Pursuant to Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission (Commission) on November 3 publicly issued proposed rules — 17 CFR §§ 240.21F-1 through 240.21F-16 — for a new whistleblower program. Dodd-Frank authorized the Commission to compensate individuals who provide information about violations of the federal securities laws generally (the prior whistleblower provisions were limited to insider trading cases) from amounts recovered in enforcement actions and increased the maximum award from 10 percent to 30 percent of the monetary sanctions collected.
The proposed rules provide that, subject to certain requirements, "the Commission will pay an award or awards to one or more whistleblowers who: (1) voluntarily provide the Commission (2) with original information (3) that leads to the successful enforcement by the Commission of a federal court or administrative action (4) in which the Commission obtains monetary sanctions totaling more than $1,000,000." Proposed Rule 17 CFR (PR) §§ 240.21F-3. In its November 3, 2010 press release accompanying the proposed rules, the Commission explained the terms in PR § 240.21F-4, the component requirements as follows.
- Voluntarily provide the SEC … — In general, a whistleblower is deemed to have provided information voluntarily if the whistleblower has provided information to the Commission before the Commission, certain other government agencies, a self-regulatory organization or the Public Company Accounting Oversight Board asks for it from the individual or his employer (unless the employer fails to provide the individual’s documents).
- … with original information — Original information must be based upon the whistleblower's independent knowledge or independent analysis, not already known to the Commission and not derived exclusively from certain public sources.
- … that leads to the successful enforcement by the SEC of a federal court or administrative action — A whistleblower's information can be deemed to have led to successful enforcement in two circumstances: (1) if the information results in a new examination or investigation being opened and significantly contributes to the success of a resulting enforcement action, or (2) if the conduct was already under investigation when the information was submitted, but the information is essential to the success of the action and would not have otherwise been obtained.
- … in which the SEC obtains monetary sanctions totaling more than $1 million.
A whistleblower must be an individual person; a corporation or other entity is not eligible. And a whistleblower is entitled to the protections against retaliation by his employer provided in 15 U.S.C. 78u-6(h)(1) regardless of whether the person satisfies the requirements to qualify for an award. A person recognized by the Commission as a whistleblower within the terms of the statute and regulations is entitled to payment of 10 percent to 30 percent of the monetary sanctions that the Commission and certain other agencies collect (if there are multiple whistleblowers, the amount is to be allocated among them). Monetary sanctions include penalties, disgorgement, and interest ordered to be paid. The Commission is required to protect the identity of the whistleblower, and a whistleblower can make an anonymous submission through an attorney. The determination of whether or to whom to make an award may be appealed to a U.S. Court of Appeals. However, as long as the Commission or the agency follows the statutory mandate to award not less than 10 percent and not more than 30 percent of the monetary sanctions collected, their determination regarding the amount of an award (and the allocation among multiple whistleblowers) is not appealable. No person may impede a whistleblower from communicating directly with the Commission staff about a potential securities law violation; if a whistleblower who is a director, officer, member, agent or employee of an entity that has counsel initiates communication with the Commission relating to a potential securities law violation, the Commission staff is authorized to communicate directly with the person without seeking consent of the entity's counsel. PR §§ 240.21F-2(a) & (b), 240.21F-5, 240.21F-4(c), 240.21F-7, 240.21F-12 and 240.21F-16.
Several categories of people cannot generally be considered whistleblowers, including an attorney disclosing information subject to the attorney-client privilege; an independent public accountant disclosing information obtained through performance of an engagement required under the securities laws that relates to a violation by the engagement client or the client's directors, officers or other employees; and a person with legal, compliance, audit, supervisory, or governance responsibilities for an entity, where the information was communicated to the person with the reasonable expectation that the person would take steps to cause the entity to respond appropriately to the violation, unless the entity did not disclose the information to the Commission within a reasonable time or proceeded in bad faith. PR §§ 240.21F-4(b)(4).
One particular aspect of the proposed rules is attracting significant controversy. Even where a corporation has a well established internal compliance office that investigates allegations of wrongdoing and has a policy of voluntary disclosure to the Commission, there is nothing in the proposed rules that requires a would-be whistleblower employed by such a corporation to disclose wrongdoing to the internal compliance office before, or instead of, going to the Commission as a whistleblower. PR § 240.21F-4(b)(7) provides that a whistleblower may inform an internal compliance office of the wrongdoing and not lose his opportunity to be a compensated whistleblower, as long as he submits the information to the Commission within 90 days thereafter. But there is no requirement that he inform the corporation. This approach has been criticized as weakening internal compliance mechanisms because would-be whistleblowers might go directly to the Commission with their allegations of unlawful activities because there is no incentive to first report the wrongdoing internally. The Commission discussion of these issues at pages 25-26, 33-35 of the Preamble recognizes the issues raised by critics. It notes the following:
"[O]ur proposal not to require a whistleblower to utilize internal compliance processes does not mean that our receipt of a whistleblower complaint will lead to internal processes being bypassed. We expect that in appropriate cases, consistent with the public interest and our obligation to preserve the confidentiality of a whistleblower, our staff will, upon receiving a whistleblower complaint, contact a company, describe the nature of the allegations, and give the company an opportunity to investigate the matter and report back. The company's actions in these circumstances will be considered in accordance with the Commission's [policies]. … Thus, in this respect, we do not expect our receipt of whistleblower complaints to minimize the importance of effective company processes for addressing allegations of wrongful conduct. [FN 40 - … in order to encourage whistleblowers to utilize internal reporting processes, we expect to give credit in the calculation of award amounts to whistleblowers who utilize established internal procedures for the receipt and consideration of complaints about misconduct.]"
Also, PR § 240.21F-14 makes plain that the proposed rules do not provide amnesty to individuals who supply information to the Commission, but notes that if the Commission does determine to pursue an action against the individual it will take the individual's cooperation into consideration. And PR § 240.21F-14 provides that in calculating whether the $1 million threshold has been met and in determining any amounts that a culpable whistleblower would be entitled to receive, the Commission would exclude any monetary sanctions that the whistleblower or an entity whose liability is based substantially on the whistleblower would be obligated to pay.
The final adoption of these proposed rules or similar rules has the potential for substantially increasing the Commission's receipt of significant information regarding violations of the securities laws by public companies, and thus provide the basis for the Commission taking action against those violating the securities laws. In theory, this should help the Commission raise the level of compliance with the securities laws among public companies and decrease the harm to shareholders resulting from fraudulent activities. Only time will tell whether the promise of potential financial rewards to whistleblowers in fact brings these results. On the other hand, the lure of financial rewards may result in undermining internal corporate compliance programs as whistleblowers (who may well be attracted more to the potential financial rewards than mere correction of corporate misbehavior) choose to go directly to the Commission instead of providing information to the internal compliance offices of their companies.
As of November 10, 2010, this proposed set of rules and the preamble had not yet been scheduled for publication in the Federal Register. The Commission has invited comments to be submitted by December 17, 2010.