SEC Adopts New Rules that Require the SEC to Pay Awards to Certain Whistleblowers

 

June 8, 2011

 

On May 25, 2011, the SEC adopted a new regulation, Regulation 21F, under Section 21F of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), to establish a whistleblower award program.  The new rules implement Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).

 

Under the new rules, the SEC is required to pay an award to eligible whistleblowers that voluntarily provide the SEC with original information about a violation of the federal securities laws that leads to a successful enforcement action which results in $1 million or more in monetary sanctions. 

 

Section 21F of the Exchange Act prohibits an employer from retaliating against an employee for, among other things, providing information to the SEC or initiating, testifying in, or assisting in any investigation or SEC enforcement action based on information tipped to the SEC. The protections apply whether or not the whistleblower is entitled to an award under the statute and related regulations.

 

A whistleblower may be able to receive between 10% and 30% of any monetary sanctions collected because of the information tipped to the SEC. 

 

The rules have been adopted substantially as proposed by the SEC.   

The new rules do not include a requirement that a whistleblower report internally first before submitting information to the SEC. However, the rule does include certain incentives for a whistleblower that uses a company’s internal compliance and reporting system.

 

Also, the final rules include a 120 day “look back” period.  This period extends the time for a whistleblower to report information to the SEC after first reporting internally and still be treated as if he had reported to the SEC at the earlier reporting date.

 

Overview of New Award Program Rules

 

Definition of Whistleblower

 

The new rules define a whistleblower as an individual who provides the SEC with original information relating to a possible violation of the federal securities laws (or a rule or regulation promulgated by the SEC) that has occurred, is ongoing, or is about to occur.  An individual who submits information that relates only to a state law or foreign law violation would not satisfy the whistleblower definition.

 

The information is required to be submitted in accordance with the SEC’s newly adopted procedures.

 

For purposes of the anti-retaliation protections of Section 21F, an individual is a whistleblower if he possesses a reasonable beliefthat the information he is providing relates to a possible securities law violation that has occurred, is ongoing, or is about to occur and he provides the information in the manner described in Section 21F(h)(1)(A).  The SEC stated in the adopting release that “the “reasonable belief” standard requires that the employee hold a subjectively genuine belief that the information demonstrates a possible violation, and that this belief is one that a similarly situated employee might reasonably possess.”

 

The anti-retaliation protections cover employees of public companies, subsidiaries whose financial information is included in the consolidated financial statements of public companies, and nationally recognized statistical rating organizations when these employees report to either a federal regulatory or law enforcement agency, any member of Congress or committee of Congress, or a person with supervisory authority over the employee or such other person working for the employer who has authority to investigate, discover, or terminate misconduct.  The protections apply whether or not the whistleblower is entitled to an award. 

 

Retaliation by an employer may be grounds for a SEC enforcement action under Section 21F.

 

Payment of Awards

 

Subject to certain eligibility requirements, the SEC is required to pay an award to a whistleblower that voluntarily provided the SEC with original information that leads to the successful enforcement by the SEC of a federal court or administrative action in which the SEC obtains monetary sanction totaling more than $1 million.

 

The SEC will also pay an award based on an amount collected in certain related actions. A related action is one that is brought by the Attorney-General of the U.S., a regulatory agency or self-regulatory organization, a state attorney-general in a criminal case, and is based on the same original information the whistleblower provided to the SEC and led to the SEC obtaining monetary sanctions of more than $1 million.

 

Voluntary Submission of Information

 

A submission is made voluntarily if it is provided before a request, enquiry or demand that relates to the subject matter of the submission is directed to the whistleblower or his attorney by the SEC, in connection with a PCAOB or other self-regulatory agency investigation, inspection or examination, or in connection with a Congressional, other federal government, or state attorney-general or securities regulatory authority investigation. 

 

Accordingly, a submission would not be voluntary if the whistleblower was contacted first by the SEC or one of the authorities even if not compelled by subpoena or other applicable law.  However, a submission will be voluntary if provided after being contacted first in connection with an entity’s internal investigation. 

 

The SEC stated in the adopting release that a “determination of whether an inquiry “relates to the subject matter” of a whistleblower’s submission will depend on the nature and scope of the inquiry and on the facts and circumstances of each case.”  However, even if the submission provides more information than was specifically requested, if the submission only describes additional instances of the same or similar conduct, provides additional details or describes other conduct that is closely related as part of a single scheme, then the SEC stated that the information will not be deemed voluntary.  Unrelated violations could still be deemed voluntary.

 

The SEC did not adopt a provision included in its proposed rules that would have treated a request of an employer as directed at all of its employees.  Thus only a request directed to the employee by the SEC or other covered regulatory agency would preclude that individual from subsequently being deemed to make a voluntary submission.

Further, the submission will not be considered voluntary if the whistleblower is under a pre-existing legal or contractual duty to report the information to the SEC or other authority designated in the rule.

 

Original Information

 

Under the rules, the information submitted to the SEC by a whistleblower must be original information. 

 

Original information is information provided for the first time after July 21, 2010, that is derived from a whistleblower’s:

  • independent knowledge or independent analysis

  • that is not already known to the SEC from any source unless the whistleblower is the original source

  • not exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report, hearing, audit, or investigation, or from the news media unless the whistleblower is the source of the information

 

Independent Knowledge and Independent Analysis

 

Independent knowledge is defined as factual information in the whistleblower’s possession that is not derived from publicly available information.

Independent analysis is defined as the whistleblower’s own analysis, whether done alone or in combination with others.

 

Exclusions

 

Subject to certain exceptions, independent information and independent analysis will not include information furnished by certain persons under certain circumstances.

 

Information will not be deemed derived from independent knowledge or independent analysis if:

  • the whistleblower obtained the information through a communication that was subject to attorney client privilege, unless disclosure would be permitted under the SEC’s attorney conduct rule, applicable state law, or bar ethics rules or if the privilege has been waived

  • the whistleblower obtained the information in connection with the legal representation of a client on whose behalf the whistleblower, his employer or firm is providing services, and he seeks to use the information to make a whistleblower submission for his own benefit unless disclosure would be permitted under the SEC’s attorney conduct rule, applicable state law, or bar ethics rules or if the privilege has been waived

  • the whistleblower obtained the information by a means or in a manner that is determined by a U.S. court to violate applicable federal or state criminal law

 

Further, subject to certain exceptions discussed below, information will not be deemed derived from independent knowledge or independent analysis if the whistleblower is:

  • i. an officer, director, trustee or partner of an entity and another person informed him of the misconduct or if he learned the information in connection with the entity’s processes for identifying, reporting, and addressing possible violations of law

  • ii. an employee whose principal duties involve compliance or internal audit responsibilities, or was employed or associated with a firm retained to perform internal compliance or audit functions for the entity

  • iii. an employee or associate of a firm retained to conduct an inquiry or investigation into possible violations of law

  • iv. an employee or associate of a public accounting firm and he obtained the information through the performance of an engagement required of an independent public accountant under federal securities laws if the information related to a violation by the engagement client or the client’s directors, officers or other employees (violations by the independent accounting firm, however, would not be excluded)

 

Exceptions to Exclusions

 

The rules except from the excluded persons in (i) through (iv) above the following:

  • a whistleblower who has a reasonable basis to believe that disclosure to the SEC is necessary to prevent the entity from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or its investors

  • a whistleblower who has a reasonable basis to believe that the entity is engaging in conduct that will impede an investigation of the misconduct, or

  • at least 120 days have elapsed since the whistleblower provided the information to the entity’s audit committee, chief  legal or compliance officer, or his supervisor

 

Finally, information will not be deemed derived from independent knowledge or independent analysis if the whistleblower obtained the information for the submission derivatively from one of the above categories of excluded persons.

 

However, the derivative information may still be original information if the person from whom it was obtained was either not excluded from using the information under the rule by reason of an exception or the whistleblower is providing the SEC with information involving violations by the person from whom the information was obtained derivatively.

 

Eligibility for an Award

 

The following will not be eligible for an award:

  • a member, officer or employee of the SEC, the Department of Justice, an appropriate regulatory agency, self-regulatory agency, the PCAOB or any law enforcement organization or certain family members of an SEC member, officer or employee

  • a foreign government member, officer or employee

  • a person convicted of a criminal violation that is related to the SEC’s action or related action for which he would otherwise be entitled to an award

  • a person who obtained the information through an audit of the company’s financial statements

  • a person who, in connection with his submission or other dealings with the SEC or in connection with a related action, knowingly and willfully makes any false, fictitious or fraudulent statement or representation or uses any false document

 

Original Source

 

To be eligible for an award, a whistleblower must be the original source of the information submitted.

 

A whistleblower will be deemed the original source of information the SEC receives from Congress or any other authority if the whistleblower voluntarily gave such authorities the information and he establishes his status as the original source of the information to the SEC’s satisfaction. 

If the SEC already knows some information about the matter submitted from other sources, the whistleblower may still be deemed an original source if he provides information that is derived from his independent knowledge or analysis and materially adds to the information the SEC already possesses.  If the whistleblower submits information to Congress or another authority first and, within 120 days, submits the information to the SEC, the SEC will consider the date of the original submission to Congress or another authority as the date of his submission.

 

A whistleblower will be an original source of the same information the SEC obtained from another source if the information satisfies the definition of original source and the other source obtained the information from the whistleblower or his representative. 

 

Monetary Sanctions

 

Monetary sanctions include money (including penalties, disgorgement, and interest) ordered to be paid and any money deposited into a disgorgement fund or other fund pursuant to Section 308(b) of the Sarbanes-Oxley Act as a result of an SEC action or related action.

 

Amount of Award

 

The amount of an award is in the discretion of the SEC but will be at least 10% and no more than 30% of the monetary sanctions collected by the SEC and other authorities.

 

In exercising its discretion regarding the award percentage, the SEC may consider a number of factors, and may increase or decrease the award percentage based on its analysis of these factors.

 

Confidentiality of Submissions

 

Subject to certain exceptions, the SEC may not disclose information that could reasonably be expected to reveal the identity of the whistleblower. 

 

The SEC may disclose information:

  • if disclosure is required to a defendant or respondent in connection with a federal court or administrative action that the SEC files or in another public action or proceeding that is filed by an authority to which the SEC provides information

  • when the SEC determines it is necessary to accomplish the purposes of the Exchange Act and to protect investors, the SEC may provide information to the Department of Justice, an appropriate regulatory authority, a self-regulatory organization, a state attorney general in connection with a criminal investigation, any appropriate state regulatory authority, the PCAOB, or foreign securities and law enforcement authorities

 

Anonymous Submissions

 

A whistleblower may submit information to the SEC anonymously but the whistleblower must:

  • have an attorney represent him in connection with the submission of information and claim for an award

  • provide the attorney’s name and contact information to the SEC

  • provide the information in accordance with the SEC’s submission procedures

  • disclose his name to the SEC before the SEC will pay an award

 

Procedures for Submitting Original Information

 

Original information must be submitted either online through the SEC’s web site or by mailing or faxing a Form TCR (Tip, Complaint or Referral) to the SEC’s Office of Whistleblower. 

 

A whistleblower must also declare under penalty of perjury that the information is true and correct to the best of his knowledge at the time of submission.  The whistleblower may also submit the information through his attorney on an anonymous basis, as discussed above.

 

Procedures for Making a Claim

 

If an SEC action results in a monetary sanction over $1 million, the SEC’s Office of Whistleblower will publish on the SEC’s web site a Notice of Covered Action.

 

A whistleblower then has 90 days from the date of the Notice of Covered Action to file a claim for an award.

To file a claim, a Form WB-APP, Application for Award for Original Information Provided Pursuant to Section 21F of the Securities Exchange Act of 1934 must be filed within the 90 day claim period.

Conclusion

 

Companies may expect an increase in whistleblower reporting as a result of the adoption of the new rules.

 

Accordingly, companies should ensure their internal compliance procedures are able deal with alleged violations of federal securities laws in a timely and effective manner.  This may require a careful review of their existing procedures in light of the new rules. 

 

Also, companies and their human resources departments should ensure employees and outsiders are aware of their internal compliance procedures and that any alleged violations of federal securities laws and rules are promptly and effectively addressed within the scope of such procedures. 

 

Companies should review their employee anti-retaliation policies in light of the new rules to ensure they comply with the new rules and the Exchange Act.

_____________________________

For more information, please contact:

 

Neil R.E. Carr
Direct Dial: +1 202 587 2983
neil.carr@somertons.com

 

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