Recognizing whistleblowers’ vital role in combating securities fraud, the SEC has issued a cease-and -desist order against BlueLinx Holdings Inc. for using overly broad confidentiality provisions in severance agreements that would likely deter employees from blowing the whistle.  In particular, to receive severance BlueLinx employees had to waive the right to recover a whistleblower award and agree to notify the company’s legal counsel before disclosing information to government agencies pursuant to legal process.  The SEC’s order imposed a substantial penalty on BlueLinx because these requirements violated Dodd-Frank Act Rule 21F-17.

BlueLinx has agreed to pay a $265,000 penalty and revise the unlawful provisions in its severance agreements to clarify that employees entering into such agreement retain the right to receive an award for information provided to a government agency.

Unlawful Severance Provisions

The SEC found that three provisions in BlueLinx’s severance agreement run afoul of Rule 21F-17.

First, the severance agreement barred employees from disclosing confidential information to anyone outside BlueLinx unless compelled to do so by law.  In particular, the agreement stated:

Employee has not and in the future will not use or disclose to any third party Confidential Information, unless compelled by law and after notice to BlueLinx. * * * If the Employee has any question regarding what data or information would be considered by BlueLinx to be information subject to this provision, the Employee agrees to contact BlueLinx’s Legal Department in writing for written clarification.

The SEC concluded that this broad provision could impede participation in the SEC’s whistleblower program and should be revised to clarify that it does not restrict an employee’s communication with a government agency or participation in a government agency’s investigation.

Second, the severance agreement required employees to waive a whistleblower award as a condition to receiving severance:

Employee further acknowledges and agrees that nothing in this Agreement prevents Employee from filing a charge with… the Securities and Exchange Commission or any other administrative agency if applicable law requires that Employee be permitted to do so; however, Employee understands and agrees that Employee is waiving the right to any monetary recovery in connection with any such complaint or charge that Employee may file with an administrative agency.

The SEC found that requiring departing employees to forgo any monetary recovery in connection with providing information to the SEC “removed the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.”

Third, the severance agreement contained notice provisions requiring employees either to provide written notice to the company or to obtain written consent from the company’s legal department before providing confidential information pursuant to legal process.  The SEC found that the notice provisions forced “employees to choose between identifying themselves to the company as whistleblowers or potentially losing their severance pay and benefits.”

Implications

The SEC should be commended for taking a firm stand against de facto gag clauses in severance and settlement agreements.  Although whistleblowers can make anonymous disclosures to the SEC, blowing the whistle is inherently risky and can result in blacklisting.  Accordingly, it is critical for the SEC to combat efforts by employers to dissuade whistleblowing, including the use of de facto gag clauses that remove the financial incentive for whistleblowers to report fraud to the SEC.  As the SEC notes in the cease-and-desist order, the legislative intent of the Dodd-Frank reward provisions is to promote whistleblowing to the SEC by providing financial incentives.  Companies should not be permitted to use agreements to undermine the Dodd-Frank Act whistleblower rewards provisions.

Some companies may complain that the enforcement of Rule 21F-17 undermines the ability of corporations to protect proprietary information.  But as SEC Chair Mary Jo White pointed out in an April 30, 2015 speech, Rule 21F-17 is not “a sweeping prohibition on the use of confidentiality agreements . . . Companies may continue to protect their trade secrets or other confidential information through the use of properly drawn confidentiality and severance agreements.”   Adding a carve out to a confidentiality agreement clarifying that the agreement does not bar lawful whistleblowing is not particularly onerous and will not risk public exposure of a company’s trade secrets.