April 7, 2015
SEC Action Further Undermines Use of Confidentiality and Non-Disparagement Agreements
Author: William F. Gutierrez
In harmony with National Labor Relations Board decisions limiting confidentiality and non-disparagement clauses, a recent settlement announced by the Securities and Exchange Commission sounds a clear warning to employers against the use of overly restrictive confidentiality provisions that tend to discourage reporting of federal securities law violations.
In an apparent “first-of-its-kind,” the SEC brought an enforcement action against KBR, Inc., a Texas-based technology company, alleging that KBR had unlawfully sought to restrict whistleblowing in violation of Rule 21F-17 of the Dodd-Frank Act. Rule 21F-17, with limited exception, prohibits “any action to impede an individual from communicating directly with the [SEC] about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement… .” KBR allegedly required those involved in internal investigations of potential securities law violations to sign confidentiality agreements which included a warning that any third party disclosures of matters discussed during the investigation without the prior written approval of KBR’s legal department could lead to discipline, up to and including termination.
Although there were no apparent instances in which KBR actually enforced the confidentiality provision, or attempted to prohibit an employee from communicating with the SEC, the SEC targeted KBR’s employment practice for the potential chilling effect it might have on the willingness of whistleblowers to report illegal conduct. Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, has explained, “SEC rules prohibit employers from taking measures through confidentiality, employment, severance, or other type of agreements that may silence potential whistleblowers before they can reach out to the SEC. We will vigorously enforce this provision.”
To resolve the administrative proceedings, KBR agreed to pay a penalty of $130,000 and further agreed to include language in their confidentiality agreements specifically noting the right of employees to report potential violations to the SEC and other federal agencies without advance approval or the fear of reprisal.
The action against KBR is undoubtedly only the first “shot across the bow” by the SEC, which has gone on record warning employers to review and amend both existing and historical employment and severance agreements to modify or eliminate any language that has the effect of discouraging the public reporting of possible securities violations. Persistent violation of Rule 21F-17 through the use of overly restrictive confidentiality provisions is bound to invite SEC scrutiny, with possible costly consequences. But, for California employers, SEC scrutiny is not the only concern.
California employers have long been subject to the rule that they cannot compel an employee to agree, in writing, to any term or condition known to be prohibited by law. Labor Code § 432.5. Section 432.5 is enforceable under the Private Attorney General Act (PAGA), and carries with it the potential for monetary penalties. Labor Code § 2699. Further, California courts recognize that the violation of a law that embodies fundamental policies can furnish grounds for a claim for wrongful employment practices. (See, e.g., D’Sa v. Playhut, 85 Cal.App.4th 929 [termination of employee for refusal to agree to unenforceable covenant not to compete stated cause of action for wrongful termination in violation of public policy].) Combined, these authorities may make California employers a potential target for private enforcement actions for using confidentiality provisions that violate Rule 21F-17, even if the employer’s practices have not caught the attention of the SEC.
Conceivably, an aggressive claimant could argue that even a standard “non-disparagement clause” runs afoul of Rule 21F-17 if it serves to chill the exercise of whistleblower rights. Such an argument invokes concerns similar to the NLRB’s criticism of non-disparagement clauses that stifle public criticism of employer practices. For employers, whether the argument has merit is perhaps less important than the cost to defend litigation until the issue is settled by the courts.
Wherever the courts eventually establish the boundaries of the law, it seems that employers can substantially mitigate their exposure by following KBR’s lead in settling the SEC enforcement action. Specifically, employers can and perhaps should include carve outs in confidentiality and non-disparagement provisions in employment or severance agreements that exclude from their scope any right to report potential securities law violations to government agencies, to discuss terms and conditions of employment or to engage in other concerted activities. Absent such carve outs, any perceived restriction of employee rights remains subject to potential challenge, including prosecution for violation of Rule 21F-17, either by the SEC or by private action under PAGA.
 The NLRB recently ruled that “boilerplate” confidentiality and non-disparagement provisions can serve to illegally restrict employee rights to collaborate on matters of common concern or to publicly grieve working conditions, in violation of Sections 7 and 8 of the National Labor Relations Act. See Quicken Loans, Inc. & Lydia E. Garza, an Individual, Case No. 28-CA-75857, 2013 WL 100863 (Jan. 8, 2013).
About the Author
Bill Gutierrez is a founding partner of Gutierrez Marca LLP and provides outside general counsel and litigation services to businesses and entrepreneurs throughout all phases of the business lifecycle. If you would like further information, please contact Mr. Gutierrez at firstname.lastname@example.org or at 415.231.6162.