What is Independent Knowledge?

Transcription

1 DODD-FRANK ALERT DECEMBER 2010 SEC Proposes Dodd-Frank Whistleblower Rules New York Office 2 Park Avenue New York, New York Phone: (212) Fax: (212) Princeton Office 210 Carnegie Center Princeton, New Jersey Phone: (609) Fax: (609) Newark Office One Gateway Center Newark, New Jersey Phone: (973) Fax: (973) Attorney Advertising The SEC has proposed rules to implement the sweeping whistleblower provisions added to the Securities Exchange Act of 1934 (the "Exchange Act") by the Dodd-Frank Wall Street Reform and Consumer Protection Act 1 (the "Dodd-Frank Act"). These provisions empower the SEC to pay awards to whistleblowers who voluntarily provide the SEC with original information about a violation of the securities laws that leads to a successful enforcement of an SEC action resulting in monetary sanctions exceeding $1 million. In addition to providing for whistleblower awards, the Dodd-Frank Act expands the Exchange Act to prohibit retaliation by employers against whistleblowers, including providing whistleblowers with a private right of action for retaliation. The SEC's new whistleblower program will supplement existing whistleblower protections under the Sarbanes-Oxley Act of 2002 and other federal and state laws. The SEC's proposed rules implement the whistleblower program established under the Dodd-Frank Act, which empowers the SEC to reward whistleblowers who provide the SEC with information on a wide range of securities law violations commited by any company, whether public or private. The proposed rules also set forth the procedures a whistleblower must follow to be eligible for an award. With these proposed rules, the SEC has attempted to strike a balance between its desire to obtain original information and the companies' concerns that these new rules would undermine the effectiveness of their existing compliance programs. Nevertheless, the speed with which the SEC acted in proposing the rules, coupled with its recent announcement 2 that it has set aside over $450 million for anticipated whistleblower claims, underscores the SEC's eagerness to use the whistleblower rules as a vital part of its overall enforcement program. Who is a Whistleblower? The proposed rules define the term "whistleblower" as a natural person who, alone or jointly with others, provides "original" information to the SEC relating to a potential violation of the securities laws. This is consistent with the broad definition in the Dodd- Frank Act, except that the SEC included the term "potential violation" to reach information beyond actual, proven securities violations at the time the information is submitted. Further, the SEC's proposed definition will permit a whistleblower to benefit from the anti-retaliation provisions (described below), regardless of whether there is an ultimate adjudication, finding or conclusion that the conduct reported by the whistleblower constituted a violation of the securities laws. What is Original Information? "Original information" means information that is (i) derived from the whistleblower's "independent knowledge" or analysis; (ii) not already known to the SEC from any other source, unless the whistleblower is the original source of the information; and (iii) not exclusively derived from an allegation made (A) in a judicial or administrative hearing, including an arbitration hearing; (B) in a governmental report, hearing, audit or investigation; or (C) from the news media, unless the whistleblower is the source of information. Only information provided to the SEC for the first time after July 21, 2010 the date of the Dodd-Frank Act's enactment will be considered original

2 information. Moreover, whistleblowers are eligible only if they provide original information voluntarily. The proposed rules define a submission as voluntary if a whistleblower submits information before the SEC, Congress, any other federal, state or local authority, any self-regulatory organization (an "SRO"), or if the Public Accounting Oversight Board (the "PCAOB") inquires, requests or demands information about the matter. The proposed rules also make clear that disclosure is not deemed voluntary if the individual has a clear duty to report securities law violations. Specifically, this will prohibit awards to members, officers or employees of an appropriate regulatory agency, the Department of Justice, an SRO, the PCAOB, a law enforcement organization, or auditors subject to the audit requirements of the Exchange Act. Additionally, the proposed rules extend to other persons who are under a pre-existing legal duty to report securities law violations to the SEC or other regulatory or law enforcement agencies. What is Independent Knowledge? Further, a whistleblower must derive the original information from his or her own "independent knowledge." This means that the information cannot be obtained from publicly available sources. However, a whistleblower is not required to have direct, firsthand knowledge of the potential securities law violations. A whistleblower may obtain original information from the whistleblower's experiences, observations, or communications as long as the whistleblower does not become aware of the original information from a publicly available source. For example, a whistleblower would have "independent knowledge" of information even if the knowledge is derived from facts or other information obtained from third parties. In addition, the SEC will not consider information to derive from "independent knowledge" and will not issue a whistleblower award if an individual obtains information: through a communication subject to the attorney-client privilege; as a result of legal representation of a client; through the performance of his engagement as an independent accountant; in connection with legal, compliance, audit, supervisory or governance responsibilities for an entity (unless the entity did not disclose the information to the SEC in a timely manner or proceeds in bad faith); from or through an entity's legal, compliance, audit or other similar functions or processes for identifying, reporting and addressing potential noncompliance with law (unless the entity did not disclose the information to the SEC in a timely manner or proceeds in bad faith); in a manner that violates federal or state criminal law; or from any of the individuals described above. By excluding these categories of persons and information, the SEC attempted to strike a balance between promoting effective compliance programs and permitting whistleblowers to step forward where a company has acted in bad faith or failed to disclose information to the SEC within a reasonable time. Accordingly, the proposed rule excludes certain company personnel working in legal, compliance or similar functions who otherwise may seek financial benefit by "front running" internal investigations. In the proposed rules, the SEC emphasized that even though it does not require a whistleblower to use internal compliance procedures before seeking a whistleblower award, the receipt of a tip will not necessarily lead to internal processes being bypassed. Instead, the SEC expects its staff to inform the company and give that company an

3 opportunity to investigate the matter. However, this cooperative approach will not apply where bypassing a company's investigation would be in the public interest or serve to protect a whistleblower's confidentiality. Successful Enforcement of an Action Under the proposed rules, a whistleblower's eligibility for an award depends on whether the original information leads to a successful enforcement of the SEC's action or a related action. Generally, an SEC enforcement action proceeds in the following stages: (i) an investigation is opened; (ii) the staff conducts its investigation to determine whether a sufficient basis exists for an enforcement action; and (iii) if such a basis exists, the SEC may file an action. For successful enforcement of an action, the SEC must establish that it is more likely than not that unlawful conduct occurred. For the purposes of these rules, an "action" means a single civil or administrative proceeding, including all defendants or respondents, and all claims, that are brought within that proceeding. For example, if a whistleblower provides original information related to unlawful conduct by a single individual, but that information leads to a case against that individual as well as four others, the "action" is the case against all five individuals. In turn, the whistleblower's award will be measured against the total monetary sanctions collected against all five individuals. If the SEC brings separate actions against each of the individuals, the whistleblower will only receive an award if an action against any one individual results in monetary sanctions in excess of $1 million. Further, the proposed rules set forth alternative tests for successful enforcement depending on whether a whistleblower's information leads to a new investigation or relates to conduct already under investigation: New Investigations If a whistleblower's information causes the SEC to open a new investigation, the proposed rules establish a two-part test for determining whether the information led to a successful enforcement of an SEC action. First, the information must have caused the SEC to commence an examination, open an investigation, reopen a closed investigation or inquire about new and different conduct as part of an open investigation or examination. Though the SEC may consider this information in connection with information it has already collected, this new information must be the principal motivating factor behind the staff's decision to begin looking into conduct the SEC is not already examining. Second, the whistleblower's information must have significantly contributed to the success of an enforcement action filed by the SEC. The SEC will determine, on a case-by-case basis, if the information is the principal motivating factor for the examination or has significantly contributed to a successful enforcement action. Conduct Already Under Investigation Alternatively, in situations where a whistleblower provides information about conduct that is already under investigation, awards would be limited to the rare circumstances where the whistleblower provided essential information that the SEC would not have otherwise obtained in the normal course of its investigation. Amount of Award If all conditions to the proposed rules are met, the SEC will pay a whistleblower an award of at least 10 percent, but no more than 30 percent, of the total monetary sanctions collected in successful SEC and related actions. Where multiple whistleblowers are eligible for an award, each individual whistleblower will receive, in the SEC's discretion,

4 a certain percentage of the total award, provided that all awards together will equal between 10 and 30 percent of the total monetary sanctions. In determining the amount of a whistleblower's award, the SEC will take into consideration (i) the significance of the information provided; (ii) the degree of assistance provided by the whistleblower; (iii) the potential to deter future violations of securities laws; and (iv) whether an award otherwise enhances the SEC's ability to enforce the federal securities laws, protect investors and encourage high-quality tips from whistleblowers. No Double Recovery The SEC's proposed rules do not permit double recovery by a whistleblower if the whistleblower has received an award from the Commodity Futures Trading Commission for that same action pursuant to the Commodity Exchange Act. Restrictions on Awards for Wrongdoers The proposed rules do not provide immunity from prosecution for whistleblowers who have participated in misconduct relating to a violation of the securities laws. Nevertheless, the SEC recognizes that in some instances these culpable whistleblowers will be able to provide original information that will significantly aid in the SEC's detection of sophisticated securities law violations. In such instances, the SEC will subtract the whistleblower's sanctions and the sanctions of any entity whose liability is based substantially on the whistleblower's conduct from the total monetary sanctions collected in the action. In turn, a culpable whistleblower will receive an award only if the monetary sanctions less these amounts exceed $1 million. Whistleblower Confidentiality The proposed rules permit a whistleblower to provide information anonymously if the whistleblower is represented by an attorney and that attorney's contact information is provided to the SEC at the time of the whistleblower's initial submission. An attorney acting on behalf of an anonymous whistleblower must certify to the SEC that he or she has verified the whistleblower's identity. An anonymous whistleblower will, however, be required to disclose his or her identity to the SEC before the SEC will pay any award. Once learned, the SEC will not reveal the whistleblower's identity, nor will it disclose other information reasonably expected to reveal the whistleblower's identity, except under limited circumstances. These circumstances include where a whistleblower's identity will be legally required or necessary for the protection of investors. Moreover, the proposed rules permit the SEC to share confidential information with other domestic and foreign regulatory and law enforcement agencies when it is necessary to achieve the purposes of the Exchange Act and to protect investors. A domestic agency is expected to uphold the confidentiality requirements of the Exchange Act, while foreign agencies, who are not subject to such requirements, must instead provide assurances of confidentiality to the SEC prior to disclosure. Communications Between the SEC and Whistleblowers The proposed rules prohibit any person from taking any action to impede a whistleblower from communicating directly with the SEC about a potential securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement with respect to such communications. This prohibition does not extend to information covered under exceptions for the attorney-client privilege, nor does it prevent a professional organization from responding to a breach of a recognized common-law or statutory privilege (e.g., between a psychiatrist and a patient) by one of its members.

5 Further, the SEC is empowered under the proposed rules to communicate directly with whistleblowers who are directors, officers, members, agents, or employees of an entity that has counsel, and who have initiated communication with the SEC related to a potential securities law violation. In other words, the proposed rules make clear that the SEC is authorized to communicate directly with these representatives without first seeking the consent of the entity's counsel. Prohibition Against Employer Retaliation The Dodd-Frank Act prohibits an employer from taking any discriminatory employment action against a whistleblower. Moreover, the Dodd-Frank Act provides a whistleblower with a private right of action against an employer that retaliates against him or her. The Dodd-Frank Act also extends these protections to a whistleblower who makes disclosures that are required or protected under the Sarbanes-Oxley Act of 2002, the Exchange Act, and any other law, rule, or regulation subject to the jurisdiction of the SEC. In its release proposing the whistleblower rules, the SEC clarifies that the scope of anti-retaliation protection extends to whistleblowers regardless of whether they ultimately qualify for awards. Significantly, the proposed rules extend whistleblower protections to the date an employee reports information to his or her company if the employee reports the same information to the SEC within 90 days. Procedures For Obtaining a Whistleblower Award The proposed rules also contain extensive procedural requirements, which set forth the form and content of a whistleblower claim. A whistleblower would first be required to submit proposed Form TCRto provide the SEC with basic identifying information about the whistleblower and information about the alleged violation of Federal securities laws. In addition, the SEC would require whistleblowers to complete proposed Form WB- DEC, which contains certain threshold questions concerning the whistleblower's eligibility to receive an award. Finally, if the SEC publishes a "Notice of Covered Action" under the proposed rules, a whistleblower would be required to submit Form WB-APP to be considered for an award. A whistleblower may submit these forms electronically through the SEC's Electronic Data Collection System available on the SEC's website or by mailing or faxing the forms to the SEC's Whistleblower Office. Comment Period The SEC has highlighted numerous areas where it is seeking public comments on its whistleblower proposal and, in particular, on suggested modifications that would avoid undermining established internal compliance programs. Comments must have been submitted to the SEC on or before December 17, 2010, and the SEC will adopt final regulations implementing the whistleblower program by April 21, We will keep you updated on this and other Dodd-Frank matters. If you have any questions about this alert, please contact Irwin Latner at (212) or [email protected], or Patrick Sweeney at (212) or [email protected]. Copyright 2010 Herrick, Feinstein LLP. Dodd-Frank Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm. 1 Pub. L. No , 124 Stat (2010). 2