April 14, 2015

HK’s Bill Ross Gives Update From The State Bar Business Law Section’s Corporations Committee – SEC Questions Restrictive Confidentiality Agreements


On April 1, 2015, the Securities and Exchange Commission announced that for the first time it has brought an enforcement action against a company for having “improperly restrictive language” in confidentiality agreements with “the potential to stifle the whistleblowing process.”

The announcement came in an action brought against KBR Inc., a large government contractor, for violating Rule 21F-17 enacted by the SEC effective August 12, 2011 pursuant to the Dodd-Frank Act. The Dodd-Frank Act, enacted on July 21, 2010 in response to the financial meltdown, includes provisions aimed at encouraging whistleblowers to report possible violations of the securities laws to the SEC through a combination of measures, including financial rewards, confidentiality protections and prohibitions on employer retaliation.

Rule 21F-17 provides in part, as follows:

“(a) 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.”

Before and after the adoption of Rule 21F-17, KBR had asked employees who were witnesses in internal investigations that KBR conducted in response to employee allegations of potential illegal or unethical conduct involving KBR to agree to or sign a confidentiality agreement containing the following statement prior to being interviewed:

“I understand that in order to protect the integrity of this review, I am prohibited from discussing any particulars regarding this interview and the subject matter discussed during the interview, without the prior authorization of the Law Department. I understand that the unauthorized disclosure of information may be grounds for disciplinary action up to and including termination of employment.”

Although the SEC was not aware of any instances in which a KBR employee was prevented from communicating with the SEC staff about possible securities law provisions or in which KBR attempted to enforce the confidentiality clause, the SEC in its order instituting a settled administrative proceeding found that such language “impedes such communications by prohibiting employees from discussing the substance of their interview without clearance from KBR’s law department under penalty of disciplinary action including termination of employment.” Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, stated that “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.”

Without admitting or denying the charges, KBR agreed to pay a $130,000 penalty to settle the charges and voluntarily amended its confidentiality agreement to make it clear that employees will not have to seek approval from KBR’s lawyers prior to communicating with the SEC or other governmental agencies about potential securities or other federal law violations, nor notify KBR after such communications nor face termination of employment or retribution for speaking to the SEC or other governmental agencies about such matters. KBR’s amended confidentiality agreement now includes the following language:

“Nothing in this Confidentiality Agreement prohibits me from reporting possible violations of federal law or regulation to any governmental agency or entity, including but not limited to the Department of Justice, the Securities and Exchange Commission, the Congress, and any agency Inspector General, or making other disclosures that are protected under the whistleblower provisions of federal law or regulation. I do not need the prior authorization of the Law Department to make any such reports or disclosures and I am not required to notify the company that I have made such reports or disclosures.”

KBR is providing employees who signed the confidentiality agreement since August 21, 2011 with a copy of the SEC order and a statement explaining the language that has now been added to the confidentiality agreement.

Although some may view the language added to KBR’s confidentiality agreement as exceedingly broad in scope, it should be noted that the SEC chose to quote the language in its order. In addition, the order does not question the validity of provisions prohibiting disclosure of confidential information involving potential violations of federal laws to non-governmental third parties or the media.

The SEC’s enforcement action did not take place in a vacuum. For example, the National Labor Relations Board has indicated that employers whose confidentiality provisions prohibit non-supervisory employees from discussing internal investigations may be violating the National Labor Relations Act, unless they can show a business justification for the prohibition, such as the protection of witnesses, the likely fabrication of testimony, or that evidence was in danger of being destroyed. The NLRB also has issued rulings that employers whose policies prevent employees from discussing various terms and conditions of employment with co-workers or their union violate the National Labor Relations Act.

In light of the current environment and the SEC’s enforcement action against KBR, it is prudent for companies to review their agreements and practices to make sure that they do not prevent or restrict the ability of their employees to report possible securities or other federal law violations to the SEC or other governmental agencies.

This e-bulletin was written by William Ross. Mr. Ross is of counsel to the law firm of Hirschfeld Kraemer LLP, and represents clients on business matters, including the formation, operation, acquisition, disposition and dissolution of business entities.