I have blogged twice already about Section 922 of Dodd-Frank, which added a new Section 21F to the Exchange Act, "Securities Whistleblower Incentives and Protection": Dodd-Frank Provides Powerful Incentives to Securities Law Whistleblowers and Larger Bounties Spur Surge in Fraud Tips. Section 922 requires a payment of between 10% - 30% of the amount of monetary sanctions to one or more whistleblowers who "voluntarily" provided "original information" to the SEC that significantly contributed to a "successful enforcement" resulting in the payment of “monetary sanctions” exceeding $1 million. (The SEC settlement with AIG was $800 million, which would have worked out to a nice $80 million bounty for someone.)
Last week, the SEC issued proposed rules on Section 922. A few of the key provisions in the proposed rules are as follows:
1. The proposed rules attempt to address the primary concern of corporations all over America: That the new whistleblower bounties are potentially a problem for every corporation in that they provide a powerful financial incentive for individuals to report an error or omission directly to the SEC, rather than the normal corporate channels.* The proposed rules allow an employee to report information internally as a whistleblower and still get credit for original reporting to the SEC as of the same date – as long as the employee provides that same information to the SEC within 90 days of that date, “ . . . employees will be able to report their information internally first while preserving their ‘place in line’ for a possible award from the SEC.” The proposed rules also provide that SEC may consider higher percentage awards for whistleblowers who report internally first, as long as the company has an effective compliance program.
2. The proposed rules make clear that officers, directors, employees, shareholders, business competitors, agents, consultants, distributors, vendors, contractors, service providers, or customers all generally can qualify as whistleblowers. However, certain individuals from receiving bounties as whistleblowers, such as:
- Persons who provide information obtained through communications protected by the attorney-client privilege, or information obtained in connection with the legal representation of a client;
- Persons who obtained the provided information in a manner that violates federal or state criminal law;
- Persons who provide information obtained in connection with the required independent public accountant’s engagement;
- Persons with legal, compliance, audit, supervisory, or governance responsibilities to whom information about potential misconduct was communicated with the expectation that they would take appropriate steps to respond (unless the company does not disclose the information to the SEC in a timely manner or proceeds in bad faith);
- Persons who provide information obtained from or through a company’s legal, compliance, audit, supervisory, or governance functions; and
- Persons who provide information that was obtained from those who would otherwise be excluded under any of the foregoing limitations.
3. The proposed rules prohibit the SEC from counting any monetary sanctions imposed against the whistleblower or against an entity for liability based substantially on conduct directed, planned or initiated by the whistleblower. However, a wrongdoer still has an incentive to blow the whistle on others who engage in the misconduct alongside him, if the conduct attributable exclusively to others could produce a large monetary sanction.
The proposed rules also clarify that whistleblowers who participated in the alleged wrongful conduct are not immune from prosecution or enforcement actions. (The SEC retains discretion to determine whether, by how much, and in what manner to credit the whistleblower’s cooperation.)
4. The proposed rules define a submission of information as "voluntary" if the whistleblower provides the SEC with information before receiving any formal or informal request, inquiry, or demand from the SEC, Congress, any other federal, state or local authority, any self-regulatory organization, or the PCAOB about a matter to which the information in the whistleblower’s submission is relevant.
5. The proposed rules define “original information” as information that is:
- Derived from the whistleblower’s independent knowledge or analysis,
- Not already known to the SEC from any other source, unless the whistleblower is the original source of the information,
- Not exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report, hearing, audit, or investigation, or from the news media, unless the whistleblower is a source of the information, and
- Provided to the SEC for the first time after July 21, 2010.
*If these incentives lead to more financial restatements, then there would be more compensation clawbacks (which is why I'm talking about the issue).