In a three-to-two vote, the U.S. Securities and Exchange Commission adopted a final rule amending its whistleblower program, which pays monetary awards to individuals who voluntarily provide information to the SEC about a violation of the federal securities laws. Although these rule changes do not call for a shift in approach by businesses, companies should continue to ensure that they have robust compliance programs in place that encourage employees to report any potential violations of the federal securities laws in-house so that the company can conduct an investigation and address any issues in a timely manner. They should also provide protections against retaliation for employees who report potential violations.
The key provisions include:
- Adoption of a single definition of “whistleblower” across the program, such that certain existing requirements for qualifying for an award, including that the employee report information to the SEC in writing, are now also required to qualify for protection against retaliation;
- Amendment of the definition of “action” to include deferred prosecution agreements, non-prosecution agreements and settlement agreements entered into by the U.S. Department of Justice or SEC, allowing whistleblowers to receive awards in connection with those actions;
- Adoption of provisions that streamline the SEC’s process of rejecting award applications by codifying the SEC’s practice of barring applicants who abuse the program and creating a summary disposition procedure for common types of denials;
- Creation of a presumption that whistleblowers with potential awards of less than $5 million will automatically receive the maximum statutory award amount, subject to certain criteria; and
- Clarification of the SEC’s broad discretion to determine the precise amount of an award, within certain statutory limits.
Although the vote on the amendment package was three to two, the dissenting commissioners made clear that they were in favor of some of the changes, but felt others, like the requirement that a report to the SEC had to be in writing for the person to qualify as a whistleblower for purposes of anti-retaliation protection, were too restrictive.
The SEC Whistleblower Program
Congress established the SEC Whistleblower Program in July 2010. The program, codified in Section 21F of the Securities Exchange Act of 1934 (“Exchange Act”), authorizes the SEC to pay awards to whistleblowers who voluntarily provide the SEC with original information about a violation of the federal securities laws leading to a successful enforcement action resulting in over $1 million in monetary sanctions. The program also provides protection against retaliation to individuals who provide information to the SEC under the program.
In May 2011, the SEC adopted a set of rules implementing its whistleblower program. Among other things, the rules established procedures for the SEC to determine the amount of awards, created policies and procedures for individuals to submit information to the SEC in order to qualify for an award and defined certain terms and phrases in Section 21F.
Record Whistleblower Awards
According to an SEC press release, in the decade since the whistleblower program was created, the SEC has paid approximately $523 million to 97 individual whistleblowers. The awards have increased in size in the past few years, including some extraordinarily large awards. Nearly half of the total amount ever awarded consists of only five individual awards, ranging from $33 million to $50 million, all of which the SEC granted in the past four years. According to the SEC, even with COVID-19 it has processed more claims in 2020 than in any previous year of the program.
Although the SEC generally has discretion to determine the precise amount of the award, there are limits: the award must be between 10-30% of the total monetary sanctions and the SEC must consider certain factors when deciding the amount of award. Those factors include the significance of the whistleblower’s information to the success of the enforcement action, the degree of assistance provided and the SEC’s interest in deterrence.
The September 23 Final Rule
The final rule adopted September 23, 2020, primarily impacts the following areas of the whistleblower program: (1) the manner in which the SEC determines the amount of awards; (2) the definition of a covered enforcement “action” and “related action” that trigger an award; (3) the anti-retaliation provisions; and (4) certain policies and procedures for submitting claims, reviewing claims and creating an administrative record.
According to the SEC’s press release, the amendments are intended to “provide greater clarity to whistleblowers and increase the program’s efficiency and transparency.”
Modifications to the Anti-Retaliation Provisions
Responding to the Supreme Court’s ruling in Digital Realty Trust v. Somers (2018), which held that the anti-retaliation provisions in the whistleblower statute must be interpreted based on Section 21F’s definition of “whistleblower,” the final rule adopts a uniform definition of whistleblower. First, new Rule 21F-2(a) creates a new definition of “whistleblower” that applies for all purposes under Section 21F – award eligibility, confidentiality and anti-retaliation protection – including that, in order to qualify as a whistleblower, an individual must provide information to the SEC “in writing.” Rules 21F-2(b), (c), and (d) then specify how that definition of whistleblower operates across the program. Rules 21F-2(b) and (c) specify that, with respect to award eligibility and confidentiality, a person must comply with the already-existing requirements in Rules 21F-2, 21F-8 and 21F-9 (which had included the requirement that the information be submitted to the SEC in writing, either through the SEC’s online portal or a particular form). Rule 21F-2(d) provides that, in order to receive retaliation protection, the individual must report his or her information to the SEC prior to experiencing the retaliation and must “reasonably believe” that the information provided relates to a possible securities law violation.
In addition, the SEC issued interpretive guidance regarding the scope of prohibited conduct under the anti-retaliation provisions. Specifically, based on the Supreme Court’s ruling in Burlington Northern and Santa Fe Railway Company v. White (2006), the SEC stated that it interprets Section 21F(h)(1)(A) as prohibiting any retaliatory activity by an employer against a whistleblower that “a reasonable employee [would find] materially adverse,” which means “it well might have dissuaded a reasonable worker” from engaging in any lawful act encompassed by the whistleblower program.
Presumption of the Statutory Maximum Award Amount for Awards Under $5 Million
The final rule includes two items relating to the SEC’s calculation of the amount of the award provided to a whistleblower. First, the final rule adds new Rule 21F-6(c), which creates an automatic presumption that the SEC will pay the statutory maximum award amount (i.e., 30% of the total monetary sanctions) where that amount is $5 million or less, provided that none of the negative award criteria specified in Rule 21F-6(b) are present. Those negative criteria include the whistleblower’s culpability or involvement in the violations, an unreasonable delay in the whistleblower’s reporting of the violations or the whistleblower’s interference with his or her company’s internal compliance or reporting system.
Second, with respect to awards over $5 million, the SEC “clarified” that it will continue to issue awards based on its analysis of the factors identified in Rule 21F-6. In its press release, the SEC stated that “[b]ased on the historical application of the award factors,” if none of the above negative criteria are present, the award amount “would be expected to be in the top third of the award range.”
Notably, the SEC did not adopt its previously proposed Rule 21F-6(d)(2), which would have created a formal process for the SEC to review awards exceeding $30 million to individual whistleblowers. In response to the proposed rule, several commentators, including Democratic senators, had complained that the proposed rule would provide the SEC with discretion to reduce the dollar value of the award based on the amount of the award (i.e., that the proposed rule would operate as a cap on larger awards). In its background and summary of the final rule adopted September 23, the SEC explained that it “did not intend to create a new restriction on, or affect the size of” the amounts of awards, and stated that after “further analysis,” it determined that the proposed rule was not necessary. The SEC instead “clarified” its “broad discretion” to consider the award factors in percentage terms, dollar terms or some combination thereof.
Expansion of Awards to a Broader Set of Enforcement Actions
The final rules also expand the types of enforcement actions pursuant to which a whistleblower may qualify for an award by amending the definition of “action” in Rule 21F-4(d). In particular, the amendment provides that the term “administrative action” will now include a deferred prosecution agreement or non-prosecution agreement entered into by the DOJ in a criminal case, and any similar settlement agreement entered into by the SEC (even if outside the context of a judicial or administrative proceeding to address violations of the securities laws).
By contrast, the SEC limited the definition of when an action brought by another regulatory body would qualify as a “related action” such that the whistleblower would be entitled to an award. Under Rule 21F-3, a whistleblower may obtain an award for providing original information that leads to a judicial or administrative action brought by the U.S. attorney general, a state attorney general in a criminal case, an appropriate regulatory authority or a self-regulatory organization. The whistleblower is only entitled to an award based on such a “related action” if the action is based on the same information the whistleblower provided to the SEC that resulted in SEC monetary sanctions over $1 million. The final rule amends the definition of “related action” in Rule 21F-3(b)(3) to exclude any law enforcement or separate regulatory action where there is a separate award scheme that more appropriately applies to such action.
Modifications to Procedures for Submission and Review of Applications
The final rule includes a series of amendments that the SEC states are intended to “clarify and enhance” certain policies, practices and procedures in implementing the program. Some of these amendments streamline the process for the SEC’s rejection of meritless award applications or those involving information that the SEC could have identified on its own, while others slightly relax the requirements for obtaining a successful award.
The final rule provides the SEC with two tools to more easily reject award applications. First, an amendment to Rule 21F-8 allows the SEC to bar applicants who submit materially false, fictitious or fraudulent information to the SEC, and permanently bar applications who submit three previous frivolous applications. Second, new Rule 21F-18 creates a summary procedure for the SEC to deny certain types of applications, including untimely applications or where the information was never provided to or used by the staff.
The final rule also amends the definition of “independent analysis” in Rule 21F-4(b)(2), which is part of the SEC’s determination of whether the information provided by the whistleblower is “original” such that it qualifies for an award. Under the final rule, the SEC provides interpretive guidance that a whistleblower’s submission cannot qualify as “independent analysis” unless it provides evaluation, assessment or insight beyond what would be reasonably apparent to the SEC from publicly-available information. To determine whether the information would have been reasonably apparent to the SEC, the SEC will consider whether the whistleblower’s information comes from sources that are not readily identified and accessed by a member of the public without specialized knowledge, unusual effort or substantial cost.
Finally, the final rule provides additional flexibility to the SEC in waiving certain requirements for the submission of applications. The final rule amends Rule 21F-9 to provide the SEC with flexibility to waive an individual’s noncompliance with the requirement to submit a Form Tip, Complaint or Referral as long as the individual later provides the form either (1) within 30 days of first providing the information that he or she relies upon as a basis for the claim; or (2) within 30 days of first obtaining actual or constructive notice of the requirements. The final rule also declines to provide any specific definition of “unreasonable delay” in providing information to the SEC. Instead, according to the SEC’s press release, it will continue to determine whether a delay was reasonable on a case-by-case basis, including consideration of whether there were circumstances outside the whistleblower’s control.
The final rule will be effective 30 days after publication in the Federal Register.
Ultimately, the commission’s whistleblower rule amendments are more subtle modifications than wholescale changes to the 10-year-old program. The most important takeaway may be the commissioners’ unanimous commitment to and belief in the worthiness and success of the program in incentivizing quality tips to SEC enforcers. As noted at the beginning of this piece, companies should continue to strengthen internal reporting mechanisms and should ensure that both in word and deed, reporting individuals do not suffer retaliation for reporting issues.