Article Summary

Oswald

Woodfield

This article by TELG managing principal R. Scott Oswald and TELG principal & general counsel Nicholas Woodfield was published by Westlaw Journal Employment on September 6, 2011.

Originally published in:

The SEC’s New Rules for the Dodd-Frank Whistle-blower Program

I. Introduction

          On July 21, 2010, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. Law No. 111-203 (codified in scattered sections of 7, 12 and 15 U.S.C.), in response to the financial crises triggered by the improper and illegal activities of large financial institutions.  The Dodd-Frank Act established the new Consumer Financial Protection Bureau, the mission of which is to make markets for consumer financial products and services work for every American and to detect and prevent financial fraud.ⁱ  In addition to establishing a new watchdog agency, the law also enlists the help of whistleblowers.  Dodd-Frank requires the Securities and Exchange Commission (SEC) to reward whistleblowers who disclose original information regarding violations of securities law that result in monetary sanctions exceeding $1,000,000.00.  The reward can range from between 10% and 30% of the amount recouped by the SEC.  Further, employers are prohibited from retaliating against those whistleblowers that do come forward.

The SEC had a largely unsuccessful whistleblower reward program prior to the enactment of the Dodd-Frank Act.  The reward ranged from 0% to 10% and the program primarily targeted insider trading.  However, the new SEC program is modeled after the successful IRS Whistleblower Program – established in 2006 – which has already resulted in the recovery of millions of tax dollars because of tips provided by whistleblowers.

Another source of inspiration for the new SEC program is the qui tam provision of the Federal False Claims Act (FCA).  Originally enacted during Abraham Lincoln’s presidency as an answer to the unscrupulous government contractors that were selling the U.S. Army, inter alia, faulty rifles and decrepit horses, the FCA authorizes whistleblowers to sue contractors on behalf of the federal government to recover ill-gotten funds.  Under the FCA, billions of taxpayer dollars have been recovered in the last two decades alone.

In November of 2010 the SEC proposed a set of rules and regulations for implementing the Dodd-Frank whistleblower program.  During this rule-making process, the SEC received hundreds of comments from companies, individuals, and law firms.  In particular, corporations argued that employees should be required to report all securities violations to internal compliance programs, noting the requirement for corporations to maintain costly internal compliance programs.ⁱⁱ  Whistleblower advocates countered that broader protections and greater incentives for whistleblowers are necessary to prevent another financial crisis.

On May 25, 2011, the SEC adopted by a 3-2 vote Rule 21F implementing the Section 922 whistleblower provisions of the Dodd-Frank Act – these rules are effective August 12, 2011.   In the end the SEC declined to require whistleblowers to first report securities law violations internally.  However, to encourage internal reporting, the SEC included internal reporting as a factor that may increase the size of whistleblower rewards for those whistleblowers who first report violations internally.ⁱⁱⁱ  Whistleblowers who report violations internally and then to the SEC within 120 days are still entitled to a reward even if the employer later reports the same violations to the SEC. ^iv

The finalized rules also delineate the types of disclosures that qualify for a reward and the types of individuals – the bad actors – that are generally prohibited from receiving a reward.  Only those whistleblowers that provide original information to the SEC leading to $1,000,000.00 or more in sanctions are eligible for a reward.  Moreover, attorneys working for the employer are often ineligible except where one of the enumerated special exceptions is applicable.

According to the SEC, the new law is already producing its intended results:

“For an agency with limited resources like the SEC, it is critical to be able to leverage the resources of people who may have first-hand information about violations of the securities laws,” said SEC Chairman Mary L. Schapiro.  “While the SEC has a history of receiving a high volume of tips and complaints, the quality of the tips we have received has been better since Dodd-Frank became law.  We expect this trend to continue, and these final rules map out simplified and transparent procedures for whistleblowers to provide us critical information.”^v

         II. Eligibility of a Disclosure

For the whistleblower to be eligible for a reward under the Dodd-Frank program, the disclosure must relate to a violation of one or more securities laws, rules, or regulations.  Importantly, the Dodd-Frank Act explicitly includes within the purview of the SEC any violations of the Sarbanes-Oxley Act (SOX) or Foreign Corrupt Practices Act (FCPA).  SOX requires corporations to abide by certain accounting rules.  The FCPA prohibits U.S. corporations from bribing foreign officials.

A whistleblower must voluntarily provide the SEC with original information regarding a securities law violation, which results in sanctions exceeding $1,000,000.00 in order to be eligible for a reward.  Disclosures are voluntary so long as the whistleblower discloses the information to the SEC before the information is requested by:

• The SEC or in connection with an investigation by:
  • The Public Company Accounting Oversight Board (PCAOB) or any self-regulatory organization;
  • Congress;
  • Any other authority of the federal government; or
  • A state Attorney General or securities regulatory authority.^vi

The $1,000,000.00 threshold can be achieved by aggregating the monetary sanctions resulting from two or more SEC, administrative, or judicial proceedings arising from the same nucleus of operative facts.^vii  “The same-nucleus-of-operative-facts test is a well-established legal standard that 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.”^viii  Monetary sanctions may include any money, penalties, disgorgement, or interest resulting from SEC enforcement.^ix

The SEC defines original information as information that is based upon the whistleblower’s independent knowledge or independent analysis and not already known to the SEC.^x  Independent knowledge pertains to any factual information in the whistleblower’s possession that is not derived exclusively from public sources, such as the news media, judicial proceedings, or government reports.^xi  However, a whistleblower’s independent analysis may also be based upon public sources so long as that analysis reveals information that is generally unknown to the public.^xii  The new rules provide that a whistleblower’s disclosure through an employer’s internal compliance program maintains its original information status so long as the whistleblower also discloses that information to the SEC within 120 days.^xiii

Requests for information made by the SEC to the employer are not automatically directed at every employee.  For example, a SEC request made to the accounting department of a company likely would not preclude an employee outside the accounting department from receiving a reward in return for providing information to the SEC.  Additionally, requests for information made by the employer during its own internal investigations would not preclude an employee from later making a voluntary disclosure to the SEC.

Finally, a disclosure must be sufficiently specific, credible, and timely such that it causes the SEC to open an investigation, or otherwise contributes significantly to a new or existing investigation.^xiv

         III. Eligibility of a Whistleblower

The SEC included rules that make certain individuals ineligible for a reward in order to avoid rewarding improper behavior.  For instance, a preexisting legal or contractual duty to report information to the SEC precludes a whistleblower from a reward.^xv  However, the duty must be one that is owed to the government.  Therefore, an employer could not preclude its employees from eligibility by requiring them to report securities law violations to the SEC.
Moreover, the SEC generally will not grant rewards to:

• Attorneys (including in-house attorneys) and non-attorneys where the information is subject to attorney-client privilege;
• Public accountants working on SEC engagements where the information relates to the engagement client;
• Personnel with compliance-related responsibilities;
• Officers, directors, trustees, or partners who learn the information in connection with the corporation’s internal reporting, compliance, or auditing procedures;
• Individuals who obtained the information through the commission of a crime; or
• Foreign government officials.

In an important victory for whistleblower advocates, the SEC included exceptions permitting eligibility to officers, public accountants, and other personnel with compliance-related responsibilities when:

• The whistleblower reasonably believes that disclosing the information to the SEC is necessary to prevent the company from substantially harming the financial interests or property of the company or its investors;
• The whistleblower reasonably believes the company is impeding the investigation of the misconduct;
• At least 120 days have elapsed since the whistleblower provided the information to internal compliance personnel or his or her supervisor; or
• At least 120 days have elapsed since the whistleblower received the information, if he or she received the information under circumstances indicating that internal compliance personnel were already aware of the information.^xvi

The foregoing exceptions permit employees who are the most likely to uncover wrongdoing to blow the whistle to the SEC when their company refuses or otherwise fails to address the misconduct.

         IV. The Anti-Retaliation Provision

Whistleblowers who report what they reasonably believe to be a possible securities law violation that has occurred, is occurring, or is about to occur will qualify for protection under the anti-retaliation provisions of the Dodd-Frank Act.  The disclosure must have a facially plausible relationship to a securities law violation, but does not necessarily have to be material.  Conversely, a frivolous disclosure would not qualify an employee for whistleblower protection under the new rules.

The rules prohibit employers from interfering with the efforts of whistleblowers to disclose information to the SEC.  The SEC is permitted to enforce the anti-retaliation provisions by investigating and sanctioning employers who practice illegal retaliation.^xvii  Should the SEC or the courts find an employer liable for retaliation, the prevailing whistleblower can:

• Be reinstated to their former position;
• Recover double the wages owed to them in the form of back pay with interest; and
• Recover attorneys’ fees and other litigation costs.

         V. Conclusion

The SEC’s rules are consistent with Congress’s intent to create a robust whistleblower reward and protection law.  Under the new SEC rules, protections for whistleblowers are broadened and the reward program is strengthened.  Those who report violations internally to their employer can receive protection and can receive a reward.  As such, the rules reflect the spirit of the Act, and the next question will be whether the court will continue to interpret the Dodd-Frank Act and its enabling regulations in a consistent manner.

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