When Congress was creating the U.S. Securities and Exchange Commission's program for rewarding whistleblowers, corporations pressed for a requirement that tipsters first report suspected misconduct to their employers. Without that mandate, the companies argued, insiders would go straight to the SEC and ignore the internal reporting systems in which industry had invested millions of dollars.

That requirement was not adopted, but corporations did not walk away from their lobbying push empty-handed. The SEC, since the inception of the whistleblower program in 2010, promoted internal whistleblowing, even incentivizing it by awarding higher bounties to insiders who first take their concerns to their employers.

The securities agency's messaging came despite the fact the law that created the whistleblower program—the Dodd-Frank Act—said tipsters must report “to the commission” in order to receive protections against retaliation. The SEC interpreted that language broadly to extend protections also to employees who only report misconduct internally.

The U.S. Supreme Court on Wednesday unanimously slapped down the SEC's broad view of anti-retaliation protections, ruling that Dodd-Frank's text clearly affords safeguards against reprisal only to those who contact the commission. Now, the open question for whistleblower and securities industry lawyers is how—or even whether—the SEC continues to promote internal whistleblowing in the new legal landscape.

“I do think that the whistleblower office is going to have to change its messaging. You really need to report to the commission if you don't want to lose one of these protections,” said Phillips & Cohen partner Sean McKessy, who stepped down in 2016 as the chief of the SEC's whistleblower office. “While I was still the head of the whistleblower office, I forewarned that if this issue were resolved the way it ultimately was by the Supreme Court, that the office's messaging would have to change to say you'd be crazy if you don't report to the commission because you lose one of the basic tenets of the whistleblower program.”

Lawyers are also watching to see whether the Supreme Court's decision backfires against the industry. “If internal compliance is ultimately destroyed, in the game of Jenga, this is the block that was pulled out to start the process of completely undermining internal reporting,” McKessy said.

Jane Norberg, head of the SEC whistleblower office, did not respond to a request for comment about the Supreme Court decision.

SEC: “Careful of What You Wish For”

As the public face of the SEC's whistleblower office, Norberg has openly questioned the wisdom of the industry challenge. At conferences with securities industry lawyers, Norberg has said that an industry victory against broad anti-retaliation protections would possibly backfire and drive into the SEC's arms whistleblowers who might otherwise report internally.

“The ironic part of all of this is that some of the same companies that commented during the rulemaking process about requiring internal reporting or incentivizing internal reporting are some of the very same companies who are in court now challenging an employee's right to bring a whistleblower retaliation lawsuit for reporting the information internally,” Norberg said last year. “So, in my view, this is a little bit of a thorny issue and a case of 'be careful of what you wish for.'”

Jane Norberg, the SEC's whistleblower chief. Credit: Diego M. Radzinschi

Indeed, whistleblower advocates and securities industry attorneys said the Supreme Court's decision could prompt more corporate insiders to contact the SEC with reports of misconduct.

Jordan Thomas, a former SEC enforcement attorney who founded Labaton Sucharow's whistleblower practice, said he expected Wednesday's ruling to lead to an increase in business for the whistleblower bar. But Thomas stressed he does not view the decision as a positive development.

'The SEC Has a Big Problem Now'

“I'm a former law enforcement person. I think law enforcement benefits when you have strong internal reporting and compliance systems,” Thomas said. “This decision, while good for business, is bad for investors because the SEC is losing its first line of defense.”

For whistleblower lawyers, the Supreme Court's decision simplifies the analysis of whether tipsters should contact the SEC, Thomas said. The SEC, on the other hand, faces difficult decisions about how to proceed.

“The SEC has a big problem now. They've been encouraging people to report internally. Now they have to think twice about that because they're essentially encouraging people to report internally and go into harm's way.”

According to the SEC whistleblower office's most recent report to Congress, about 62 percent of award recipients were current or former insiders. Almost 83 percent of those insiders raised their concerns internally “or understood that their supervisor or relevant compliance personnel” knew of the violations before they reported wrongdoing to the SEC, according to the report.

The SEC has awarded more than $179 million to 50 whistleblowers since issuing the first bounty in 2012. Whistleblowers who help the SEC bring successful enforcement actions with sanctions exceeding $1 million can receive between 10 percent and 30 percent of the money collected.

Justice Ruth Bader Ginsburg on Wednesday noted a separate law, the Sarbanes-Oxley Act, protects internal whistleblowers against retaliation. For many whistleblowers, the Dodd-Frank Act is preferable, however, because it gives more time to file a complaint over retaliation and awards double back pay to victorious whistleblowers.

The court's unanimous decision handed a victory to Digital Realty Trust, represented by Williams & Connolly partner Kannon Shanmugam, in its defense against a would-be whistleblower. The tipster, Paul Somers, claimed he was fired for raising concerns internally about accounting irregularities.

The ruling also resolved a split among the federal circuit courts, where the SEC had inserted itself into retaliation cases between companies and former employees to defend the agency's broad view of whistleblower protections. The U.S. Justice Department backed the SEC's push for broad whistleblower protections.

Digital Realty's gain might mean long-term pain for compliance professionals who rely on internal reporting, said Paul Hastings partner Thomas Zaccaro, a former chief trial counsel in the SEC's Pacific regional office.

Companies, he said, want the opportunity to self-investigate reports of wrongdoing and fix any problem before disclosing it to the SEC and receiving credit for doing so. “That dynamic changes once there's more reporting directly to the SEC,” Zaccaro said.

Amar Sarwal, chief legal officer at the Association of Corporate Counsel, said in-house lawyers should take steps to promote internal reporting, which he described as the “lifeblood of compliance systems.”

“What in-house counsel should not do is look at this opinion as a get-out-of-jail-free card,” he said. “You need to make sure your employees don't feel they're going to get fired or disciplined if they come forward with good-faith allegations of misconduct.”