Vol. 44 No. 18 October 19, 2011
LAURENCE S. LESE is a partner with Duane Morris LLP in Washington, D.C. MICHAEL E. CLARK is Special Counsel with the firm in Houston, Texas. Their e-mail addresses are
Lese@duanemorris.com and Meclark@duanemorris.com.
IN THIS ISSUE
● INSIGHTS INTO THE SEC’S WHISTLEBLOWER PROGRAM
INSIGHTS INTO THE SEC’S WHISTLEBLOWER PROGRAM
The SEC’s final rules implementing the program enacted by Dodd-Frank define who
qualifies as a whistleblower, what original information is required for an award, and the
factors the SEC will consider in determining the amount. Significantly, the rules do not
require a whistleblower to report a violation internally before reporting to the SEC, but
provide for increased awards if the whistleblower utilizes an internal reporting system.
The rules provide whistleblowers important protection from retaliation by employers.
By Laurence S. Lese and Michael E. Clark *
On May 25, 2011, the SEC adopted final rules (the “Rules”) for the expanded whistleblower program established by the Dodd-Frank Act.1 Section 21F of the Exchange Act, as enacted by Dodd-Frank, provides that the SEC, in any covered judicial or administrative action, must pay an award to whistleblowers who voluntarily provided original information to the SEC that led to the successful enforcement action that results in monetary sanctions exceeding $1 million. This article discusses the Rules’ basic requirements for a
whistleblower to earn a monetary award, and provides the SEC’s views, mostly derived from its adopting release, about various requirements and definitions under the Rules.
————————————————————
1The adoption of the final rules follows the November 3, 2010, issuance of proposed rules and the subsequent criticism that such rules potentially undermined corporate internal reporting and compliance programs established under the Sarbanes-Oxley Act by incentivizing employees to report directly to the SEC.
Dodd-Frank directed the SEC to adopt regulations to provide payment of awards to eligible individuals for reporting violations of federal securities laws to the federal government. Specifically, it requires the SEC, if the agency and other specified authorities recover over $1 million in enforcement and related actions, to award qualifying whistleblowers a bounty of 10% to 30% of the aggregate money recovered in eligible actions resulting from original information provided to the SEC by the whistleblowers. The Rules took effect on August 12, 2011.2 They raise some challenging issues, perhaps the most significant being their impact on existing compliance and corporate governance procedures. Listed entities are concerned that their compliance programs will be bypassed by whistleblowers – for all
————————————————————
2http://www.sec.gov/rules/final/2011/34-64545.pdf (the “Release”). Footnotes in this article cite page numbers of the Release printed from the SEC’s website. Dodd-Frank gave the SEC broad rule-making discretion in crafting the whistleblower regulations.
practical purposes, their trusted employees – who now have strong financial incentives to place their personal interests ahead of loyalties to their employers.
A Few Key Differences in the Proposed and the Final SEC Whistleblower Regulations
For an in-depth review of issues raised by the proposed SEC and Commodity Futures Trading Commission (“CFTC”) whistleblower rules to implement Dodd-Frank, see Michael E. Clark, The
Dodd-Frank Act’s Bounty Hunter Provisions, 44 Rev.
Sec. & Comm. Reg. No. 3 (Feb. 9, 2011). In general, despite strong lobbying by business interests, the SEC’s final implementing rules favor would-be whistleblowers by, among other things:
rejecting suggestions that a whistleblower must first notify a company of problems through its existing compliance mechanisms in order to qualify for a bounty;
rejecting the request that the SEC limit
whistleblowers to a “one-bite” approach in gathering evidence to turn over to the government from an employer; and
broadening the pool of eligible whistleblowers from that set out in the proposed rules (i.e., one of the most controversial measures is that attorneys and other fiduciaries now can rather easily meet an exception to the general rule (that disqualifies them from a bounty) if they believe that not disclosing confidential information would put the entity or others at risk).
Who Qualifies as a Whistleblower under the Rules?
Under Dodd-Frank, a whistleblower is an individual3 who provides information about a possible violation of
————————————————————
3Release, at 14. The SEC requires the whistleblower to be a natural person and cites the Dodd-Frank statutory definition, which provides that a whistleblower must be an “individual.” The SEC states that “The ordinary meaning of ‘individual’ is ‘natural person.’”
the securities laws that he or she reasonably believes has occurred, is ongoing, or is about to occur.
The SEC and commenters considered triggering phrases such as “potential violation,” “probable
violation,” and “likely violation,” but the agency decided to adopt “possible violation” as the operative language. In its view, “possible violation” requires the information to indicate a “facially plausible relationship” to some securities law violation (and frivolous submissions will not qualify for whistleblower status).4
“Whistleblower” is broadly defined to include employees, agents or other individuals who provide relevant original information, and the term includes independent contractors, consultants, joint venture partners, sales agents, persons involved with a private, wholly owned subsidiary consolidated in a publicly traded entity’s balance sheet, or even persons involved with a wholly owned foreign subsidiary consolidated in a publicly traded entity’s balance sheet.
But, the Rules further limit the pool of qualified applicants by restricting the eligibility of certain individuals – including officers and directors, lawyers, auditors, and compliance personnel – from receiving an award under the program, unless certain exceptions apply. Such individuals will be eligible for an award under the whistleblower program only if: (1) the whistleblower has a reasonable belief that disclosure may prevent the issuer from “engaging in conduct . . . likely to cause substantial injury to the financial interest or property” of the entity or its investors; (2) the whistleblower has a reasonable belief that the entity is engaging in conduct that will impede an investigation of the misconduct; or (3) 120 days have passed since the whistleblower reported the information to the
appropriate supervisor or senior responsible person, or the whistleblower learns that 120 days have passed since such persons became aware of the information.5
Regarding these “excepted” whistleblowers, the SEC states that, in most cases, it expects the whistleblower to
————————————————————
4Release, at 13.
5
Rule 21F-4(b)(v).
RSCR Publications LLC Published 22 times a year by RSCR Publications LLC. Executive and Editorial Offices, 2628 Broadway, Suite 29A, New York, NY 10025-5055. Subscription rates: $1,197 per year in U.S., Canada, and Mexico; $1,262 elsewhere (air mail delivered). A 15% discount is available for qualified academic libraries and full-time teachers. For subscription information and customer service call (866) 425-1171 or visit our Web site at www.rscrpubs.com. General Editor: Michael O. Finkelstein; tel. 212-876-1715; e-mail mofinkelstein@hotmail.com. Associate Editor: Sarah Strauss Himmelfarb; tel. 301-294-6233; e-mail shimmelfarb@comcast.net. To submit a manuscript for publication contact Ms. Himmelfarb. Copyright © 2011 by RSCR Publications LLC. ISSN: 0884-2426. Reproduction in whole or in part prohibited except by permission. All rights reserved. Information has been obtained by The Review of Securities & Commodities Regulation from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, The Review of Securities & Commodities Regulation does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions, or for the results obtained from the use of such information.
demonstrate that responsible management or governance personnel at the entity knew of the imminent violation but did not take steps to prevent it. In this regard, the SEC did not include a requirement of a “material violation” because most whistleblowers under this exception will not be attorneys. Therefore, it determined not to require them to make legal judgments about whether a material violation has occurred. Rather, the whistleblower must have a reasonable basis for believing that the entity is about to engage in conduct likely to cause substantial injury to the financial interests of the entity or investors, and that notification to the SEC is necessary to prevent the entity from engaging in that conduct. In this regard, the SEC believes it is in the public interest to reward whistleblowers – even if they are officers, directors, auditors or other similar responsible personnel – who give information to the SEC that allows it to prevent substantial injury to the entity or investors.6
Significantly, many commentators, including two SEC Commissioners, expressed concerns that the exceptions for lawyers who owe fiduciary
responsibilities to a company likely will swallow the rule. As Commissioner Kathleen L. Casey noted, “[t]he . . . exclusion will not apply where the
attorney-whistleblower has a reasonable basis to believe that disclosure of the privileged information is necessary to prevent substantial injury to the financial interest or property of investors,” citing ABA Model R. Prof. Cond. 1.6(b)(3).7 In such cases, it may be difficult for the SEC to challenge a whistleblower-lawyer who claims that an immediate reporting was necessary to avoid significant harm to innocent investors and others involved with a company. The Rules also allow anonymous reporting, if done through counsel.8
————————————————————
6Release, at 74.
7ABA Model R. Prof’l Cond. 1.6(b)(3) states “[a] lawyer may
reveal information relating to the representation of a client to the extent the lawyer reasonably believes necessary: . . . to prevent, mitigate or rectify substantial injury to the financial interests or property of another that is reasonably certain to result or has resulted from the client’s commission of a crime or fraud in furtherance of which the client has used the lawyer’s services.” Statement by SEC Commissioner Kathleen L. Casey: Adoption of Rules for Implementing the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934 (May 25, 2011), available at http://www.sec.gov/news/speech/2011/ spch052511klc-item2.htm.
8
Rule 21F-7(b).
What Information is Considered for an Award under the Rules?
To qualify for an award, a whistleblower must
“voluntarily” provide “original information” to the SEC. “Original information” is defined as information:
derived from the “independent knowledge”9
or “independent analysis” of the whistleblower;
not already known to the SEC from any other source, unless the whistleblower is the “original source” of the information;
not exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report, hearing, audit or investigation, or from the news media, unless the whistleblower is a source of the information; and
provided to the SEC for the first time after July 21, 2010.10
It is instructive to understand the SEC’s considerations behind each of these seminal definitions.
“Voluntarily.” Both the Exchange Act and the Rules require that the whistleblower, to be successful in earning an award, must voluntarily provide the SEC with information before receiving any request, inquiry, or demand from the SEC, Congress or other cited authorities. The SEC indicates that all requests from the SEC are covered because it believes that a whistleblower award should not be available to an individual who makes a submission after first being questioned about a matter, or who is otherwise requested to provide information by the SEC staff pursuant to any of its investigative or regulatory authorities. However, the SEC notes that the Rule only precludes a
whistleblower’s submission from being
“voluntarily” provided if a previous request was directed to the whistleblower or his or her personal representative. It cautions that individuals who wait to make their submission until after a request is directed to their employer will face a difficult task to gain an award, because the SEC will carefully
————————————————————
9“Independent knowledge” does not have to be the
whistleblower’s direct, firsthand knowledge, as long as such knowledge consists of factual information not derived from publicly available information. Release, at 47.
10
scrutinize all of the attendant circumstances in determining whether such submissions “significantly contributed” to a successful
enforcement action.11 The SEC further cautions that an employer who requires its employees to sign confidentiality agreements that might prevent the employee from providing information to the SEC without a subpoena may violate Rule 21F-17(a), which provides that no person may take any action to impede a whistleblower from communicating directly with the SEC about a possible securities law violation, including by enforcing or threatening to enforce a confidentiality agreement.12 The SEC would be eager to prosecute such a transgression, since its rulemaking signals the agency’s view that such a provision offends public policy.
“Original information.” The SEC indicates that an individual can be considered the original source of information provided to it by another, including the individual’s employer, or of information that “materially adds” to information already in the SEC’s possession. The Release states that, even after an investigation has commenced, a
whistleblower can be eligible for award
consideration by providing original information that “significantly contributes to the success” of the SEC’s action.13
“Independent knowledge.” The SEC states that “independent knowledge” means any factual information in the whistleblower’s possession not derived from publicly available sources, citing that “Congress primarily intended our whistleblower program ‛. . . to motivate those with inside knowledge to come forward and assist the
Government’ to identify and prosecute persons who
————————————————————
11Rule 21F-4(a)(1); Release, at 30-33.
12
Rule 21F-17(a). The SEC states that “efforts to impede an individual’s direct communications with the Commission staff about a possible securities law violation would conflict with the statutory purpose of encouraging individuals to report to the Commission. Thus, an attempt to enforce a confidentiality agreement against an individual to prevent his or her communications with Commission staff about a possible securities law violation could inhibit those communications even when such an agreement would be legally unenforceable, and would undermine the effectiveness of the countervailing incentives that Congress established to encourage individuals to disclose possible violations to the Commission.” Release, at 201.
13
Rule 21F-4(b); Release, at 42.
have violated the securities laws. . . .” The SEC further notes that it is consistent with this purpose to require that “independent knowledge” be derived from a whistleblower’s own experiences, observations or communications, and not from information available to the general public. While the SEC’s Staff does not believe that “independent knowledge” should be further limited to direct, first-hand knowledge, nevertheless a whistleblower must provide information that is sufficiently specific, credible, and timely that it causes the Staff to open an investigation, or that significantly contributes to the success of an enforcement action. This
requirement is meant to effectively address concerns expressed about whistleblowers providing wholly speculative or unsubstantiated information.14
“Independent analysis” means the whistleblower’s
own examination and evaluation of information that
may be publicly available, but which reveals information not generally known or available to the public. The SEC believes that “independent analysis” requires that the whistleblower do more than merely point the Staff to disparate publicly available information the whistleblower has assembled, whether or not the Staff was previously aware of the information. An “independent
analysis” requires bringing to the public information “some additional evaluation, assessment or insight,” and the SEC says that an award will primarily depend on its evaluation of whether the analysis “is of such quality that it either causes the Staff to open an investigation or significantly contributes to a successful enforcement action.”15
“Original source.” The SEC will consider the whistleblower to be the “original source” of information that it obtains from another if the information satisfies the definition of “original information” and the other source obtained it from the whistleblower in compliance with the rules. The SEC provides this example: “If B makes a
whistleblower submission based on information from A, and A later makes his or her own submission of that information, then A will be considered the ‘original source’ of that information.” As to additional information, the SEC states that a whistleblower will be deemed to be an “original source” of information he or she provides that
————————————————————
14Release, at 48.
15
“materially adds to the Commission’s bases of knowledge” about a matter.16
The Rules provide some notable exceptions to the definition of “original information” that reflect the SEC’s attempt to balance the congressional mandate to implement this program with public-policy concerns about the value of preserving the attorney-client privilege and a company’s internal and external audit functions. In particular, the Rules generally exclude information obtained:
through a communication subject to attorney-client privilege, unless disclosure would otherwise be permitted;17
by a person with compliance or audit responsibilities if the information was communicated to the
whistleblower in connection with the company’s internal compliance processes, unless the person has: (1) a reasonable basis to believe that disclosure is necessary to prevent substantial injury to the financial interest or property of the company or its investors; (2) a reasonable basis to believe that the company is engaged in conduct that will impede an investigation of the misconduct; or unless (3) 120 days have elapsed since such person either reported the violation to the appropriate company compliance personnel or received such information under circumstances indicating that the appropriate company personnel were already aware of it;
in a manner that is determined by a U.S. court to violate applicable federal or state criminal law; or
from a person who is subject to the exceptions outlined above, unless the information is not excluded from such person’s use as provided above, or information is being provided about possible violations involving such person.18
The SEC focused extensively on the above-referenced exclusions. Regarding the permitted disclosure of attorney-client privilege information, the SEC cites its own rule, codified at 17 CFR § 205.3(d)(2), which
————————————————————
16Rule 21F-4(b)(5); Release, at 85, 88.
17
Comment 5 to ABA Model Rule 4.2 addresses communications “authorized by law” and says that such communications may “include communications by a lawyer on behalf of a client who is exercising a . . . legal right to communicate with the government.”
18
Rule 21F-4(b)(4).
permits attorneys representing issuers of securities to reveal to the SEC “confidential information related to the representation to the extent the attorney reasonably believes necessary” (1) to prevent the issuer from committing a material violation that is likely to cause substantial injury to the financial interest or property of the issuer or investors; (2) to prevent the issuer, in an SEC investigation or administrative proceeding, from committing perjury, suborning perjury or committing any act that is likely to perpetrate a fraud against the SEC; or (3) to rectify the consequences of a material violation by the issuer that caused, or may cause, substantial injury to the financial interest or property of the issuer or investors in the furtherance of which the attorney’s services were used. The SEC further notes that the Rule clarifies that the agency’s intention is that all attorneys, whether retained or working in-house, are eligible for awards only to the extent that their
disclosures are consistent with their ethical obligations and SEC Rule 205.3.19
Regarding Rule 21F-4(b)(4)(v) referenced above, the SEC further notes that the rule is not intended to, and does not, create any new or special duties of disclosure on entities to report violations or possible violations of law to the SEC or to other authorities.20
Regarding the 120-day exception to information exclusion, the SEC states that “Nor do we intend to suggest that an internal investigation should in all cases be completed before an entity elects to self-report violations or that 120 days is intended as an implicit ‘deadline’ for such an investigation. Companies frequently elect to contact the staff in the early stages of an internal investigation in order to self-report violations that have been identified. Depending on the facts and circumstances of the particular case, and in the exercise of its discretion, the staff may receive such information and agree to await further results of the internal investigation before deciding its own investigative course.”21
In addition, the Rules specify that only information of high quality, reliability, and specificity will warrant an
————————————————————
19Rule 21F-4(b)(4)(i); Release, at 56, 60.
20Release, at 76. The SEC further explains that the “provisions of
this rule are solely designed to provide greater specificity to certain types of potential whistleblowers about the
circumstances in which their submissions will or will not make them eligible to receive an award.”
21
award.22 The SEC indicates that in assessing whether information “led to” a successful enforcement action, it will examine the relationship between the information in a submission and the allegations in the SEC’s complaint filed in the civil action or order filed in the
administrative proceeding, and states that “Our inquiry will focus on whether the submission identifies persons, places, times, and/or conduct that correspond to those alleged by the Commission in the judicial or
administrative action.”23 The SEC, accordingly, will not grant an award to every tip and complaint, but only to information from a whistleblower that “leads to” a successful action, when the information provided was sufficiently specific, credible, and timely to cause the agency to commence an examination, open an
investigation, reopen an investigation that it had closed or to inquire as to different conduct as a part of a current examination or investigation.24
How is an Award Determined under the Rules?
The Rules require that the award must be between 10% and 30% of the monetary recovery from successful SEC and related actions, although the Rules delegate to the SEC’s discretion the determination of the amount of an award.25 To determine the amount, the Rules require the SEC to consider:
the significance of the information to the success of the action;
the degree of the whistleblower’s assistance in the action;
the SEC’s “programmatic interest” in deterring violations of the securities laws by making such an award; and
whether an award otherwise enhances the SEC’s ability to enforce the federal securities laws, protect
————————————————————
22 Rule 21F-4(c). 23 Release, at 98. 24 Release, at 98-99. 25Rule 21F-5(a) and (b). If multiple actions result from the information provided by the whistleblower, the monetary recovery from such actions may be aggregated for purposes of determining the award. Because Section 21F caps total award payments under the whistleblower regime to between 10% and 30% of the monetary sanctions collected in the SEC’s action and the related actions, the Rules limit the payment of awards to multiple whistleblowers who are entitled to awards under the Rules to not more than 30%, in the aggregate, of the monetary sanctions collected. Rule 21F-5(c).
investors, and encourage the submission of high-quality information by future whistleblowers.26 In reaching the $1 million triggering threshold, the Rules define “monetary sanctions” to mean any money, including penalties, disgorgement, and interest, ordered to be paid, and any money deposited into a disgorgement fund or other fund pursuant to Section 308(b) of the Sarbanes-Oxley Act as a result of SEC action or a related action. Rule 21F-3(b)(1) defines “related action” as a judicial or administrative action brought by the U.S. Attorney General, an appropriate regulatory authority, a self-regulatory authority or a state attorney general in a criminal case. Thus, according to the SEC, regardless of how designated, it will consider all amounts “ordered to be paid” in an SEC or a related action as “monetary sanctions.”27
Moreover, the Rules provide that an award may be increased (but not over the 30% ceiling) if a
whistleblower voluntarily participates in a company’s internal compliance and reporting systems; conversely, an award may be decreased (but not below the 10% floor) if a whistleblower interferes with such internal compliance and reporting systems. In short, the SEC may exercise a high degree of discretion regarding the granting of awards under the program.28
————————————————————
26Rule 21F-6.
27
Rule 21F-4(e); Release, at 112.
28
Rule 21F-6. It is interesting to note that awards may be granted to individuals who are liable for the reported securities violation. However, the SEC may adjust a whistleblower’s award based upon such whistleblower’s culpability. Rule 21F-6(b)(1). The SEC states that it does not believe that a per se exclusion for a culpable whistleblower is consistent with Section 21F, but that by allowing certain less-culpable
whistleblowers to receive awards consistent with the limitations presented in the Rules, the SEC has provided incentives for persons involved in wrongdoing to come forward and disclose illegal conduct involving others while limiting the awards to those whistleblowers. Release, at 126. However, Exchange Act Section 21F(c)(2)(B) provides that no award may be made to a whistleblower who is convicted of a criminal violation related to the action for which the whistleblower could otherwise receive an award. The SEC states that for purposes of determining whether the $1 million threshold has been satisfied or calculating the amount of an award, the SEC will not count any monetary sanctions that the whistleblower is ordered to pay or that are ordered to be paid against any entity whose liability is based substantially on conduct that the whistleblower directed, planned or initiated. Rule 21F-16. The SEC also states that as part of a negotiated settlement
The final rules require the SEC to assess both the positive and negative factors involved in the proceeding. The SEC states that, “[i]n the end, we anticipate that the determination of the appropriate percentage of a
whistleblower award will involve a highly individualized review of the facts and circumstances surrounding each award using the analytical framework set forth in the final rule.”29
How Do the Rules Affect Existing Internal Compliance and Reporting Systems?
Although many corporations requested that the SEC require a whistleblower to report problems internally to management prior to becoming eligible under the program, the Rules do not require internal reporting. Instead, to encourage the use of existing internal compliance and reporting systems, the Rules:
allow an award to be made to a whistleblower who reports a potential violation internally before or at the same time that the whistleblower reports it to the SEC;30
provide that an award may be increased if a
whistleblower utilized the internal reporting system; and
footnote continued from previous page…
agreement, deferred prosecution agreement, non-prosecution agreement, and similar agreements with a highly culpable whistleblower, the SEC has the ability to obtain the whistleblower’s agreement to accept less than the statutory minimum or to forego seeking a whistleblower award. The SEC states that it may exercise this authority where the whistleblower substantially directed, planned, or initiated the violation. Release, at 195.
29
Rule 21F-6; Release, at 124-125.
30
It is likely that a whistleblower, on his or her own accord or on the advice of counsel, will report the potential violations to the company, thereby acting in accordance with the rules and thus possibly enhancing his or her award from the SEC, and shortly thereafter will submit a report to the SEC, thereby alerting the SEC of the potential violation. This dual reporting would bring the SEC into the process and would provide the whistleblower further assurance that the company, knowing that the SEC had been alerted, would handle the matter more professionally and perhaps more dispassionately. The whistleblower may gain confidence that, with the SEC alerted, the potential violation will be fully investigated by the company and any
whistleblowing award by the SEC will be more effectively preserved.
give full credit to a whistleblower for additional information developed by a company following the whistleblower’s internal reporting and subsequently provided to and used by the SEC in a successful enforcement action.
The SEC states that Rule 21F-4(c)(3) incentivizes whistleblowers to report internally by providing them a “meaningful opportunity” to increase their probability of receiving an award. Thus, when the whistleblower reported a possible violation through the company’s internal compliance regime, prompting the employer to provide information to the SEC that “led to” a successful enforcement action, the whistleblower will be eligible for an award, even if the information originally provided to the employer would not have satisfied the “led to” requirement. The SEC further states that if an entity does not have established internal procedures for reporting violations of law, the agency will consider an employee who reports a possible violation to the entity’s legal counsel, senior management or a director to have provided the information “through the appropriate internal whistleblower, legal or compliance procedures.” The SEC advises that, to qualify for consideration under Rule 21F-4(c)(3), a whistleblower must establish that “he or she provided original information through the appropriate internal whistleblower, legal or compliance procedures”; and that, accordingly, “prospective
whistleblowers will be better able to support their claims under this provision if they generate, obtain, and retain contemporaneous documentation (e.g., e-mails or other written records) demonstrating their compliance with the requirements of the Rule, including documents
evidencing: (i) the substance of the information; (ii) the means by which the information was provided; (iii) the recipients of the information; and (iv) the date on which the information was provided.”31
It appears problematic that granting credit to a whistleblower for information developed by a company will undermine internal compliance and reporting systems because a whistleblower stands to reap an even larger benefit from reporting to the SEC on or after the date the whistleblower internally reports. On the other hand, a company considering a whistleblower report it finds to be valid may be highly motivated to self-report to try to receive some benefit under the Sentencing Guidelines and the SEC’s Seaboard Report (such as reduced fines/penalties, a deferred or non-prosecution agreement, and avoiding suspension or debarment from government programs). The predictable effect will be increased numbers and costs of internal investigations,
————————————————————
31along with self-reporting, as well as follow-on litigation, such as shareholders’ derivative suits and class action securities-fraud strike suits.32
The SEC emphasizes that the final rule does not require it to evaluate whether the internal compliance and reporting systems of an entity are “effective.” The final rule relies on whistleblowers to determine whether reporting potential securities violations internally would be appropriate or desirable, without requiring the SEC to independently and subsequently assess the effectiveness of their entity’s internal compliance procedures. The SEC states that “[w]e have determined not to adopt an eligibility exclusion based on a whistleblower’s conduct with respect to an internal investigation” because in some cases “a whistleblower may have a reasonable concern that causes him or her to report misconduct directly to the Commission.” The SEC further states that it believes that a categorical rule that excludes
whistleblowers for not reasonably cooperating with internal investigations would create too much uncertainty and too great a disincentive for whistleblowers who are considering how to report misconduct.33
How Does the SEC View Multiple Actions that Comprise a Judicial or Administrative Proceeding?
Although Section 21F(a)(1) of the Exchange Act makes reference to a “covered judicial or administrative action,” the SEC expanded the phrase to permit
consideration of multiple cases that “arise out of a common nucleus of operative facts as a ‘single’ action.”
The SEC states that, notwithstanding the use of the singular term “action” in Section 21F, it believes that Congress did not intend for a meritorious whistleblower to be denied consideration for an award simply because the SEC chose to bring separate proceedings against respondents or defendants involved in the same closely related action. Therefore, while Rule 21F-4(d) generally defines the term “action” to mean a single captioned judicial or administrative proceeding brought by the
————————————————————
32In fact, there is nothing in the language of Dodd-Frank or the Rules that preclude a qualifying whistleblower from recovering both a bounty for providing original information that leads to an enforcement action and later being a lead plaintiff in a private securities fraud class action or even obtaining double recoveries by taking advantage of the Dodd-Frank bounty provisions and filing a qui tam action if available under the federal False Claims Act seeking the same percentage of recovery from the defendant for violating that statute.
33
Release, at 125, 139.
SEC, the rule identifies two exceptions: (1) an action will constitute two or more SEC proceedings arising from the same nucleus of operative facts; and (2) for purposes of making payments under the Rules, the SEC will treat as part of that same action any subsequent SEC proceeding that, individually, results in a monetary sanction of $1 million or less, and that arises from the same nucleus of operative facts. The SEC states that the “same nucleus of operative facts” is satisfied where two proceedings, although brought separately, share such a close factual basis that the proceedings might logically have been brought together in one proceeding. In this regard, the SEC stated that “we intend to apply a flexible approach and will consider a number of factors,
including whether the separate proceedings involve the same or similar: (1) parties (whether named as defendants/respondents or simply named within the complaint or order); (2) factual allegations; (3) alleged violations of the federal securities laws; or
(4) transactions or occurrences.” Citing federal case law, the SEC indicated that to determine whether two or more proceedings involve the same nucleus of operative facts, courts look at factors such as whether the facts are related in time, space, origin or motivation, whether they form a convenient trial unit, and whether treating them as a unit “conforms to the parties’ expectations. . . . Put another way, as long as the new complaint grows out of the same transaction or series of connected
transactions as the old complaint, the causes of action are considered to be identical.”34
What Protections are Provided to Whistleblowers against Employer Retaliation?
To provide whistleblowers with protection and comfort that their employers will not retaliate against them for acting as a whistleblower, the Rules prohibit retaliation by employers and afford both the
whistleblower and the SEC the right to sue an employer if a whistleblower is discharged or otherwise
discriminated against in connection with his or her whistleblowing actions.35 These protections supplement
————————————————————
34Rule 21F-4(d); Release, at 109-110.
35
Damages for a Dodd-Frank retaliation claim include: reinstatement with the same seniority status; two times the amount of back pay owed plus interest; and compensation for litigation costs, expert-witness fees, and reasonable attorneys’ fees. Section 806 of the Sarbanes-Oxley Act protects employees of public companies for reporting conduct they reasonably believe violates federal laws prohibiting mail, wire or bank fraud; any rule or regulation of the SEC; or any provision of federal law relating to fraud against shareholders. While Sarbanes-Oxley, like Dodd-Frank, does not provide for
similar provisions contained in the Sarbanes-Oxley Act by increasing a whistleblower’s potential recovery to an amount equal to double lost wages. Additionally, the Rules expand the scope of such anti-retaliation protections to apply to all otherwise-eligible
whistleblowers who possess a “reasonable belief” that the information they provided relates to a possible securities law violation that has occurred, is ongoing or is about to occur, rather than only those who have met all of the procedural and other prerequisites to receiving a whistleblower award. Also, under Dodd Frank, unlike Sarbanes-Oxley, a whistleblower has a direct federal cause of action.
To secure anti-retaliation protection, Rule 21F-2(b)(1) provides that an individual is a whistleblower if (1) he or she possesses a “reasonable belief” that the information being provided relates to a possible securities law violation that has occurred, is ongoing or is about to occur, and (2) he or she reports that information in the manner required by the Rules. In this regard, the “reasonable belief standard” requires that the employee hold a “subjectively genuine belief that the information demonstrates a possible violation, and that this belief is one that a similarly situated employee might reasonably possess.” The SEC believes that this standard strikes the appropriate balance between encouraging individuals to provide high-quality tips without fear of retaliation and while not encouraging bad faith or frivolous reports, or permitting abuse of the anti-retaliation protections.
footnote continued from previous page…
punitive damages, a prevailing individual is entitled to compensation for any special damages sustained as a result of discrimination, including litigation costs; expert-witness fees; and reasonable attorneys’ fees; and may include damages for impairment of reputation, personal humiliation, mental anguish, and suffering, and other non-economic harm resulting from retaliation. Sarbanes-Oxley also provides that state and federal laws are not preempted, so the direct causes of action and remedies under applicable state laws are available to
whistleblowers. Section 806(a) of Sarbanes-Oxley. The SEC’s administrative authority against violators of the Exchange Act, including Section 21F and Rule 21F thereunder, includes its ability to issue cease-and-desist orders and impose substantial fines ranging up to $500,000. Exchange Act Section 21B. Additionally, Section 32 of the Exchange Act provides, in cases of willful violation of the Exchange Act and the rules
thereunder, upon conviction, for fines ranging to $5 million and/or imprisonment of up to 20 years for an individual, and for fines of up to $25 million for an entity. Moreover, section 1107 of Sarbanes-Oxley imposes criminal liability (fines or imprisonment for not more than 10 years) for knowing retaliation against a whistleblower in such matters.
Additionally, the retaliation protections apply to a whistleblower irrespective of whether the whistleblower is ultimately entitled to an award. The SEC emphasizes that an employer cannot require employees to waive their anti-retaliation rights because Section 29(a) of the Exchange Act voids any “condition, stipulation or provision binding any person to waive compliance with any provision” of the Exchange Act. The SEC notes that it has enforcement authority for violations of the anti-retaliatory provisions of the Rules by employers who retaliate against employees for making reports in accordance with Section 21F of the Exchange Act.36
Clawback Requirements under Dodd-Frank and the Sarbanes-Oxley Act
Section 954 of Dodd-Frank adds Section 10D of the Exchange Act, which requires the SEC to adopt
regulations that direct national securities exchanges and national securities associations to prohibit the listing of the securities of any company that does not comply with Section 954. The required regulations must provide that, if an issuer is required to prepare an accounting
restatement due to the material non-compliance with any financial reporting requirement under the securities laws, the issuer will recover from any current or former executive officer of the issuer who received incentive-based compensation, including stock options awarded as compensation, based on the erroneous data, in excess of the compensation he or she would have been paid under the accounting restatement.37 The clawback period is the three-year period preceding the date on which the issuer is required to prepare an accounting restatement.38
Section 954 represents an expansion of Section 304 of the Sarbanes-Oxley Act. Section 304 provides that, in the case of an accounting restatement due to material non-compliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and the chief
————————————————————
36Rule 21F-2(b)(1); Release, at 15-20. Exchange Act Section 21F(h)(1)(A) specifically incorporates the anti-retaliatory protections specified in Section 806 of the Sarbanes-Oxley Act and thereby affords protection to employees when they report to a federal regulatory or law enforcement agency, any member of Congress or committee of Congress, or a person with supervisory authority over the employee, or such other person working for the employer who has authority to investigate, discover, or terminate misconduct.
37
The required regulations have not yet been finalized.
38
In view of the ambiguity of this phrase, which lacks precision as to the scope of the look-back period, its meaning cannot be ascertained until the SEC adopts its final regulations.
financial officer must reimburse the issuer for (1) any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the SEC of the subject financial statements and (2) any profits received from the sale of securities of the issuer during that 12-month period.
It is interesting to note that Section 954 expands the class of executive officers subject to clawback and the look-back period for recovering “tainted” compensation; additionally, while Section 304 requires the finding of misconduct to trigger the clawback, there is no such requirement under Section 954.
What about the CFTC’s Final Rules?
The CFTC subsequently voted to adopt its final rules, which were posted on August 18, 2011, and slated to take effect in 60 days after publication in the Federal Register.39 The CFTC’s final rules largely mirror those of the SEC. A good overview of these rules appears in a Fact Sheet posted by the CFTC entitled “Final
Regulations Regarding Whistleblower Incentives and Protection.”40
As the agency observed, “The final regulations are substantially similar to the proposed regulations. The Commission has also made minor changes to the final regulations to ensure consistency and promote harmonization with the Securities and Exchange Commission’s whistleblower final regulations and program.”
Steps to Potentially Limit the Risks of Dodd-Frank Whistleblowers
In light of the significant risks that Dodd-Frank presents to publicly traded companies – and particularly for multinational enterprises under the Foreign Corrupt Practices Act – companies should reassess the adequacy of existing compliance programs (including training) to try to potentially limit these risks. Compliance is a key part of business operations, and it requires periodic assessments since what may have been acceptable in the past may no longer remain so in the eyes of a
government regulator, particularly in the aftermath of a whistleblower complaint.
While some companies have considered rewarding employees for using their internal compliance
————————————————————
39 http://www.cftc.gov/ucm/groups/public/@newsroom/ documents/file/federalregister080411c.pdf. 40 http://www.cftc.gov/ucm/groups/public/@newsroom/ documents/file/wb_factsheet_final.pdf.mechanisms, the value of such measures may be viewed as controversial and problematic. At a minimum, companies may want to conduct exit interviews with departing employees to assess why they are leaving the company, whether they are aware of serious wrongdoing within the organization, and if they have reported it internally or otherwise.
D & O policies should be carefully reexamined to assess whether the exclusions are written in a manner that leaves significant gaps in existing coverage.
Businesses should consider seeking legal counsel regarding what measures are needed in view of the many significant risks involved, including obstruction of justice or unnecessarily provoking a regulatory agency.
Not all is gloom and doom. Even when a company learns about a whistleblower issue that has been or likely will be reported to the SEC, opportunities remain for companies to limit the damage. For one thing, they may be able to help shape the SEC’s decision about whether to proceed with an enforcement action. This is because the SEC currently is not fully staffed nor prepared to handle the expected number of whistleblower complaints, which it estimates to be about 30,000 annually.41 Moreover, the SEC has said that its staff will consider, upon receiving a whistleblower complaint, contacting the company, describing the nature of the allegations, and giving the company an opportunity to investigate the matter and report back to the SEC.42 Therefore, companies may want to seek outside counsel to help advise them and oversee an expedited but thorough internal investigation.
Henry IV, Part 1
Glendower. Why, I can teach thee, cousin, to
command the devil.
Hotspur. And I can teach thee, coz, to shame
the devil,
By telling truth: tell truth and shame the devil.
If thou have power to raise him, bring him hither,
And I’ll be sworn I have power to shame him hence.
O! while you live, tell truth and shame the devil! ■
