Sunday, May 22, 2011

Senator Grassley Says SEC Dodd-Frank Whistleblower Proposals Are Overbroad; Urges SEC to Follow IRS Model in Crafting Whistleblower Office

Ahead of the SEC’s imminent adoption of whistleblower regulations mandated by Dodd-Frank, a key Senate author of many different whistleblower protection statutes said that the draft regulations are overly complex and overly restrictive and emphasize internal compliance over accuracy. In a letter to SEC Chair Mary Schapiro, Senator Charles Grassley (R-Iowa) also noted that the proposed whistleblower regulations perpetuate an environment hostile to whistleblowers by failing to provide any guidance to prevent retaliation against employees who speak up. Senator Grassley, the Ranking Member on the Judiciary Committee, urged Chairman Schapiro to use the time left before releasing final rules to make sure the SEC whistleblower program is as strong as possible and complies with what Congress intended for whistleblowers with the Dodd-Frank Act. He suggested that the SEC whistleblower office and structure be modeled on the one Congress created for the IRS.

Senator Grassley was involved in developing the SEC whistleblower provisions that are part of the Dodd-Frank Act. He has authored numerous whistleblower protection statutes, including the 1986 and 2009 amendments to the False Claims Act, the 2006 amendments to the Internal Revenue Service whistleblower program, and the Sarbanes-Oxley whistleblower protections for employees of publicly traded companies. Senator Grassley said he also has seen other federal agencies struggle to implement strong whistleblower provisions.

The most recent example is the Internal Revenue Service, which ultimately was able to ensure the independence of a new whistleblower protection director who consolidates all tips and is able to prevent enforcement personnel from invalidating individual whistleblower claims. The whistleblower program mandated by Section 922 of Dodd-Frank is modeled on the IRS whistleblower program enacted in 2006. As the author of the 2006 IRS law, Senator Grassley believes that the reformed SEC whistleblower program will increase the SEC’s enforcement power. But he is concerned that the proposed regulations for implementing the Dodd-Frank whistleblower provisions will hinder a successful program.

In his view, the SEC proposal creates procedures for submitting an award and claiming an award that are overly complex, unduly burdensome, and include undefined terms that are vague or overbroad. Once a whistleblower has provided information to the SEC, said the Senator, they should not be have to monitor SEC actions related to that information. For example, a whistleblower should not have to file a separate claim for an award after the SEC issues a final order on a related action. While the IRS is significantly bound by taxpayer privacy laws when engaging in communications with whistleblowers, noted the Senator, the SEC is not similarly bound and should be maximizing outreach to whistleblowers, especially regarding the payment of awards.

More broadly, Senator Grassley is also concerned about the potential operation and possible lack of independence of the SEC’s new whistleblower office. He urged the SEC to consult with the IRS on how to best ensure the independence of the SEC’s whistleblower. Senator Grassley wrote the statute creating a separate, independent whistleblower office at the IRS, which now serves as the central repository of all whistleblower claims and the director, who reports to the IRS Commissioner, serves as the traffic cop for the agency, with consolidated intake of all claims and is responsible for the disposition of each claim.

Given the IRS success with this arrangement, the Senator urged the SEC to follow suit and ensure the independence of the new whistleblower director by a direct chain command to the SEC Chair. The SEC whistleblower director should also be consolidating all tips regardless of whether they are received through the new procedures, website or hotline.

Section 922 defines original information as, among other things, information derived from independent knowledge or analysis of a whistleblower. Senator Grassley is troubled by the proposal that the SEC will not consider information to be derived from independent knowledge or analysis if the knowledge was obtained or was based on seven different proposed exemptions which, in his view, constrain the applicability of Dodd-Frank whistleblower reforms by creating a non-statutory basis for denying an award.

Two of the most problematic of the proposed exemptions would preclude a whistleblower from eligibility for an award if the information provided is derived from communications subject to the attorney-client privilege or information learned from legal representation. According to Senator Grassley, this would effectively exclude attorneys from acting as whistleblowers unless the information is independently obtained outside of their employment. These exemptions are overbroad, he said, and would significantly limit the information the SEC will receive from an entire class of prospective whistleblowers.

The attorney-client privilege exemption may lead to an increase is the amount of communications that are copied to in-house counsel just for the purpose of preserving an argument that they could be protected by the attorney-client privilege which, explained the Senator, could limit the information that the SEC could receive as a source to cut off fraud. The IRS whistleblower program excludes the use of attorney-client information in many circumstances, said the Senator, but it does not include a blanket exclusion of these communications as the basis for an award. The Senator urged the SEC to adopt a more limited exemption excluding individual evidence that is privileged and not simply precluding recovery should part of the submission incorporate a privileged document.

The exemption for information arising from legal representation is similarly overbroad. This exemption would preclude a whistleblower from recovering an award for information derived from legal representation either between a client that has retained an individual attorney or any other member of the retained law firm. Excluding all the firm’s attorneys who may not have knowledge of the client limits potential sources of information.

Another troubling proposed exemption provides that information would not qualify as independent knowledge or analysis if obtained through an audit required by the securities laws to be completed by an independent outside auditor and if it relates to a securities violation by the company or its directors, officers or employees. This exemption goes beyond Section 922(c)(2)(C ), which denies a whistleblower award to someone who gains information through the performance of an audit of financial statements required by the securities laws and for whom the submission would be contrary to Section 10A of the Exchange Act, which requires auditors to notify the audit committee or board about an illegal corporate act and, ultimately, if the company fails to act, resign or inform the SEC.

The problem with the proposed exemption, said the Senator, is that it does not contemplate an audit firm’s lack of compliance with Section 10A. While the proposal and Dodd-Frank 922(c)(2)(C) appear similar, he noted, the proposal further restricts any information obtained by an auditor acting under the securities laws. In his view, a fair reading of Section 922(c)(2)(C) would allow an employee of the audit firm to be recognized as a whistleblower and recover if the firm failed to comply with 10A, such as failing to report violations to the SEC after no remedial action was taken by the board. In that instance, the audit firm employee’s submission would no longer be contrary to the requirements of Section 10A, reasoned the Senator, who urged the SEC to allow recovery by whistleblowers in accounting firms in what he called ``this extreme situation.’’

Indeed, he continued, this is exactly the type of situation where we want information from a whistleblower, presumably where an audit firm could be working with the company to hide violations and where whistleblowers should be rewarded. He cautioned that such recoveries should be limited to extreme circumstances and should not ``open the flood gates’’ for all auditors to come forward.