates providing all kinds of financial services. One of those wholly owned affiliates is J.P. Morgan Securities LLC (“JPMS”), a Delaware limited liability company with its principal office in New York City. JPMS is registered with the SEC as both an investment adviser and as a broker-dealer. According to its Form ADV dated March 23, 2023, JPMS had approximately $212.9 BILLION in assets under management (author’s emphasis).

Despite its auspicious history, JPM, including JPMS, has proven to be a very complex human institution -- one that makes occasional mistakes. Thus, from 2020 through July 2023, JPMS settled approximately 362 client claims involving payments of $1000 to $165,000 for errors arising out of events concerning their JPMS accounts. As a matter of firm policy, each client receiving such a payment was asked to sign a Release, which obligated the settling defendant to keep the terms of the settlement confidential, including the amount paid to the client. The Order sets out the key text of the Release:

…the [JPMS client] promises not to sue or solicit others to institute any action or proceeding against [JPMS] arising out of events concerning the Account and that if the JPMS client breaches that provision, JPMS ‘may undertake whatever legal action they deem appropriate to address the breach(s), including, but not limited to, injunctive relief, and monetary damages not to exceed the settlement amount... 

[the JPMS client] shall keep this Agreement confidential and not use or disclose (including but not limited to, media statements, social media, or otherwise) the allegations, facts, contentions, liability, damages, or other information relating in any way to the Account, including but not limited, to the existence or terms of this Agreement…. Notwithstanding, [JPMS client] and [JPMS client’s] attorneys are neither prohibited nor restricted from responding to any inquiry about this settlement or its underlying facts by FINRA, the SEC, or any other government entity or self-regulatory organization, or as required by law.

The JPMS Release allowed a settling client to respond freely to inquiries from FINRA, the SEC, or other governmental or quasi-governmental entity. What the language does NOT allow is for the JPMS client to initiate contact with the regulators. As the Order issued against JPMS notes, this allowance “does not in any way mitigate the language in the Release that impeded [JPMS] clients from reporting potential securities law violations to the Commission.” Hence, the SEC determined that JPMS “willfully violated Exchange Act Rule 21F-17(a).” Particularly noteworthy is the fact that this is the first SEC enforcement action triggered by confidentiality agreements with clients of the capital market participant, and not with employees. This enforcement action fundamentally restructures what is permissible in settling claims with clients.

PAINFUL CONSEQUENCES

The Commission, having found willful violations of SEC Rules, ordered JPMS to cease and desist from causing any future Rule 21F-17 violation; censured JPMS for its violations; and ordered it to pay a civil penalty of $18 million. In determining the size of the civil penalty, the SEC expressly considered:

1. that JPMS revised the Release immediately after the SEC staff notified JPMS of its violation; and
2. sent written notice to all previously settling clients that the Release does not restrict them from contacting regulators about their accounts.

A Press Release issued by the SEC on Jan. 16, 2024, quotes Corey Schuster, the Co-Chief of the SEC’s Enforcement Division’s Asset Management Unit as saying:

Investors, whether retail or otherwise, must be free to report complaints to the SEC without any interference.

Indeed, Gurbir Grewal, the former Attorney General of the State of New Jersey and currently the SEC’s Director of Enforcement warned capital market participants:

Whether it’s in your employment contract, settlement agreements or elsewhere, you simply cannot include provisions that prevent individuals from contacting the SEC with evidence of wrongdoing.

Sometimes the careful crafting of releases as part of a settlement of adverse claims introduces an entirely new aspect of illegal acts. And thus, JPMS not only made a bad situation worse, but also compounded the economic damage which it suffered.