The numerous submissions made in response to the requests for comment by the Securities and Exchange Commission (the “SEC” or “Commission”) highlight that many of the proposed amendments to the whistleblower rules, if adopted, will present additional challenges for regulated entities. The amendments would create greater incentives for individuals to report certain violations of the securities laws to the SEC and to report on such violations more quickly than they do now. The rules would also enable the staff to address meritorious tips and commence enforcement actions more quickly than they do now.
Notwithstanding the foregoing, there are some potential upsides to the amendments for regulated entities. The proposed rules would decrease the financial incentives for individuals to report the most significant violations to the Commission. The amendments would also make it more difficult for individuals to qualify for awards based upon public information.
Ultimately, the proposed amendments leave many important issues unresolved. Perhaps most important, it remains to be seen whether the SEC will continue to consider participation in and interference with internal reporting and compliance programs when determining award amounts. Legislative action will likely be necessary to implement the sort of anti-retaliation protection that will protect individuals who report possible violations internally before going to the SEC. Further guidance from the Commission will also be required to address how regulated entities might protect their confidential information in employment and severance agreements without being charged with impeding communications with the SEC.
In July 2010, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”), which, among other things, established the SEC’s current whistleblower incentive and protection.1 The SEC adopted implementing rules in May 2011, and they became effective in August 2011.2 Since that time, the Commission has awarded incentive payments of more than US$326 million to 59 individuals. The SEC has also brought four enforcement actions for violation of the anti-retaliation rules.
The implementing rules currently define whistleblowers differently, depending on whether the term is used for purposes of incentive awards and confidentiality protection, on the one hand, or for purposes of anti-retaliation protection, on the other hand.3 As a result of that distinction, under the rules as currently written, individuals qualify for anti-retaliation protection even if they only report information internally and not to the SEC.
In 2013, the United States Court of Appeals for the Fifth Circuit held that the Dodd-Frank Act does not provide protection for individuals who fail to report information to the SEC.4 Following that decision, in 2015, the SEC issued interpretive guidance, stating that for purposes of employment retaliation protection, an individual’s status as a whistleblower does not depend on whether he or she reported information to the SEC.5 In February 2018, the Supreme Court rejected the SEC’s interpretation of the Act’s anti-retaliation provisions and held in Digital Realty Trust, Inc. v. Somers that the Act only protects individuals who provide information to the SEC and does not protect those who just report such information internally.6
Proposed Rule Amendments
In the wake of the Supreme Court’s decision in Digital Realty, the SEC voted on June 28, 2018 to propose amendments to the rules governing its whistleblower incentive and protection program.7 According to the SEC’s press release issued on that date, the amendments would not only “clarify the requirements for anti-retaliation protection under the whistleblower statute,” but they would also “provide the Commission with additional tools in making whistleblower awards to ensure that meritorious whistleblowers are appropriately rewarded for their efforts, [and] increase efficiencies in the whistleblower claims review process.”8 This article focuses on the proposed amendments with the greatest potential impact on regulated entities.
Reconciling the Anti-Retaliation Rules with the Digital Realty Decision
The proposed rules reflect a change in the definition of whistleblower for purposes of anti-retaliation protection that comports with the Supreme Court’s decision in Digital Realty Trust, Inc. v. Somers, 138 S. Ct. 767 (2018). In particular, the proposed amendments state that to qualify as a whistleblower for purposes of anti-retaliation protection, an individual must provide information to the Commission.9 The SEC also proposes changes to make the definition of whistleblower consistent throughout the rules, regardless of whether the term is used in connection with anti-retaliation protections, incentive awards or confidentiality protections.10
In addition to proposing rules to change the definition of who may be a whistleblower for anti-retaliation protections, the proposed amendments address certain questions raised by Digital Realty, including what activity is protected and when the anti-retaliation protections attach. The activity covered would include reporting internally, even if it is done before reporting to the SEC.11 However, the protection would not attach until a report to the Commission is made.12 As a result, an individual who reports internally before reporting to the SEC is protected from retaliation that occurs after the report to the SEC is made, but not from retaliation that occurs before that report.13
Rewarding Meritorious Whistleblowers
The proposed rules would permit the SEC to be more generous to whistleblowers in some respects. For example, the proposed amendments would allow the SEC to take into account the dollar value of potential awards when they would potentially be below US$2 million so that such awards can be adjusted upwards (to an amount no higher than US$2 million and the statutory cap of 30% of the sanctions collected).14 In addition, the proposed amendments would allow the SEC to count money required to be paid pursuant to deferred prosecution agreements (“DPAs”) and non-prosecution agreements (“NPAs”) entered into with the U.S. Department of Justice and state attorneys general, and settlement agreements entered into with the Commission, when determining whether recoveries meet the US$1 million threshold for making an award.15
The proposed rules would also permit the SEC to limit or deny awards in certain circumstances. For example, the proposed amendments would allow the SEC to take into account the dollar value of potential awards when the monetary sanctions collected would equal or exceed US$100 million so that awards can be adjusted downward (to an amount no lower than US$30 million and the statutory minimum of 10% of the sanctions collected).16 The amendments would prevent whistleblowers from obtaining double recoveries based upon the same information by allowing the SEC to deny applications for awards by individuals who have already received an award from another whistleblower program and to condition the receipt of awards upon the whistleblower’s making an irrevocable waiver of any claim to an award from another award program.17
The proposed amendments would improve the speed with which the SEC handles tips and applications for awards. For example, the amendments would allow the SEC to reject applications for awards summarily on certain grounds, including when an award application is untimely, when an individual fails to comply with certain procedural requirements, and when an individual’s information is not provided to or used by the SEC staff handling a particular matter.18 In addition, the amendments would allow the Commission to bar certain individuals from obtaining awards if they submit false information to the SEC or repeatedly submit frivolous applications for awards.19
Requests for Comments
The Commission requested comment on numerous aspects of the proposed rule amendments, as well as on proposed guidance concerning how the staff might construe various terms in the existing rules. In addition, the SEC requests comment on potential future interpretive guidance, rule-making and legislative action. This article addresses the requests that raise issues of greatest significance to regulated entities.
Relevance of Participation in Internal Compliance Systems in Award Determinations
The existing rules provide that the amount of an incentive award is determined by reference to a set of specific factors, including participation in internal compliance and reporting systems.20 Now that the Supreme Court has held that an individual who only reports information internally is not entitled to the Act’s anti-retaliation protections, the Commission has requested comment on whether the SEC should still consider participation in internal compliance systems in determining the size of whistleblower awards.21
The request for comment ignores the fact that even if all of the proposed amendments were adopted, participation in internal reporting systems would remain relevant under the existing rules. For example, the rules would continue to provide that officers, directors, trustees, compliance personnel, internal audit personnel and others similarly situated will not be deemed eligible for an award if the information upon which they base an award application was obtained through an entity’s internal compliance and reporting system, unless, among other things, at least 120 days have elapsed since they provided the information to the relevant entity’s audit committee, chief legal officer or supervisor.22 The rules would also continue to allow the SEC to determine whether an individual is an original source of information, and therefore qualified for an award, based on when he or she reported information internally, thereby eliminating the prejudice an individual might suffer by reporting first internally and then reporting to the SEC.23
Proposed Guidance on What Constitutes Unreasonable Reporting Delay
The SEC is allowed under the present rules to reduce potential awards based upon unreasonable reporting delay.24 The Commission is considering the issuance of possible guidance on how the staff decides whether an award applicant delayed unreasonably in reporting information to the agency.25 Given that the Supreme Court has held the SEC is time-barred from seeking disgorgement and penalties if it fails to bring an enforcement action within five years of the date of the underlying violation,26 the Commission is under more pressure than ever to move its investigations along quickly. Accordingly, the SEC is proposing that “any delay in reporting to the Commission beyond 180 days is presumptively unreasonable” and requests comment on whether such a rebuttable presumption is appropriate.27
Proposed Guidance on What Information Can Form the Basis of an Award
The Dodd-Frank Act allows an individual to obtain an award if he provides information derived from his “independent knowledge or analysis.”28 The SEC rules currently define independent analysis to include information that may be publicly available, but which reveals information that is not generally known or available to the public.29 The proposed guidance would narrow the scope of information considered to be derived from independent analysis by requiring a whistleblower’s submission to provide evaluation, assessment or insight beyond what would be “reasonably apparent” to the Commission from publicly available information.30 The SEC requests comment on the interpretation of the phrase “independent analysis” and on whether any aspect of the interpretation should be codified in rule text by, for example, clarifying that “the whistleblower’s examination and evaluation should contribute ‘significant independent information’ that ‘bridges the gap’ between the publicly available information and the possible securities violations.”31
Possible New Rule Allowing Discretionary Awards
Currently, an individual may not receive an incentive award unless she satisfies specific criteria, including that the information provided led to the successful enforcement of a covered action that resulted in monetary sanctions exceeding US$1 million.32 The SEC seeks comment on whether it should propose a rule that would afford the SEC discretion to give awards in situations where a claimant would not otherwise qualify for an award, including where a Commission action does not result in monetary sanctions exceeding US$1 million, an application is based solely on publicly available information, or the collection of sanctions would result only in a de minimus payment.33
Overview of Comments
The proposed rules were open for comment through September 18, 2018. Although some commenters requested more time to allow for additional study of the proposals and more input from the whistleblower community, more than 100 individual comments were filed before the deadline, not including form letters, and several more comments were filed after the deadline had passed. This article summarizes below the most common comments on the proposed amendments, highlighting the particular issues most likely to be of concern to regulated entities.
Conformation of Whistleblower Definition to Digital Realty
Although nobody disputes that a change in the definition of “whistleblower” for purposes of the anti-retaliation protections is required as a result of Digital Realty, there is disagreement over what additional changes might be necessary. Most commenters associated with business interests state that the Commission should still consider participation in internal reporting programs when determining award amounts, because a company’s ability to discover and address wrongdoing promptly depends upon employee participation in such programs. However, some commenters associated with whistleblowers argue that such participation should no longer be considered since individuals are not protected from retaliation until after they report information to the SEC. For the same reason, many of these commenters also suggest that the Commission should do away with the existing requirement that compliance officers, managers and directors report internally before reporting to the SEC.
Consideration of Recoveries from DPAs, NPAs and Settlements
There is general agreement that the Commission should be allowed to consider amounts required to be paid pursuant to DPAs, NPAs and settlements in determining whether monetary sanctions exceed US$1 million. The commenters associated with whistleblowers embrace this proposal enthusiastically. The vast majority of commenters associated with business interests do not have any real objection to the proposal, though they note that it will likely increase the number of individuals who qualify for incentive awards.
Consideration of Potential Dollar Amounts of Awards to Increase Small Awards
As one would expect, organizations representing business object to considering the amount of a potential small award in considering whether to increase it, arguing that allowing the SEC to do so could incentivize additional whistleblowers to come forward with more tips on less important and potentially frivolous matters. Whistleblowers commented favorably on the proposal to the extent it would allow the SEC to increase relatively small potential awards based on the amount of the monetary sanctions, asserting that increased award sizes will increase the incentives for individuals to come forward with information about possible violations.
Elimination of Double Recoveries
Organizations representing the interests of business favor the Commission’s proposal to eliminate the risk of double recoveries from the SEC’s incentive program and those of other organizations. As one would expect, most commenters associated with whistleblowers object to this proposal, arguing that the possibility of an individual’s recovering from more than one whistleblower program provides additional incentives for reporting information to the SEC and to other agencies that might be in positions to deter wrongdoing.
Consideration of Potential Dollar Amounts of Awards to Decrease Large Awards
Organizations representing the interests of business tend to view the proposed amendments positively insofar as they would allow the SEC to reduce awards based on their sizes, asserting that it is not necessary to award more than US$30 million to induce individuals to come forward with tips, even on large matters. Whistleblowers and their advocates strongly object to allowing the Commission to consider the amount of a potential award in determining whether to reduce it and further object to capping awards. These commenters assert that large awards are necessary to induce individuals, especially high-level executives, to blow the whistle on large frauds and to compensate whistleblowers for the risks they undertake in coming forward.34
Summary Dispositions and Bars
There is general support for allowing the SEC to dispose summarily of certain applications and to bar individuals who abuse the SEC’s whistleblower program from recovering awards. These tools would arguably allow the Commission to devote more resources to meritorious tips and award applications. Some whistleblowers, however, object to the proposed rules on the grounds that summary dispositions do not provide adequate protection of a whistleblower’s due process rights and that the Commission could use its ability to bar individuals unfairly to exclude individuals who raise important issues the SEC does not want to address. That said, many comments by whistleblowers expressed a strong desire that the Commission take additional steps to speed up the handling of meritorious tips and award applications.
Proposed Guidance on What Information May Serve as the Basis of an Award
While most commenters associated with business interests expressed support for the SEC’s proposed guidance on the meaning and application of “independent analysis,” whistleblowers objected vehemently. The primary opposition is that the proposal to limit the sort of public information on which an award may be based to that which is beyond what would be reasonably apparent to the Commission is overly vague, subjective and ambiguous, and would give the Commission too much discretion to deny applications based on 20-20 hindsight.35
Possible New Rule or Mechanism That Would Allow Awards When the Existing Requirements for Awards Are Not Met
Commenters associated with whistleblowers enthusiastically embrace the possibility that the SEC will propose a rule or mechanism that would allow the Commission to exercise discretion to give awards in situations where claimants would not otherwise qualify for awards, for the obvious reasons. Commenters associated with business interests strongly oppose such a rule, largely based upon the lack of statutory support for such a rule or mechanism, but also based on the concern that affording the SEC more discretion to grant awards would encourage additional frivolous applications for rewards.
The Use of Confidentiality, Settlement and Other Agreements that Impede Reporting to the SEC
Some commenters associated with business interests noted with disappointment that the proposed amendments do not attempt to clarify the Commission’s position on confidentiality, severance and other agreements insofar as they concern reporting on potential violations to the SEC. Under the existing rules, it is impermissible to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including through the use of confidentiality agreements.36 The Office of Compliance Inspections and Examinations issued a Risk Alert on October 24, 2016, notifying regulated entities that it was focusing examinations on actions that impede communications with the SEC.37 The SEC brought several enforcement actions against regulated entities on the grounds that they impeded individuals from communicating with the staff by, among other things, prohibiting employees and terminated individuals from disclosing confidential information and requiring individuals to waive their rights to an incentive award. Since the orders regarding the settlement of those actions fail to provide sufficient information to guide future actions relative to confidentiality, severance and other agreements, business interests request that the Commission provide guidance on how they can legitimately protect their confidential information without running afoul of Rule 21F-17.
Eligibility of Wrongdoers for Awards
Some comments submitted by or on behalf of business interests express dissatisfaction with the fact that the proposed amendments do not go far enough to address the eligibility of wrongdoers for awards. Under the existing rules, the culpability of an individual may be considered in determining the amount of an award.38 Under the proposed amendments, the Commission would not increase an award below US$2 million for a wrongdoer, but the existing rules would remain unchanged.39 Commenters who filed on behalf of regulated entities suggest that the Commission amend the existing rules to prohibit wrongdoers from recovering altogether.
- The definition of who qualifies as a whistleblower will most definitely be revised to require individuals to report to the Commission before they are entitled to retaliation protections; however, the revision does not represent a change for practical purposes, since the Supreme Court effectively changed the definition in February 2018. In any event, individuals concerned about retaliation are more likely to report information to the Commission before or contemporaneously with reporting internally. To ensure that individuals are appropriately incentivized to report internally, it is likely that further legislation will be required to ensure that individuals who report information internally before going to the SEC will be protected from retaliation that occurs prior to the SEC report.
- The rules will likely be amended to allow the SEC to count money required to be paid pursuant to DPAs, NPAs and settlement agreements when determining whether sanctions exceed US$1 million. As a result, it is likely that more individuals will be able to meet the threshold for award eligibility, and that there could be an increase in the number of tips and enforcement activity.
- With regard to potential awards below US$2 million, the rules will likely be amended to allow the SEC to consider the award amounts in determining whether to increase them. As a result, potential whistleblowers with information on relatively small matters will have more incentive to report that information to the SEC, which could result in more tips and enforcement activity on relatively small matters.
- Given the time pressure the Commission currently faces with regard to commencing enforcement actions, the SEC will likely issue guidance stating that unreasonable reporting delay for purposes of determining the amount of an award will be presumed at 180 days from knowledge of the possible violation. As a result, individuals will have a greater incentive to report information to the Commission sooner than they do currently.
- The rules will likely be amended to allow the SEC to reject unmeritorious applications summarily and bar certain individuals from receiving awards. As a result, the Commission should be able to act on tips, commence enforcement actions and grant awards on meritorious matters more quickly than it does currently.
- With regard to large matters with monetary sanctions equal to or exceeding US$100 million, the rules will likely be amended to allow the SEC to consider the amounts of larger awards in determining whether to decrease or cap them. As a result, potential whistleblowers with information on relatively large matters will have less of a financial incentive to report such information to the SEC, which could result in fewer tips from high-level executives and decreased enforcement activity on larger matters.
- The SEC will likely issue guidance narrowing the scope of information that can form the basis for an award to exclude more public information than is currently permissible. As a result, it may become more difficult for individuals to satisfy the requirements for obtaining incentive awards.
- It is likely the Commission will amend the rules to eliminate the possibility that a whistleblower might recover under two different whistleblower programs based on the same information. This may reduce the incentive for an individual to report information to the SEC, but any reduction would likely be offset by incentives to report wrongdoing to other whistleblower programs.
- With regard to the Commission’s possible adoption of a rule or mechanism to grant awards when the requirements for doing so are not met, it not likely the SEC will move forward any time soon given the constraints imposed by the existing legislative framework for the whistleblower program. It is likely that legislation will need to be adopted to allow the Commission to grant awards in situations where the existing requirements have not been met.
- Unless the Commission issues additional proposed rules or guidance, it is likely that there will be no clarification of how registered entities are to go about protecting their confidential information when preparing employment and severance agreements without risking an enforcement action for impeding communications with the SEC.
- It is also likely that wrongdoers will continue to be eligible for awards, unless the Commission amends the existing rules in a manner not contemplated by the Proposed Rules.