On Oct. 1, 2013, the Securities and Exchange Commission (SEC) announced that it had awarded more than $14 million to an unidentified whistleblower who provided information leading to a successful enforcement action — by far the largest payout to date under the SEC’s two-year-old whistleblower program. Later that same month, on Oct. 30, the SEC announced another whistleblower award of more than $150,000.
To put these recent awards in context, before Oct. 1, 2003, the SEC had made awards to four whistleblowers; combined, they totaled only around $75,000. The SEC announced the first award under the program on Aug. 21, 2012: approximately $50,000 paid to a single whistleblower. A year later, in August 2013, the SEC announced that three whistleblowers who helped the SEC bring a case against Locust Offshore Management and its CEO Andrey Hicks would share an award of $25,515.
Judging by the number of recent media reports, the two whistleblower awards announced in October 2013, one of them an eye-catching $14 million, already have increased the visibility of the SEC’s whistleblower program. In the fiscal year ending Sept. 30, 2013, the SEC received 3,238 whistleblower tips and complaints. After the announcements made in October 2013, it is reasonable to assume that this number will increase, perhaps dramatically, in fiscal year 2014.
Background on the Whistleblower Program
The Dodd-Frank Act created an incentive and protection regime for whistleblowers who report violations of the securities laws to the SEC. Under the program, whistleblowers who voluntarily provide the SEC with information that is: 1) original; 2) specific; 3) credible; 4) timely; and that 5) leads to a successful enforcement action in which the SEC obtains more than $1 million in sanctions, are entitled to a bounty equal to 10%-30% of the amount collected by the government. Although the SEC has discretion to determine the amount of the award, within the 10%-to-30% range, it must pay an award to any whistleblower who meets the statutory and regulatory criteria.
In addition to the award provisions, the whistleblower program provides strong anti-retaliation protections to whistleblowers. A whistleblower can bring a private cause of action in court to seek relief for retaliation, and the SEC can also bring an action or proceeding to enforce the provisions. If successful, the individual is entitled to reinstatement, doubled back pay with interest, attorney fees and litigation costs.
An Incentive to Bypass Internal Corporate Compliance Programs?
Some critics have argued that the bounty offered by the whistleblower program may lead employees who know of misconduct to bypass their companies’ internal compliance programs and report potential violations to the SEC without first notifying the employer. In its regulations, the SEC made some attempt to address this concern. First, the SEC will give a whistleblower credit for information provided by a company after an internal investigation that was undertaken due to the whistleblower's reporting internally through the company’s compliance process, so long as the whistleblower reported the same allegations to the SEC before or at the same time that he reported internally.
Thus, even if the information provided by the whistleblower did not meet the criteria for an award, the whistleblower nonetheless would receive credit for higher-quality information provided by the company after an internal investigation based on the whistleblower’s report. Second, when determining the amount of a whistleblower’s award, the SEC will consider whether the whistleblower reported the violation through internal compliance systems and assisted in any internal investigation. The SEC may increase the award based on such participation, or decrease the award if the whistleblower “undermined the integrity” of an internal compliance system by making false statements or interfering with compliance processes. However, receipt of an award is not conditioned on internal reporting or cooperation with an internal investigation, and the SEC is required to pay an award within the statutory range to a whistleblower who meets the statutory and regulatory criteria, even if the whistleblower interfered with his or her company’s compliance program.
The whistleblower protection provisions of the program may also have the effect of encouraging external reporting. Sarbanes-Oxley’s anti-retaliation provisions protect some employees who report internally, but they are not as robust as the Dodd-Frank anti-retaliation provisions that are part of the SEC’s whistleblower program. First, while Sarbanes-Oxley protects internal whistleblowers who report mail fraud, wire fraud, bank fraud, securities fraud, fraud against shareholders, or violations of any SEC rule or regulation, the Dodd-Frank provisions protect whistleblowers who report those same violations or any other violation of the securities laws to the SEC. Thus, while the Department of Labor has found that a report of FCPA violations (without additional allegations of fraud or violations of SEC rules or regulations) is not protected by the Sarbanes-Oxley anti-retaliation provisions, the Dodd-Frank provisions would clearly prohibit retaliation based on disclosure of an issuer’s FCPA violations through the SEC whistleblower program.
Second, Dodd-Frank grants whistleblowers who have been subject to retaliation greater relief than Sarbanes-Oxley does. Under Sarbanes-Oxley, employees subject to retaliation are entitled to reinstatement at the same seniority they would have had but for the retaliation, compensation for special damages such as litigation costs and attorneys’ fees, and back pay with interest. Under Dodd-Frank, whistleblowers who have suffered retaliation are entitled to double back pay plus interest, in addition to reinstatement, litigation costs, and attorneys’ fees.
Finally, Dodd-Frank makes it easier for whistleblowers to bring retaliation claims in court. Under Sarbanes-Oxley, an employee must file a complaint with the Department of Labor and wait 180 days for an administrative decision before bringing an action in court. However, Dodd-Frank permits whistleblowers alleging retaliation to bring an action in federal district court in the first instance. And while the Sarbanes-Oxley statute of limitations is 180 days after the date of the violation or the date when the employee became aware of the violation, Dodd-Frank provides a much more generous limitations period of six years after the violation or three years after the date when the employee became aware of facts material to the right of action (up to a maximum of 10 years from date of the violation). In short, the Dodd-Frank whistleblower protection regime is more robust than that of Sarbanes-Oxley.
It is unclear whether an employee who only reports violations internally can ever avail him- or herself of the Dodd-Frank regime. The SEC (Dodd-Frank) anti-retaliation provisions only apply to whistleblowers. The statute defines “whistleblower” as an individual who provides “information relating to a violation of the securities laws to the [SEC].” On the face of the statute, then, an employee who reports violations internally through his company’s compliance program but does not report those violations to the SEC is not a “whistleblower” under the SEC whistleblower program. However, the anti-retaliation provisions (which appear in the same statutory section as the “whistleblower” definition) sow confusion by providing, in part, that:
No employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower … in making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002 …
Of course, Sarbanes-Oxley protects some purely internal disclosures. Faced with this seemingly contradictory language, courts have come to different conclusions on whether the SEC whistleblower protections apply to an employee who makes disclosures protected by Sarbanes-Oxley (such as internal disclosures) but who does not meet the Dodd-Frank definition of “whistleblower” because he did not disclose to the SEC. Some district courts have tried to reconcile the contradiction by reading a narrow exception into the definition of “whistleblower” for purposes of the anti-retaliation provisions. Under these decisions, an employee who did not report to the SEC but whose disclosure is protected by the Sarbanes-Oxley anti-retaliation provisions would also be protected by the Dodd-Frank anti-retaliation regime. The SEC itself has construed the statute in this manner by providing in its whistleblower program regulations that “[t]he anti-retaliation protections apply whether or not you satisfy the requirements and conditions to qualify for an award.” See 17 C.F.R. § 240.21F-2(b)(1)(iii).
However, in Asadi v. G.E. Energy, 720 F.3d 620 (5th Cir. 2013), the Fifth Circuit held otherwise, finding that the Dodd-Frank anti-retaliation provisions are not ambiguous and, on their face, clearly apply only to “whistleblowers” as defined by the statute, i.e., whistleblowers who report violations to the SEC in accordance with the SEC’s whistleblower program. The Fifth Circuit reasoned that while the Dodd-Frank anti-retaliation provisions apply only to those people who report to the SEC, they protect whistleblowers from retaliation based on the act of making disclosures required or protected by Sarbanes-Oxley. The court gave the example of an employee who reports violations both internally and to the SEC, but who is fired based on the internal report and whose employer did not even know about the report to the SEC. Such an employee would be protected by the Dodd-Frank anti-retaliation provisions even though the cause of the retaliation was the employee’s internal report, which was protected by Sarbanes-Oxley, and not his report to the SEC.
Given the doubts about whether an internal whistleblower, even one protected by Sarbanes-Oxley, can avail himself of the Dodd-Frank anti-retaliation provisions, an employee who knows of or suspects securities laws violations may choose on the advice of counsel to disclose to the SEC, rather than internally, in order to gain the SEC’s whistleblower protections.
What Can Companies Do?
The bounty payment and strong anti-retaliation protections of the SEC’s whistleblower program make it more important than ever for issuers to re-evaluate and strengthen their internal compliance and reporting systems. As described above, there are strong incentives for employees to report potential violations to the SEC, perhaps without first notifying the company. This puts companies in the undesirable position of potentially being investigated for violations without knowing the allegations and without being able to swiftly remediate damage and offer full cooperation to the SEC and other investigating authorities.
To combat this risk, companies should have strong incentives for employees to report any suspected wrongdoing internally, and reliable systems to ensure that such reports are dealt with quickly and appropriately. Well-publicized policies requiring that misconduct be reported, clear and easy procedures for anonymous reporting, top-down promulgation of a culture of openness and compliance, and strong anti-retaliation policies are important ingredients of a first-rate compliance program and will encourage employees to report internally. Companies also need clear and strictly-enforced procedures for dealing with internal complaints. An employee’s report of misconduct to a mid-level supervisor does the company no good if the supervisor does not know what to do with the information and therefore does nothing; or if the complaint is simply filed in a drawer and ignored.
Most employees want to report misconduct to their employers. At a panel presentation in Washington, DC, on Oct. 3, 2013, Sean McKessy, Chief of the SEC’s Office of the Whistleblower, indicated that of the five whistleblowers who had received announced awards as of that date, all those who blew the whistle on their own employer had reported internally as well.
Finally, in light of the strong anti-retaliation protections afforded by the SEC whistleblower program, employers must have well-publicized internal anti-retaliation policies and robust procedures for documenting and communicating performance concerns. Blowing the whistle does not immunize an employee from justified discipline or termination, but a court or agency will cast a skeptical eye on disciplinary action that follows on the heels of the employee’s report of misconduct and is not well-supported by a paper trail demonstrating past performance concerns.
Republished with permission.This article first appeared in Business Crimes Bulletin, March 2014 Issue, Volume 21, Number 7.