In Second-Ever Enforcement Action of Its Kind, SEC Stands with Whistleblower Against Company’s Attempt to Muzzle Reporting
Imagine that, after you invest in a company, you start to smell a rat. After you try to alert other investors or report what you believe is a fraudulent scheme, the company you invested in draws up an agreement that conditions your shareholding on a prohibition on speaking with regulatory agencies. If it seems illegal, that’s because it is. Yet that’s exactly what online auction and memorabilia company Collectors Café did in 2015 after several of its shareholders tried to report that something was amiss.
On Monday, November 4, the Securities and Exchange Commission alleged that Collectors Café and its CEO, Mykalai Kontilai unlawfully sought to prevent their investors from reporting misconduct. According to the SEC’s press release:
The SEC previously charged Collectors Café and Kontilai with a fraudulent $23 million securities offering based on false statements to investors, and alleged that Kontilai misappropriated over $6 million of investor proceeds.
The SEC’s amended complaint alleges that Collectors Café and Kontilai attempted to resolve investor allegations of wrongdoing by conditioning the return of investor money on the investors signing agreements prohibiting them from reporting potential securities law violations to law enforcement, including the SEC. According to the complaint, these agreements violate the SEC’s whistleblower protection rules. The complaint alleges the defendants went so far as to sue two investors that they believed breached one of the illegal agreements.
The precise violation at issue is Dodd-Frank Rule 21F-17, which prohibits any actions taken to prevent people from reporting securities laws violations to the SEC.
Collectors Café’s unlawful conduct went far beyond the prohibition. In addition to drawing up these agreements for its shareholders, after the SEC froze Kontilai’s assets, Kontilai lied to investors and told them he was being falsely accused by the agency. According to a recent article, during that same call, Kontilai tried to convince investors to support his request to unfreeze assets.
The SEC issued the following statement: “The purpose of the June 18 call was to lull investor-victims into falsely believing that they had not been victimized. [Over the course of years,] Collectors Café and Kontilai took actions to impede investors from communicating directly with SEC staff about a possible securities law violation, including by enforcing and threatening to enforce confidentiality agreements.”
This is the first whistleblower protection enforcement action for the SEC in recent years, and the second of its kind in the SEC’s history. The SEC filed its first enforcement action against a company for including improperly restrictive language in confidentiality agreements that deterred whistleblowers in 2015 against Houston-based technology and engineering firm KBR Inc.
Confidentiality agreements like the one at issue in Collectors’ Café have come under greater scrutiny. As corporations try to discourage whistleblowers from coming forward, government agencies have responded by tightening their grip and prohibiting companies to require their employees to sign agreements with such provisions. For example, also in 2015, the Department of Defense moved to bar anti-whistleblower confidentiality provisions.
The SEC’s whistleblower rewards program, like the False Claims Act and other similar whistleblower statutes and programs, entitles investors or employees who report fraud to protection from retaliation by their employers based on their reporting of securities violations. Enforcement actions like those against Collectors’ Café or KBR go further, however, by actively punishing and deterring companies from trying to stifle individuals who report illicit activity or misconduct. This is an encouraging step in the SEC’s enforcement priorities.
To learn about our SEC whistleblower practice and its retaliation protections, click here.
To learn more about other federal whistleblower laws that provide protections for those engaged in whistleblowing activity in different contexts.
If you think you have a whistleblower case, please click here.
- Department of Defense Moves To Bar Anti-Whistleblower Confidentiality Provisions
- False Claims Act
- Other Whistleblower Laws
- SEC Charges KBR with Violating Whistleblower Protection Rule
- SEC Whistleblower Program