The SEC s Whistleblower Program: Issues and Strategies Securities Enforcement Forum 2014 October 14, 2014

Transcription

1 The SEC s Whistleblower Program: Issues and Strategies Securities Enforcement Forum 2014 October 14, 2014 Christian R. Bartholomew Jenner & Block LLP 1099 New York Avenue, NW, Suite 900 Washington, DC cbartholomew@jenner.com (202)

2 Christian R. Bartholomew Partner, Jenner & Block, LLP Washington, D.C. Office Christian R. Bartholomew is a member of the firm s Securities Litigation and Enforcement Practice. As a former undefeated trial lawyer for the Securities and Exchange Commission (SEC) with more than two decades of public sector and private practice experience, Mr. Bartholomew has successfully resolved regulatory and internal investigations and litigation matters on behalf of well-known financial institutions and public companies on virtually every securities-related issue confronting these clients. Recognized by Chambers USA as a leader in the area of the SEC s whistleblower rules, Mr. Bartholomew has represented a number of prominent financial institutions and public companies in internal and regulatory investigations regarding sensitive whistleblower allegations. He has also advised companies on strengthening their internal protocols to incentivize internal reporting, and has written and spoken extensively on these issues. 1

3 OVERVIEW Dodd-Frank amended the Securities Exchange Act of 1934 to add Section 21F providing awards to whistleblowers in SEC actions SEC rules went into effect in August 2011 Rules provide for payments of 10-30% of sanctions where: whistleblower voluntarily provides original information about a violation of the federal securities laws that leads to a successful enforcement action in which the SEC recovers monetary sanctions over $1 million Monetary sanctions defined very broadly to include penalties, disgorgement, and interest and can aggregate actions in determining amount Rules allow whistleblowers to provide information relating to any violation of the federal securities laws not just (as before) insider trading Potential for huge awards just last week the SEC announced an award of over $30 million. 2

4 Program to Date: 2013 Annual Report Annual Report for fiscal year 2013 (Sept Sept 2013): received 3,238 whistleblower tips through its Tips, Complaints, and Referrals System ( TCR System ) about 8% more than FY 12 informal reports that FY 14 will be in the same ballpark most common tips involved corporate disclosures and financials (17.2%), offering fraud (17.1%), and manipulation (16.2%); only 4.6% of tips involved FCPA violations; 6.1% involved insider trading largest category of tips were in other category 22% received tips from all 50 states and D.C., Puerto Rico, and 55 foreign countries SEC has never disclosed how many tips led to open investigations, how many applications for awards have been received, or how many are currently being processed In January 2013, Inspector General found that 69% of sampling of tips were deemed to require No Further Action (NFA) after initial review. 3

5 Program to Date: Awards Size of awards growing last week s award of more than $30 million is close to twice the total of all previous awards combined with last year s $14 million award, the two largest awards comprise approximately 96% of the total amount awarded 15 other awards total about $2 million SEC is going to great lengths to protect the anonymity of the whistleblowers Given the lack of information provided, there is still uncertainty regarding the nuances of the program and how the SEC will exercise its significant discretion But expect these large awards to fuel additional tips as whistleblowers are reassured that that they will not be identified and that payouts will be meaningful Beyond the $30 million award, two others are particularly interesting: In July, SEC gave a $400k award to a whistleblower who first reported the misconduct internally head of OWB said that the whistleblower did everything feasible to correct the issue internally In August, SEC gave a $300k award to a compliance officer which requires exceptional circumstances to be eligible but gave no further details regarding those circumstances 4

6 SEC Office of Whistleblower As of last November, Office staffed with 9 lawyers and 3 paralegals view themselves as liaison between whistleblower community and SEC Division of Enforcement have pot of more than $400 million to work with/distribute Office conceded that substantial portion of tips are meritless or turn out to be meritless but process laborious and every closing decision has to be signed off on by Associate Director and head of Market Intelligence the program is also grappling with how to deal with serial tipsters providing frivolous or false information. in May 2014, the SEC banned one repeat offender from the whistleblower program who had submitted close to 300 meritless tips. Chief of OWB said that he was not interested in receiving privileged materials from whistleblowers but made clear that will accept anything else, even stolen documents not the Division s problem 5

7 Requirements for Bounty: Who Qualifies as a Whistleblower? Must be a natural person company or other entity not eligible May act alone or jointly Need not be employee can be third parties (consultants, competitors, etc) Need not be within or from United States 12% of the FY13 tips (404) came from outside U.S. $30 million award went to tipster outside of the U.S. No materiality requirement information need only have facially plausible relationship to federal securities law violation May be anonymous but then must act through an attorney May be culpable (to a degree) but culpability affects size of award Generally attorneys, officers and directors, auditors and compliance personnel excluded although exceptions 6

8 Requirements for Bounty: When is a Submission Voluntary? Whistleblower must come forward before receiving (directly or through an attorney) any formal or informal request, inquiry or demand from: SEC PCAOB, FINRA or any other SRO Congress, the CFTC or any other federal authority State attorney general or securities regulator but request from other state agency or foreign regulator will not disqualify whistleblower Request to employer will not be considered a request to employee however, SEC has said that individuals who wait until after their employer receives a request will not face an easy path to an award 7

9 Requirements for Bounty: What is Original Information? Must be derived from independent knowledge or independent analysis may not be derived from public sources unless whistleblower s evaluation reveals unique or original analysis whistleblower does not need to have first-hand knowledge could have learned the information from someone else (as long as the source of the information is not excluded by the rules) Generally, information subject to the attorney-client privilege, obtained by an officer or director, or obtained by compliance or audit personnel is excluded on policy grounds for this reason, information learned through a company s internal investigation will typically not qualify as original information because it will have come from an excluded source but if have independent knowledge of the conduct, then can qualify 8

10 Requirements for Bounty: What is Original Information? (continued) But exceptions where information from these excluded sources will qualify reasonable basis to believe disclosure is necessary to prevent substantial injury to the financial interest of the company or investors; company is engaging in conduct that will impede an investigation; or (for information not subject to attorney-client privilege) 120 days have elapsed since the person reported internally to the audit committee, CLO, CCO or supervisor or received the information under circumstances indicating that one of those individuals were already aware and failed to act 9

11 Requirements for Bounty: When Does Information Lead to Successful Enforcement Action? Where the conduct is not already under investigation or examination information is sufficiently specific, credible and timely to cause the SEC staff to commence a new investigation, reopen a closed investigation or to inquire about different conduct under a current investigation Where the conduct is already under investigation or examination information significantly contributes to the success of the SEC action (e.g., saves a significant amount of time or resources, or enables additional successful claims) Whistleblower reports internally and the company s internal investigation produces information meeting one of the above criteria in this scenario, conduct uncovered by company can satisfy led to requirement Where whistleblower has already submitted information, second whistleblower is eligible for award if he or she provides information that materially adds to what Commission already knew 10

12 Internal Reporting and Incentives SEC did not require whistleblowers to first report internally to company However, rules seek to incentivize internal reporting in three ways whistleblower s place in line for award preserved for 120 days; whistleblower gets extra credit for reporting internally in determining award; AND whistleblower gets credit for everything company s internal investigation turns up Appears incentives are working Chief of Whistleblower Office reports that significant majority of whistleblowers report internally first and he would be hard pressed to think of one that did not empirical evidence suggests that whistleblowers typically report internally first potential whistleblowers who know about the SEC program will likewise know about the benefits of internal reporting and the anti-retaliation provisions However, the $400k award made in July 2014 was first time the Award Order acknowledged that the whistleblower had first reported internally. 11

13 Incentive for Reporting Internally: Credit for Internal Investigation Reporting internally can help whistleblower qualify for an award and increase amount of award Example: whistleblower reports internally that she thinks there are revenue recognition issues in Subsidiary A; company investigates and uncovers specific evidence of revenue recognition issues at Subsidiary A and discovers evidence of similar issues at Subsidiary B had whistleblower gone directly to SEC, she may not have had sufficient specific and credible evidence to qualify for award, but since she first reported internally, the evidence uncovered by the company can be used to qualify her for award whistleblower will also now be entitled to receive 10-30% of monies received from actions against both Subsidiary A and B; if she had reported directly to SEC, would only qualify for award based on action against Subsidiary A 12

14 Anti-Retaliation Provisions Whistleblowers are effectively a protected species under the rules Anti-retaliation provisions much broader than bounty provisions protect employees even if complaint does not result in action or employee is not entitled to an award as long as employee had a reasonable belief that a possible violation occurred, is ongoing, or is about to occur SEC s interpretation is that the whistleblower does not even need to make a report to the Commission if whistleblower is otherwise protected by Sarbanes- Oxley Moreover, Dodd-Frank gives SEC authority to bring a proceeding or an action to enforce the retaliation provisions BUT, rules only prohibit retaliation because of report to SEC; does not prohibit discipline based on underlying culpable conduct e.g., if whistleblower participated in scheme to cook the books, company can discipline whistleblower for her participation 13

15 Anti-Retaliation Provisions (continued) There has been substantial litigation as to who qualifies for this protection: Although most district courts have held that a whistleblower who makes an internal report to the company is protected so long as the information is ultimately reported to the SEC, the Fifth Circuit recently held that such second-hand reporting is insufficient and that to be protected the whistleblower must report directly to the SEC; Both the Second and Eighth Circuits have declined to address the issue in recent months. Second Circuit decided Siemens case on other grounds (i.e., foreign whistleblowers reporting foreign conduct not covered); SEC filed amicus brief urging the appeals court to find that reporting misconduct internally was sufficient to trigger anti-retaliation protections. Eighth Circuit declined to hear an interlocutory appeal finding that whistleblower provisions applied to whistleblower who only reported misconduct internally. 14

16 Anti-Retaliation: SEC Brings Its First Case Dodd-Frank specifically gives the SEC the power to bring an enforcement action against any entity that retaliates against a whistleblower. The SEC brought its first case under this power in July 2014 after a year of officials promising that such action was coming. The SEC s first retaliation case, In re Paradigm Capital Management, Inc., et anon., was against a NY hedge fund. A culpable trader reported to SEC and then told firm he had done so; Literally next day, firm removed him from trading desk, relieved him of supervisory duties, put him on leave. Then firm assigned him make work (manually reviewing trading data) and ultimately terminated him for using personal account despite previously having authorized such use. The SEC found that these actions effectively marginaliz[ed] the whistleblower; The hedge fund and individual owner settled the case and paid disgorgement and penalties of $2.2 million; it is unclear what portion of these penalties was for the underlying misconduct (prohibited principal transactions) versus the retaliation. The case highlights: the SEC s commitment to enforcing the anti-retaliation provisions; but also the difficulties a firm facing when it learns of a whistleblower (or potential whistleblower) who is also culpable in the underlying misconduct Firms must tread carefully to not punish employees for the whistleblowing, while still taking action to prevent future misconduct and discipline past misconduct. 15

17 Entities Cannot Seek to Limit Information Potential Whistleblowers Could Provide to SEC Whistleblower rules prohibit confidentiality agreements or contractual limitations designed to prevent individuals from reporting to SEC applies to both employees and third parties Limits steps companies can take to protect themselves from whistleblowers threat that third parties engaged by company such as consultants, vendors, etc. will provide information learned through engagement to SEC some plaintiffs attorneys have even suggested this means that companies cannot enforce confidentiality agreements against employees who steal documents or information from the company to provide to the SEC uncharted territory rules only exclude information obtained in violation of criminal laws, and not civil laws, and some courts have found that criminal laws are not the proper vehicle in such situation SEC is actively hostile to any attempts to use NDAs or severance agreements contingent on not providing information to regulators like the SEC. SEC received a petition this summer to make a rule prohibiting just such conduct May also seek to litigate the validity of such an agreement under the antiretaliation provisions of Dodd-Frank 16

18 Enforcement Implications: Potential Scenarios Companies may encounter a range of scenarios Whistleblower complains to company first (internal report) Whistleblower complains to company and SEC simultaneously Whistleblower complains only to SEC 17

19 Enforcement Implications: Internal Report 120-day look back increases pressure to investigate quickly and may change and complicate calculus for deciding whether and when to report a whistleblower complaint to the SEC In most situations, company will want to report within 120-day period where complaint has merit and certain or near-certain that whistleblower will go to SEC better for SEC to learn of conduct from company than from whistleblower permits company to control and define the issues, rather than playing catch up if whistleblower gets to SEC first company may be eligible for self-reporting credit under SEC s cooperation guidelines This means that as soon as company receives report, must aggressively, quickly, and thoroughly investigate allegations quickly understand conduct and get ahead of whistleblower 18

20 Enforcement Implications: Internal Report (continued) In some situations company will want to report well before expiration of 120-day period issues to consider gravity and materiality of allegations whether senior management and/or board members are the subject of the allegation degree to which initial findings are problematic Company will also want to report early where there are signs that the whistleblower is headed to the SEC But company may not want to report when it believes complaint to be entirely without merit (or to relate to a matter outside the federal securities laws) if SEC inundated with self-reports, risk that value of self-reporting will decrease but company should fully document the nature and scope of investigation and be prepared to walk staff through issues if they do come calling 19

21 Enforcement Implications: Whistleblower Goes Directly To SEC Adopting Release says SEC will continue general practice of notifying companies about complaint and allowing them to investigate and report back in deciding whether to permit company to self-investigate, SEC says will consider nature of alleged conduct, level at which conduct occurred, and company s existing culture related to corporate governance SEC has also said that it will also consider what role, if any, internal compliance had in bringing the information to management s or the Commission s attention thus, SEC unlikely to permit company to self-investigate where whistleblower tells SEC brought matter to attention of CLO, CCO or audit committee and they failed to take action So, should take steps to avoid these situations by encouraging internal reporting fully examining reports and documenting reasons for closure/resolution Paradigm case highlights the difficulties faced by culpable whistleblowers who may need to be suspended or have their duties restricted to prevent further violations, but such discipline may be treated as retaliation by the Commission. 20

22 SEC Has Great Discretion in Applying Whistleblower Rules Many discretionary areas: amount of award whether to aggregate actions; what are related actions dividing award among multiple whistleblowers potential increase in award where whistleblower first reports internally potential increase in award because of expanded company investigation amount of award where whistleblower is culpable when to permit attorneys or compliance/audit personnel, etc., to be whistleblowers whether to permit companies to self-investigate whether to give credit for self-reporting where company initially alerted to conduct by an internal report whether to exercise authority to bring actions to enforce anti-retaliation provisions of rules whether and to what extent SEC will utilize stolen information or data that was otherwise obtained improperly 21

23 Strategy: What to do Now Reexamine whistleblower policies and procedures many policies adopted after Sarbanes-Oxley were limited to accounting, internal control and auditing matters within the audit committee s purview consider broadening to cover all violations of the federal securities laws ensure policies emphasize the value the company places on employees coming forward, and that policies are easy to understand and use policies can mention SEC program s incentives for internal reporting but should avoid explicitly or implicitly discouraging individuals from reporting directly to SEC consider requiring employees to periodically complete and sign certifications as to their knowledge of unethical or unlawful conduct at the company Ensure employees know about the company s whistleblower program publicize whistleblower program/hotline through training sessions, s, internal memos, posters, and employee handbook educate employees about anti-retaliation provisions be prepared to answer questions from employees about company and SEC programs consider permitting anonymous reporting from employees 22

24 Strategy: What to do Now (continued) Review and strengthen existing procedures to prevent retaliation or the appearance of retaliation performance management or disciplinary action against a whistleblower should first be reviewed by HR and Legal involve HR and Legal in decisions concerning compensation, performance reviews and promotion to ensure that whistleblowers do not have any legitimate claim that they are being treated less favorably set up a direct line of communication between whistleblowers and HR so that whistleblowers can flag situations where they feel they are being treated inappropriately Review and strengthen existing procedures for logging, evaluating, investigating, signing off and, where appropriate, responding to complainants or the disposition of complaints. Document the involvement of the audit committee or board where warranted do not apply a materiality filter in assessing the merits of a complaint ensure that all tips are fully vetted and none slip through the cracks be careful when dismissing whistleblower complaints that may appear on the surface to more clearly implicate HR or other concerns 23

25 Strategy: What to do Now (continued) Take a holistic approach to internal compliance under the board s oversight re-examine compliance programs in important substantive areas, such as FCPA, that can be the subject of whistleblowing re-examine policies and processes at regular intervals, with results reported to the appropriate board committee or full board Consider cultural measures to encourage internal reporting thoroughly investigate any complaints appoint a chief compliance officer regularly communicate with and provide meaningful training for employees about internal compliance policies and procedures and complaint mechanisms, with special training for supervisors have the board, CEO and other top management make it a priority to communicate the seriousness with which they regard compliance and the importance they place on employees coming forward with concerns 24