Recent SEC enforcement relating to workplace misconduct

The SEC’s order 

In February, the SEC issued a cease-and-desist order against a company for violating Exchange Act Rules 13a-15(a) and 21F-17(a) by failing “to maintain disclosure controls and procedures to ensure that the company could assess whether its disclosures pertaining to its workforce were adequate” and for violating an SEC whistleblower protection rule. The company agreed to pay USD35 million to settle these allegations.  

While the company disclosed the presence of risk factors to its workforce and how those risk factors might materially impact its business, the SEC found that the company did not have adequate controls and procedures in place to properly capture and assess these risk factors. This included the lack of “controls and procedures among its separate business units designed to collect or analyze employee complaints of workplace misconduct” and therefore, the company was “without the means to determine whether larger issues existed that needed to be disclosed to investors”. 

In terms of the whistleblower violations, the SEC found that the company had a significant number of separation agreements that “required former employees to notify the company if they received a request from a government administrative agency in connection with a report or complaint”. The SEC concluded that this undermined the prohibition on taking “any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation”, even though the SEC was “not aware of any specific instances in which a former company employee was prevented from communicating” with the SEC. 

One commissioner dissented with this decision on the basis that the Order failed to “articulate any securities law violations” and stated it was “difficult to see where the logic of this Order stops”.

Next steps for companies   

While it remains unclear whether the SEC will continue down this path of broadening their authority to encompass more “social” disclosure regulation, looking forward, companies must be vigilant and take steps to ensure: 

1. their disclosure controls and procedures are up-to-date and clearly address known and reported risk factors; 
2. their ESG frameworks implement a corporate strategy that focuses on maintaining an inclusive workforce; and
3. that whistleblower protections are not impeded in anyway. 

It is clear the SEC is no longer solely focused on purely financial disclosures and is taking steps to show that “materiality” for enforcement purposes extends beyond a company’s financials. 

What remains to be seen is how the SEC will determine whether risks surrounding alleged workplace misconduct will satisfy the standard for materiality as laid out in TSC Industries v Northway, Inc.,  426 U.S. 438 (1976) (holding that a fact is material if there is “a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote…Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”). 

Of particular note is a decision handed down in March 2023 by the Delaware Court of Chancery, which dismissed shareholders’ claims against members of an executive board claiming the board members violated their duty to shareholders in the handling of the sexual harassment and misconduct allegations. The shareholders brought this suit under a Delaware law that allows shareholders to sue directors over alleged oversight failures, including ensuring that there are compliance processes in place to address mission-critical risks. The court found that the shareholders failed to show that the directors ignored red flags that demonstrated widespread sexual harassment was taking place, with the court stating, “Whether the response fixed the problem is not the test. Fiduciaries cannot guarantee success, particularly in fixing a sadly recurring issue like sexual harassment. What they have to do is make a good faith effort”.

Therefore, to be better positioned, companies should ensure that they have comprehensive procedures in place that address not only the handling of workplace misconduct and complaints but procedures that allow for ease of reporting such misconduct and maintenance of records of such reports and misconduct. Further, companies should carefully scrutinize the language used in any employee separation agreements to ensure there is no language that may be construed as undermining SEC whistleblower protections. Finally, companies must be aware and properly consider any disclosure implications when considering terminations and what those terminations mean for executive compensation and the impact on investors.