SEC Proposes Dodd-Frank Whistleblower Rules

Transcription

1 SEC Proposes Dodd-Frank Whistleblower Rules SEC Proposes Rules for Implementing the Whistleblower Protection and Award Provisions of the Dodd-Frank Act that Leave Open Issues of Concern for Employers SUMMARY Last week, the Securities Exchange Commission ( SEC ) proposed rules under a new program that encourages whistleblowing by providing for mandatory cash rewards to persons who report information about violations of the securities laws ( Whistleblower Program ). As we reported in our publication of August 5, 2010, the whistleblower reward program is required under Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ( Dodd-Frank Act ). 1 The proposals address some, but not all, of the concerns raised by employers in connection with the program. In particular, although the proposed rules include some structural safeguards to allow employees to first report information as part of a company s internal compliance process, the proposed rules ultimately permit employees to be eligible for the mandatory rewards even if they bypass that internal process. In addition, employees who learn of information as part of a company s internal compliance process may themselves be eligible for rewards if they report the information to the SEC after the company fails to act in good faith or to disclose the information to the SEC within a reasonable period of time. The SEC is seeking public comment on these proposals through December 17, BACKGROUND Section 922 of the Dodd-Frank Act added a new Section 21F to the Exchange Act, entitled Securities Whistleblower Incentives and Protection. Section 21F established a whistleblower program that requires the SEC to pay an award, subject to certain limitations, to eligible whistleblowers who voluntarily provide the SEC with original information about a violation of the federal securities laws that leads to a successful New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 federal court or administrative action resulting in monetary sanctions exceeding $1,000,000. Section 21F also contains provisions preserving the confidentiality of whistleblowers and prohibiting retaliation by employers against individuals who provide the SEC with information about potential securities violations. The SEC is directed to issue final regulations implementing the provisions of Section 21F no later than 270 days after the date of enactment. THE PROPOSED RULES Proposed Rules 21F-1 through 3 provide a general description of the Whistleblower Program, confirm that an eligible whistleblower must be a natural person, and state that whistleblowers will be eligible for an award if they: Voluntarily provide the SEC with original information that leads to the successful enforcement by the SEC of a federal court or administrative action in which the SEC obtains monetary sanctions totaling more than $1,000,000. Information will not be considered voluntarily submitted if the SEC, or other select authorities, has first made a request or demand to the whistleblower or if the individual falls within the scope of an SEC request or demand made to the individual s employer. Proposed Rule 21F-4(a). A whistleblower will remain eligible for an award even if he or she submitted information first to the employer. A submission will be considered voluntary even if the employer s personnel, in conducting an internal investigation, compliance review, or similar function, made the request or demand to the employee. This is an important provision, as a good number of commentators were concerned that the whistleblower provisions could give an incentive to employees to avoid internal reporting processes, in order to pursue an award. The Proposed Rules make clear that those who respect their employer s internal reporting processes remain eligible for an award. Nevertheless, the proposed rules ultimately permit employees to be eligible for the mandatory rewards even if they intentionally bypass the employer s internal processes, including the very processes that employers were required to establish pursuant to the Sarbanes-Oxley Act of 2002, which raises significant concerns for employers. Original information is defined as information derived from the whistleblower s independent knowledge or analysis; that is not already known to the SEC from any other source (unless the whistleblower is the original source); and is not taken exclusively from an allegation made in a judicial or administrative hearing, in a government report, or from the news media, unless the whistleblower is the source of that information. Proposed Rule 21F-4(b). Under this Proposed Rule, information will not be considered to derive from a person s independent knowledge or analysis, and thus will not be eligible for the grant of a whistleblower award, in seven circumstances: -2-

3 If it was derived from a communication subject to the attorney-client privilege, unless disclosure is otherwise permitted; If the information resulted from the legal representation of a client on whose behalf the person s services, or the services of his employer or firm, have been retained, and he seeks to use the information to make a whistleblower submission for his own benefit; If it was obtained through the performance of an engagement required under the securities laws by an independent public accountant, if that information relates to a violation by the engagement client or the client s directors, officers or other employees; If the information was communicated to the person because he was someone with legal, compliance, audit, supervisory, or governance responsibilities for an entity, and it was expected that he would take steps to cause the entity to respond appropriately, unless the entity did not disclose the information to the SEC within a reasonable time or proceeded in bad faith; If it was obtained from or through an entity s legal, compliance, audit or other similar functions or processes for identifying, reporting and addressing potential non-compliance with law, unless the entity did not disclose that information to the SEC within a reasonable time or proceeded in bad faith; If the information was acquired by a means or in a manner that violates applicable federal or state criminal law; or If it was received from any of the individuals described in the preceding six categories. The fourth and fifth exclusions under Proposed Rule 21F-4(b) are designed to prevent potential whistleblowers from seeking to circumvent or undermine the proper operation of an entity s internal processes for responding to a violation of law. The persons to whom these exclusions would apply include officers, directors, employees, and consultants who learn of potential violations as part of their corporate responsibilities. These exclusions also apply to persons who gain knowledge about the misconduct through their participation in, or access to, the various processes that companies employ to identify problems and advance compliance with legal standards. Significantly, however, these exclusions are removed if the entity acts in bad faith or fails to disclose the information obtained through its internal processes to the SEC in a reasonable time. Thus, employees who learn of information as part of a company s internal compliance process may themselves still be eligible for rewards if they report information to the SEC, which is another area of concern for employers. In assessing bad faith, the SEC will, among other things, consider whether affirmative steps were taken to hinder the preservation of evidence or a timely and appropriate investigation. A reasonable time will depend on the facts and circumstances of each particular case. In addition, the potential whistleblower would receive the benefit of a 90-day look-back for subsequent submission of information to the SEC, a rule designed to encourage an individual not to forego a company s internal compliance processes and report directly to the SEC in the first instance, but which, as noted above, ultimately does not preclude an award under such circumstances. Proposed Rule 21F-4(b)(7). Proposed Rules 21F-5 and 6 address the amount of a potential award and the criteria the SEC will use in determining that amount. The award must fall within a statutory range of 10 to 30 percent of the total -3-

4 monetary sanctions collected in successful SEC and related actions, provided that the sanctions amount to at least $1,000,000. In Proposed Rule 21F-6, the SEC provides a non-exclusive list of criteria for determining the exact amount of the available award, which includes the character of the enforcement action, the dangers to investors, and the time and resources conserved due to the whistleblower s actions. A further criterion is whether the whistleblower reported the potential violation through effective internal legal or compliance procedures before reporting the violation. This would apply to those employees who have acquired their information independently and who fall outside of the fourth and fifth exclusions of Proposed Rule 21F-4(b). The SEC notes that this is not a requirement, and the whistleblower shall not be penalized for failing to do so, but it will consider higher percentage awards for those who first report through their compliance programs. Proposed Rule 21F-7 reflects the SEC s policy and practice to treat all information obtained during its investigations as confidential and nonpublic. Barring certain circumstances in which disclosure to a defendant or respondent in an action or proceeding is required, the identity of a whistleblower is to remain confidential. 2 This assurance of confidentiality, coupled with Proposed Rule 21F-16, which authorizes SEC staff to communicate directly with whistleblowers who are directors, officers, members, agents, or employees of an entity that has counsel and who have initiated that communication with the SEC, is designed to protect potential whistleblowers from retaliatory action. 3 Proposed Rule 21F-8 specifically addresses the question of eligibility and allows the SEC staff to request necessary proofs from whistleblowers in that regard. In addition, subsection (c) recites various categories of individuals who are automatically ineligible for an award. These include persons who are, or were at the time of acquiring the information, members, officers, or employees of an appropriate regulatory agency, the Department of Justice, a self-regulatory organization, the Public Accounting Oversight Board, or a law enforcement organization. Ineligibility also extends to persons who are convicted of criminal violations related to SEC or related actions, or who obtained the information as part of an audit of a company s financial statements, or who are related to members or employees of the SEC. The procedures for submitting information and making a claim for an award are described in Proposed Rules 21F-9 through 11 and include time frames for filing and review. Whenever a judicial or administrative action brought by the SEC results in monetary sanctions exceeding the $1,000,000 threshold, a Notice will be published. Proposed Rule 21F-10 then requires a whistleblower to file his claim for an award within 60 days of the date of the Notice. The claim is evaluated by the SEC and a Preliminary Determination is issued. If the whistleblower fails to contest this determination within 30 days, it becomes a Final Order. Appeals from the SEC s final decision as to whether or to whom to make an award are addressed in Proposed Rule 21F-12. Such appeals must be made within 30 days of the final decision. The amount of the award is not appealable at all when the SEC has followed the statutory mandate to award between 10 and 30 percent of the monetary sanctions collected. The actual payment of awards, and the procedures applicable to such payment, is covered by Proposed Rule 21F

5 Proposed Rules 21F-14 and 15 address the role a whistleblower s own culpability plays in the process. As a general matter, the SEC is disinclined to grant amnesty to individuals simply because they have provided information to the SEC. Becoming a whistleblower will not preclude the SEC from bringing an action against that person for his own conduct, although the SEC may take into account that individual s cooperation. 4 The SEC will not count any monetary sanctions that the whistleblower is ordered to pay toward the $1,000,000 threshold for making an award. The SEC will also discount the monetary sanctions ordered against any entity whose liability is based substantially on the conduct that the whistleblower directed, planned, or initiated. * * * ENDNOTES Available at 2b56190d2183/Presentation/PublicationAttachment/65561fae-42de-445a-89fa- 2e31d1b2c7ba/SC_Publication_Dodd_Frank_Act_Whistleblower_Provisions.pdf. Under the statute, even an anonymous whistleblower seeking an award is required to be represented by counsel. Section 21F(d)(2). Proposed Rule 21F-16 also provides that no person may take any action to impede a whistleblower from communicating directly with the SEC about a potential securities law violation. The statute itself specifically forbids retaliatory measures against whistleblowers. Section 21F(h). This is in accordance with the SEC s Policy Statement Concerning Cooperation by Individuals in its Investigations and Related Enforcement Action. 17 C.F.R Copyright Sullivan & Cromwell LLP

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