On May 25, 2011, the SEC commissioners announced final rule changes to the Securities Exchange Act of 1934 (Exchange Act), which implement the whistleblower program Congress prescribed in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Since the SEC announced proposed rules in November 2010, the business and legal communities have lobbied the Commission for further support of internal compliance programs. As a result, the SEC made slight modifications to the proposed rules to incentivize internal reporting.
The addition of a whistleblower bounty program has far-ranging repercussions for company compliance programs. However, every institution can be prepared for the future by following some basic recommendations, which may decrease exposure and minimize risk of lawsuits.
Section 922 of Dodd-Frank added new Section 21F to the Exchange Act entitled, “Securities Whistleblower Incentives and Protection.” Section 21F directs the SEC to pay awards to whistleblowers who voluntarily provide the SEC with original information about a violation of the securities laws which leads to the successful enforcement of an action brought by the SEC or a related action and which results in monetary sanctions exceeding $1 million.
On November 3, 2010, the SEC proposed rules to define and implement the statutory language of the whistleblower provisions of Dodd-Frank. The rules encouraged whistleblowers to first report their concerns internally through established compliance channels; however, they provided very little time or opportunity for companies to respond and remediate any issues before a whistleblower filed suit. On May 25, 2011, the SEC issued final regulations implementing Section 21F of the Exchange Act.
Key Provisions of Rule 21F
The SEC's formal announcement trumpeted Rule 21F as a program “primarily intended to reward individuals who act early to expose violations and who provide significant evidence that helps the SEC bring successful cases.” There are, however, certain restrictions on recovery.
Who Qualifies as a “Whistleblower”?
Rule 21F-2(a) defines a whistleblower as an individual who, “alone or jointly with others, provides information to the Commission relating to a potential violation of the securities laws.” A whistleblower must be an individual; a company or other entity is not eligible to receive a whistleblower award. The definition of “whistleblower” tracks the statutory definition of a “whistleblower,” except the rule allows persons to report either actual or potential violations of the law.
Rule 21F-8 sets forth categories of individuals who are ineligible to receive a whistleblower award, including: employees of regulatory or self-regulatory agencies, the Public Company Accounting Oversight Board, and law enforcement agencies; attorneys (including in-house counsel) who use information obtained from clients to make claims for themselves; individuals convicted of a criminal violation related to the Commission action; company employees who use original information provided by another employee (for example, through a hotline); persons who obtained the information through an audit of a company's financial statements; and, individuals who knowingly made false statements or representations in connection with their dealings with law enforcement or the SEC. In short, the whistleblower should not be an individual trying to turn corporate compliance into financial gain, purely for gain's sake.
However, otherwise exempt persons, such as compliance and audit personnel, may become whistleblowers where disclosure may prevent substantial injury to the entity or to investors; the entity is engaging in conduct that will impede an investigation; or at least 120 days have elapsed since the company became aware of a whistleblower complaint, and the company failed to address the reported violation.
Amount of Whistleblower's Award
Rule 21F-5 states that, if all conditions are met, the SEC will pay an award of at least 10 percent and not more than 30 percent of the total monetary sanctions collected in successful SEC and related actions. The rules permit the Commission to aggregate multiple SEC cases arising out of a common set of facts as a single action. In response to comments made on the proposed rules, the final rules also provide that when determining the amount of an award, a whistleblower's voluntary participation in a company's internal compliance and reporting systems is a factor that can increase the amount of an award. Conversely, a whistleblower's interference with internal compliance and reporting is a factor the SEC can use to decrease the amount of an award.
Rule 21F-6 provides that in considering the amount of an award, the SEC will consider: (a) the significance of the information provided to the success of the SEC action or related action; (b) the degree of assistance provided by the whistleblower and his or her legal representatives in the SEC action or related action; (c) the SEC's “programmatic interest” in deterring violations of the securities laws by making whistleblower awards; and, (d) whether an award otherwise enhances the SEC's ability to enforce the federal securities laws, protect investors, and encourage the submission of high-quality information by future whistleblowers. Awards will vary based on the Commission's assessment of these factors.
Rule 21F-14 provides notice that the provisions of Section 21F of the Exchange Act do not provide amnesty to individuals who provide information to the Commission relating to a violation of the securities laws. The fact that a whistleblower may assist in SEC investigations or enforcement actions does not preclude the SEC from bringing an action against the whistleblower based upon his or her own conduct in connection with violations of the federal securities laws. Rather, the Commission will analyze the unique facts and circumstances of each case in accordance with its Policy Statement Concerning Cooperation by Individuals in its Investigations and Related Enforcement Actions, to determine whether, how much, and in what manner to credit cooperation by whistleblowers who have participated in misconduct.
Despite corporations' requests, the final rules do not require whistleblowers to first report violations internally to qualify for a bounty. But to incentivize potential whistleblowers to work with their employer's compliance department, the rules: (1) do not preclude recovery for whistleblowers who report violations to the company, which then self-reports to the SEC; (2) allow recovery for whistleblowers who report to the SEC and their employer at the same time; and, (3) provide that a whistleblower's voluntary participation in an entity's internal reporting system may increase a whistleblower's award. In response to comments made by corporate compliance personnel and the legal community, the final rule extends the time period during which a whistleblower who reports to the Commission after first reporting internally will still receive “credit” as if he or she had reported to the Commission on the date of the internal reporting from 90 to 120 days.
Despite the SEC's failure to require whistleblowers to report perceived violations internally, companies can still take certain actions that may minimize exposure and encourage internal dialogue under the new program:
- Affirmatively request employees and outside consultants to report violations internally through corporate compliance programs first and articulate a clear anti-retaliation policy. By trumpeting their own compliance efforts and actions, or even offering “rewards” for compliance, companies can successfully market their own remediation efforts, thereby reducing the likelihood that would-be whistleblowers will call the SEC before their own compliance officers.
- Impose and abide by internal time limits for internal investigations, in an effort to self-report (where necessary) to the SEC within its 120-day reporting window. Where there are victim investors, reduce the time to investigate, which sends a message to the Commission and the whistleblower that you took the allegations seriously. Make prompt decisions about whether to self-report, and document all efforts made to fully comply with “reasonable” response time.
- As the number of internal investigations is on the rise, the government has become skeptical of their purpose. If you learn your company has no exposure or a rogue whistleblower is off track, request a proactive meeting with the government to inform the Commission that there are two sides to the allegations. The SEC's rules, the Department of Justice's corporate charging policy, and the United States Sentencing Guidelines all provide credit for timely disclosure and cooperation.
- If you learn of a complaint, ask the SEC for an opportunity to formally respond before making a decision whether to accept the whistleblower's referral.
By following these simple recommendations, companies may increase employees' willingness to avail themselves of internal reporting mechanisms — or allow a company to timely address allegations — thus accomplishing the compliance goals intended by Congress, which prompted Rule 21F in the first place.