1 FCPA Self-Reporting and the Effects of the Dodd-Frank Whistleblower Provisions: A New Calculus A. Introduction Prepared by Lucinda A. Low, Owen Bonheimer and William Gordon Steptoe & Johnson LLP for PLI The Foreign Corrupt Practices Act 2011 May 5, 2011 New York City 2010 brought continued high levels of FCPA enforcement. A total of 39 cases were brought by the DOJ or SEC. (For further detail about the 2010 cases, see Attachment A.) Of the 26 cases that settled in the past year, at least 8, or 31%, appear to be the result of a voluntary disclosure. The remainder are the result of a variety of factors: (1) industry sweeps or a following of leads developed in a prior case; (2) whistleblowers; (3) traditional law enforcement techniques, such as sting operations ; and (4) referrals from other authorities. (In a small number of the cases (4), it is not possible to determine from the public record how the case arose.) Voluntary disclosures of FCPA issues have been encouraged by the enforcement agencies for several years. Officials in both the prior and current administrations have highlighted the agencies intention to give significant credit for such disclosures. 1 Because of the 1 See Prepared Remarks of Alice S. Fisher, Ass t Att y Gen., U.S. Dept. of Justice, at the ABA Nat l Institute on the FCPA, Omni Shoreham Hotel, Washington, D.C. (Oct. 16, 2006) stating although nothing is off the table when you voluntarily disclose, I can tell you in unequivocal terms that you will get a real benefit ; Remarks by former SEC Enforcement Division official Richard Grime, BNA Sec. Reg. & Law Rep., Vol. 38 No. 42 (Oct. 23, 2006), at 1766 stating I don't think there's a case I'm aware of where there was a worse result because of early disclosure ; Lanny A. Breuer, Assistant Attorney General, Criminal Division, U.S. Department of Justice, Prepared Remarks to Compliance Week th Annual Conference for Corporate Financial, Legal, Risk, Audit & Compliance Officers (May 26, 2010) stating If you come forward and if you fully cooperate with our investigation, you will receive meaningful credit for having done so ; see also Memorandum from Larry D. Thompson, to Heads of Department Components and United States Attorneys, re Principles of Federal Prosecution of Business Organizations (Jan. 20, 2003) ( Thompson Memorandum ); Memorandum from Eric H. Holder, Jr., Deputy Attorney General, to All Component Heads and United States Attorneys, re Federal Prosecution of Corporations (June 16, 1999); Memorandum from Paul J. McNulty to Heads of Department components and United States Attorney, re Principles of Federal Prosecution of Business Organizations (Dec. 12, 2006) ( McNulty Memorandum ); Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission
2 degree of prosecutorial discretion present in the U.S. enforcement system, however, ranging from whether to prosecute at all, what charges to bring, and what penalty-mitigation credit to give in a negotiated resolution, it remains difficult to isolate the benefits of voluntary disclosure. This creates a lack of certainty and predictability that has made disclosure (in the sense of selfreporting to U.S. enforcement authorities) decisions often very difficult for companies. While the costs of self-reporting are fairly predictable and substantial, the benefits are not. 2 Despite these uncertainties, self-reporting is often the decision taken when a company believes the matter is going to come to the attention of the enforcement authorities sooner or later. In that case, it is often preferable for the company to be the first one in the door. However, whistleblower provisions of the 2010 financial reform legislation, while not adopted with the FCPA specifically in mind, may have profound consequences for the disclosure calculus in FCPA cases in which SEC reporting companies are involved. These provisions may also have significant implications for corporate compliance efforts and for employee relationships. While these provisions have not enhanced the predictability of benefits from making a disclosure, in many cases, they do increase the potential costs of not making one. In the section that immediately follows we briefly describe these whistleblower provisions and the SEC s proposed implementing regulations. Based on that overview, we then examine the implications of the provisions for self-reporting, compliance programs, and employee relationships more generally. B. Overview of the Dodd-Frank New Whistleblower Incentives and Protections The new whistleblower incentives and protections in the Dodd-Frank financial reform legislation of 2010 are the result of the Bernard Madoff scandal and other perceived failures by the SEC s Enforcement Division that were thought to have contributed to the financial crisis of To encourage persons with information about illegal activity to report it to the SEC, Section 922(a)-(g) of Dodd-Frank (to be codified as Securities Exchange Act Section 21F) gives a mandatory bounty of between 10 and 30 percent of collected penalties in eligible enforcement Statement on the Relationship of Cooperation to Agency Enforcement Decisions (Oct. 23, 2001), SEC Exchg. Act Rel ( Seaboard Report ); SEC Policy Statement Concerning Cooperation by Individuals in its Investigations and Related Enforcement Actions, SEC Exchg. Act Rel (Jan. 19, 2010) (adopting 17 C.F.R (a)(1)(ii), which counts timeliness of individual s report to the SEC as a factor in evaluating the individual s level of cooperation). 2 See generally Lucinda A. Low, Owen Bonheimer, David S. Lorello, The Uncertain Calculus of Voluntary Disclosures, ACI 17th Nat l Conference on the FCPA (Mar. 2007). 3 SEC Office of the Inspector General, Office of Audits, Assessment of the SEC s Bounty Program (Mar. 29, 2010) (recommending changes to the SEC bounty program in light of the Madoff scandal), available at
3 actions to qualifying whistleblowers. 4 The SEC is in the process of adopting implementing regulations; proposed regulations (hereinafter, the Proposed Regulations ) were issued November 3, Final regulations are due by April 21, 2011, but the SEC currently plans to release them early, in March Key Elements of the Provision Based on the provisions of the statute and the Proposed Regulations, to be eligible for this bounty, a whistleblower must: o voluntarily provide o to the SEC o original information o leading to a successful SEC enforcement action (administrative or judicial) o in which the total monetary sanctions exceed $1 million Qualifying Persons A qualifying whistleblower must be an individual; entities are not eligible. 8 Beyond this requirement, who qualifies is defined in the Proposed Regulations primarily by exclusions. Under Rule 21F-4(a)(3), Rule 21F-4(b)(4), and Rule 21F-8(c)(1) of the Proposed Regulations, a qualifying whistleblower cannot be: o persons who have a preexisting legal or contractual duty to report their information; o external financial statement auditors, where the information relates to a violation by the client, its directors or officers, or its employees, or where the submission 4 Exchange Act 21F(b)(1), adopted by Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L (July 21, 2010) ( Dodd-Frank Act ) 922(a). 5 See SEC Rel. No (Nov. 3, 2010), available at see also Proposed Rules for Implementing the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934; Proposed Rule, 75 Fed. Reg et seq. (Nov. 17, 2010) (official Federal Register version) ( Proposed Regulations ). Although the comment period expired December 17, 2010, the SEC has continued to receive a stream of comments, as seen at 6 Dodd-Frank Act 924(a) (setting deadline of 270 days from enactment); but see SEC Web site (indicating the adoption of final rules is planned for March 2011), available at 7 Dodd-Frank Act 922(a) (adopting Exchange Act 21F(b)(1); Proposed Regulations, 75 Fed. Reg. at Proposed Regulations, 75 Fed. Reg. at (Proposed Rule 21F-2(a)).
4 would violate the internal reporting process set out in Section 10A of the Exchange Act; o attorneys who have obtained information through privileged engagements, unless SEC or state bar rules permit disclosures; o foreign government officials; o compliance personnel or persons of responsibility within a company who receive information through reporting mechanisms, unless the company does not disclose the information to the Commission within a reasonable amount of time or acts in bad faith; o a person who is criminally convicted in connection with the conduct or who made false statements or provided false information; or o employees of certain U.S. government agencies (SEC, DoJ, Public Company Accounting Oversight Board, Comptroller of Currency, Board of Governors or Federal Reserve, Federal Deports Insurance Corporation, Office of Thrift Supervision, law enforcement organizations, and other agencies as defined in the Proposed Regulations, Rule 21F-4(f)); or o persons whose information is obtained from any of the foregoing persons. 3. Discussion of Key Elements i. Voluntary Under Rule 21F-4(a) of the Proposed Regulations, for a whistleblower submission to qualify as voluntary, the information must be provided in advance of a formal or informal request to the individual covering the information from the SEC, the U.S. Congress, any federal, state, or local law authority, any self-regulatory organization, or the Public Accounting Oversight Board. The information also must be provided in advance of any such request to the entity employing the individual (even if the request is not made to the individual directly), unless the individual provides responsive information or documents to the employer which the employer does not produce to the requesting authority in a timely manner. ii. Original Information Information must be provided after July 21, 2010, the date of enactment of Dodd-Frank; the provision is not retroactive to information that was reported earlier. Information reported must also be based on independent knowledge or analysis, and cannot from publicly available sources. 9 However, it does not have to be first-hand information. The Proposed Regulations include multiple exclusions, many paralleling who a qualifying whistleblower can be. Under these provisions (Proposed Rule 21F-4(b)(4)), original information cannot be: o Information obtained through attorney-client privileged communications (assuming the privilege has not been waived, or disclosure is permitted by relevant rules); 9 Proposed Regulations, Rule 21F-4(b)(3).
5 o Information obtained through a legal representation, thereby barring attorneys and those working for or with them, including experts and accountants, from making claim on their own behalf (although they can claim on behalf of their client); o Information received by independent auditors regarding the client or its personnel; o Information received by legal, compliance, audit, supervisory or governance personnel for purposes of causing the entity to respond or for purposes of addressing potential non-compliance with laws; this exception only applies, however, if the entity in question does not disclose the non-compliance within a reasonable period of time or the entity acts in bad faith (e.g., by destroying evidence, interfering with witnesses, hindering the internal investigation, engaging in a sham investigation); o Information secured through violation of federal or state criminal laws; or o Information obtained from anyone subject to any of the preceding exceptions (an anti-evasion rule). It is important to note that under the Proposed Regulations, the information need not be entirely new or original. Even if the SEC has some information about the matter, the originality requirement may still be deemed to be satisfied if the information provided is independent and materially adds to the information the SEC already possesses. See Proposed Rule 21F-4(b)(6). iii. Monetary Sanctions Monetary sanctions that count against the $1 million threshold, or as the basis for calculating an award to the whistleblower, cannot include monetary sanctions against whistleblowers themselves or amounts paid by companies based substantially on conduct the whistleblower directed, planned, or initiated. See Proposed Rule 21F-15. Otherwise, they can, however, include disgorgement amounts calculated based on benefits received (standard fare in SEC FCPA settlements today) as well as penalties and interest. See Proposed Rule 21F-4(e). iv. Leading to Successful Enforcement Under the Proposed Regulations, a distinction would be made between new cases and already opened cases at the SEC. As to the latter, a higher standard would prevail, whereby the information would basically have to be essential to the success of the case (effectively, a butfor test); while for the former, the test would be whether the information made a significant contribution to the successful outcome. See Proposed Rule 21F-4(c). 4. Criteria for Determining the Amount of an Award The statute specifies three criteria for determining the amount of an award (within the 10% to 30% statutory range), while the Proposed Regulations add a fourth. The three statutory criteria, set forth in Exchange Act Section 21F(c)(1)(B)(i), are: (1) the significance of the information provided to the success of the action or a related action, (2) the degree of assistance provided, and
6 (3) the programmatic interest in deterrence through awards. The statute also grants the SEC authority to proscribe additional factors. Pursuant to that authority, the fourth criterion in the Proposed Regulations is whether the award otherwise enhances the SEC s ability to enforce the federal securities laws, protect investors, and encourage submissions of high quality information by whistleblowers. See Proposed Rule 21F- 6. The SEC is allowed to determine different percentages for awards based upon SEC actions and related actions by other authorities. If more than one award is to be paid for a single action, then the SEC also will aggregate all such awards for purposes of calculating the 10% to 30% range. See Proposed Rule 21F-5. Thus the need for payment of an award to one whistleblower may reduce the amount awarded to another. 5. Confidentiality of Identity of the Whistleblower Under Exchange Act Section 21F(h)(2)(a) and Rule 21F-7 of the Proposed Regulations, the SEC would generally maintain the identity of the whistleblower in confidence. Proposed exceptions include the following: (1) when disclosure is required to a defendant or respondent in court or administrative proceedings, (2) in referrals to DoJ or certain other regulatory agencies, state criminal authorities, as well as foreign authorities; or (3) inter-agency disclosures permitted under the Privacy Act, 5 U.S.C. 552a. However, the proposed rules would permit anonymous submissions to be made through attorneys, subject to certain verification requirements on the part of the attorneys. Prior to payment of any award, however, disclosure of the whistleblower s identity to the SEC would be required. 6. The Process for Making Claims Rule 21F-9 and Rule 21F-10 of the Proposed Regulations set out a process involving the following steps: o Submission of a form (described in the Proposed Regulations as Form TCR (Tip, Complaint or Referral)) by fax, mail, or electronically through the web to the SEC s new Office of Whistleblower Protection ( Whistleblower Office ); o Submission of a second form (Form WB-DEC, Declaration Concerning Original Information) under penalty of perjury; o After the enforcement action has concluded, the Whistleblower Office will issue a public notice of the qualifying resolution; and o At that point the claim process starts; the Proposed Regulations also identify the proposed claim form (Form WB-APP). Under Proposed Rule 21F-4(b)(7), if the Form TCR is submitted within 90 days after the submission to another authority or to company compliance personnel, then, for purposes of evaluating the claim for an award, the submission to the SEC will be deemed to have been made as of the date of the submission to the other authority or company compliance personnel.
7 7. Appeal Rights The SEC has complete, unreviewable discretion as to where in the 10 to 30 percent range of mandatory awards a claim should be fixed. Its decisions whether to make any award, and to whom, are appealable, however No Guarantee of Immunity of Whistleblowers from Prosecution Whistleblowers will have no amnesty from prosecution. 11 Thus, whistleblowers who blow the whistle on their own conduct are not guaranteed immunity. However, it seems likely their disclosure could affect enforcement agencies exercise of prosecutorial discretion, including in terms of whether to prosecute the individual, what charges to bring, and to what extent to grant penalty mitigation predicated on the disclosure. 12 Moreover, because the awards are mandatory, assuming the whistleblower qualifies for an award under the criteria described above (which excludes whistleblowers who are criminally convicted), he or she may still end up receiving an award, notwithstanding their own culpability (though their own monetary sanctions would not count toward the award amount, as noted above). C. Implications of the Whistleblower Provisions 1. Impact on Corporate Compliance Programs Numerous commentators, ranging from industry coalitions, to the American Bar Association (ABA), to the U.S. Chamber of Commerce, have raised concerns that the whistleblower provisions of Section 922 of the Dodd-Frank Act may undermine companies internal reporting mechanisms, such as hotlines and the like, established as part of their compliance programs. For example, the ABA has suggested that the company s internal processes would be rendered meaningless if the employee could, without consequence from the company, gather up (and even retain) information privately and disclose it to the Commission without first disclosing it to the company and providing the company an opportunity to respond. 13 Several major multinational companies also have observed that employees may seek to hold on to information about a problem so that it could escalate by several orders of See Exchange Act Section 21F(f). Rule 21F At the same time, however, in circumstances where prosecutors believe the whistleblower is not acting in good faith, they could be motivated to criminally charge the whistleblower in order to disqualify them for an award. 13 See ABA Business Law Section, Committee on Federal Regulation of Securities, Comment Letter (Jan. 4, 2011), at 15, available at 10/s pdf.
8 magnitude to ensure that a future SEC action is above the $1 million threshold. 14 Further, the U.S. Chamber of Commerce has commented that the Proposed Regulations create a set of incentives that are skewed overwhelmingly in favor of direct reporting to the SEC 15 For example, the Chamber notes, whistleblowers and their counsel may fear that a company s early involvement in and mitigation of the matter could either eliminate or reduce any resulting award. 16 These are serious concerns. The proposed rules try to address this concern in two principal ways: first, by treating the date of reporting to the SEC as the date of internal reporting, provided the employee provides the same information to the SEC within 90 days (preserving a place in line), see Proposed Rule 21F-4(b)(7); and second, by suggesting the SEC could consider higher percentage awards to persons who first report information through effective company compliance programs. See 75 Fed. Reg. at In addition, the SEC notes that, if an employee goes directly to the SEC, the SEC still may contact the company to suggest it investigate. 18 Assuming the final rules carry these provisions forward, it remains to be seen how effective they will be in countering the strong incentive created by the statute for a whistleblower to go directly to the SEC as quickly as possible. 2. Impact on Corporate Self-Reporting The Proposed Regulations estimate that the SEC will receive 30,000 whistleblower reports each year. 75 Fed. Reg. at That would be an average of more than five reports per exchange-listed company. 19 Yet the prospect for a report to lead to an award appears to be extremely low the SEC estimates that it will only receive 117 applications for an award each year. If the prior SEC bounty program for insider trading is any guide, only slightly more than 10% of applications would lead to a bounty. As a result, one could project 12 awards per-year, as against 30,000 reports. Those odds of obtaining an award (1:2,500) are identical to the odds 14 Letter from Alcoa Inc., Celanese Corp., Citigroup, Ingersoll-Rand plc, Intel Corp., Johnson & Johnson, JP Morgan Chase & Co., Kraft Foods Inc., Pfizer Inc., Prudential Insurance Company of America, and Tyco International Ltd. (Dec. 17, 2010), at 12 (also stating that Proposed Regulations would deprive companies of the ability to act promptly in order to prevent misconduct., available at 15 U.S. Chamber of Commerce, Comment Letter (Dec. 17, 2010), at 3, available at 16 U.S. Chamber of Commerce, Supplemental Comment Letter (Feb. 15, 2011), at 3, available at 17 This is a mere suggestion in the proposing release, however, and is not proposed to be a mandatory consideration in the Proposed Regulations themselves Fed. Reg. at See GrantThornton Study, A Wake Up Call for America (Nov. 2009) at 1 (citing 5,401 listings on U.S. exchanges as of 2008).
9 winning one of 16 monetary prizes in the D.C. Lottery. 20 Even if the chance of an award is similar to the chance of winning a monetary prize in the lottery, however, that may not prevent a race to the SEC door. Unlike the lottery, there is no monetary cost to the mere filing of a whistleblower report. Thus the Dodd-Frank Act whistleblower provisions still may create a powerful incentive for companies to self-report within 90 days in any circumstance where they cannot rule out the possible presence of a whistleblower, and they have not achieved virtual certainty that there has been no potential violation of law. However, in any internal investigation, it may be difficult to rule out the possibility that any given witness would seek to become a whistleblower. Moreover, 90 days will seldom be adequate time to conduct an FCPA internal investigation. Accordingly, companies may find themselves forced to make more placeholder disclosures. Such disclosures also could be the first step in a strategy to diffuse the value of any whistleblower report, given that, as one source has put it, the [whistleblower] reports they are receiving are not the thoroughly-investigated and skillfully-presented matters that companies report as part of a voluntary disclosure. 21 In addition, there will likely be an increased need for investigators to try to come to some early assessment regarding the seriousness of alleged misconduct so as to help inform the disclosure decision, and to begin remediation. Even where the early assessment suggests there may not be a real issue, however, if a whistleblower may be lurking, a company may still decide to report the matter so as to enhance its ability to respond to, and receive cooperation credit in, any investigation that the SEC may wish to conduct and to position itself as a responsible corporate citizen. 22 Further tipping the scales in favor of such early, and even premature disclosures, is the exception for reporting by compliance personnel. By allowing compliance personnel (other than lawyers subject to attorney-client privilege) to make reports if the company does not do so within a reasonable period of time, the Proposed Rule also creates what could be perceived as a virtually mandatory disclosure requirement. Whereas there has never been a requirement that a company make a disclosure to the SEC within a reasonable period of time, the Proposed Regulations seek to make such a disclosure a requirement for the company to preserve its expectation of confidentiality of its own compliance personnel. 20 See D.C. Lottery, Di$strict Dollars, Game Information (Mar. 10, 2011) (citing overall odds of 1:2,500). 21 Alexandra Wrage, Anti-bribery Predictions for 2011, Ethisphere (Q4 2010) at Similar pressures are emerging to make placeholder disclosures to the DoJ, which has recently sought to encourage companies to make voluntary disclosures ahead of time, before the results of an internal investigation are known. See Lanny A. Breuer, Assistant Attorney General, Criminal Division, U.S. Department of Justice, Remarks at Council on Foreign Relations (May 4, 2010), available at
10 3. Other Potential Effects Besides the question of the effect on corporate compliance programs and self-reporting, the whistleblower provisions are likely to have other important effects on how companies deal with their personnel. For example, confidentiality agreements between the company and employees, which are not infrequently entered into, could run into enforcement problems. If such agreements are perceived as interfering with a company s communications with SEC, an attempt to enforce them may be prosecuted as a violation of the securities laws. For example, discipline against an employee for reporting to the SEC without reporting internally could be misconstrued as retaliation, prohibited under SOX, as discussed below. In addition, Dodd-Frank has added anti-retaliation provisions to the federal securities laws that protect employees of foreign affiliates who are part of the company s consolidated group, not just U.S. citizens, from retaliation for whistleblowing activities. (Dodd-Frank Act 922, adding Exchange Act Section 21F(h), and 929A.) To date, the SEC has not proposed any implementing regulations with respect to this provision, although the SEC has requested comment as to whether such regulations are desirable. Under the statute, an employer cannot discharge, demote, suspend, threaten, harass, or discriminate, directly or indirectly against a whistleblower in terms and conditions of employment because of lawful acts performed by him or her in providing information to the SEC under the whistleblower provisions, in testifying, or assisting in actions based on or related to information provided by the whistleblower, or in making SOX disclosures. U.S. Federal District courts will have jurisdiction over causes of action for violations of this provision, and relief shall include reinstatement with two times back pay, with interest and costs including attorney s fees. See Exchange Act Section 21F(h)(1). Employees of foreign affiliates in countries where salary scales are lower than in the United States may be the most tempted by the bounties offered by Dodd-Frank. At the same time, those same personnel may not have a clear understanding of the U.S. securities laws and may be in possession of only a limited set of facts. Given the FCPA s applicability to a wide array of business conduct, including many practices that may be entirely legitimate, the incentives of Dodd-Frank are likely to be especially pernicious in FCPA cases. 23 The plaintiffs bar has lost no time seizing the opportunity posed by the Dodd-Frank whistleblower provisions. A quick internet search for SEC whistleblower lawyer will reveal dozens of sites for plaintiff s counsel, including sites directed at foreign nationals. For example, the following Portuguese site describes the new law and exhorting whistleblowers to come forward: 23 See After Dodd-Frank, SEC Getting At Least One FCPA Tip A Day, Wall Street J. (Sept. 30, 2010), available at
11 Conclusions The Dodd-Frank whistleblower provisions make a voluntary disclosure decision under the FCPA less voluntary than ever for SEC reporting companies. While the final regulations may attempt to mitigate the perverse effects of this legislation on corporate compliance efforts, the provisions create powerful incentives that will be difficult to counteract. Now more than ever, companies need to factor whistleblower risks into their voluntary disclosure calculus when an FCPA issue arises.