Wednesday, May 25, 2011

SEC Adopts Dodd-Frank Whistleblower Regulations Encouraging Use of Internal Corporate Compliance Programs

The SEC has adopted regulations implementing the whistleblower provisions of Dodd-Frank that would incentivize rather than require prospective whistleblowers to use internal company compliance programs. SEC Chair Mary Schapiro said that the final regulations strike the correct balance between encouraging whistleblowers to pursue the route of internal compliance when appropriate, while providing them the option of heading directly to the SEC. This makes sense, she reasoned, because it is the whistleblower who is in the best position to know which route is best to pursue.

Noting that offering financial incentives for whistleblowers to report appropriate concerns to internal company compliance is unprecedented, Chairman Schapiro believes that incentivizing rather than requiring internal reporting is more likely to encourage a strong internal compliance culture. The SEC rules create incentives for people to report misconduct to their employers, she added, but only if those companies have created an environment where employees feel comfortable that management will take them seriously and where they are free from possible retaliation.

Specifically, the regulations lengthen the period of time in which a whistleblower can wait before coming to the SEC, after reporting internally. Now whistleblowers will be able to get credit for the original date they reported to their company so long as they notify the SEC within 120 days. Through this provision, employees would be able to report their information internally first while preserving their place in line for a possible award from the SEC.

Moreover, the regulations clarify that the Commission, when considering the amount of an award, will consider how much a whistleblower has participated in the internal compliance process. Thus, a whistleblower’s voluntary participation in a company’s internal compliance and reporting systems is a factor that can increase the amount of an award, and, conversely, a whistleblower’s interference with internal compliance and reporting is a factor that can decrease the amount of an award.

Perhaps most significantly, the final rules would give credit to a whistleblower whose company passes the information along to the Commission even if the whistleblower does not. According to Chairman Schapiro, this could create an opportunity for a whistleblower to obtain an award through internal reporting where the whistleblower might not otherwise have qualified for an award because the information was not sufficiently specific and credible.

In other areas, the regulations clarify that whistleblower protections apply to anyone who provides information even if that information relates to a possible securities law violation, and regardless of whether it leads to a successful enforcement action. Agreeing with advocates of a more streamlined procedure for submitting information, the final regulations include a single form that a whistleblower can submit.

The final rules define a whistleblower as a person who provides information to the SEC relating to a possible violation of the securities laws that has occurred, is ongoing or is about to occur. 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.

Persons who would generally not be considered for whistleblower awards under the regulations include people who have a pre-existing legal or contractual duty to report their information to the SEC, attorneys who attempt to use information obtained from client engagements to make whistleblower claims for themselves unless disclosure of the information is permitted under SEC rules or state bar rules, people who obtain the information by means or in a manner that is determined by a federal court to violate federal or state criminal law, foreign government officials, and officers and directors who are informed by another person of allegations of misconduct, or who learn the information in connection with the company’s processes for identifying, reporting and addressing possible violations of law, such as through the company hotline.

Also not to be considered for whistleblower awards are compliance and internal audit personnel and public accountants working on SEC engagements, if the information relates to violations by the engagement client. However, compliance and internal audit personnel as well as public accountants could become whistleblowers when the whistleblower believes disclosure may prevent substantial injury to the financial
interest or property of the entity or investors, the whistleblower believes that the entity is engaging in conduct that will impede an investigation, at least 120 days have elapsed since the whistleblower reported the information to his or her supervisor or the entity’s audit committee, chief legal officer, chief compliance officer, or at least 120 days have elapsed since the whistleblower received the information, if the whistleblower received it under circumstances indicating that these people are already aware of the information.

Under the rules, a whistleblower who provides information to the Commission is protected from employment retaliation if the whistleblower possesses a reasonable belief that the information he or she is providing relates to a possible securities law violation that has occurred, is ongoing, or is about to occur. In addition, the rules make it unlawful for anyone to interfere with a whistleblower’s efforts to communicate with the SEC, including threatening to enforce a confidentiality agreement.