The SEC recently issued an Order against Paradigm Capital Management, Inc. (Paradigm), a registered investment adviser, and its principal for allegedly engaging in principal trades without effective client disclosure and consent, and for retaliating against an employee who reported such activity to the SEC.  According to the SEC, this is the first enforcement action it has taken for violations of the Dodd-Frank anti-retaliation provisions.

Dodd-Frank Anti-Retaliation Rules

Dodd-Frank prohibits an employer from retaliating against an employee for reporting potential violations to the SEC and/or assisting in any resulting enforcement action.  The Act also allows whistleblowers to reap a percentage of the monetary damages obtained by the SEC in a successful enforcement action.  In May 2011, the SEC adopted Rule 21F-2, which specifies the conditions for receiving anti-retaliation protection and whistleblower rewards under Dodd-Frank.  Under Rule 21F-2(b), an employee is entitled to anti-retaliation protection as a whistleblower if, among other things, he or she possesses a reasonable belief that the information he or she provided relates to a possible securities law violation.  Notably, an employee still may receive anti-retaliation protection as a whistleblower even if he ultimately is not entitled to a reward.

SEC Order

The SEC’s Order asserted that Paradigm violated the anti-retaliation provisions of Dodd-Frank by engaging in a series of retaliatory actions against a head trader who had reported improper principal trades to the SEC.  According to the Order, when the head trader informed Paradigm of his disclosures to the SEC, Paradigm immediately removed him from the trading desk and stripped him of his day-to-day trading and supervisory responsibilities.  In addition, Paradigm purportedly tasked the head trader with preparing a report on the alleged trading violations and instructed him to work offsite.  Despite his repeated requests, Paradigm allegedly refused to allow the head trader to resume his regular trading and supervisory role, ultimately resulting in his resignation.  The SEC found that Paradigm had no legitimate reason for changing the head trader’s functions or removing his supervisory responsibilities, concluding that Paradigm retaliated against him for reporting the principal trades to the SEC.

Without admitting or denying any wrongdoing, Paradigm and its principal agreed to pay disgorgement of $1.7 million, prejudgment interest of $181,771 and a civil penalty of $300,000.  The precise amount specifically attributed to the retaliation claim is not clear.  Paradigm and its principal also agreed to cease and desist from committing or causing further violations of Dodd-Frank’s anti-retaliation provisions, and to hire an independent compliance consultant to review its trading policies.

Implications

The Order against Paradigm is consistent with the SEC’s repeated statements that it intends to pursue anti-retaliation enforcement actions.  As the Chief of the SEC’s Office of the Whistleblower stated in a press release accompanying the SEC Order:

[the SEC] will continue to exercise [its] anti-retaliation authority in these and other types of situations where a whistleblower is wrongfully targeted for doing the right thing and reporting a possible securities law violation.

Employers should make concerted efforts to train managers to take all appropriate steps to comply with anti-retaliation policies and strengthen their internal whistleblower compliance programs and policies.  Here is a reference to our Top 10 steps to paring the risks.