At an open meeting on Wednesday morning, the SEC adopted final rules to implement Section 922 of the Dodd-Frank Act regarding securities whistleblower incentives and protection. One of the significant highlights of the final rules is that the Commission has sought to struck a compromise between the importance of the corporation's compliance programs on the one hand, and the incentive for the whistleblower to report directly to the SEC (and by-pass the corporation) on the other hand. The SEC's Press Release announcing the adoption of the rules (and providing a brief summary) is here, while a copy of the SEC's Release and the rules themselves are available here.
At the beginning of Wednesday's open meeting regarding the adoption of the rules, SEC Chairman Mary Schapiro acknowledged that it was "critical to be able to leverage the resources of people who may have first-hand information about potential violations," and that "it is especially important to investors whose savings or retirement funds may hinge on our ability to stop an ongoing fraud or obtain hidden evidence." She also cited an improvement in the "quality of the tips," the Commission had received since the passage of the Dodd-Frank Act, and expected that trend to continue.
In November 2010, the Commission issued a draft set of rules and regulations for comment. Both before and after the draft rules were issued, the Commission received over 240 comments by letter and 1,300 form letters regarding the proposed rules from various companies and organizations, which resulted in a number of revisions and refinements to the proposed rules.
Leading up to Wednesday's announcement, one of the central concerns regarding the proposed rules was the role of internal compliance programs. One school of thought was that if employee whistleblowers simply presented information to the Commission, without reporting to the corporation, it would have a devastating impact on compliance programs by depriving companies of one of the key sources of information necessary to identify and resolve potential issues.
A second school of thought was that whistleblowers need to be able to approach the Commission directly (as opposed to reporting to the company) on order to protect their interests. Indeed, this very issue was recently addressed by Judge Leonard Sand in New York in Egan v. TradingScreen Inc., 1:10-cv-08202 (S.D.N.Y.). In that case, plaintiff Patrick Egan alleged that Philippe Buhannic, the CEO of TradingScreen, Inc. was diverting TradingScreen’s corporate assets to another company which he solely owned,. After Mr. Egan reported Mr. Buhannic's behavior to the President of TradingScreen and attorneys for the Independent Directors of TradingScreen’s Board, Mr. Buhannic fired him, resulting in Mr. Egan's suit, asserting, inter alia, claims under the whistleblower provisions of the Dodd-Frank Act. On May 4, 2011, Judge Sand ruled that:
[T]he anti-retaliation whistleblower protection provisions of the Dodd-Frank Act require Plaintiff to show that he either provided information to the SEC [or that one of four exceptions existed, which were not alleged here].
Judge Sand granted plaintiff leave to amend his Dodd-Frank Act claim to plead facts supporting his knowledge (as opposed his claimed information and belief), that Mr. Buhannic’s conduct was reported to the SEC. In short, under the language of the Dodd-Frank Act (prior to the SEC's rules), a whistleblower who reports to the company does not necessarily secure his or her rights and protection under the whistleblower provisions.
According to Chairman Schapiro, the Commission's final rules announced today "strikes the correct balance – a balance between encouraging whistleblowers to pursue the route of internal compliance when appropriate – while providing them the option of heading directly to the SEC." She highlighted three elements of the final rules which address this issue:
- the rules expand length of time by which a whistleblower must report to the SEC (after reporting to the corporation internally) from 90 to 120 days;
- the rules provide that when determining the amount of the award, the Commission will consider how much a whistleblower has participated in or interfered with the internal compliance process; and
- the rules will give credit to a whistleblower who reports to the corporation internally when the company passes the information along to the Commission, even if the whistleblower does not (which may overcome the issue highlighted by the Egan case).
Commissioner Luis Aguilar further stressed this solution in his comments, pointing out that "our rule does not mandate one reporting avenue." and adding that "many companies will continue to maintain robust compliance programs, and by doing so, this should provide employees with more confidence to report matters internally."
A key issue for the Commissioners considering the rule was whether the whistleblower should be required to report to the company prior to approaching the SEC. Commissioner Elisse Walter agreed with the solution that a whistleblower was not required to do so, but had a choice: "If we want our whistleblower program to work, we must encourage potential sources of information to come forward. And, I believe that we cannot do so without assuring those who fear for their jobs, their livelihood and their families’ welfare that they have an avenue to come directly to the government." Commissioner Troy Paredes disagreed and did not think "that the final rule adequately preserves the important role that corporate compliance programs serve in ensuring that the law is complied with and that other misbehavior is deterred." He disagreed with allowing "a whistleblower to knowingly bypass a company’s good-faith attempts to identify and investigate alleged violations," and expressed that the rules should have mandated that a whistleblower must report alleged violations to the company first.
Chairman Schapiro highlighted several other changes to the rules, including:
- addressing the categories of persons who may claim a reward by narrowing the exclusions and creating exceptions which apply to lawyers, auditors and internal compliance personnel;
- creating a simpler, more streamlined procedure for submitting information in a single form; and
- clarifying that the statute’s whistleblower protections apply to anyone who provides the SEC information, even if that information relates to a possible securities law violation, and regardless of whether it leads to a successful enforcement action.
The rules will become effective 60 days after they are published in the Federal Register. The Commission has established an Office of the Whistleblower, headed by Sean McKessy, to work with whistleblowers, handle their tips and complaint, and helps the Commission determine the awards for each whistleblower.