The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") added Section 21F to the Exchange Act, entitled "Securities Whistleblower Incentives and Protection." This new section requires the SEC to pay awards to whistleblowers who provide the SEC with original information about a violation of the federal securities laws that leads to successful enforcement action and monetary sanctions in excess of $1 million. On May 25, 2011 the SEC adopted final rules to implement this Dodd-Frank mandate ("Whistleblower Rules"). The Whistleblower Rules define the conditions that must be met for whistleblowers to be eligible for an award. They include provisions to protect whistleblowers from retaliation, and encourage (but do not require) whistleblowers to utilize a company's internal reporting system. The full text of the adopting release for the Whistleblower Rules is available at http://www.sec.gov/rules/final/2011/34-64545.pdf.
A whistleblower is an individual who voluntarily reports a possible violation of federal securities laws that has occurred, is ongoing or is about to occur. A whistleblower may be an employee of the company that is the subject of the report, but need not have any connection with the company at all.
Some categories of individuals whose job duties specifically involve the identification and remediation of potential internal control issues are not eligible for awards under the Whistleblower Rules except under limited circumstances. For example, the following categories of individuals are generally not eligible for awards:
These excluded individuals can be eligible for awards under the Whistleblower Rules in some special circumstances. In particular, they may be eligible if:
One interpretative aspect of the Dodd-Frank mandate involved the extent to which the whistleblower's culpability in the reported violation would disqualify that person from receiving an award. As adopted, the rules provide that fraud or misconduct on the part of the whistleblower, even if it is the same fraud or misconduct that is being reported, does not per se disqualify the whistleblower from receiving an award. However, sanctions levied against the whistleblower, or ordered against the company based substantially on the whistleblower's own conduct, will be excluded for purposes of determining whether the $1 million minimum threshold is reached, and will be a negative factor in calculating the amount of any award to that whistleblower.
Information obtained through a communication that was subject to the attorney-client privilege will not be eligible for a whistleblower award. This applies to privileged communications with both in-house and external counsel. However, if the attorney-client privilege has been waived – a determination that is often subject to judgment and difficult to determine – the information may be the subject of an award.
In order to secure an award, an individual must voluntarily supply original information about securities violations to the SEC. If a report is made in response to a demand, inquiry or request from the SEC, PCAOB, Congress or a self-regulatory organization, the information is not considered voluntary and thus cannot be the basis for an award. Similarly, individuals under a pre-existing contractual or legal duty to report the original information to the SEC or other authorities will not meet the "voluntary" requirement and will not be eligible for an award.
Original information is information derived from the whistleblower's independent knowledge or analysis that was unknown to the SEC before the whistleblower provided it. Information available from the news media, or stemming from allegations made in judicial or administrative hearings or governmental reports, hearings, audits or investigations, will generally not be considered original information for purposes of an award.
The Whistleblower Rules do not require that an individual first make a report through the company's internal reporting procedures. In recognition of the positive effects of adopting and enforcing robust internal controls to detect and prevent improper behavior, the Whistleblower Rules do contain some incentives for individuals to utilize corporate internal compliance programs to report potential misconduct:
It is notable that, to be eligible for an award, someone who has followed internal procedures and reported a potential violation through the company's internal whistleblower program must still report it to the SEC within 120 days after making the internal report. As a consequence, if a company receives what appears to be a legitimate whistleblower complaint and undertakes a comprehensive internal investigation, it is now more likely that the SEC will be brought into the picture – and brought in at an earlier point in time – than would have ever been the case historically.
The Whistleblower Rules specify that whistleblowers who provide information to the SEC are protected from retaliation if the whistleblower possesses a "reasonable belief" that the information he or she provides relates to a possible federal securities law violation that has occurred, is ongoing, or is about to occur. The anti-retaliation provisions protect whistleblowers regardless of whether they ultimately qualify for an award. Key to appreciating the anti-retaliation protections is recognition that the whistleblower need only report a possible violation – an actual violation of the securities laws is not necessary. In order to have a "reasonable belief," an employee must genuinely believe the information demonstrates a possible violation of the securities laws, and the belief must be one that a similarly situated employee might possess.
No. The anti-retaliation provisions of the Whistleblower Rules protect the employee from being disciplined for behavior in accordance with the Rules, including reporting directly to the SEC. A company policy requiring internal reporting could not be enforced without violating those anti-retaliation provisions. However, there is, of course, nothing objectionable about encouraging internal reporting and reinforcing internal compliance programs.
If monetary sanctions in excess of $1 million are ultimately collected as a result of a successful enforcement action based on the whistleblower's information, eligible whistleblowers may receive payments of 10% - 30% of the amount collected, in the discretion of the SEC. Two or more smaller actions with the same nucleus of facts may be aggregated to meet the $1 million dollar threshold. The Whistleblower Rules spell out several factors to be considered in determining the amount of the award.
These rules will be effective August 12, 2011.
The Whistleblower Rules do not require companies to adopt any new policies or procedures. Nor do they mandate any new company disclosure. However, the creation of a formal SEC whistleblower program, and financial incentives for individuals to report information, are likely to increase the level of whistleblower activity. As a result, companies should anticipate an increase in the pace of internal or other investigations and related costs.
Now would be an appropriate time for companies to:
For more information, you may contact:
Horace Nash at 650.335.7934 or email@example.com;
Susan S. Muck at 415.875.2325 or firstname.lastname@example.org;
Daniel J. Winnike at 650.335.7657 or email@example.com;
Emily St. John Cohen at 415.875.2394 or firstname.lastname@example.org.
©2011 Fenwick & West LLP. All Rights Reserved.
The views expressed in this publication are solely those of the author, and do not necessarily reflect the views of Fenwick & West LLP or its clients. The content of the publication ("content") should not be regarded as advertising, solicitation, legal advice or any other advice on any particular matter. The publication of any content is not intended to create and does not constitute an attorney-client relationship between you and Fenwick & West LLP. You should not act or refrain from acting on the basis of any content included in the publication without seeking the appropriate legal or professional advice on the particular facts and circumstances at issue.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice in this communication (including attachments) is not intended or written by Fenwick & West LLP to be used, and cannot be used, for the purpose of (i) avoiding penalties under the internal revenue code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.