Standard Severance Agreements May Need to Be Revised

employment contractMy colleagues, Bill Hayden and Anne Dwyer, recently published a legal alert addressing two recent cease-and-desist orders issued by the Securities and Exchange Commission (SEC). The lessons learned from the cease-and-desist orders could impact both publicly and privately held employers who may want to consider if their severance agreements need to be revised.

Legal Alert:  Standard Severance Agreements May Need to Be Revised
by William R. Hayden and Anne E. Dwyer

Many employers offer severance agreements to departing employees which, at least in part, are designed to protect the employer from disclosures of confidential information and from any future claims or recovery by the departing employee. Unfortunately, two recent cease-and-desist orders issued by the Securities and Exchange Commission (SEC), which contained both large monetary penalties and burdensome notice requirements, may require employers, both publicly and privately held, to revise the language that is currently contained in most standard severance agreements.

In less than one week, the SEC issued two cease-and-desist orders against publicly held companies finding that the contents of their standard severance agreements violated Rule 21F-17 of the Dodd-Frank Act, which prohibits any person from taking “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.”

First, on August 10, 2016, the SEC announced a cease-and-desist order against BlueLinx Holdings, Inc. finding that the confidentiality and waiver provisions contained in its standard employee severance agreements violated Rule 21F-17. Specifically, BlueLinx’s severance agreements contained confidentiality provisions prohibiting employees from disclosing confidential Company information unless compelled by law to do so and only after notifying the Company’s legal department. For example, some of the Company’s severance agreements required the departing employee to confirm that he or she “has not and in the future will not use or disclose to any third party Confidential Information, unless compelled by law and after notice to BlueLinx.”

Further, in 2015, BlueLinx added to its agreements a provision that is found today in many companies’ severance agreements providing:

[N]othing in this Agreement prevents Employee from filing a charge with … the Equal Employment Opportunity Commission, the National Labor Relations Board, the Occupational Safety and Health Administration, the Securities and Exchange Commission or any other administrative agency if applicable law requires that Employee be permitted to do so; however, Employee understands and agrees that Employee is waiving the right to any monetary recovery in connection with any such complaint or charge that Employee may file with an administrative agency.

The SEC found these two provisions unlawfully restricted the ability of departing employees to disclose confidential corporate information and “forced those employees to choose between identifying themselves to the company as whistleblowers or potentially losing their severance pay and benefits.” Further, the agreements “removed the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.” (often referred to as a whistleblower’s “bounty”).

After the SEC instituted legal proceedings against BlueLinx, the Company settled by agreeing to a cease-and-desist order and the payment of a $265,000 fine. In the SEC’s view, the mere presence of the above discussed provisions in severance agreements was enough to warrant such a monetary penalty, in that there is no indication that the Company ever took any steps to enforce those provisions. In addition, BlueLinx was required to agree to include a provision in all future severance agreements assuring former employees that they were not prohibited from filing a charge, communicating or participating in any investigation with government agencies and further assuring the employees that the severance agreement did not prevent the employee from accepting an award for providing information to the government agencies. Even more onerous, BlueLinx was forced to agree to contact all former employees who had signed a severance agreement with the Company over the past five years and inform them of the SEC’s order and that they were not prohibited from providing information to the Commission or accepting a whistleblower award from the Commission (i.e., “bounty”).

Less than one week later, on August 16, 2016, the SEC announced a second cease-and-desist order that included a $340,000 penalty against a California-based health insurance provider, HealthNet, based upon the same alleged violations of Rule 21F-17. HealthNet’s standard severance agreements contained a provision providing:

nothing in this Release precludes Employee from participating in any investigation or proceeding before any federal or state agency or governmental body … however, while Employee may file a charge, provide information, or participate in any investigation or proceeding, by signing this Release, Employee, to the maximum extent permitted by law … waives any right to any individual monetary recovery ….

Again, the SEC found that this provision “directly targeted the SEC’s whistleblower program by removing the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations.” In addition to being required to pay a $340,000 fine, HealthNet was also required to agree to contact all former employees who had signed a severance agreement, provide them notice of the SEC’s order, and provide them a statement that HealthNet does not prohibit employees from seeking and obtaining a whistleblower award from the SEC (i.e., “bounty.”). Again, these sanctions were imposed even though it was undisputed that the company had taken no action to enforce these provisions.

While the SEC generally regulates only public employers, the SEC has made it clear that its reasoning in these actions will apply to both private and publicly traded companies. In fact, Rule 21F-17 was specifically designed to encourage employees of both privately and publicly held companies to report possible violations of securities laws.

In summary, in these recent actions, the government held that it is unlawful for severance agreements to contain provisions that:

  1. prohibit the disclosure of confidential company information unless required by law;
  2. prohibit the disclosure of confidential company information without prior notice to the company; and
  3. prohibit the former employee from recovering additional compensation in the form of whistleblower “bounties.”

Considering the large fines ($265,000 and $340,000) and onerous notice requirements compelled by the SEC in these recent actions, both privately and publicly held companies may want to have their severance agreements reviewed in order to decide whether they need revision in light of these recent actions.

About Ashley Kasarjian

Attorney at Snell and Wilmer in Phoenix, Arizona, and publisher of the blog, Employment and the Law.
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