European Union: The EU's Whistleblowing Directive Proposal's Impact On Financial Services Firms

Last Updated: 20 July 2018
Article by Michael Huertas, Katja Michel and Markus Schrader
Most Popular Article in Germany, July 2018

QuickTake – A further step to empower individuals to act against corporate wrongdoings? Or more window dressing?

In light of recent corporate scandals uncovered by whistleblowers, such as the Panama Papers, the Luxleaks and Cambridge Analytica, the European Commission (the Commission) has decided to step in to strengthen the protection of whistleblowers. This Client Alert covers the scope, content and impact of the proposed EU rules on whistleblowing on financial services firms.

What does the Whistleblowing Directive Proposal aim to do?

On April 23, 2018, the Commission published a Communication and made a proposal of a Directive to introduce EU-wide standards, guaranteeing a high level of protection to whistleblowers within the EU when they report breaches of EU law1 (the Proposal). The Commission noted that the current protection granted to whistleblowers in Europe is fragmented with only 10 EU countries having comprehensive rules on whistleblowing in place. In the remaining countries, whistleblowing laws usually only cover specific sectors, such as financial services, or specific offenses, such as corruption.

The new rules will encompass, among others, the introduction of reporting mechanisms across all industry sectors within both private companies and public institutions. The Proposal also envisages protection against dismissal, demotion and other forms of retaliation by the employer.

All of this is supposed to strengthen whistleblowing as a valuable detection and compliance mechanism.

For financial services, an area where whistleblowing measures are more prevalent due to existing requirements, this most recent Proposal pushes the scope of coverage much further. It also delivers on regulatory and supervisory policymakers' aims that firms embed a deeper compliance and challenge culture. Whether this Proposal as a Directive, i.e. requiring implementation by individual EU Member States rather than taking effect in the form of an EU Regulation, will achieve its intended and rather transformative aims or instead merely cause firms to take some basic compliance action and update policies remains to be seen.

What the Proposal certainly does do is extend the scope of firms caught, including by virtue of a linkages created due to ownership chains i.e. private equity funds invested in underlying company may need to consider multiple potential whistleblowing exposure levels. The same applies to managers vis-à-vis underlying pension funds and/or (re-)insurers and policyholders.

Which firms are in scope of the rules?

The proposed rules will apply to all employers as far as protection against retaliation is concerned. Additionally, all enterprises with at least 50 employees or with an annual turnover or total assets of more than €10 million will be required to set up internal processes for whistleblower reporting.2 The obligation to set up such reporting mechanisms and channels for whistleblowers will apply to all financial services firms and firms vulnerable to money laundering or terrorist financing, irrespective of their size or turnover.3 Micro- and small companies will be exempted from the rules on setting a reporting mechanism. However, Member States may further extend the rules to small companies in specific sectors. In summary, the Proposal could, if left unchanged, cover a wide range of financial services firms and other market participants. This could translate into increased initial costs in terms of reviewing existing policies or drafting new policies as well as documenting how compliance with the new obligations is evidenced and how this is monitored and audited. While the new Proposal aims to reduce fragmentation by introducing minimum EU-wide standards, there is a risk that polices and processes across affected firms will remain fragmented despite increased common obligations and standards.

What type of disclosures will be covered?

The proposed legislation pertains to whistleblower protection when breaches of EU law are reported. Breaches of national measures remain a national matter. Leaving aside the potential for confusion for persons wanting to report a breach, whistleblowers will thus be entitled not only to disclose information about unlawful activities, but also about abuse that goes against the spirit of the law. The areas where EU-wide rules exist and where breaches can be reported have been listed in the Directive.4 These include:

  1. Public procurement
  2. Financial services, prevention of money laundering and terrorist financing
  3. Product safety
  4. Transport safety
  5. Protection of the environment
  6. Nuclear safety
  7. Food and feed safety, animal health and welfare
  8. Public health
  9. Consumer protection
  10. Protection of privacy and personal data, and security of network and information systems
  11. Breaches or avoidance of corporate tax avoidance
  12. EU competition law

In cases of areas such as protection of privacy and personal data, the whistleblowing rules may become a powerful tool to ensure compliance with the stringent new legislation, the General Data Protection Regulation (GDPR), in force since May 25, 2018. The proposed rules are also likely to be of relevance to and importance for stakeholders affected by the EU's proposal on collective redress (class actions) proposed in a Communication and additional documents published by the Communication on April 11, 2018.5

Overview of the requirements on firms and public authorities

According to the impact study prepared for the Commission, the highest implementation costs will be borne by medium-sized enterprises (€433.8 million, compared to an estimated €104.1 million for large organizations). Given the extent of the proposed changes described below, firms may want to preemptively engage in a dialogue on the Proposal with EU policymakers and national lawmakers, as well as take preparatory action in reviewing existing or drafting new policies in relation to people, products and procedures. Some of the key elements that the Proposal introduces includes:

1. Reporting mechanism

The Directive details the workings of a proposed reporting mechanism. Three means of reporting have been foreseen, involving recourse to different institutions:

  1. Internal reporting within companies – the first point of call for whistleblowers, however, may be omitted if the whistleblower has grounds to believe that an internal report could jeopardize subsequent investigation into the company's alleged wrongdoing6
  2. External reporting to the competent national authorities – this route opens if the company does not respond to the report in three months or the internal route has been otherwise exhausted
  3. Media reporting – a whistleblower can only turn to the media if no timely action has been taken by either the company or the public authorities, or if the breach must be disclosed immediately as there is an imminent danger to the public interest7

If the appropriate procedure is followed, including the exceptions detailed above, the Whistleblowing Directive requires that a whistleblower be granted protection. The definition of a "whistleblower" in the proposed legislation is broad and thus companies will need to handle reports not only from employees, but also shareholders, interns, volunteers and the self-employed.8 This potentially opens a whole new range of persons who may want to report. In case of small and micro-companies which are exempt from the obligation to set up a reporting mechanism, the whistleblowers may report directly to the public authorities. It is worth noting that to prevent an abuse of the reporting mechanism, penalties for malicious reporting have also been envisaged.

Companies will need to ensure the reporting channels are secure and confidential and that a response is provided within a three-month frame. Organizations must facilitate written (electronic or paper) or telephone reports, as well as the possibility to have a physical meeting. Moreover, in-scope firms are required to designate a person or a department responsible for following up on the reports. The Proposal foresees that the reporting mechanism may either be operated internally or be outsourced. Companies will also need to be able to provide information about reporting procedures.9

So why all of this now? The willingness to strengthen companies' internal procedures for reporting whistleblowing may be motivated by cases including specific regulatory investigations into the conduct of senior management and/or key function holders across a breadth of financial services firms as well as a number of instances that have seen the misuse of company's internal security channels to identify a whistleblower.

Public authorities will also need to ensure confidentiality and security of reporting and keep the reporting channels separate from other means used to communicate with the public. The external reporting mechanism should facilitate at least three ways of reporting: a written paper or electronic report, a dedicated telephone line and a physical meeting with staff.10 The authorities must have dedicated staff members for this purpose who must be trained to provide the public with information on whistleblower reporting procedures and receive and follow up on the reports. The authority also will be obliged to respond to the report within three months, as well as keep records of all the reports.11

2. Protection against retaliation

A wide range of actions have been listed as classifying as retaliation, including lay-off, demotion of positions, transfer of duties or location, a reduction of salary or hours, disciplinary or financial penalties and discrimination.12 The burden of proof will be on the employer to demonstrate that they did not act in retaliation. In cases of retaliation, the whistleblower will be entitled to remedies to prevent workplace harassment or dismissal, as well as access to free advice.

3. Protection as part of judicial proceedings

Further proposed measures include protection of the whistleblower as part of judicial proceedings. This special legal status would address cases such as the one of Antoine Deltour, who helped reveal large scale tax avoidance. Mr. Deltour was repeatedly tried in Luxembourg by his employer, for an alleged breach of law. The protection includes the right to an effective remedy and fair trial, the presumption of innocence and the right of defense. If the whistleblowers report to public authorities or media in a lawful way, they will be exempted from liability for breach of any restriction on disclosure of information imposed by contract, such as an employment agreement, or by law. Those who blow the whistle will also be entitled to legal aid from the state.

Estimated impact on business

Firms will be required to budget the cost of any required external services and assess additional staffing requirements, as well as review current policies and procedures. The policy review should cover areas such as existence of anti-retaliatory measures. The instrument puts the onus on the employers to prove that they did not apply retaliation, such as dismissal or demotion, against the whistleblower, and companies can face penalties for doing so. Therefore, it is important to determine whether anti-retaliatory measures exist, whether they are documented in the form of a policy and consistently enforced.

An internal reporting procedure for handling whistleblower reports, ensuring confidentiality (which interfaces with the GDPR) will need to be set up or made compliant with the legislation. Companies will also need to respond to whistleblowers' reports within three months which may require further compliance effort. In terms of staff requirements, a specific person or department will need to be designated to follow up on the reports.

The extent of the changes required will depend on the existence of national whistleblowing frameworks in each country, but the overall costs are likely to be higher than the Commission's cost estimate of establishing the reporting mechanism for medium sized businesses (€1,374 one-off implementation cost and €1,054.6 annual operational cost of running the internal reporting system).13

Impact assessment of the extent of application of the rules

The timelines for transposition of the Directive by EU Member States will only become clear closer to the time when the negotiations over the draft by EU institutions are concluded and the final legislative text adopted. However, there are a few factors that may increase or diminish the importance of the proposed rules.

Factors which may increase the impact of the legislation:

  1. Member State discretion in setting penalties for companies: The proposal provides that the Member States may introduce stronger protections for whistleblowers than those envisaged in the proposed Directive. The level of penalties will be set by each Member State individually, while ensuring the penalties are effective, proportionate and dissuasive.
  2. Interaction with the class-action lawsuits: The whistleblowing legislation may in the future be used in conjunction with the first Europe-wide class action system proposed by the Commission in the same month as the whistleblowing rules, details of which are covered in a separate Client Alert. In the United States, class actions often follow whistleblowers' disclosures. The calls for the EU to introduce class-action lawsuits as a tool for consumer protection became louder after various emissions scandals.

Factors which may reduce the impact of the rules:

1. Potential whistleblowers may be dissuaded from blowing the whistle:

  • The Commission's proposal lacks significant financial incentives for whistleblowers, comparable to the bounty system adopted by the Securities Exchange Commission (SEC) in the United States. The SEC's regime allows whistleblowers to claim between 10 to 30 percent of any penalty exceeding US$1 million paid as a result of an investigation based on information provided by the whistleblower. Given the press coverage on whistleblowers who brought to light the corporate scandals of recent years, including reports on their lives being destroyed, the new EU legal protection may not be enough to incentivize individuals to blow the whistle on breaches of EU law.
  • Furthermore, potential whistleblowers may be discouraged from reporting a breach as a person will only be protected if they followed the specified order of reporting channels. The burden of proof is on the whistleblower to justify the decision to bypass the internal and external reporting channels and go straight to the media. The boundary for allowing a whistleblower to have a direct recourse to the media is set quite high, although it seems that this route would be open in cases such as Luxleaks. The provision has also been criticized for limiting the freedom of speech. On the other hand, the obligation for whistleblowers to exhaust the internal reporting route may be an opportunity for a company to remedy any issues internally before the company's reputation is damaged by a press report.
  • The draft Directive does not mention the possibility of anonymous reporting which is a standard lower than currently applicable in some EU legislation, such as the Anti-Money Laundering Directive, or in jurisdictions such as Germany in respect of financial regulation where anonymity for whistleblowers is granted in the Banking Act (Kreditwesengesetz - KWG).

2. Potential conflict with existing rules: The whistleblowing proposals may potentially conflict with other legislation, such as intellectual property laws or the Directive on Trade Secrets.14 For example, France opted for a stricter implementation of the Trade Secrets Directive, removing a civil fine for retaliation against whistleblowers. Although the protections against retaliation in the whistleblowing rules are likely to offset the current lack of civil penalties for retaliation against whistleblowers by enterprises, it remains to be seen what room for discretion is granted to Member States.

Outlook and Next Steps

In conclusion, although the proposed legislation seems to be a middle ground between the existing and lacking national whistleblowing regimes, the impact of the new rules is likely to be high, not only in terms of one-off and ongoing compliance burden on firms, but also in terms of the intended social empowerment. The proposed whistleblowing law is part of a wider movement, notable in the EU proposals for class action lawsuits, to encourage individuals to take action against corporate wrongdoings.

The Proposal is still very much a proposal and would need to go through the legislative procedure at the EU level and then be transposed into national laws. Lobbying opportunities and time to prepare thus exists, and we will update at relevant stages. What however should not be discounted, is the increased strength, in light of various scandals and shortcomings, of EU and national level political support to foster greater transparency and accountability. Consequently, these pieces of legislation have the potential to introduce a long-lasting change by handing the EU citizens the legal means to first identify and report failures of corporates to abide by EU law, as well as potentially seek redress in court by way of a class-action. However, they also require a strong corporate compliance commitment and/or a stronger institutional-led enforcement culture. Even if the Proposal aims to harmonize rules in a much stronger fashion and offer a common minimum standard, the relevant cultural change may require much more to cause shifts to deep rooted views. It also very much remains to be seen if the incentives offered to potential whistleblowers to report breaches of EU law under the new Directive will be strong enough to ensure that the Directive is an effective tool.

Financial services firms, especially private equity firms that own and/or operate "real economy" enterprises, are likely to be affected. They will want to lobby, scenario plan and also take preparatory action in respect of creating new or amending existing policies and processes at various levels. This could, unless firms take an overarching top down view, lead to duplication, even if one tenet of the practical impact of this Proposal very much is that firms need to adopt a much more rounded view of their own obligations with respect to whistleblowing exposure and protections as well as those of exposures to which they are directly or indirectly connected.

Footnotes

1. Proposal for a Directive of the European Parliament and of the Council on the protection of persons reporting on breaches of Union law on 23.04.2018; Reference: COM (2018) 218.

2. Article 4(3) of the Proposal. This applies to any type of organization – whether for profit or non-profit.

3. Article 4(3)(c) of the Proposal.

4. Article 1 of the Proposal.

5. See: https://ec.europa.eu/info/sites/info/files/communication_11.4.2018.pdf and related documents.

6. Article 13(2)(e) of the Proposal.

7.Article 13(4)(b) of the Proposal.

8. A whistleblower is referred to as the "reporting person" in the Proposal and is defined on page 19, Article 3(9) of the Proposal as "a natural or legal person who reports or discloses information on breaches acquired in the context of his or her work-related activities".

9. Article 5 of the Proposal.

10. Articles 6, 7 and 11 of the Proposal.

11. Articles 9 and 11 of the Proposal.

12. The full list in Article 14 of the Proposal.

13. Page 9 of the Proposal.

14. Directive (EU) 2016/943 of the European Parliament and of the Council of June 8, 2016 on the protection of undisclosed know-how and business information (trade secrets) against their unlawful acquisition, use and disclosure.

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