Stinson Leonard Street Dodd Frank

MAKING SENSE OF DODD-FRANK

The Dodd-Frank Act has broad and deep implications that will touch every corner of financial services and multiple other industries. This site, developed and maintained by attorneys at Stinson Leonard Street, is dedicated to making sense of this complex legislation and helping businesses understand how it will affect them specifically. Our Bloggers »

Dodd-Frank

Test Your Knowledge of the Whistleblower Rules

by   |   June 2, 2011

Consider these hypothetical facts:  Joe Ledger, an accountant at HighTech Co., an exchange traded company, finds some evidence of some mysterious transactions that occurred in the fourth quarter of 2010, indicating that revenue may have been improperly inflated.  In accordance with HighTech’s policy, Joe reports this information to Pete Flyspeck, HighTech’s Chief Compliance Officer, who is not an attorney.  Pete, again in accordance with HighTech’s policies, immediately reports the information to the Chair of the Audit Committee.  The Audit Committee promptly engages outside counsel to conduct an investigation.  In the meantime, Pete did some additional checking around, and finds additional credible evidence that revenue was inflated.  Two days after getting the initial information from Joe, Pete files a whistleblower claim with the SEC, knowing that HighTech was likely to miss its earnings expectations for 2011, like it did in 2010.  The SEC commences an investigation.  A couple weeks later, Joe also files a whistleblower claim with the SEC.  The Audit Committee subsequently completes its investigation, which is far more detailed and thorough than the information Pete and Joe provided, and turns over the results to the SEC.  The SEC and HighTech subsequently agree to settle the matter, with HighTech paying $1,500,000 in civil penalties for violations of securities laws.

Are Joe and Pete both whistleblowers, entitled to collect an award from the SEC?  Well the new rules are extraordinarily complex, and it may not be possible to answer that question with definitive certainty.  But some of the guideposts to consider are clear.

Joe

Joe’s case is pretty straightforward.  Assuming Joe is not an internal auditor and excluded from being a whistleblower in many circumstances, the fact that Pete made a whistleblower claim before him is not determinative.  Joe provided “original information” to the SEC under Rule 21F-4(b)(7).  Because he reported the information internally and filed a whistleblower claim within 120 days of reporting internally, Joe’s whistleblower claim relates back to the date of first internal reporting.

On the facts, the information Joe gathered appears a bit hazy, and Joe has to surmount the hurdle that the information he provided was “sufficiently specific, credible and timely to cause the staff to commence an examination.”  Under Rule 21F-4(c)(3) however, this test is likely deemed met.  Joe reported through HighTech’s compliance procedure, duly filed a whistleblower claim within 120 days and HighTech later provided the results of the investigation to the SEC.  The way the Rule reads, since the SEC had already commenced an investigation, the internal investigation must have “significantly contributed to the success of the action,” which we assume was met.

Pete

Pete has some different shoals to navigate.  First amongst them is Pete may not meet the requirement that the information was based on his “independent knowledge” and therefore he did not provide “original information” because of his role as Chief Compliance Officer.  Pete will strenuously argue that the guilty parties inflated revenue to in an attempt to meet earnings targets in 2010, and since HighTech is currently trailing expectations, the guilty parties are likely to do the same in 2011 unless the SEC stops them.  Pete will point to an exception from the rules barring compliance officers from being whistleblowers because he had a reasonable basis to believe that disclosure of the information to the SEC is necessary to prevent the relevant entity from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or investors.  Whether this argument would succeed or not is an open question, but it may not be the most compelling reasoning.

Pete cannot claim to be the original source of the information Joe provided because of the look back rule.  Since the SEC already knows some information about the matter from Joe, Pete will have to show the information he independently provided “materially adds” to the information the SEC already possesses. 

Pete cannot tag-along on HighTech’s submission of its investigation to the SEC like Joe.  The reason is Pete did not report internally any original information he developed in connection with HighTech’s policies.  Nonetheless, that does not appear to be fatal in and of itself as the facts indicate the SEC commenced an investigation based on Pete’s report.

Who gets the money?

The above analysis addresses whether Joe and Pete are whistleblowers–not how much of a monetary reward they might receive.  The amount of the monetary award is in the discretion of the SEC, and will be at least 10% and no more than 30% of the monetary sanctions collected.  If the SEC decides to make an award to more than one whistleblower, it will determine an individual percentage for each whistleblower.  The rules set forth a list of factors the SEC will consider in determining the amount of the award.  Here Joe appears to have the upper hand since he reported to HighTech in accordance with its compliance procedures.

Follow me on Twitter – @squinlivan

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.