SEC’s Proposed Whistleblower Rules—the Good, Bad and Ugly
The SEC has published its proposed whistleblower rules, complete with almost 30 pages of forms for whistleblowers to use. Employers (and let’s not forget that this applies to all employers, public and private) have rightly been concerned about the provisions of Section 21F of the Securities Exchange Act, as set forth in Section 922 of the Dodd-Frank Act. The concern is employees will run to the SEC to report violations instead of advising the employer of the misconduct and permitting the employer to take appropriate action. It appears the proposed rules only permit an employer to cut off a whistleblower claim if the employer self reports the violation. And employees who have engaged in wrongful misconduct can collect a whistleblower award so long as they were not convicted of a related crime.
Claims Are Difficult After the SEC Requests Information from an Employer
While it is not my intention to analyze in detail every page of the 181 page release, a few points merit close examination. A good feature of the proposed rules is once the SEC commences an investigation, it is difficult for an employee to be considered a whistleblower. A whistleblower must do more than merely provide the SEC with information that is not compelled by subpoena or by other applicable law. Rather, the whistleblower or his representative (such as an attorney) must come forward with the information before receiving any formal or informal request, inquiry, or demand from the SEC staff or from any other authority described in the proposed rule about a matter to which the whistleblower’s information is relevant. A request, inquiry, or demand that is directed to an employer is also considered to be directed to employees who possess the documents or other information that is within the scope of the request to the employer. Accordingly, a subsequent whistleblower submission from any such employee will not be considered “voluntary” for purposes of the rule, and the employee will not be eligible for award consideration, unless the employer fails to provide the employee’s documents or information to the requesting authority in a timely manner.
Other provisions of the proposed rules also make it more difficult to collect a whistleblower award if the SEC has already opened an investigation, even if the SEC has not already requested information from the employer.
Compliance Counts, But Only if You Report What Your Learn to the SEC
To be eligible for a whistleblower claim, the information supplied to the SEC must be derived from an individuals “independent knowledge” or “independent analysis.” However, there is an exclusion from the proposed definition of those terms for information that is obtained from or through an entity’s legal, compliance, audit, or similar functions or processes for identifying, reporting, and addressing potential non-compliance with applicable law. However, the exclusion ceases to be applicable, with the result that an individual may be deemed to have “independent knowledge,” and therefore may become a whistleblower, if the entity does not disclose the information to the SEC within a reasonable time or if the entity proceeds in bad faith.
There is another curious part of the proposal where I have trouble connecting the dots. If all the conditions of the rule are met, the SEC must pay the whistleblower an amount between 10% and 30% of monetary sanctions collected. The proposal states the SEC will consider “higher percentage awards for whistleblowers who first report violations through their compliance programs.” This seems like an incentive for a whistleblower to both report a matter through a compliance process and then immediately to the SEC. But no relief appears to be given to employer that effectively addresses a violation it learns of through a compliance program but does not report the matter to the SEC.
It Will be Difficult for Attorneys, Auditors, Supervisors and Compliance Officers to Make Whistleblower Claims
There are several other exclusions from the definitions of “independent knowledge” or “independent analysis.” First, it will be difficult for an attorney to make a whistleblower claim. One exclusion, subject to some exceptions, is for information that was obtained through a communication that is subject to the attorney-client privilege. Another exclusion applies when a would-be whistleblower obtains information as a result of the legal representation of a client on whose behalf the whistleblower’s services, or the services of the whistleblower’s employer or firm, have been retained, and the person seeks to make a whistleblower submission for his or her own benefit. This exclusion would, for example, preclude an attorney from using information obtained in connection with the attorney’s representation of a client to make a whistleblower submission for the attorney’s own benefit. This exclusion would not be limited to information obtained through privileged communications, but would instead extend to any information obtained by the attorney in the course and as a result of representation of the client.
Likewise, there is an exclusion that applies to persons who obtain information through the performance of an engagement required under the securities laws by an independent public accountant, if that information relates to a violation by the engagement client or the client’s directors, officers or other employers.
Another exclusion operates when a person with legal, compliance, audit, supervisory, or governance responsibilities for an entity receives information about potential violations, and the information was communicated to the person with the reasonable expectation that the person would take appropriate steps to cause the entity to respond to the violation. As discussed above, the exclusion ceases to operate if the entity does not disclose the information to the SEC within a reasonable time or if the entity proceeds in bad faith.
The SEC May Make Awards to Individuals Participating in Misconduct
Proposed Rule 21F-14 provides notice that the provisions of Section 21F of the Exchange Act do not provide amnesty to individuals who provide information to the SEC relating to a violation of the securities laws. However, some whistleblowers who provide original information that significantly aids in detecting and prosecuting sophisticated securities fraud schemes may themselves be participants in the scheme who could be subject to SEC enforcement actions. These individuals will not be immune from prosecution. Rather, the SEC will analyze the unique facts and circumstances of each case in accordance with its current policies to determine whether, how much, and in what manner to credit cooperation by whistleblowers who have participated in misconduct. However, awards will not be made to persons who are convicted of a criminal violation related to the SEC action or certain other matters for which the whistleblower may be otherwise entitled to receive an award.
A Warning for Employers
Proposed Rule 21F-16(a) provides that no person may take any action to impede a whistleblower from communicating directly with the SEC staff about a potential securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement. The SEC believes the Congressional purpose underlying Section 21F of the Exchange Act is to encourage whistleblowers to report potential violations of the securities laws by providing financial incentives, prohibiting employment-related retaliation, and providing various confidentiality guarantees. Efforts to impede a whistleblower’s direct communications with SEC staff about a potential securities law violation, however, would appear to conflict with this purpose.
The SEC Can Communicate With Your Whistleblower Employees without the Consent of Your Lawyer
Proposed Rule 21F-16(b) would clarify the SEC staff’s authority to communicate directly with whistleblowers who are directors, officers, members, agents, or employees of an entity that has counsel, and who have initiated communication with the SEC related to a potential securities law violation. The proposed rule would make clear that the staff is authorized to communicate directly with these individuals without first seeking the consent of the entity’s counsel.
Next, the CFTC
The CFTC will propose its whistleblower rules on November 10, 2010.
Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.
Contact Steve Quinlivan for more information.