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When you open an account with a new financial advisor, the account opening process can be daunting. Expect to see lots of pages, some of which will be marked with red “sign here” stickers. Resist the temptation to sign any documents without reading them carefully and asking questions. The same cautious approach is useful if you are asked to sign any new documents during the course of your relationship with the financial advisor. The existence of any confidentiality provision could be a red flag.
Registered investment advisers and registered broker dealers owe their clients a duty to maintain relevant information about their clients and their accounts in confidence. However, it is unusual to see a confidentiality provision in an agreement between a client and his/her financial advisor. A recent enforcement case illustrates the important rights that clients have under the Whistleblower Program established by the United States Securities and Exchange Commission (Commission) in 2011.
Nationwide Planning Associates, Inc.
On September 4, 2024, the SEC settled an enforcement proceeding with a Nationwide Planning Associates, Inc., a New Jersey-based broker-dealer and two affiliated investment advisers (Respondents) who had been charged with willful violations of Rule 21F-17(a) under the Securities Exchange Act of 1934 (Exchange Act) which prohibits any person from taking any action to impede an individual from communicating directly with SEC staff about a possible securities law violation. The Respondents were censured and ordered to pay civil monetary penalties.
The Commission found that during the period from May 2021 through February 2024, Respondents had asked eleven brokerage customers and advisory clients (Clients) to sign confidentiality agreements in connection with “compensatory” payments that the Respondents made to the Clients’ investment accounts. These agreements contained provisions that impeded the Clients from reporting potential securities law violations to the Commission or any other federal, state, or self-regulatory securities commission or authority, and permitted communication only where the Commission or other regulatory first initiated an inquiry. Some of the agreements further required the Clients to represent that they had not reported the underlying dispute to the Commission or another securities regulator and would forever refrain from such reporting. These provisions violated Rule 21F-17(a) under the Exchange Act. The Consent Order did not specify any of the underlying disputes that provided the basis for the illegal agreements.
The Whistleblower Program
Prior to the establishment of the Commission’s Whistleblower Program in 2011, individuals with knowledge of internal fraudulent schemes were understandably reluctant to report the suspect activity to their supervisors. Retaliation was commonplace in the financial services industry, and employees understood that, as a result of their likely status as “at will” employees, they would be vulnerable to the whims of their employers if they reported misconduct. Internal reporting was viewed as a career ending event.
Following the exposure of numerous frauds both during and after the financial crisis of 2008, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd Frank) which resulted in significant regulatory changes that were intended to address the causes of the crisis. Among the most significant aspects of this comprehensive legislation was the addition of Section 21F to the Securities Exchange Act of 1934 (Exchange Act), which directed the Commission to establish a program designed to encourage individuals to come forward with information about possible violations of the federal securities laws, and to provide anti-retaliation protection for those individuals. Thereafter, the Commission adopted a series of rules under the Exchange Act (Whistleblower Rules) and established the Office of the Whistleblower (OWB).
Since its inception thirteen years ago, the Whistleblower Program has been enormously successful. Whistleblowers may be eligible for an award when they voluntarily provide the SEC with original, timely, and credible information that leads to a successful enforcement action. Whistleblower awards can range from 10 to 30 percent of the money collected when the monetary sanctions exceed $1 million. At the end of the Commission’s fiscal year ending September 30, 2023, a total of almost $2 billion had been awarded to nearly 400 whistleblowers through the Commission’s whistleblower award program. As set forth in the Dodd-Frank Act, the Commission protects the confidentiality of whistleblowers and does not disclose any information that could reveal a whistleblower’s identity.
Although awareness of the Whistleblower Program has grown, as measured by the significant increase in tips and awards since FY 2012, the first year for which full-year data is available, it is clear that many firms have not yet made an effective transition to the new paradigm. As we have seen, some firms have actively resisted the new paradigm, and, instead, have structured their operations to subvert the purpose of the Whistleblower Program. Confidentiality provisions in contracts that seek to impede clients or employees from reporting information to the OWB violate federal law.
The Commission’s Division of Examinations has issued Risk Alerts that reinforce the theme that efforts to impede whistleblower activity will not be tolerated. The Risk Alerts serve to remind industry participants of the specific prohibitions of Exchange Act Rule 21F-17, and to advise them that, in connection with its examination of registered investment advisers and registered broker-dealers, it will reviewing compliance manuals, codes of ethics, employment agreements and severance agreements, among other things, in an effort to determine whether provisions in those documents pertaining to confidentiality of information and reporting of possible securities laws violations may raise concerns under Rule 21F-17. Firms that have addressed the Whistleblower Rules squarely have typically adopted and implemented policies and procedures to comply with the mandates.
Patricia Foster is a securities law attorney whose experience includes representation of clients in both registered and exempt securities offerings, as well as in various sectors of the financial services industry, including broker-dealers, investment advisers and investment companies. The information in this column is provided for educational purposes and does not constitute legal or investment advice.
© 2024. Patricia C. Foster. All Rights Reserved.
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