SEC s Whistleblower Program Under the Dodd-Frank Act

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1 SEC s Whistleblower Program Under the Dodd-Frank Act 2011 Chicago Chapter Annual Conference October 17, 2011 The University of Chicago The Gleacher Center Prepared by: Robert J. Wild Katten Muchin Rosenman LLP robert.wild@kattenlaw.com

2 Overview of Whistleblower Program Authorizes the SEC to pay rewards to individuals who voluntarily provide the SEC with original information about a violation of the federal securities laws that leads to a successful enforcement action that results in monetary sanctions totaling more than $1 million. Total amount of the award is between 10% and 30% of monetary sanctions. Awards paid out of Investor Protection Fund (current appropriation in excess of $450 million). Rules 21F-1 21F-17 under Section 21F of the Securities Exchange Act of 1934 (Dodd-Frank Section 922) Final rules effective August 12,

3 Whistleblowers Eligible for Awards Only natural persons. The following individuals are not eligible to receive awards: SEC, DOJ, SROs (FINRA, NYSE, NASDAQ), PCAOB or foreign government employees; individuals convicted of a criminal violation related to the SEC action or a related action; individuals who obtain the information provided to the SEC through an audit of a company s financial statements; family members or someone sharing a household with an SEC employee or member; or individuals who knowingly and willfully make any false, fictitious or fraudulent statement or provide false or misleading documents in their dealings with the SEC. 2

4 Voluntarily Information provided before a request, inquiry or demand by the SEC, FINRA, an SRO, PCAOB, Congress, a state Attorney General or a securities regulatory authority in connection with an investigation, inspection or examination. Information is not voluntarily provided if the individual had a pre-existing legal or contractual duty owed to the SEC to report such information. Still voluntarily where duty to employer to report 3

5 Original Information Information is original if it is: derived from the whistleblower s independent knowledge or independent analysis; not already known by the SEC; not entirely derived from an allegation in a hearing, audit or investigation or the news media; and first provided to the SEC after July 21, 2010 (Dodd-Frank effective date). 4

6 Original Information Independent Knowledge or Independent Analysis Independent knowledge Factual information gained from whistleblower s experiences, communications and observations not public sources. Independent analysis Examination and evaluation of information (including publicly available information) done alone or with others that reveals information that is not generally known or available. 5

7 Original Information Independent Knowledge or Independent Analysis Requirement not met if information obtained: in violation of state or federal criminal law, subject to attorney-client privilege*, or in connection with legal representation of a client on whose behalf the whistleblower or the whistleblower s firm is providing services.* Except if otherwise permitted to disclose such information pursuant to state or SEC attorney conduct rules. 6

8 Original Information Independent Knowledge or Independent Analysis Attorney-Client Privilege Permitted Disclosure ABA Model Rules Model Rule 1.6(b) permits disclosure where the lawyer reasonably believes the disclosure is necessary to prevent: reasonably certain death or substantial bodily harm; the client from committing a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in which the client has used or is using the lawyer's services; and mitigate or rectify substantial injury to the financial interests or property of another that is reasonably certain to result or has resulted from the client's commission of a crime or fraud in which the client has used the lawyer's services. 7

9 Original Information Independent Knowledge or Independent Analysis Attorney-Client Privilege Permitted Disclosure ABA Model Rules Model Rule 1.13(c) permits disclosure notwithstanding Rule 1.6, but only to the extent the lawyer reasonably believes necessary to prevent substantial injury to the organization where: the highest authority that can act on behalf of the organization insists upon or fails to address in a timely and appropriate manner an action, or a refusal to act, that is clearly a violation of law, and the lawyer reasonably believes that the violation is reasonably certain to result in substantial injury to the organization 8

10 Original Information Independent Knowledge or Independent Analysis Attorney-Client Privilege Permitted Disclosure SEC Standards of Professional Conduct For Attorneys (Part 205) SEC Rule 3(d)(2) permits attorneys representing issuers of securities to disclose to the SEC confidential information related to the representation to the extent the attorney reasonably believes necessary: to prevent the issuer from committing a material violation that is likely to cause substantial injury to the financial interest or property of the issuer or investors; to prevent the issuer from committing perjury or any act that is likely to perpetrate a fraud in an SEC investigation or administrative proceeding; to rectify the consequences of a material violation by the issuer that caused, or may cause, substantial injury to the financial interest or property of the issuer or investors in which the attorney's services were used. 9

11 Original Information Independent Knowledge or Independent Analysis Requirement also not met if whistleblower obtained the information: as an officer, director, trustee or partner of an entity; as an employee of an entity or outside consultant whose primary responsibility involves compliance or internal audit responsibilities; as an employee or otherwise associated with a firm hired to conduct inquiry into possible violations of law; or as an employee or otherwise associated with a public accounting firm, if information was obtained in performance of an engagement required under the federal securities laws other than a financial statement audit. 10

12 Original Information Independent Knowledge or Independent Analysis Officers, compliance professionals and certain accountants (described in the previous slide) may be eligible whistleblowers if: such individuals had a reasonable basis to believe: disclosure was necessary to prevent the entity from engaging in conduct likely to cause substantial injury to the financial interest or property of the entity or investors; the entity would impede an investigation of the misconduct; or at least 120 days have elapsed since: the individual reported the information to appropriate individuals within the entity, or those appropriate individuals knew this information. 11

13 Leads to Successful Enforcement Requirement is satisfied if the original information reported: was sufficiently specific, credible and timely to cause the SEC to commence or reopen an investigation and the SEC brought a successful action based on information; significantly contributed to the success of an ongoing investigation; or was reported to the entity s internal whistleblower program (before or at the same time as the SEC) and the entity subsequently provided the information to the SEC and one of the two bullets above are met. Whistleblower must report the same information to the SEC within 120 days of reporting it to the entity to be eligible for an award. 12

14 Monetary Sanctions SEC must obtain monetary sanctions in excess of $1 million. Includes penalties, disgorgement and interest. Can be multiple SEC actions from common nucleus of facts Once the SEC obtains $1 million in sanctions, sanctions in actions related to same information imposed by DOJ, state attorney general or SROs may be included in calculation of award available to whistleblower. 13

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19 Compliance Program Considerations Review following components of existing compliance programs: timeliness of review and internal investigation procedures; follow-up communications with the whistleblower; reporting the matter to management and Board; and self-reporting to the SEC. Robust compliance programs and timely self-reporting to the SEC will benefit companies in negotiation and resolution of SEC actions. Assess employee education about internal hotlines and retaliation protections to encourage internal reporting. Review HR policies for whistleblower employees. 18

20 Resources Final rule: SEC Chairman Opening Statement: SEC's whistleblower reporting site: Society of Corporate Secretaries & Governance Professionals SEC comment letter: Katten client advisory: Best Buy Video: Story of a Vendor Fraud Whistleblower 19