The financial reforms in the Dodd-Frank Wall Street Reform and Consumer Protection Act ("the Dodd-Frank Act") passed in 2010 contain sweeping expansions to the protections and incentives given to employees who report violations of federal securities laws. In addition to enhancing existing whistleblower protections, the Act now allows individuals who provide "original information" regarding securities laws violations to the SEC or CFTC sanctions to recover up to 30% of the amount sanctioned. This "bounty" may give employees an incentive to bypass internal ethics and compliance controls which emphasize early internal reporting and remedial action, in favor of going straight to the government in order to reap a potentially lucrative financial reward.
Significantly, the Dodd-Frank Act makes a potential financial award available to individuals who provide "original information" to the SEC or CFTC concerning alleged violations of the federal securities laws. "Original information" includes information derived from the independent knowledge or analysis of a whistleblower that is not known to the SEC or CFTC from any other source, and is not exclusively derived from an allegation made in a judicial or administrative hearing; in a government report, hearing, audit, or investigation; or from the news media, unless the whistleblower is a source of the information. If the original information leads to the recovery of more than $1 million in sanctions, the SEC or CFTC must reward these whistleblowers 10-30% of the collected monetary sanctions, subject to certain restrictions.
The Dodd-Frank Act defines a "whistleblower," for purposes of the bounty provision, as an individual who provides, or two or more individuals acting jointly, who provide information relating to a violation of the securities laws to the SEC. This means that employees, agents, counterparties, and even unrelated third parties may qualify as whistleblowers. However, the risk of an employee reporting is most likely for publicly traded companies and their subsidiaries and affiliates, who are directly subject to the securities laws.
In some respects, the bounty provision provides incentives that may be at odds with the focus on internal corporate compliance mandated by the Sarbanes Oxley Act (SOX), which itself created strong anti-retaliation protections to individuals who report securities violations in the wake of Enron and other financial scandals of the early 2000s.
However, the SEC's proposed regulations implementing the Dodd-Frank Act contain provisions which continue to encourage the use of internal reporting procedures before going to the SEC. For example, the regulations clarify that certain people would generally not be considered for whistleblower awards, including people who have a preexisting legal or contractual duty to report their information; attorneys who attempt to use information obtained from client engagements to make whistleblower claims for themselves (unless disclosure is otherwise legally permitted); independent public accountants who obtain information through an engagement required under the securities laws; and people who learn about violations through a company's internal compliance program or who are in positions of responsibility for an entity, and the information is reported to them in the expectation that they will take appropriate steps to respond to the violation (unless the company does not disclose the information to the SEC within a reasonable time or acts in bad faith).
Further, the proposed regulations would treat an employee as a whistleblower under the SEC program as of the date the employee reports the information internally, provided the employee provides the same information to the SEC within 90 days. This would allow employees to report internally without losing their place in line for the SEC bounty. The regulations would also permit the SEC to consider higher percentage awards for whistleblowers who first report their information through company compliance programs.
These regulations were proposed on November 3, 2010, and were open for public comment through December 17, 2010. The SEC is now reviewing the comments. It remains to be seen whether they will strike the right balance between encouraging internal compliance and providing an incentive for employees to report to third-parties when internal controls are insufficient.
In addition to providing a financial reward for external whistleblowers, the Dodd-Frank Act enhances pre-existing remedies available under SOX to employees who are subjected to retaliation for reporting financial fraud or securities laws violations. Among other things, the Dodd-Frank Act expanded the scope of covered employees to include employees of private subsidiaries or affiliates of publicly traded companies whose financial information is included in the consolidated financial statements and expanded whistleblower protection to nationally recognized statistical rating organizations.
Further, the Dodd-Frank Act created new private rights of action for employees who are retaliated against for reporting, or participating in the investigation, or prosecution of violations of securities and commodities law, and for employees in the financial services industry have been retaliated against for engaging in certain protected activity, including but not limited to reporting violations to the Bureau of Consumer Financial Protection.
In light of the strong employee incentive to report misconduct, employers subject to federal securities laws must make certain that they have strong policies in place to ensure compliance with the securities laws. Further, employers should train their managers to be receptive and responsive to employee complaints so that employees will be more inclined to report internally before going to the SEC, and so that if an employee does report internally the issue is addressed immediately (and before the 90 day grace period, if it is ultimately adopted by the SEC).
www.franczek.comThe content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
