SEC Issues Final Rules Implementing the Dodd-Frank Whistleblower Provisions SUMMARY On May 25, 2011, the Securities and Exchange Commission voted 3 to 2 to approve the final rules implementing the whistleblower provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 1 In November 2010, the SEC issued proposed rules and solicited comments, resulting in extensive submissions from the corporate community and whistleblower advocacy groups. One of the principal subjects addressed by the public commentary was whether the SEC should require that a whistleblower first make a report through internal corporate compliance channels in order to be eligible for a monetary award. In response to the comments, the SEC made a number of revisions to the proposed rules, including changes designed to encourage internal reporting. Discussed below are the major substantive points. KEY PROVISIONS OF THE WHISTLEBLOWER PROGRAM Section 922 of Dodd-Frank requires that the SEC and/or CFTC provide cash awards to whistleblowers who voluntarily supply the Commission with original information leading to a judicial or administrative action (or settlement of such an action) in which the agency obtains monetary sanctions exceeding $1 million. Whistleblowers are eligible for a cash award of not less than 10 and up to 30 percent of the monetary sanctions. To be eligible for the cash award however, the whistleblower must provide information that is derived from the whistleblower s independent knowledge or independent analysis and is not already known to the government from any other source. In addition, Dodd-Frank prohibits retaliation against a whistleblower and creates a federal cause of action under which a whistleblower who experiences retaliation can sue his or her employer for reinstatement, back pay with interest and damages. 2 New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com
CHANGES MADE TO THE PROPOSED RULES In November 2010, acting pursuant to the mandate provided by Dodd-Frank, the SEC issued proposed rules for the whistleblower program. Those rules were met with substantial criticism from the business community and, in response, the SEC made a number of revisions. Definition of a Whistleblower The proposed rules defined a whistleblower as an individual who provides information to the SEC relating to a potential violation of the securities laws. The SEC final rules define a whistleblower as an individual who provides information to the SEC about a possible violation of the federal securities laws that has occurred, is ongoing or is about to occur. According to the SEC, these changes were intended to make clear that only information relating to federal securities violations qualify and that information about future violations may qualify. Under the final rules, the violation need not be material, probable or even likely; rather it is sufficient if the information has a facially plausible relationship to a securities law violation. Additionally, unlike the proposed rules, the final rules require that the whistleblower possess a reasonable belief that his or her employer is violating federal securities laws in order to receive protection from retaliation. Use of Internal Compliance Programs Not Required Under the proposed rules, whistleblowers were not required to report through internal corporate compliance channels in order to be eligible for an award. Despite assertions from the corporate community that this would greatly undermine internal compliance programs, the final rules do not condition whistleblower eligibility on initial internal reporting by the employee. Nonetheless, the final rules do appear to strengthen incentives for first reporting internally. For example, under the final rules: voluntary participation in an internal compliance program can lead to an increased award, while interference with a company s internal compliance program can result in a decreased award. the time for a whistleblower to report to the SEC after first reporting internally and still be treated as if he or she had reported to the SEC on the date of the original internal disclosure is extended from 90 days to 120 days. if the whistleblower reports information through the company s internal compliance program, and if the company subsequently reports information to the SEC that leads to a successful SEC action, the original whistleblower is credited with the report and any resulting award. Under this provision, all the information provided by the company to the SEC will be attributed to the whistleblower, which means that the whistleblower may obtain a greater award based on any additional information obtained by the company in its internal investigation. Aggregation of Smaller Actions to Meet $1 Million Threshold Permitted Under the proposed rules, awards were to be available only when the SEC successfully brought a single judicial or administrative action in which it obtained monetary sanctions of more than $1 million. Under the -2-
final rules, the SEC will aggregate two or more smaller actions that arise from the same nucleus of operative facts, making whistleblower awards available in more cases. Exclusion from Award Eligibility of Certain Persons Narrowed The proposed rules excluded a number of persons from award eligibility by providing that officers, directors and those with legal, audit and compliance responsibilities were ineligible for whistleblower status unless the company did not disclose the alleged misconduct in a reasonable time or acted in bad faith. The final rules broaden the circumstances under which senior officials will be eligible to receive awards by providing that officers, directors, auditors or compliance personnel are eligible for whistleblower awards if: they reasonably believe that disclosure to the SEC is necessary to prevent the company from engaging in conduct that is likely to cause substantial financial injury to the company or the investors; they reasonably believe that the company is engaging in conduct that will impede an investigation of the misconduct; or at least 120 days have passed since the whistleblower made an internal report or since the whistleblower received the information at a time when it was already known internally and the company has not yet made its own disclosure. The final rules do not expand the restrictions on awards to culpable parties, as many commentators had urged. Nonetheless, like the proposed rules, the final rules state that the SEC will not pay whistleblowers awards that are based on monetary sanctions that such individuals themselves pay in the resulting SEC action, or where the awards are based substantially on conduct that the whistleblower directed, planned, or initiated. Notably, the final rules also provide that information acquired through a communication subject to attorney-client privilege or as a result of legal representation may not form the basis for an award unless disclosure of the information would be permitted by an attorney under the SEC s attorney conduct or state ethics rules. EFFECTIVE DATE The SEC s final rules will become effective on July 25, 2011, 60 days after their publication in the Federal Register. Because the Dodd-Frank whistleblower program has been in effect since Congress s adoption in July 2010, however, whistleblowers may already benefit from the general rights provided by the provisions. IMPLICATIONS The SEC has already reported an increase in the number and quality of reports it has received from whistleblowers, no doubt resulting at least in part from the incentives provided by Dodd-Frank. A rise in -3-
the number of investigations of potential violations of the Foreign Corrupt Practices Act appears particularly likely given the high recoveries associated with these cases and the corresponding incentives for would-be whistleblowers. Given this potential for increased enforcement activity, and the new incentives and protections introduced by the final rules, it is increasingly important for companies to ensure that their compliance programs (1) adequately deter misconduct, (2) promote internal reporting of potential wrongdoing, and (3) provide for the prompt investigation and remediation of any indications of potential wrongdoing. On May 4, 2011, Congressman Michael Grimm (R-NY) introduced proposed legislation that, if adopted, would place further restrictions on the eligibility of compliance officers to participate in recoveries, require whistleblowers to report misconduct internally, and prohibit contingency fee arrangements with attorneys representing whistleblowers. Accordingly, the SEC s final rules may turn out not to be the last word on the Dodd-Frank whistleblower provisions. * * * ENDNOTES 1 2 SEC Rel. 34-64545, Implementation of the of Section 21F of the Securities Exchange Act of 1934 (May 25, 2011), http://www.sec.gov/rules/final/2011/34-64545.pdf. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 922 (2010). Copyright Sullivan & Cromwell LLP 2011-4-
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