New SEC Whistleblower Rules Effective Today

August 12, 2011

The new rules implementing the SEC whistleblower program under the Dodd-Frank Act (Section 21F of the Securities Exchange Act of 1934 (the “Rules”)) become effective today, August 12, 2011. The Rules are intended to incentivize individuals to report misconduct to the SEC to assist investigations of possible securities law violations, regardless of whether the violation involves a public or privately held company, or an entity that is registered with the SEC. Under the Rules, individuals who voluntarily provide the SEC with original information about possible federal securities law violations that leads to a successful enforcement action in which the SEC recovers monetary sanctions of more than $1 million are entitled to receive an award of between ten and thirty percent of the sanctions collected by the SEC.

The Rules, among other things, address the role of internal compliance programs; whistleblower status for compliance professionals, directors, auditors and attorneys; and protections for whistleblowers against retaliation by their employers.

Internal reporting encouraged but not required. The Rules are expressly designed to encourage individuals to report possible securities law violations to the SEC, and do not require that whistleblowers first report possible violations through a company’s internal compliance program. In the adopting release, the SEC, however, recognized the valuable role internal compliance programs play in fraud prevention, and the Rules include certain incentives intended to encourage whistleblowers to initially report possible violations internally, including:

  • if a whistleblower reports a possible violation internally and the company then reports the possible violation to the SEC, the whistleblower receives credit, not only for the original information reported, but also for any information established by the company’s investigation;
  • if a whistleblower initially reports internally a possible violation, and reports the same information to the SEC within 120 days, the whistleblower will be deemed to have reported the potential violation to the SEC as of the date of the internal report; and
  • cooperating with a company’s internal compliance program is a factor that may increase the amount of a whistleblower award (and interfering with a company’s internal compliance process may decrease the size of an award).

Complaints by compliance professionals, directors, auditors and attorneys. The Rules generally exclude certain individuals from whistleblower awards to ensure that those most responsible for a company’s compliance lack an incentive to promote their own interests at the expense of the company’s interests. In that regard, the following individuals are generally not eligible for an award under the Rules:

  • employees who are principally involved in compliance and internal audit;
  • officers, directors, trustees and partners who learn about possible violations through another person or through the company’s internal reporting process; and
  • public auditors who learn of potential violations in the course of an engagement.

These persons, however, may report possible violations to the SEC and be eligible to receive a whistleblower award if:

  • they reasonably believe that disclosure is necessary to prevent the company from causing substantial injury to the property or financial interests of the company or its investors;
  • they reasonably believe that the company is impeding an investigation of the misconduct; or
  • at least 120 days have passed since they initially reported the information internally.

Attorneys (including in-house counsel) who learn information about possible violations through an attorney-client communication are also generally not eligible for an award under the Rules, unless disclosure is permitted under applicable SEC or ethics rules (e.g., by waiver, where disclosure is necessary to prevent a crime).

Protection for whistleblowers against retaliation. The Rules strengthen protections for whistleblowers against retaliation from their employers, even if their tip relates only to “possible” violations and regardless of whether there is a successful SEC enforcement action. The Rules create an express private right of action for whistleblowers against employers who retaliate against them with remedies including reinstatement and two times back pay. The anti-retaliation provisions of the Rules protect only those who report the possible violations to the SEC, and do not apply to employees who only report possible violations internally.

Client considerations. While the Rules prevent any person from interfering with a whistleblower report to the SEC, including by threatening to enforce a confidentiality agreement, there are steps that a company should consider to encourage persons to report possible securities law violations internally rather than report the violations in the first instance to the SEC, including:

  • Review internal reporting and compliance policies to evaluate their effectiveness. If whistleblowers perceive the company’s internal processes to be ineffective, they are more likely to bypass internal reporting and report possible violations directly to the SEC.
  • Consider adopting policies that provide employees who report internally with the protections they are afforded if they report possible violations to the SEC, including confidentiality and assurances against retaliation.

In terms of protecting against complaints of impermissible retaliation against a whistleblower, a company should take steps to inform its human resources personnel of the anti-retaliation provisions under the Rules, and ensure that its employment policies and codes of conduct are consistent with the Rules. The SEC has made clear that disciplining or terminating a whistleblower for reasons independent of their whistleblowing activities is permitted. Taking such action against a whistleblower, even for reasons unrelated and independent from their whistleblowing activity, however, is risky. In order to mitigate that risk, it is important to maintain clear, contemporaneous written records of poor performance or disciplinary problems so if an adverse employment action against a whistleblower is challenged, the company can establish a basis for the action taken separate and apart from the whistleblowing activity.

If you have any questions concerning this, please contact your primary attorney at Seward & Kissel LLP.