SEC Approves Whistleblower Rules
By: RUILIN LI
September 2011
The Securities and Exchange Commission (SEC) has approved its final rules to implement the whistleblower award program under § 21F of the Securities Exchange Act of 1934 (Exchange Act), which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
Overview
Section 21F of the Exchange Act, entitled “Securities Whistleblower Incentives and Protection,” requires the SEC to pay awards, subject to certain limitations and conditions, to whistleblowers who provide the SEC with original information about violations of the federal securities laws. In a nutshell, the rules provide that (1) a whistleblower (2) who voluntarily provides the SEC (3) with original information (4) that leads to the successful enforcement by the SEC of a federal court or administrative action (5) in which the SEC obtains monetary sanctions totaling more than $1 million (6) is eligible for an award of 10 to 30 percent of any amount recovered.
Whistleblower
A whistleblower is an individual, either alone or jointly with others, who provides the SEC with information that relates to a possible violation of the federal securities laws that has occurred, is ongoing, or is about to occur. A whistleblower must be an individual; a company or another entity is not eligible to be a whistleblower.
Voluntary Submission of Information
The submission of information is voluntary if it is made before a request, inquiry, or demand is directed to the whistleblower by the SEC, the Public Company Accounting Oversight Board, any self-regulatory organization, Congress, any other authority of the federal government, or a state Attorney General or securities regulatory authority. The submission will not be voluntary if the whistleblower is required to report the original information to the SEC as a result of a pre-existing legal duty or a contractual duty that is owed to the SEC.
Original Information
All information provided must be original. Original information must be: (1) derived from the whistleblower’s independent knowledge or independent analysis; (2) not already known to the SEC from any other source; (3) 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; and (4) provided to the SEC for the first time after July 21, 2010, the enactment date of the Dodd-Frank Act.
Exclusions
The rules preclude certain categories of individuals from award eligibility subject to certain exceptions. The excluded individuals include:
- An officer, director, trustee, or partner of an entity who received the information from another person or learned the information in connection with the entity’s processes for identifying, reporting, and addressing possible violations of law;
- An employee whose principal duties involve compliance or internal audit responsibilities, or an individual employed by or otherwise associated with a firm retained to perform compliance or internal audit functions for an entity;
- Attorneys who obtained the information from client engagements or attorney-client privileged information; this exclusion applies to in-house attorneys and the exclusion for privileged information extends to non-lawyers who learn the information through confidential attorney-client communications with company counsel;
- An employee of, or other person associated with, a firm retained to conduct an inquiry or investigation into possible violations of law; or
- An employee of, or other person associated with, a public accounting firm, who obtained the information through the performance of an engagement required of an independent public accountant under the federal securities laws, and that information related to a violation by the engagement client or the client’s directors, officers, or other employees.
Exceptions to the Exclusion
The above exclusions do not apply if the whistleblower:
- Has a reasonable basis to believe that disclosure of the information to the SEC is necessary to prevent the entity from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or investors;
- Has a reasonable basis to believe that the relevant entity is engaging in conduct that will impede an investigation of the misconduct; or
- At least 120 days have elapsed since the whistleblower provided the information to the relevant entity’s internal reporting system.
No Internal Reporting Required
Under the proposed rules, whistleblowers will not be required to first utilize the relevant internal compliance system prior to submitting a report to the SEC. Despite assertions from the corporate community that this would greatly undermine internal compliance programs, the final rules do not condition whistleblower eligibility on the initial internal reporting system prior to submitting to the SEC. However, the final rules do appear to incentivize using internal reporting:
- A whistleblower will obtain the same award when he or she reports internally and the company reports to the SEC;
- Voluntary participation in an internal compliance program can lead to an increased award, while interference with the company’s internal compliance program can result in a decreased award; and
- An individual could still qualify for a whistleblower award if he or she first reported the possible violation to the company’s internal reporting system and then within 120 days submitted the same information to the SEC.
No Retaliation
Anti-retaliation provisions apply whether or not an aspiring whistleblower satisfies the requirements, procedures, and conditions to qualify for an award. He or she need only have a “reasonable belief” that the information provided related to a possible violation of the federal securities laws or any other laws within the scope of the anti-retaliation provisions of the Sarbanes-Oxley Act of 2002. To satisfy the “reasonable belief” standard, an individual must have a subjectively genuine belief that the information demonstrates a possible violation, and this belief is one that a similarly situated employee might reasonably possess.
Employers are prohibited from taking a wide range of adverse actions, including discharging, demoting, suspending, threatening, harassing directly or indirectly, or discriminating in any other manner, because of any lawful act done by the whistleblower. The final rules also provide that because the anti-retaliation provisions are codified within the Exchange Act, the SEC has enforcement authority for violations by employers who retaliate against employees for making reports in accordance with § 21F.
Conclusion
This summary highlights just a few of the key provisions of the final whistleblower rules. The final rules also underscore the importance of companies examining their internal reporting policies and procedures to determine whether they can be enhanced. Following enactment of the Sarbanes-Oxley Act in July 2002, many public companies have spent considerable time and effort to enhance their internal compliance systems by establishing an anonymous reporting hotline, a “tone at the top” atmosphere, and a “zero tolerance” policy for misconduct and retaliation. In order to prevent wrongdoings and encourage employees to report possible violations through a company’s internal reporting system, developing and promoting robust internal compliance policies and procedures is now more important than ever. Companies should also review the investigative procedures to ensure that prompt and appropriate response and action will take place upon receipt of an allegation of possible violation. Finally and most importantly, a company policy and culture that protects employees from retaliation should be strongly emphasized.