On November 3, 2010, the Securities and Exchange Commission announced proposed rules that have the potential to significantly impact the role of internal corporate compliance programs. The proposed rules implement the whistleblower provisions in Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 922 of the Act authorizes the SEC to pay rewards to individuals who provide the Commission with original information that leads to successful SEC enforcement actions and certain related government actions. The Act requires the SEC to pay eligible whistleblowers “bounties” of 10 to 30 percent of monetary sanctions obtained by the government, as long as total sanctions exceed $1 million.
This “bounty” provision creates a strong incentive for whistleblowers to bypass a corporation’s internal reporting system and bring claims directly to the SEC. Accordingly, the “bounty” provision has the potential to undermine the internal controls corporations have established in response to the Sarbanes-Oxley Act of 2002. These internal corporate whistleblower programs now serve as a “front line” defense to ferret out potential corporate wrongdoing.
Before the SEC announced its proposed rules, numerous commenters, including Arent Fox LLP, encouraged the SEC to implement Section 922 in a manner consistent with Sarbanes-Oxley. Encouragingly, the SEC appears to have taken these comments into account as it included provisions to discourage employees from bypassing their own company’s internal compliance programs in its proposed rules.
Internal Compliance Programs
The SEC rule proposal would treat an employee as a whistleblower under the SEC program as of the date that employee reports the information internally as long as the employee provides the same information to the SEC within 90 days. This ensures that employees can report their information internally first without losing their “place in line” for a possible award from the SEC. The proposal also permits the SEC to consider higher percentage awards for whistleblowers who first report their information through effective company compliance programs. However, the proposed rule still seems to contemplate all whistleblower complaints eventually going to the SEC, which may be impractical and frustrate the prior congressional intent.
Excluding Individuals with Legal Obligations From Whistleblower Awards
The SEC also appeared to take into account Arent Fox’s and other commenters’ suggestions that the SEC ensure that individuals with certain legal obligations, such as lawyers, auditors, and internal compliance personnel, cannot use their positions to “front run” internal programs and reap benefits under Section 922. The proposal does this by excluding the following individuals from consideration for whistleblower awards:
- People who have a pre-existing legal or contractual duty to report their information.
- Attorneys who attempt to use information obtained from client engagements to make whistleblower claims for themselves (unless disclosure of the information is permitted under SEC rules or state bar rules).
- Independent public accountants who obtain information through an engagement required under the securities laws.
- Foreign government officials.
- People who learn about violations through a company’s internal compliance program or who are in positions of responsibility for an entity, and the information is reported to them in the expectation that they will take appropriate steps to respond to the violation.
Unfortunately, senior management and internal legal and audit personnel do not appear to be specifically excluded in the proposal.
Excluding Wrongdoers From Whistleblower Awards
Finally, the proposal clarifies that the SEC will not pay awards to individuals who are directly responsible for the securities law violations they report. Specifically, as proposed, the SEC will not pay culpable whistleblowers awards that are based upon either the monetary sanctions that such people themselves pay in the resulting SEC action, or on sanctions paid by entities whose liability is based substantially on conduct that the whistleblower directed, planned, or initiated.
This may not go far enough, in that it does not prevent co-conspirators whose conduct is actionable, but who are determined to be less than “substantially” responsible for the entity’s wrongdoing from getting a bounty.
Under Dodd-Frank, the SEC is required to adopt final regulations implementing Section 922 by no later than April 21, 2011. However, the SEC has announced that it will adopt final rules before that date, and is seeking public comments and data on its rule proposal until December 17, 2010. These whistleblower proposals have serious potential impacts. All public companies should avail themselves of this short comment period to make their views known.