The lesson for firms in the securities industry? Keep your unforced error rate down. Update your policies and procedures regularly and make sure that you are not including things in severance agreements or client settlement agreements that the SEC has said are illegal. And if you receive a subpoena from the SEC – regardless of what the SEC is investigating – make sure to hire an attorney with substantial experience in defending SEC matters who can apprise you of all your risks before you respond.

One of the most obvious examples of an unforced error is when financial services firms repeatedly ignore the directive from the SEC that they cannot prohibit clients, employees, or anyone else from reporting securities laws violations to the SEC, state regulators, or self-regulatory organizations. Pursuant to Dodd-Frank Act’s whistleblower protections, the SEC prohibits registrants, brokerage firms, and investment advisors from including such “anti-whistleblowing” prohibitions in settlement agreements with disgruntled investors, as well as in employment agreements, separation agreements and settlement agreements with current or former employees. See https://www.sec.gov/enforcement-litigation/whistleblower-program/whistleblower-protections#anti-retaliation.  Specifically, pursuant to the Dodd-Frank Act, the SEC in 2011 adopted Securities Exchange Act Rule 21F-17(a), which provides:

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.

Despite this Rule and the SEC’s well-publicized cases enforcing the Rule, firms continue to punish employees for reporting securities violations to governmental authorities. See /blog/supreme-court-protects-whistleblowers/. See also https://www.sec.gov/files/litigation/admin/2023/33-11196.pdf (settlement with Gaia, Inc. and its CFO for violations of Rule 21F in May 2023, including firing whistleblower purportedly for making “unfounded complaints”); SEC v. GPB Capital Holdings, LLC et al., No. 21-cv-583 (E.D.N.Y. filed February 4, 2021), https://www.sec.gov/enforcement-litigation/litigation-releases/lr-25909 (complaint filed against investment advisor and several related entities and individuals for, inter alia, firing and taking other adverse action against whistleblower; court later appointed a receiver over the companies).

And it’s not just retaliating against employee-whistleblowers that can get companies in trouble. Some firms still include anti-whistleblowing provisions in employment agreements or separation agreements with prospective and former employees. On September 9, 2024, the SEC announced settlements with seven public companies for using agreements that violated the rule prohibiting firms from impeding potential whistleblowers from reporting potential misconduct to the SEC. https://www.sec.gov/newsroom/press-releases/2024-118. In this most recent instance, the firms required employees to waive their rights to disclose information or file a complaint with a governmental or regulatory body, and to waive their rights to any possible whistleblower monetary awards in hundreds of employment agreements, separation agreements, retention agreements, and settlement agreements. While the SEC did not allege that the companies had taken actions to enforce the waivers, the SEC takes the position that these waivers, while unenforceable in a court of law, still discourage employees and ex-employees from engaging in entirely legal conduct. In total, the seven companies agreed to pay more than $3 million combined in civil penalties. This is an expensive unforced error.

Just a couple of weeks later, the SEC announced that Florida advisory firm GQG Partners LLC agreed to a cease-and-desist order and to pay $500,000 in civil penalties for requiring one former and a dozen prospective employees over three years to agree to non-disclosure agreements limiting their ability to voluntarily report potential illegality to the SEC. See https://www.sec.gov/newsroom/press-releases/2024-150. The agreements these employees/prospective employees signed permitted them to respond to requests for information from the SEC but not affirmatively reach out and contact the SEC. That too is illegal. 

Similarly, firms continue to include these anti-whistleblowing/confidentiality provisions in arbitration settlement agreements to discourage or impede settling investors from reporting violations. See, e.g., In the Matter of Nationwide Planning Associates, Inc., NPA Asset Management, LLC, and Blue Point Strategic Wealth Management, LLC, File No. 3-22056 (Sept. 4, 2024), https://www.sec.gov/files/litigation/admin/2024/34-100908.pdf (settlement with broker-dealer and investment advisor for confidentiality provisions barring clients settling claims for investment losses from reporting conduct to regulators); SEC v. Sanchez, et al., No. 24-cv-00939 (S.D. Tex.) (filed Mar. 14, 2024), https://www.sec.gov/files/litigation/complaints/2024/comp-pr2024-35.pdf (SEC alleged defendant told investors he would help them recover their investment losses “if they took back everything they said to the SEC”).

Perhaps some firms believe that because these types of anti-whistleblowing provisions are unenforceable makes them harmless. See In re JDS Uniphase Corp. Sec. Litig., 238 F. Supp. 2d 1127, 1136 (N.D. Cal. 2002) (party cannot enforce agreement against former or current employees to prevent them from providing information about party’s allegedly illegal activities); FTC v. AMG Services, Inc., 2:12-cv -00536-GMN-VCF, 2013 U.S. Dist. LEXIS 206720, at *7 (D. Nev. Aug. 20, 2013) (collecting cases) (confidentiality agreements are unenforceable to prohibit former employees from willingly cooperating with government investigations); Woodson v. Runyon, Civ. Action No. 13-4098, 2013 U.S. Dist. LEXIS 96833, at *14 (D.N.J. July 11, 2013) (“While a confidentiality agreement can be used to safeguard such matters as trade secrets, the ‘whistleblower-type information about allegedly unlawful acts’ does not fall into that category”). That is far from true. The SEC has been clear that it will bring actions against firms for including these provisions in agreements, regardless of whether the provisions are enforceable. As a result, it makes sense for firms to review all templates that in-house and outside counsel are using for settlement agreements, employment agreements, and separation/severance agreements to eliminate any restriction on anyone reporting any potential violation of securities laws or rules to the SEC as well as to state securities regulators and self-regulatory organizations like FINRA.

In addition to the penalties that these firms paid to the SEC, it is likely that the firms incurred substantial attorney’s fees during the SEC’s investigations. These are unforced errors that a review of existing templates for agreements could eliminate.

If you are facing an SEC or other governmental agency investigation, it is essential that you talk to an attorney with substantial experience representing individuals and firms in securities investigations before responding to the government.

***UPDATES BELOW – 3/19/24 and 6/4/24***

For a government agency with the talent and resources of the Securities and Exchange Commission, its ability to lose its focus and score an own goal is sometimes remarkable. At the same time the Supreme Court has power of administrative agency powers squarely within its cross-hairs, see, e.g., Loper Bright Enterprises, et al. v. Raimondo, et al., Dkt. No. 22-451 (Sup. Ct. argument Jan. 17. 2024) (challenge to Chevron doctrine); Axon Enterprise, Inc. v. FTC, and SEC v. Cochran, 143 S.Ct. 890 (2023) (parties can challenge constitutionality of agency action prior to adjudication on merits); AMG Capital Mgmt., Inc. v. FTC, 141 S. Ct. 1341 (2021) (restricting ability of FTC to obtain monetary redress for victims of consumer protection statutes); SEC v. Jarkesy, Dkt. No. 22-859 (Sup. Ct. argument Nov. 29, 2023) (whether SEC’s discretion to determine whether to proceed via federal court or in administrative proceedings is constitutional, and whether SEC is entitled to obtain civil penalties in administrative proceedings without a jury), the SEC’s blunders in certain high profile cases may be providing those intent on clippings its wings all the ammunition they need.

For example, last October in SEC v. Desilu Studios, Inc., et al., No. 2:22-cv-05652-JLS (C.D. Cal.), the SEC had its entire case dismissed when it sought a default judgment against the key defendant based on a blatant misrepresentation that it had properly served the defendant with its application for default. The defendant, subject to a parallel criminal proceeding, had been declared mentally incompetent by the same judge as in the SEC’s case. Federal Rule of Civil Procedure 55(b)(2) (and a similar local rule) provides that a default judgment can only be entered against an incompetent person if they are represented by a guardian or similar fiduciary. The SEC ignored that rule, so angering the district court that it not only denied the application for default but dismissed the entire case, holding that “the SEC’s misrepresentations regarding its compliance with the governing rules also undermine the Court’s confidence in the SEC’s representations regarding proper service and the merits of the case as a whole.” Dkt. 26 (C.D. Cal. Oct. 23, 2023).

SEC v. Debt Box

The SEC faces potentially greater sanctions for its misconduct in a recent case that has likely received outsized attention because it involves cryptocurrency. In SEC v. Digital Licensing, Inc., d/b/a DEBT Box, et al., No. 2:23-cv-482, 2023 U.S. Dist. LEXIS 213581 (D. Utah), the district court took the unusual step of not only dissolving a temporary restraining order (“TRO”) that the court had issued months earlier, but entered an Order to Show Cause (“Show Cause Order”) against the SEC requiring it to demonstrate why the court should not impose further sanctions against the SEC for what the court termed “false or misleading representations” made in the SEC’s filings and by its counsel in court. A hearing on the Show Cause Order will likely happen in the next few weeks.

The SEC’s complaint, which was filed under seal in July 2023, alleges that the defendants defrauded investors out of at least $49 million by selling unregistered securities called “node software licenses,” which supposedly enabled purchasers to receive crypto assets from DEBT Box. The complaint also named as a defendant a multi-level marketing company, iX Global, which partnered with DEBT Box, as well as various other individuals and entities and several relief defendants.

Ex Parte TRO and asset freeze

The SEC filed an ex parte motion for a TRO and asset freeze at the same time it filed its complaint. Such motions are heard by the court without providing notice to the defendants, and ordinarily before the defendants even know they are the target of an SEC investigation, let alone a defendant in an SEC action because the SEC requests that the court keep the case under “seal.” The SEC employs this tactic in many of its cases. See, e.g., SEC v. Zera Fin. LLC, et al., No.: SACV 23-01807-CJC (ADSx), 2023 U.S. Dist. LEXIS 215129 (C.D. Cal. Oct. 30, 2023); SEC v. Royal Bengal Logistics, Inc., et al., No. 23-61179-CIV-SINGHAL, 2023 U.S. Dist. LEXIS 181090 (S.D. Fla. June 21, 2023).

In most federal courts, the standard for a government agency to obtain a TRO or preliminary injunction is minimal – and they are routinely granted. See FTC v. Consumer Defense, LLC, 926 F. 3d 1208, (9th Cir. 2019) (federal agency seeking a preliminary injunction or temporary restraining order pursuant to statutory enforcement scheme need not demonstrate irreparable harm).

The SEC relied on this relaxed standard in its motion for TRO in the DEBT Box case, even though district courts in Utah often hold that government plaintiffs should be subject to a higher standard. Indeed, it is common knowledge amongst government regulators that the District of Utah can be quite inhospitable to government enforcement actions. See, e.g., Basic Research, LLC v. FTC, 807 F. Supp. 2d 1078 (D. Utah 2011) (denying motion to dismiss declaratory judgment action seeking clarification of administrative consent decree, despite parallel lawsuit brought by agency); Utah Div. of Consumer Protection v. Stevens, 398 F. Supp. 3d 1139 (D. Utah 2019) (dismissing action brought by state agency, holding it lacks jurisdiction to take action against Utah company for conduct occurring in Utah, but where alleged fraud targeted out-of-state victims).

SEC counsel seemed startled when the district court informed them in an ex parte hearing that it was likely to deny the motion without a further showing. The district court characterized the SEC request as “disfavored injunction,” which required it to “’make a strong showing both on the likelihood of success on the merits and on the balance of harms.’” 2023 U.S. Dist. LEXIS 213581, at *9 (quoting Colorado v. EPA, 989 874, 884 (10th Cir. 2021)).

In particular, when the district court judge informed SEC counsel that it intended to deny its application for a TRO for failure to provide support for all of the prongs private litigants are ordinarily required to prove for a TRO, and most importantly, irreparable harm. 9. SEC counsel, apparently flustered by the court’s position, proceeded to mischaracterize certain evidence, some of which had already been presented to the court, to suggest that the defendants had only recently closed several bank accounts and moved assets outside the court’s jurisdiction, and was likely still in the process of doing so. 2023 U.S. Dist. LEXIS 213581, at **9-10. To be fair to SEC counsel, although not highlighted by the judge, some of what got the SEC in trouble were statements made by SEC witnesses in declarations that were stated as categorical facts, when the SEC had presented evidence supporting just one link in a possible chain that might support its conclusion. Id. at **7-8. (Of course, those SEC witness statements were likely drafted by SEC counsel in the first place, so the blame cannot be shifted too far. In the interests of full disclosure, Bragança Law is litigating a separate case involving many of the same SEC personnel, and they have employed the same tactic, i.e., having a witness characterize a possible inference as a categorical fact.)

Relying on the SEC’s representations –whether true, false, or misleading – the district court entered the TRO, and extended it several times without objection. The court also entered a broad asset freeze and appointed a Receiver to take full control of the main corporate defendants. Id. at 11.

Defendants move to dissolve TRO

Certain defendants moved to dissolve the TRO, presenting evidence disproving, inter alia, claims of recent asset transfers and supposed efforts by the defendants to evade SEC detection. The SEC initially doubled down and tried to defend its misrepresentations. But by the time of the hearing on defendants’ motions, the SEC apparently recognized the trouble it had caused itself and not only made no effort to rebut the defendants’ contentions, but chose to not even oppose dissolution of the TRO. Id. at 15. The court dissolved the TRO, asset freeze and receivership, and then took the extraordinary step of issuing its Show Cause Order, stating:

After carefully reviewing the Commission’s filings and statements at the ex parte TRO hearing, the court is concerned the Commission made materially false and misleading representations that violated [Federal Rule of Civil Procedure] Rule 11(b) and undermined the integrity of the proceedings.

No. 2:23-cv-482 (Dkt. 215). A hearing is scheduled for later in March 2024 to determine whether the court should impose sanctions on the SEC. While the defendants were successful in undoing the TRO, asset freeze, and receivership, the victory came at a significant cost – their business was shut down for several months and they lost many or most of their employees and users.

Moreover, the substantial costs involved in operating the Receivership, including work done for the receiver by more than a half dozen lawyers from one of the largest law firms in the country, will mostly be paid out of the defendants’ previously frozen assets. And that is on top of the hundreds of thousands of dollars defendants likely paid or owe their own lawyers, representing at least ten different law firms.

SEC retreat

Although the matter is ongoing, the SEC’s initial response was extraordinary. In particular, the SEC Director of Enforcement, Gurbir Grewal, filed a declaration with the court – a very rare occurrence by someone in his position. In Grewal’s declaration, see No. 2:23-cv-482 (Dkt. 233-6) (filed Dec. 21, 2023), and other declarations filed by the SEC, see No. 2:23-cv-482 (Dkt. 233-1 through 233-5) (all filed Dec. 21, 2023), the SEC acknowledged having misrepresented some of the allegations in its request for a TRO. Grewal concluded that the SEC’s conduct “fell short” of the SEC’s standards, not only by making representations that were inaccurate, but failing to have “quickly and appropriately addressed and corrected” the misrepresentations when they were discovered.

In what might be seen as window-dressing, Grewal announced that the SEC would conduct mandatory training for all its enforcement staff in January 2024 regarding their “professional responsibilities” and any unique issues that might arise when seeking ex parte relief. Of course, SEC attorneys are already required to attend annual ethics meetings and many have an independent state bar-imposed continuing legal education requirement to take a certain number of hours focusing on ethics.

Grewal’s most consequential step, however, was to remove the entire team of lawyers from its Salt Lake City office prosecuting the case and to replace them with staff from the Commission’s Denver Regional Office. That step, however, has not deterred defendants in other cases from arguing that the SEC has engaged in similar misconduct. See, e.g., Defendants’ Notice of Supplemental Authority, SEC v. TerraForm Labs, PTE, Ltd., et al., No. 23 Civ. 1346 (S.D.N.Y. Dec. 4, 2023) Dkt. 136 (J. Rakoff).

In the course of briefing the Show Cause Order, the parties have filed dueling motions to dismiss. Debt Box has argued that the case should be dismissed with prejudice, meaning it cannot be refiled, while the SEC has sought a complete reset, asking that it be given the chance to reinvestigate the case and possibly engage in settlement discussions with the defendants, but that the dismissal be without prejudice to refile if it deems it is warranted. If the SEC were successful in getting the dismissal without prejudice, it would technically could refile the case as an administrative action, thereby escaping the jurisdiction of a federal court judge clearly frustrated by its litigation behavior. The SEC pledged that if it chose to “refile the case,” it would do so before the same judge, but it’s not obvious that an administrative action possibly including some different allegations or parties would fall under its understanding of what constitutes “the case.”

It would be quite shocking if the court grants the SEC’s request that the case be dismissed without prejudice. In addition to the substantial costs already imposed on defendants described above there have been 268 filings on the court docket as of the end of February 2024, and it is reasonable to interpret the SEC’s motion as merely an attempt to evade the substantial sanctions it may face in the current proceeding.

A court decision on both the sanctions and dismissal could come later in March 2024. The attorneys at Bragança Law have more than five decades of experience in government actions seeking temporary restraining orders, preliminary injunctions, asset freezes and receiverships. If you or your company is facing such an action, it is essential that you contact an attorney with such experience as soon as possible.

UPDATE

On March 18, 2024, the district court entered an 80-page order finding that the SEC’s misconduct in this case merited severe sanctions. Although the parties will still have to file pleadings to establish the total amounts, the Court ordered the SEC to pay all of the defendants’ attorneys fees and costs related to opposing the TRO, plus all of the fees and costs associated with the Receivership. The court declined to order the SEC to pay all of the fees and costs incurred during the entire litigation, but these amounts will still likely constitute a high six-figure, or possibly seven-figure, sanction.

Moreover, the Court was particularly troubled by the SEC’s continuing its pattern of misconduct, noting that in its pleadings opposing sanctions, the SEC failed to cite a controlling Tenth Circuit precedent on the issue of whether sovereign immunity barred a sanction — which the Court opined may have constituted an ethical breach by the SEC attorneys in and of itself.

Finally, the Court struck the SEC’s request to dismiss the case without prejudice for failure to cite any controlling authority, in violation of local rules. The Court gave the SEC an opportunity to refile the motion in compliance with the rules.

FURTHER UPDATE – 6/4/24

On May 28, 2024, the Court entered its final order for sanctions against the SEC, ordering the SEC to pay more than $1.8 million to defense counsel and the Receiver. The attorneys fees totaled approximately $1.1 million (half of that amount goes to the lead corporate counsel) and nearly $750,000 to the Receiver. Throughout the opinion, the judge made clear that there were various time entries for which the attorneys and Receiver had not sought reimbursement, but likely should have been included in the award. In particular, the Receiver heavily discounted the amount it sought, well beyond the substantially discounted rates and time-keeping policies it had agreed to at the outset of the matter — presumably simply as a gesture of good will to the SEC in the hopes of future engagements. All told, this already staggering award could have easily topped $2.5 million.

Finally, as explained in our original post, the SEC replaced its entire team from its Salt Lake City office, assigned to this case, replacing them with personnel from the SEC’s Denver office. More recently, those SEC lawyers have withdrawn from other cases to which they were assigned (including the case Braganca Law is litigating). Reportedly in April 2024, the Regional Director of the SEC’s Salt Lake City, who was part of the teams and submitted sworn testimony in both the Debt Box case and the case Braganca Law is litigating, office left the SEC. On June 4, 2024, the SEC took the further step of announcing that it was permanently closing its Salt Lake City office, although it characterized the decision as being based on attrition and budgetary issues.

Bragança Law LLC || February 10, 2024

In a unanimous opinion announced just Thursday of this past week, the United States Supreme Court rejected the attempt of securities industry players to remove a key protection for SEC whistleblowers. In the case Murray v. UBS, the Supreme Court reversed an opinion of the Second Circuit Court of Appeals, which we criticized on this website in June 2023 (https://www.secdefenseattorney.com/blog/new-risks-for-whistleblowers/), that had the potential to make it much easier for employers to retaliate against employees who reported employer wrongdoing to a regulator.

As we have explained in another post (https://www.secdefenseattorney.com/blog/what-should-a-potential-whistleblower-know-before-blowing-the-whistle/ ), the risks to current employees of becoming a whistleblower are substantial, including facing a very real risk of retaliation if they are not careful. If the Second Circuit ruling had been allowed to stand, it would have been virtually impossible for someone to blow the whistle on their current employer without facing financial ruin.

Who is a Whistleblower?

A whistleblower is an individual who exposes unlawful actions occurring in either the public or private sector by reporting them to the SEC or another government agency. To become a whistleblower, you must have specific credible information, based on independent knowledge or analysis, about violations of the federal securities laws that is not publicly available. To learn more about whistleblowing, check out our earlier posts. (https://www.secdefenseattorney.com/blog/new-risks-for-whistleblowers/ and https://www.secdefenseattorney.com/blog/what-should-a-potential-whistleblower-know-before-blowing-the-whistle/).

The SEC Office of the Whistleblower was established under the Dodd-Frank Act of 2010, which relied in part on the Sarbanes-Oxley Act of 2002 (”SOX”) to provide some protection for whistleblowers. Awards are limited to cases in which the SEC collects at least $1 million and the awards range between 10% and 30% of the amount collected. Any awards, however, are almost completely at the SEC’s discretion. In November 2023, the SEC announced that enforcement actions involving whistleblowers had resulted in financial remedies exceeding $6 billion since 2011, and that whisteblowers had been awarded more than $1 billion. (https://www.sec.gov/page/whistleblower-100million).

Retaliation claim in Murray v. UBS

In Murray v. UBS, the plaintiff Murray filed retaliation claims against his former employer, UBS. Murray was an independent analyst at UBS who reported efforts by his superiors to change the results of his reports to support UBS’s trading strategies, essentially sacrificing the best interests of investors to benefit UBS’s clients. Murray had previously received stellar performance reviews, but internal UBS emails revealed that Murray’s superiors decided to either fire him or move him to a different department where his reports could be altered without violating any SEC regulation. At trial, UBS claimed that Murray was not terminated for his reports, but rather as part of widespread layoffs because of the bank’s poor economic performance.

            District Court Jury Finds in Favor of Murray

The district court in Murray instructed the jury that to find that UBS terminated Murray “because of” his whistleblowing, it need only conclude that the whistleblowing was a “contributing factor” in his dismissal. UBS would then have the burden of disproving that its actions constituted retaliation. Indeed, this “burden-shifting” approach was settled law at the time. The jury sided with Murray reaching a verdict that UBS must pay $2.6 million in damages and attorney’s fees.

            UBS’s Appeal – Verdict is Reversed

UBS appealed, however, and the Second Circuit reversed the judgment in favor of Murray. The Second Circuit rejected what had previously seemed to be settled law, holding that it is not sufficient for an employee to merely demonstrate that their whistleblowing was a “contributing factor” to their employer’s actions. The employee must also prove the negative, i.e., that there was no non-retaliatory motive for the employer’s actions. Murray appealed the reversal to the Supreme Court, and on February 8, 2024, the Supreme Court reversed again, holding that the district court had applied the correct standard.

            U.S. Supreme Court Finds in Favor of Murray

In the unanimous opinion, written by Justice Sotomayor, the Court made short work of UBS’s argument that SOX required whistleblowers to demonstrate that the only motive for their termination (or other negative action taken against them) was to retaliate for their whistleblowing. Relying on the plain language of the statute, analogies to other employment statutes, and Congress’s clear intent, the Court held that once a whistleblower demonstrates that their protected activity (i.e., whistleblowing) was a “contributing factor” in the unfavorable personnel action, the burden shifts to the employer to prove that it would have taken the same action but for the protected activity. This is likely to result in the jury verdict being reinstated, but the case went back to the Second Circuit to apply the correct standard in reviewing the district court verdict.

How do you protect yourself?

It is essential that you talk to an attorney with substantial experience representing whistleblowers. To maximize the chances of getting an award and not getting fired, whistleblowers should contact such an attorney before submitting any tips to the SEC or reporting suspected misconduct to their employer or any government agency.

Update March 15, 2025: Second Circuit Renews its Rejection of Whistleblower’s Claim

Almost exactly a year after it was unanimously reversed by the Supreme Court as to the burden in proving retaliatory intent, the Second Circuit Court of Appeals held firm, finding a new reason to again reject a jury verdict in favor of the whistleblower. Stymied by the Supreme Court’s rejection of its earlier deviation from settled law, the Second Circuit took a different tack rejecting a different jury instruction – this time as holding that the instructions as to the term “contributing factor” were potentially ambiguous. The majority opinion is almost comical – as emphasized in a forceful dissent – essentially reading 6 words in isolation from the evidence presented and the other 5700 words in the jury instructions, but it’s extremely unlikely the Supreme Court will take the case once again.

So now Murray, who was fired by UBS in December 2011, will have to decide whether to move forward with his case. At this time, Murray is apparently considering filing a motion for rehearing by the full Second Circuit Court of Appeals, but such motions are rarely successful. Assuming the case goes back to the district court, and even assuming the district court expedites the scheduling of a new trial, it is extremely unlikely that would happen until at least next year.

Bragança Law LLC | September 8, 2023.

Many legal ”experts” warn people to add a passcode lock to their phone if they suspect they will be arrested, or change to a passcode if they have a biometric lock. This summer, however, Illinois became the latest state to moot this advice when the Illinois Supreme Court held that the police can force a suspect to provide their passcode, regardless of its nature. While there is still no clear federal rule on this issue, Illinois is just the latest state to conclude that the Fifth Amendment does not bar compelling suspects to provide their phone passwords to law enforcement.

What is the Fifth Amendment?

The Fifth Amendment to the U.S. Constitution defines several limits to the power of the federal government, which were later extended to state governments after adoption of the Fourteenth Amendment. The most famous provision of the Fifth Amendment prohibits a person from being “compelled in any criminal case to be a witness against himself,” which is known as the Self-Incrimination clause.

The Self-Incrimination clause encompasses a range of safeguards to prevent self-incrimination. Importantly, it does not just apply in court. In Miranda v. Arizona, 384 U.S. 436 (1966), the Supreme Court held that the protection against self-incrimination applies whenever an individual is in police custody, which is why the police (even in television shows and movies) are required to affirmatively inform the suspect that they “have the right to remain silent” and why failure to provide the warning can often result in “confessions” being ruled inadmissible in future proceedings. When witnesses choose not to respond to inquiries that could implicate themselves, it is commonly referred to as “Pleading the Fifth,” a colloquial expression used to invoke the Self-Incrimination Clause.

So how does this affect phone passwords?

Whether an individual can be compelled to provide a biometric or key lock password to their phone is a continuing area of controversy. The United States Supreme Court has not yet weighed in, and state and federal courts have split on the issue. Some courts have held that compelling someone to provide their phone password would be a violation of the Fifth Amendment, as it forces an individual to provide testimonial evidence that could potentially incriminate them. Other courts have ruled that providing a phone password is a physical act rather than testimonial in nature and, therefore, the Fifth Amendment does not apply. They treat being forced to provide a password as similar to being compelled to provide a key to a lock, which is considered a physical act.

This can be particularly important in SEC investigations. For example, in the recent SEC action against a real estate broker (and former Kirkland & Ellis lawyer) being investigated for insider trading, the SEC seeks a court order requiring the broker/lawyer to provide the SEC with his password. The SEC argued that the broker/lawyer’s assertation of his Fifth Amendment privilege was improper, and that the Foregone Conclusion doctrine allowed them to compel him to provide his device along with his password. See SEC v. Charnas, Case No. 1:23-mc-22764 (S.D. Fla.) (filed July 25, 2023). While the SEC had already obtained many of the broker/lawyer’s text messages from other sources, it “believes” other relevant texts could be found on his phone. The SEC’s position in this application is not surprising, but the fact that it chose to issue a press release announcing the application is, according to Charnas, unprecedented. Further, despite the SEC’s assurances of confidentiality to respondents in its investigations, SEC counsel disclosed to Charnas that none of the other respondents in the investigation had raised a Fifth Amendment challenge. Such a disclosure is contrary to the SEC’s usual (and repeatedly stated) practice of keeping those kinds of details confidential.

The Illinois Supreme Court’s latest ruling in People v. Sneed, 2023 IL 127968, is consistent with the position advocated by the SEC. The Court made it clear that the rule is the same whether the password is a string of letters or numbers or is provided biometrically using a fingerprint, facial recognition or a retina scan. While courts are increasingly moving toward the position that requiring a suspect to provide a password does not violate the Fifth Amendment, Sneed is unusual in the breadth of authority it gives to prosecutors. More often, courts have crafted more narrow rules allowing the police to compel production of a password, often relying on court-crafted common law doctrines like the “Foregone Conclusion Doctrine.”

What is the Foregone Conclusion Doctrine?

The “Foregone Conclusion Doctrine” provides that an individual can be compelled to produce evidence or documents that may be incriminating if it is already a “foregone conclusion” that the evidence exists, that the evidence is authentic and owned by the suspect, and that the evidence is within the suspect’s possession or control. If the government can meet this standard, then the Fifth Amendment privilege against self-incrimination does not bar the government from demanding the individual’s cooperation in producing the evidence.

The doctrine originates from Fisher v. United States, 425 U.S. 391 (1976), where the Supreme Court held that defendants could be compelled to produce incriminating financial records because the records that were being subpoenaed already existed and providing the records would not be testimonial and therefore would not be protected under the Fifth Amendment. How a state treats subpoenas for cellular phones largely depends in practice on the state’s interpretation of the Foregone Conclusion Doctrine. Missouri and New Jersey tend to interpret the state’s knowledge that a passcode simply exists as allowing the Foregone Conclusion Doctrine to be applied. For example, the New Jersey Supreme Court held that “even production that is of a testimonial nature can be compelled if the Government can demonstrate it already knows the information that act will reveal — if, in other words, the existence of the requested documents, their authenticity, and the defendant’s possession of and control over them — are a foregone conclusion.” State v. Andrews, 243 N.J. 447, 456, 234 A.3d 1254, 1259 (2020)

Although it went further than many courts, the Illinois Supreme Court in Sneed relied largely on the Foregone Conclusion Doctrine. Specifically, the court found that the contents of the defendant’s phone themselves were not testimonial in nature and it was a foregone conclusion that he had the passcode (as the defendant had already consented to a subpoena for the contents of his phone). Thus, the court held that the Fifth Amendment did not protect the defendant from being forced to provide the passcode. See also, People v. Hollingsworth, 2022 IL App (4th) 190329-U, which interpreted the Foregone Conclusion Doctrine to allow the State to compel defendants to unlock any device secured with a biometric password.

Could I possibly be compelled to provide a biometric password?

Even where courts have treated the act of providing a password as testimonial in nature, the application of the Fifth Amendment to biometric authentication methods, like facial recognition or thumb scans is less clear. The distinction seems to based on the notion that providing biometric data involves the production of physical characteristics—which has not been seen as testimonial, rather than the disclosure of knowledge—which is more likely characterized as testimonial. Where the distinction exists, the courts treat biometric features as tangible physical evidence, akin to providing a key or a fingerprint sample, and therefore not protected by the Fifth Amendment.

Can I refuse to provide my phone at all if I receive a subpoena for it?

Generally speaking, you cannot refuse to provide the evidence requested in a subpoena. If you receive a subpoena for your phone’s data, it’s essential to take it seriously. Refusing to comply without proper legal grounds can lead to serious consequences. However, there are some potential ways to avoid providing your phone.

You, generally through an attorney, can object to producing the phone on the basis of the Fifth Amendment. Your attorney can discuss that objection with the government staff. The government staff may disagree and bring a subpoena enforcement action as they did with Charnas (the broker/lawyer). The court will then decide. Regardless of the Fifth Amendment, certain information on your phone might be protected by privileges, such as attorney-client privilege, allowing you to withhold it under specific circumstances. Additionally, data privacy laws in your jurisdiction might limit the type of data that can be accessed or obtained. However, it’s crucial to seek legal advice from an attorney to determine the best course of action based on your specific situation. Keep in mind that the laws concerning subpoenas and data access can be complex and vary by state. Also regulators take varying approaches to how they approach this issue.

The most important step is to contact an attorney before providing your phone, your password, or any data on the phone. As demonstrated by Sneed and numerous other state and federal cases, even providing your phone or data in an encrypted format may waive your right to exercise your Fifth Amendment rights.

It is important to note that while all of the cases discussed above involved valid search warrants, no warrant is necessary to search your cellphone if you’re crossing into the country from abroad. For example in Malik, et al. v. United States Dept. of Homeland Security, et al., No. 22-10772 (5^th Cir. Aug. 15, 2023), the Fifth Circuit recently held that a warrantless search of an attorney’s cellphone at a border crossing, including engaging in a months-long decryption by a forensics lab to bypass the phone’s password encryption, did not violate any constitutional right.

What should I do if I receive a subpoena for my cell phone?

Make sure to contact an attorney experienced in handling demands from prosecuting or investigatory bodies. It is essential that you contact an attorney as soon as possible to ensure that you can take advantage of the full extent of your Fifth Amendment rights without inadvertently waiving your rights, while still complying with the subpoena.

In May 2023, the Securities and Exchange Commission announced a record $279 million award to a whistleblower for providing “invaluable assistance” in a successful SEC enforcement action. Other than the fact that it was making the award, the SEC has not provided many details as to the circumstances surrounding this award. The SEC has only said the assistance involved multiple targets.¹

The SEC uses these large awards as an incentive to encourage people to report potential misconduct through its whistleblower program. While this latest award dwarfs the previous largest whistleblower award ($114 million in October 2020), large awards are still quite uncommon.

There are significant reasons for potential whistleblowers to hesitate, however, before talking to the SEC. For a discussion of the potential pros and cons of becoming a whistleblower, and advice on how to find the proper attorney to help you navigate the process, see our recent post (/blog/what-should-a-potential-whistleblower-know-before-blowing-the-whistle/). In that post, we lay out the risks of becoming a whistleblower and the potential benefits.

The risks to current employees of becoming a whistleblower are substantial. If a current employee is not careful in reporting employer misconduct, they risk retaliation from their employer which can be financially ruinous. A recent case may increase that risk to current employees.

What is a whistleblower?

A whistleblower is an individual who exposes unlawful actions occurring in either the public or private sector by reporting them to the SEC or another government agency. A whistleblower can be a current employee, a former employee, or someone completely outside the company. What you need to have as a whistleblower is specific credible information about violations of the federal securities laws that is not publicly available. The tip has to be based on your independent knowledge or independent analysis. In some cases, the analysis of outside individuals has been so valuable to the SEC in identifying fraud that the SEC has awarded a whistleblower award, even though the analysis was of publicly-available information.

What are the potential challenges a whistleblower can face?

The Dodd-Frank Act of 2010 created the whistleblower award system, and provided that, depending on the relevant employee’s terms of employment, an employer could require that any claim of retaliation be decided in private arbitration, rather than a court of law. In those cases, an employee who thinks they were terminated or unfairly disciplined because of whistleblowing may have bring their retaliation claim via arbitration. Many employees in the financial services industry may be forced to bring retaliation claims in FINRA arbitration. In addition to the Dodd-Frank Act, the Sarbanes-Oxley Act of 2002 (”SOX”) also provides some protection for whistleblowers. Those SOX provisions may allow individuals to have their day in court even when they are subject to arbitration clauses.

Murray v. UBS, a case in the United States District Court for the Southern District of New York, presented just such a mixed result. Murray filed retaliation claims against his former employer in court. His employer, UBS, sought to have those claims heard in FINRA arbitration. The court reached a split decision. The court held that Murray’s Dodd-Frank claims had to be determined in arbitration, but it allowed Murray to pursue his separate SOX claims in court. This reveals how complex the law is concerning protections for whistleblowers.

The facts of Murray’s case are instructive. Murray was an independent analyst at UBS who reported efforts by his superiors to change the results of his reports to support UBS’s trading strategies. He essentially claimed that UBS was sacrificing the best interests of investors to benefit UBS’s clients. Murray had previously received stellar performance reviews, but internal UBS emails revealed that Murray’s superiors decided to either fire him or move him to a different department where his reports could be altered without violating any SEC regulations. At trial, UBS claimed that Murray was terminated as part of widespread layoffs based on the bank’s poor economic performance and not for his reports.

The district court in Murray instructed the jury that to find that UBS terminated Murray “because of” his whistleblowing, it need only conclude that the whistleblowing was a “contributing factor” in his dismissal. In that case, UBS would have the burden of disproving that its actions constituted retaliation. Indeed, this “burden-shifting” approach was settled law at the time. The jury sided with Murray, and the court ordered that UBS must pay $2.6 million in damages and attorney’s fees.

So what changed?

UBS appealed the jury verdict and the Second Circuit Court of Appeals reversed the judgment in favor of Murray. The Second Circuit rejected the settled law, and held that it is insufficient for an employee to merely demonstrate that their whistleblowing was a “contributing factor” to their employer’s actions. The Second Circuit held that an employee must also prove the negative, i.e., that there was no non-retaliatory motive for the employer’s actions. Murray appealed the reversal to the Supreme Court, and on May 1, 2023, the Court agreed to hear the case in its fall term.

Amicus briefs in support of Murray have been submitted by the consumer advocacy group Public Citizen and by the unlikely pair of Senators Grassley (R-Iowa) and Wyden (D-Oregon) of the Senate Whistleblower Protection Caucus. Both briefs highlight how the Second Circuit’s interpretation of SOX conflicts with the lower standard for proving retaliation that Congress intended to have apply when it enacted SOX. As the primary authors of the antiretaliation provisions of SOX, Senators Grassley and Wyden stated that the Second Circuit’s interpretation was not consistent with the purpose of SOX’s anti-retaliation provisions that lower the bar for employee-whistleblowers to prove retaliation.

How do you protect yourself?

Talking to an attorney experienced in dealing with the SEC or other regulatory agency BEFORE submitting a tip to the SEC is essential. For a potential whistleblower, this maximizes their options and ensures they can take full advantage of the antiretaliation protections of Dodd-Frank and SOX, particularly with the law currently in flux.

Your attorney should have substantial experience in securities law and representing whistleblowers. To maximize the chances of getting an award and not getting fired, whistleblowers should contact an attorney specializing in such claims before submitting any tips to the SEC or reporting suspected misconduct to their employer.

^{1 See https://www.sec.gov/rules/other/2023/34-97438.pdf. Although there has been some media speculation regarding the SEC investigation meriting this award, it will likely remain a mystery unless the whistleblower comes forward because the SEC scrupulously protects the anonymity of its whistleblowers.}

Who is a Whistleblower?

A whistleblower is someone who reports illegal activity in either the public or private sector to the Securities and Exchange Commission – the SEC – or other government agency. Before you report a violation of the law, consult an SEC whistleblower attorney to ensure that you have the maximum legal protection against any type of retaliation.

You are not required to be an employee of the company to submit a tip about that company.

The SEC relies on whistleblowers to detect violations of federal securities laws. Whistleblowers often help the SEC find fraud and other crimes sooner than the agency would have discovered itself, and can provide valuable information in a useful format.

What are a Whistleblower’s Rights?

After the recession of 2007-2009, Congress passed and President Obama signed into law a set of federal statutes that provide substantial incentives for whistleblowers to share information on illegal activity that may have an impact on the offer, purchase or sale of securities. Securities include financial instruments such as stocks, bonds, warrants, notes and options for private or public companies.

A tip to the SEC can be original, pertinent information about insider trading, foreign bribery, fraud in offerings, accounting fraud, market manipulation, Ponzi or pyramid schemes, false statements in financial filings, and more. It does not matter if the illegal activity has or has not personally affected you. In some cases, a tip can be valuable information that substantially assists the SEC in an ongoing investigation. But you must have independent knowledge or do independent analysis for it to qualify as a whistleblowing tip.

Can Whistleblowers Be Compensated?

If a whistleblower reports valuable non-public details about illegal activity to the SEC, and if that report results in a recovery of more than $1 million, the whistleblower may receive from 10 – 30% of whatever is recovered.

In 2022, more than 100 whistleblowers received approximately $229 million. One whistleblower was awarded $32 million for a single tip. In that year, however, the SEC received more than 12,300 whistleblower tips. So most tips do not result in whistleblower awards. Even when a tip does result in an enforcement action, the SEC retains the discretion to determine the amount of the award. This underscores the need for help from an experienced SEC whistleblower attorney before submitting your tip.

When Should Someone Blow the Whistle?

Many whistleblower laws include deadlines, so you should contact a whistleblower attorney and report illegal activity as quickly as possible after you become aware of the illegal activity. Moreover, if you are seeking a monetary reward, the amount of time between your awareness of illegal activity and your reporting will play a part in determining your award amount.

A whistleblower attorney will examine your claim, take the appropriate action on your behalf, and explain your prospects for compensation. The amount you may receive depends on how valuable the SEC staff considers your information to be.

What Else Should Potential Whistleblowers Know?

Choosing to blow the whistle on a possible securities law violator is a serious decision, and whistleblowers often need to get advice that what they have witnessed or learned is in fact illegal. You should seek an attorney’s advice to determine what actions are legal and illegal. It is not a good idea to file lots of tips with the SEC.

It is also not a good idea to file unjustified claims for whistleblower awards. The SEC will permanently bar a person from the Whistleblower Program if they submit three or more frivolous claims for awards that lack a colorable connection between the tip and the actions for which the whistleblower is seeking an award.

The SEC Office of the Whistleblower takes very seriously the confidentiality of the information submitted as tips and the identity of those submitting tips. But, the best way to keep your identity confidential is to anonymously submit a whistleblower tip through an attorney. That is the only way to submit an anonymous tip.

How are Whistleblower Awards Determined?

The SEC considers a number of factors when it determines the compensation amount that a whistleblower may receive. That amount is determined by the unique circumstances and details of each case. The SEC may boost a whistleblower award based on:

•  the importance of a whistleblower’s information
•  the extent of a whistleblower’s assistance
•  the extent of a whistleblower’s contribution to a successful prosecution
•  whether the whistleblower participated in a company’s internal compliance or reporting system

However, a whistleblower’s award may be decreased if the whistleblower:

•  has participated personally in the illegal activity
•  has unreasonably delayed the reporting of the illegal activity
•  has made any false statements that impeded the investigation of the illegal activity

The most common reason for reducing awards is delay so it is important to contact a whistleblower attorney as quickly as possible.

How Do You Choose the Right Attorney?

A potential whistleblower should select an attorney who knows the Securities and Exchange Commission well and who has abundant experience representing clients in SEC-related matters. Such an attorney will help you present a comprehensive and well-researched tip to the SEC.

Your whistleblower attorney should have substantial experience in securities law, accounting fraud, and other types of securities fraud. You will be in the best possible position if your whistleblower attorney is already known to – and has established credibility with – the SEC, or if your whistleblower attorney has actual experience working for or with the Securities and Exchange Commission.

In order to give yourself the best chance of receiving a whistleblower award before you blow the whistle on a possible securities law violator, or if you need to learn more about a securities whistleblower’s legal rights and options, contact an SEC whistleblower attorney before submitting a tip to the SEC.

What are Non-Compete Provisions?

Non-compete provisions are contractual terms that prohibit an employee from working for a competitor of the current company. The purpose is to protect a company’s proprietary information – like customer lists or trade secrets – from being used by a competitor. 

What Did the Federal Trade Commission Propose?

On January 5, 2023, the Federal Trade Commission (FTC) announced a “Notice of Proposed Rulemaking” proposing a rule banning the use of “non-compete” agreements in employment contracts or relationships. The proposed rule would make national the practice of several states in banning such clauses and would be applied retroactively, requiring employers to notify employees and ex-employees the clauses can no longer be enforced. The proposal is consistent with a number of recent FTC actions to focus on anticompetitive practices impacting workers and not just consumers.

Courts have frequently created special carveouts and exceptions to enforcing such provisions, but the proposed rule would impose a ban. Such a ban is needed because it would likely eliminate the widespread practice of employers threatening to enforce non-compete provisions even when they know for a fact that the provisions are unenforceable. Employers appear to make widespread use of illegal non-compete provisions. The FTC study found that employers are just as likely to include non-compete provisions in employment contracts in states which forbid them like California, North Dakota and Oklahoma, as they are in states where non-competes are completely legal.

Why is the FTC Proposing Banning Non-Compete Provisions?

It makes sense for the FTC to take this action, which is similar to an action the Securities and Exchange Commission (SEC) took years ago. In 2017, the SEC adopted a rule prohibiting companies from interfering with anyone’s ability to obtain a financial reward for being a whistleblower. The SEC sanctioned several companies for requiring in severance agreements that employees give up their ability to obtain a whistleblower award – a provision that violated the SEC rules and was unenforceable.   

Calling non-compete provisions “agreements” is usually a misnomer. Non-compete provisions are typically imposed by employers as a condition of employment and are not subject to any negotiation. According to a study cited by the dissenting FTC commissioner, at least one-third of employees are not informed of the existence of a non-compete until after they begin employment. 

The FTC notice and supporting statements identify four main reasons for the proposal.

• Non-compete clauses exploit workers and reduce workers’ wages, by preventing workers from switching jobs or even threatening to switch jobs which might spur their current employers to pay fairer wages.
• Non-compete clauses stifle competition, by interfering with the creation of new businesses and adoption of new ideas. This is not just because workers are unable to start their own competing businesses, but also because it prevents the cross-fertilization of good ideas that can take place when workers take jobs with competitors.
• Non-compete clauses hinder economic liberty, by coercing employees into staying in jobs they would rather leave.
• Employers have other ways to protect their interests in proprietary information. Importantly, nothing in the proposed rule prevents employers from negotiating confidentiality or non-solicitation agreements with prospective employees, or seeking to protect trade secrets. Most of the potential harm cited by opponents of the rule conflate non-competes with these other more targeted protections. In fact, the proposed rule contemplates exceptions in the sale of a business or for certain kinds of senior executives. 

Who Should and Should Not Be Subject to Non-Compete Provisions?

Until recently, only senior executives were typically subject to non-compete agreements. Those clauses only recently became ubiquitous – covering fast food workers and other low-wages workers. The ubiquity of non-compete clauses seems to be part of the motivation for the FTC to act at this time. Estimates are that 30 million workers in US are subject to non-competes. Reports suggest that at least one-third of workers covered by non-compete clauses earn less than $13 per hour. For example, in a case the FTC announced along with its Notice of Prospective Rule Making, it described a Michigan-based security company that includes non-compete clauses for all its employees, including security guards being paid minimum wage. The company has actively enforced these non-compete provisions, which include a $100,000 liquidated damages clause. 

In a recent case brought by the FTC against a multi-level marketer (MLM), the MLM’s policies and procedures barred the half million current and former members from working in any capacity in the health or beauty products industry anywhere in the U.S. – or working for any other MLM regardless of what it sold — for at least two years, even though most members never earned a penny working for the MLM. Even unpaid workers are often subject to non-competes, including entry-level unpaid interns, and in at least one instance, volunteers for a youth soccer league.

Why is the FTC Issuing This Proposal Now?

A little background on the FTC may be helpful to explain the timing of this proposal. The FTC has two missions, which are sometimes but not always complementary: 

• protecting consumers and 
• protecting competition. 

Historically, and particularly in recent years, the FTC has focused the bulk of its enforcement efforts on the first of those missions – protecting consumers. The FTC has done this by filing cases for violations of the FTC Act – usually in federal court, but also in administrative proceedings. 

To fulfill its mission of protecting competition, the FTC has the power to issue “trade regulation rules,” like this proposed ban on non-compete provisions. These rules are virtually indistinguishable from statutes enacted by Congress or state legislatures, and the FTC has created and enforces more than fifty trade regulations and guidelines – which include the rule that created the national Do-Not-Call-Registry as well as obscure rules like the Test Procedures and Labelling Standards for Recycled Oil Rule or the recently rescinded Picture Tube Rule.

But whether for political reasons or simply institutional reluctance, the FTC rarely proposes “trade regulation rules.” There is no statutory prohibition on such rulemaking, and based on the statements made by Commissioners both supporting and opposing this non-compete proposal, we should expect more competition-based proposed rules in the next few years.

The FTC may be turning to rule-making because of recent Supreme Court rulings limiting the FTC’s ability to obtain money judgments in consumer cases under the FTC Act. Two years ago, the Supreme Court reversed nearly forty years of precedent and held in AMG Capital Management, LLC v. Federal Trade Commission, 141 S. Ct. 1341 (2021), that the FTC is precluded from obtaining redress (sometimes referred to as disgorgement or restitution, but essentially just money judgments) in cases it brings under the FTC Act. This ruling does not, however, affect the FTC’s ability to recover money for victims in cases it brings to enforce one of its trade regulations or consumer protection regulations. There are certain limitations, but the FTC has begun to bring consumer protection matters to recover losses for consumers under its regulations rather than the FTC Act.  

What Can You Do? 

This is the time to make your voice heard by submitting a comment to the FTC. The FTC will review all comments before it decides on a final rule. If you are seeking to retain an attorney to prepare your comment on this proposed rule, contact David O’Toole at David@SECDefenseAttorney.com or (847) 906-3460.