Protections for SEC Whistleblowers Post-Digital Realty (11-6-2020)
A recent decision in Kuhns v. Ledger, No. 15-civ-3246-NRB, 2016 WL 4705160 (S.D.N.Y. Aug. 24, 2016), underscores the broad scope of protected conduct under the Dodd-Frank Act’s whistleblower-retaliation provision. John D. Kuhns brought suit, alleging that NanoFlex Power Corp. terminated his employment in retaliation for his raising concerns about potential shareholder fraud. NanoFlex and other defendants moved to dismiss on the basis that Mr. Kuhns did not engage in protected whistleblowing.
Mr. Kuhns’ Dodd-Frank Act Protected Whistleblowing
Mr. Kuhns served as Co-CEO and Executive Chairman of the Board of NanoFlex, during which time NanoFlex became unable to pay its officers. In response, Defendant Dean Ledger, Co-CEO of NanoFlex, attempted to infuse cash into the company by telling investors that NanoFlex was worth $50–60 million and that the company’s shares would soon be listed on the New York Stock Exchange. He offered “units” of shares of common stocks to potential investors without reliably valuating them. Mr. Ledger also offered a warrant with a $2.50 strike price, and then proposed to change that strike price without the board of director’s authorization. Finally, Mr. Ledger procured short-term loans that NanoFlex was unable to repay. Mr. Kuhns told Mr. Ledger several times not to make such statements to investors.
Mr. Kuhns, through an agreement between his investment banking firm and NanoFlex, procured a financing proposal from another company. That proposal, for a three-year loan, stipulated that certain NanoFlex managers resign. The proposal was withdrawn following resistance from Mr. Ledger and Defendant Robert Fasnacht, Executive Vice President of NanoFlex. Mr. Ledger and Mr. Fasnacht then told Mr. Kuhns that, on behalf of “the shareholders,” who deemed the proposal “unacceptable,” they wanted him to resign. Instead, Mr. Kuhns submitted a notice of default to NanoFlex, demanding that the company cure its breaches of the employment agreement. This included the company’s failure to compensate Mr. Kuhns.
Subsequently, in his comments to NanoFlex’s draft Form 10-K, Mr. Kuhns stated that “[t]he manner in which we are offering our securities could engender an inquiry from the regulators. In that event, we would find it expensive and difficult to defend ourselves.” Mr. Kuhns continued:
[e]ven though the [c]ompany is a registrant, its shareholders’ ability to trade the [c]ompany’s shares is extremely limited, and has not been adequately disclosed, as follows: 1) the [c]ompany has no market makers, in the absence of which trading may not take place; and 2) the [c]ompany’s shares may not be uplisted to a better exchange without the approval of the exchange in question, which in turn is vague and generally depends on the [c]ompany doing an underwriting with a recognized broker/dealer. The [c]ompany has no such arrangements.
Mr. Kuhns requested disclosure relating to a senior executive, including his importance to NanoFlex and how his absence would affect the company. For Mr. Kuhns to sign the 10-K, his requested changes would need to be made.
The next day, Mr. Kuhns received a notice of termination for breaching his fiduciary duties, based on the written consent of 67.26% of the shareholders.
No Requirement to Use “Magic Words” to Allege Shareholder Fraud
Defendants asserted that Mr. Kuhns’ comment on the draft Form 10-K, that “[t]he manner in which we are offering our securities could engender an inquiry from the regulators,” was not protected because it did not allege a particular violation of law. Citing the Second Circuit’s Nielsen decision—which rejected prior cases’ requiring a SOX whistleblower to show that he or she alerted management “definitively and specifically” that one of the varieties of fraud enumerated in Section 806 of SOX had taken place—the court found that “relief pursuant to § 1514A turns on the reasonableness of the employee’s belief that the conduct violated one of the enumerated provisions.” Kuhns, 2016 WL 4705160, at *4 (quoting Nielsen v. AECOM Tech. Corp., 762 F.3d 214, 221 (2d Cir. 2014)).
Subjective Belief
Defendants argued that Mr. Kuhns’ statement that “[t]he manner in which we are offering our securities could engender an inquiry from the regulators” did not demonstrate a reasonable subjective belief because it did not indicate any particular violations of law, and “[a]nything could engender such an inquiry.”
The court rejected this argument, stating that a reasonable interpretation of Mr. Kuhns’ statement is that, due to the conduct’s being illegal, it would catch regulators’ attention. Moreover, the court said that Mr. Kuhns’ subsequent comment—that “[i]n that event, we would find it expensive and difficult to defend ourselves”—indicated Mr. Kuhns’ belief that NanoFlex would struggle to defend itself because it violated the law.
The court also pointed to Mr. Kuhns’ allegation that he “told Ledger on multiple occasions to cease his fraudulent behavior.” This allegation, the court found, “clearly sufficiently alleges a subjective belief that Ledger’s actions constituted securities fraud.” Id. at *5.
Objectively Reasonable Belief
The court found an objective basis for Mr. Kuhns’ belief that Defendants had violated Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, which “prohibit making any material misstatement or omission in connection with the purchase or sale of any security.” Id. at *5 (quoting Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2407 (2014)). The allegations that Mr. Ledger lied to investors about the value of NanoFlex and about the company’s prospects for listing on the New York Stock Exchange were “sufficient to survive a 12(b)(6) motion.” Id. And so, Mr. Kuhns’ allegation that he “told Ledger on multiple occasions to cease his fraudulent behavior” had an objective basis.
In a last-ditch argument, Defendants attempted to dismiss the statements Mr. Kuhns made orally to Mr. Ledger. The court rejected this argument, stating that information provided under Section 1514A need not be in writing. Id. (citing Leshinsky v. Telvent GIT, S.A., 942 F. Supp. 2d 432, 442, 444–48 (S.D.N.Y. 2013)).
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