The Securities and Exchange Commission recently took two steps that together illustrate the agency’s strong interest in (i) protecting investors’ right to report securities violations directly to the SEC and (ii) rewarding investors who disclosure such violations through the whistleblower program. These actions were unusual because they dealt with disclosures or potential disclosures not by employees or other company insiders, but by outside investors.
First, in early November the SEC amended a pending complaint by adding a claim that the defendants, an online auction portal and its CEO, attempted to use settlement agreements to block investors from reporting the defendants’ fraud. In the original complaint, filed in May 2019, the SEC alleged that the defendant company (Collector’s Coffee, a Nevada corporation) and its CEO raised approximately $23 million from at least 140 investors by means of false and misleading statements. The complaint further alleged that the CEO misappropriated much of the investors’ funds. SEC v. Collector’s Coffee, No. 19-cv-04355-LGS-GWG (S.D.N.Y.). In the amended complaint, filed November 4, 2019, the SEC also alleged that when investors demanded the return of their funds, the defendants required the investors to enter into a confidentiality agreement barring them from reporting the fraud to the SEC or other law enforcement agencies. Indeed, when certain investors nevertheless reported the fraud to the SEC, the defendants sued those investors, relying on the confidentiality agreements.
SEC Rule 21F-1(a) provides that “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 . . . .” 17 CFR § 240.21F-17. In the amended complaint in the Collector’s Coffee matter, the SEC asserted that by conditioning the return of investors’ funds on agreement not to report the fraud, the defendants violated Rule 21F-17. Although the SEC had previously pursued Rule 21F-17 violations involving confidentiality provisions in employee severance agreements, this appears to be the first time the SEC has sought to use Rule 21F-17 to preserve the right of investors to report violations to the SEC. By asserting the Rule 21F-17 claim in the Collector’s Coffee case, the SEC has sent a strong signal that similar disclosure restrictions in other investor-related documents (such as subscription agreements and partnership agreements) could also violate Rule 21-F.
Second, on November 15, 2019, the SEC awarded $260,000 to three investors who jointly submitted a tip through the SEC’s whistleblower program. Securities Exchange Act Rel. No. 87544 (Nov. 15, 2019). In announcing this award, the SEC indicated that the whistleblowers alerted the agency to a “well-concealed fraud targeting retail investors.” SEC Press Release 2019-238 (Nov. 15, 2019) . Most important here, the SEC decision specifically states that a factor in favor of the monetary award was that the whistleblowers “were harmed investors who lost their retirement savings.” Rel. No. 87544 at 2. The SEC decision also notes that the amount collected as disgorgement and penalties in the SEC’s enforcement action was “low,” thus suggesting that the SEC would not be able to fully reimburse investors for their losses via a Fair Fund distribution.
These recent SEC actions make clear that (i) an investor has a legal right to report fraud and other securities law violations directly to the SEC regardless of any restrictive language in a confidentiality agreement, settlement agreement, or similar document, and (ii) an investor may be eligible for a monetary whistleblower award if the investor provides original and valuable information to the SEC, in accordance with the SEC’s whistleblower regulations.
The foregoing discussion is provided by Whistleblower Aid for general information purposes and is not intended to be, and should not be, taken as legal advice. For guidance on how to contact Whistleblower Aid, see https://whistlebloweraid.org/contact#whistleblower-contact.
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