September 13, 2024
What happened?
On September 4, 2024, the SEC announced settled charges against three affiliated registrants, a broker-dealer, and two investment advisers. The charges stem from asking eleven retail clients to sign confidentiality agreements in conjunction with compensation to client accounts for losses caused by the firm’s alleged breaches of securities laws. The agreements contained language that impeded these clients from reporting the potential violations of law to the SEC, allowing communication to regulators only if the regulator first initiated the inquiry. Some of the agreements went further making the compensation contingent on representations from the client that they had not reported the possible violations to the SEC or other regulators and would never make such reports in the future.
Under Rule 21F-17 of the Securities Exchange Act, “[n]o 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.” The client agreements all included provisions that impeded clients from reporting the potential violations to the SEC and other regulators. Even though responses to unsolicited, regulator inquiries were permitted, limiting the ability to voluntarily report potential securities law violations to the authorities violates the whistleblower protections of Rule 21F-17.
What does this mean for me?
First, do no harm. Making the clients whole again after allegedly breaching securities laws was the right idea. Requiring the harmed clients to agree to keep these breaches confidential was a willful violation of additional securities laws. It is unclear whether these template provisions in the agreements were the idea of the registrants or their legal counsel. The SEC did point out that the registrants had made remedial efforts to remove those provisions from their template agreements and had contacted clients to inform them that they were not prohibited from providing information to regulators.
When you work with counsel, bear in mind that your legal agreements must comply not just with contract laws but with securities laws as well. The SEC has brought enforcements for misleading hedge clauses that attempt to waive fiduciary duties and client rights that are nonwaivable. Similarly, a confidentiality agreement to keep someone from reporting misdeeds to a regulator will violate whistleblower protections. Review your template agreements to make sure a hard line to protect the firm did not open the firm up to a new line of regulatory enforcement.
