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News June 13, 2011 Issue

Ten Things You Need To Know About The New Whistleblower Rules

1. Whistleblowers can head straight for the SEC.

The new rules do not require a whistleblower to report an actual or possible violation internally to the company first. "This makes sense," said SEC Chairman Mary Schapiro, "because it is the whistleblower who is in the best position to know which route is best to pursue."

To be considered for an award, all a whistleblower needs to do is voluntarily provide the SEC with "original" information – not public information or information produced by investigation or another party with a duty to produce it – that leads to a successful SEC federal court or administrative action in which the SEC obtains money penalties of $1 million or more. Whistleblowers awarded for their assistance are eligible to receive 10-30 percent of the money penalties, the percentage based on, and adjusted up or down by, a number of factors.

The final rules do include some incentives for a whistleblower to avail him- or herself of a firm’s internal compliance procedures first. An award may be reduced if a whistleblower determines to circumvent an established internal compliance function, and similarly, an award may be increased if the whistleblower went to the firm first.

The final rule treats information as "original" if at the time a whistleblower reports the information internally, the information was not then known to the SEC. A whistleblower now has 120 days (over the originally proposed 90 days) after reporting to the company to bring information to the SEC. Under these circumstances the information will be treated as if it had been provided to the SEC as of the time the whistleblower first brought it to the firm’s attention. If the firm self-reports to the SEC in that period, the whistleblower is still credited with producing the information, and keeps his or her "place in line" for any award.

2. Internal compliance personnel, lawyers and auditors are not eligible whistleblowers.

Anyone with an investigative responsibility, or who learned of a violation through another person or as the result of an investigation is ineligible for any whistleblowing bounty. Both internal and external counsel and auditors are ineligible, as well as persons who learned information from an attorney-client communication, for example. Also, executive officers, directors, trustees and partners are excluded from eligibility if they are informed of misconduct or learned of it through their official responsibilities. An officer could be a whistleblower however, if the officer discovered information indicating that other members of senior management were engaged in a securities law violation.

3. "Culpable" whistleblowers can be eligible for awards.

The proposed rule would have disqualified culpable whistleblowers by requiring the information provided to be about possible or actual misconduct "by another person." The final rule removed the "by another person" qualifier to allow for a wider variety of whistleblowers, including participants in the misconduct. The SEC will take into consideration how "bad" or involved the whistleblower’s conduct was when determining whether to allow an award, and if so, the amount of any award. For example, an individual who directed or planned the misconduct would be ineligible for any award. Also, wrongdoers with prior criminal convictions and certain categories of government employees are among ineligible whistleblowers.

4. Related actions can be aggregated to reach the minimum $1 million in sanctions required for a whistleblower’s award.

An "action" under the rule is any single-captioned judicial or administrative proceeding, i.e. "In the Matter of X" plus "In the Matter of Y," etc. Multiple actions that arise from the same "nucleus of operative facts" may be aggregated to determine a whistleblower’s eligibility for an award. "While a whistleblower cannot recover twice, the final rules allow sanctions from a broader pool of actions to be used in calculating the bounty awarded," said law firm Goodwin Procter.

5. Anti-retaliation provisions protect all good-faith whistleblowers.

The proposed rule would have afforded anti-retaliation protection only to whistleblowers qualifying for an award. The SEC noted in the adopting release that this would have resulted in a gap in protection that may have had a chilling effect on prospective whistleblowers.

In the final rule, whistleblowers are protected whether they ultimately qualify for an award or not. The only requirement is that the whistleblower possessed a reasonable belief that the original information reported relates to a possible securities law violation that "has occurred, is ongoing, or is about to occur."

"Reasonable belief" is defined as:

  • specific, credible, and timely information;
  • information related to a matter already under investigation by the SEC, but that makes a "significant contribution" to the investigation; or
  • information the whistleblower provided through the employer’s internal compliance function that is later reported to the SEC by the employer that satisfies one of the first two prongs of the definition.

The SEC has enforcement authority for violations of the anti-retaliation provisions of Rule 21F-2 under the Exchange Act.

6. Rethink making that bribe – FCPA actions are expected to rise under the new whistleblower incentives.

Law firm Morgan Lewis predicted "[t]he whistleblower provisions of the Dodd-Frank Act will almost certainly result in a significant increase in the number of Foreign Corrupt Practices Act (FCPA) investigations initiated by current and former employees through allegations related to bribery of foreign officials." In a client alert last month, the firm noted that some of the SEC’s highest recoveries – $77 million, $137 million, and $218 million in recent actions – have been in FCPA actions, and a 10-30 percent bounty on "those staggering amounts" will highly incentivize whistleblowers to report allegations of books and records violations of the FCPA.

7. Keep up the firm’s culture of compliance – you can incentivize whistleblowers, too.

Competition is the American way. Don’t let the SEC one-up you on teasing out possible violations that may be flying under the radar of your compliance scheme. Let it be known as part of your compliance program that you’ve got a good deal for whistleblowers, too. Remind them how many years it may take before an SEC or court action is concluded, and that you’re more interested in nipping a problem in the bud for an attractive bonus than paying a $1 million-plus fine for problems you weren’t aware you had. "Companies will want to consider how to encourage prompt internal reporting by whistleblowers," said Goodwin Procter.

8. Submitting whistleblower tips is user-friendly.

The SEC has made it easy for whistleblowers to provide the staff with information by setting up an online form available on the SEC’s website. Prospective whistleblowers can link to the form directly from the SEC homepage. More complete information about the whistleblower program can be found under the Division of Enforcement area of the website at "Office of the Whistleblower."

9. Approval for the whistleblower rules squeaked by on a 3-2 party line approval.

SEC Commissioners Kathleen Casey and Troy Paredes used phrases like "materially suffers" and "missed an opportunity" to describe the newly adopted whistleblower rules. They were deeply concerned, circumspect, fearful of and disappointed by the results. Casey noted that the new program "significantly underestimates the negative impact on internal compliance programs" and "significantly overestimates our capacity to effectively triage and manage whistleblower complaints."

Paredes said whistleblowers will be confused by an "overly burdensome and perplexing" process for submitting information. His strongest concern though, was that "I do not think that the final rule adequately preserves the important role that corporate compliance programs serve in ensuring that the law is complied with and that other misbehavior is deterred."

10. The new rules are effective on August 12, 2011.

You’ve got just under two months to review and make any adjustments to your compliance program.