The Sec's Forgotten Power of Exemption: How the Sec Can Receive Deference in Favor of Internal Whistleblowers Even When the Text Is Clear

• Publication year: 2018

The SEC's Forgotten Power of Exemption: How the SEC Can Receive Deference in Favor of Internal Whistleblowers Even When the Text Is Clear

Lesley Chen

THE SEC'S FORGOTTEN POWER OF EXEMPTION: HOW THE SEC CAN RECEIVE DEFERENCE IN FAVOR OF INTERNAL WHISTLEBLOWERS EVEN WHEN THE TEXT IS CLEAR

Abstract

In 2008, the United States suffered its worst financial crisis since the Great Depression. This crisis was precipitated by corporate fraud committed by some of the largest Wall Street firms. Congress responded by passing the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) to improve accountability and transparency in the financial system. Recognizing the importance of whistleblowers in exposing corporate fraud, Congress included an anti-retaliation provision in Dodd-Frank, which was designed to protect whistleblowers from retaliation after coming forward with evidence of corporate wrongdoings.

However, until recently, it was unclear who qualified as a whistleblower under this provision. On the one hand, the statute expressly defines "whistleblower" as an individual who discloses corporate wrongdoing externally to the Securities and Exchange Commission (SEC), and the anti-retaliation provision prohibits employers from retaliating against a "whistleblower" who engaged in various protected activities. On the other hand, the anti-retaliation provision lists three categories of protected activities, one of which does not require disclosure to the SEC. The SEC attempted to clarify the scope of anti-retaliation protection by creating a rule that included internal whistleblowers as "whistleblowers" for anti-retaliation purposes, regardless of whether they satisfied the requirement of reporting "to the Commission." Rather than resolving the issue, the SEC's rule introduced a new and related question: Should a court defer to the SEC's rule under the two-step framework established by the U.S. Supreme Court in Chevron, U.S.A. Inc. v. Natural Resources Defense Council, Inc.? This issue created a circuit split, primarily derived from divergent court interpretations of the anti-retaliation provision's text. Recently, in Digital Realty Trust, Inc. v. Somers, the Supreme Court resolved this split by applying Chevron and holding that one must disclose to the SEC to qualify as a "whistleblower" under Dodd-Frank. The Supreme Court reasoned that Dodd-Frank explicitly defined "whistleblower" as requiring disclosure to the SEC, leaving no room to defer to the SEC's interpretation.

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The Supreme Court, however, left open the question of whether the SEC could nevertheless relieve internal whistleblowers from this requirement through the SEC's general exemptive authority, a power explicitly granted by Congress that allows the SEC to broadly exempt any person or class from Dodd-Frank requirements. This Comment surveys existing case law to highlight how the SEC may still extend Dodd-Frank anti-retaliation protection to internal whistleblowers while conforming to Chevron and the recent Supreme Court ruling. The SEC can accomplish this by exempting internal whistleblowers from disclosing to the SEC. Ultimately, this Comment argues that the SEC can advance Dodd-Frank's goals of expanding whistleblower protections by exercising its forgotten general exemptive authority to protect internal whistleblowers, even if Dodd-Frank's text clearly requires disclosure to the SEC.

Introduction............................................................................................1046

I. Background of the Sarbanes-Oxley Act, the Dodd-Frank Act, and the SEC's Rejected Interpretation of "Whistleblower"..........................................................................1050

A. The Sarbanes-Oxley Act of 2002 ............................................. 1050
B. The Dodd-Frank Act of 2010 ................................................... 1053
C. The SEC's Invalidated Rule..................................................... 1054
D. The SEC's General Exemptive Authority ................................ 1055

II. Court Decisions Applying Chevron to "Whistleblower" Protection.....................................................................................1059

A. The Berman Approach: Dodd-Frank's Text Is Ambiguous, So the SEC's Rule Is Entitled to Deference .................................. 1060
B. The Asadi and Bussing Approaches: The SEC Is Not Entitled to Deference Under Chevron Step One ................................... 1063

1. The Asadi Approach: Dodd-Frank's Text Is Unambiguous That an Individual Must Report to the SEC for Protection 1063
2. The Bussing Approach: Dodd-Frank's Text Is Unambiguous That an Individual Does Not Need to Report to the SEC for Protection....................................... 1064

C. The U.S. Supreme Court's Decision in Somers ....................... 1065

III. The SEC Should Receive Deference in Light of Its General Exemptive Authority Even if the Dodd-Frank Anti-Retaliation Provision Is Clear..................................................1066

A. The SEC's New Rule Would Satisfy Chevron Step One Because the Language of the SEC's General Exemptive Authority Is Sufficiently Broad................................................ 1068

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B. The SEC's New Rule Would Satisfy Chevron Step One Under Its General Exemptive Authority Because the Rule Is Consistent with Public Interest................................................ 1071

Conclusion................................................................................................1074

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Introduction

The financial crisis of 2008 was estimated to have cost Americans more than $12.8 trillion, including the jobs of 23.1 million Americans and the destruction of household net worth.¹ This crisis was escalated in part by corporate fraud committed by a string of Wall Street firms,² some of which were exposed by persistent whistleblowers.³

In response to the financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act⁴ (Dodd-Frank) in 2010 "[t]o promote . . . financial stability by . . . improving accountability and transparency in the financial system."⁵ Section 21F of Dodd-Frank, entitled "Securities whistleblower incentives and protection," was drafted with the goal of strengthening the corporate-whistleblower incentives and protections of existing legislation, particularly those of the Sarbanes-Oxley (SOX) Act of 2002.⁶ To encourage whistleblowers to report securities laws violations, Dodd-Frank established a whistleblower awards program, which provides large monetary incentives to those who report securities violations under specified conditions.⁷ The Act also consists of an anti-retaliation section, which prohibits employers from retaliating against whistleblowers who report securities laws violations.⁸

However, until recently, it was unclear who qualified as a whistleblower for Dodd-Frank anti-retaliation protection. For instance, when an employee discovers corporate fraud, she typically faces two reporting routes. She could choose to first report internally by alerting a supervisor or "higher-up" within

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the company.⁹ Alternatively, she could first report externally, to someone outside of the company, such as a government regulatory agency.¹⁰ While one might think that an employee should be protected from retaliation under Dodd-Frank regardless of which route she takes, some courts have limited protection to only those who report externally.¹¹

In Asadi v. G.E. Energy (USA), L.L.C.,¹² the Fifth Circuit did not extend Dodd-Frank protection to a whistleblower who was fired after reporting securities violations to his supervisor instead of to the Securities and Exchange Commission (SEC), and in doing so, declined to defer to the SEC's rule,¹³ which extends protection to internal whistleblowers.¹⁴ The Sixth Circuit in Verble v. Morgan Stanley Smith Barney, LLC also declined to defer to the SEC's rule, but dodged the issue of the scope of protection by dismissing the case on procedural grounds (insufficient pleading).¹⁵ However, the Second Circuit's recent decision in Berman v. Neo@Ogilvy LLC¹⁶ created a circuit split by deferring to the SEC's rule.¹⁷ On February 21, 2018, the Supreme Court ultimately resolved the split and declined to defer to the SEC's rule, holding that Dodd-Frank's text explicitly required a whistleblower to report to the SEC to qualify for anti-retaliation protection, leaving no room for the SEC's interpretation.¹⁸ The Supreme Court did not discuss whether the SEC may nevertheless exempt internal whistleblowers from this requirement of reporting to the SEC because this precise issue was never raised by the parties or discussed in any case law on Dodd-Frank's anti-retaliation provision.¹⁹ This would be an appropriate way for the SEC to still provide internal

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whistleblowers with Dodd-Frank anti-retaliation protection because Congress expressly granted the SEC a broad exemptive authority that would allow the SEC to relax Dodd-Frank whistleblower requirements for any person or class, as long as doing so is within the public interest.²⁰

It is important for the SEC to exercise its broad exemptive authority to promulgate a new rule in favor of internal whistleblowers because the interests of internal whistleblowers, corporate employers, the SEC, and shareholders are at stake. For instance, more than half of Americans are corporate shareholders²¹ and depend on individuals with special information to report securities fraud and prevent catastrophic loss similar to that caused by the financial crisis.²² Nevertheless, even though reports of securities violations have both steadily risen since Congress implemented Dodd-Frank and played tremendous roles in exposing the largest securities violations,²³ retaliation rates remain at a record high.²⁴ If the SEC allows for a blanket requirement of reporting to the SEC to qualify for...