Monday, July 18, 2011
Navigating the Minefield of the SEC Whistleblower Program
Companies are appropriately concerned about additional enforcement actions from SEC whistleblowers. The SEC recently issued its whistleblower rules. The new rules provide for a bounty or award to eligible whistleblowers who provide: “original information;” concerning a violation of federal securities laws; which results in a successful (judicial, administrative or related) enforcement action resulting in a fine or penalty (including disgorgement) of at least $1 million. Eligible whistleblowers can receive between 10 – 30% of the monetary sanctions actually recovered. The rules themselves provide definitions and operational details for the program.
Companies need to prepare for an increased in whistleblower activity and SEC enforcement actions. Whistlesblowers can proceed on dual tracks – reporting the violation internally and to the SEC. Companies will feel an increased pressure to “voluntarily” disclose issues which the whistleblower may raise in order to preempt aggressive SEC enforcement actions. In order to increase internal reporting, companies need to offer attractive benefits to the whistleblower so that they rely on internal reporting.
Federal laws providing bounties for whistleblowers are not new. T he new rules largely track existing whistleblower rules used by the IRS. The federal false Claims Act offers rewards to person who report government fraud, waste and abuse. The IRS pays bounties to whistleblowers who report persons or entities who fail to pay federal taxes. If the government’s recovery exceeds $2 million, the IRS will pay the whistleblower 15 – 30% of the amount collected.
The SEC enforcement program has historically been very reliant on tips and information from third parties, including other federal government agencies, state and foreign government agencies, self-regulatory organizations, and private parties. There is no information as to the number of tips that the SEC receives annually, but the SEC has stated that it receives a “high volume” of tips. According to the SEC’s 2010 Report, in fiscal 2010, only 21.9% of SEC investigations were based on internally-generated “tips or prospects” for investigations.
The SEC has been very successful in securing monetary sanctions. In fiscal 2009 and 2010, the amounts of monetary sanctions ordered in SEC proceedings were $2.4 billion and $2.8 billion, respectively.
In adopting the whistleblower rules, the SEC estimated that it will receive about 30,000 “tips” concerning alleged violations of federal securities laws each year. Of those, approximately one half will include information from eligible persons. Almost half of the enforcement actions during the first half of 2011 involved monetary sanctions of $1 million or more. This high percentage of monetary awards is likely to encourage potential whistleblowers to participate in the program.
With the increase in enforcement proceedings, the SEC will probably refer many of the complaints back to the subject company for investigation with a report back to the SEC, which could lead to an enforcement action without dedicating staff resources. The SEC is likely to prioritize among the securities law violations and pursue the more serious ones, resulting in even more actions resulting over $1 million.
The SEC whistleblower rules are designed to encourage whistleblowers to report both internally and to the SEC, but to report such complaints internally. This reporting protocol will create significant pressure on companies to self-report securities law violations discovered in the course of any investigation initiated by a whistleblower.
The SEC’s rules also provide a plus-factor for an award when a whistleblower participates initially in an entity’s internal compliance procedures. In addition, a whistleblower can receive credit for information discovered by a company during an internal investigation which is eventually reported to the SEC.
The whistleblower has to wait for at least 120 days from the initial internal reporting date, unless certain circumstances exist which may permit the whistleblower to report before the expiration of 120 days. If the company self-reports to the SEC during the 120 days period, the whistleblower cannot receive a bounty. Even in cases where the company knows that the person making the internal report is subject to a 120-day waiting period, the company will be under pressure to make an investigation and if warranted, report to the SEC before the lapse of the 120-day period. However, there is an important exception to the 120 day waiting period: the 120 day waiting period does not apply if a reporting person has a reasonable basis to believe that disclosure of the information to the SEC is necessary to prevent the relevant entity from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or investors.
Companies should assume that every internal report of wrongdoing within the scope of the whistleblower rules will be followed by a report to the SEC by the whistleblower. In such a situation, companies should also assumed that, in all except for complaints that are facially frivolous or fraudulent, the SEC will eventually contact the company to ask for the results of the company’s investigation or in connection with a formal or informal investigation. Companies should plan that every complaint that is not facially frivolous or fraudulent should be treated as if the results of the internal investigation will eventually be turned over to the SEC.
Even though the whistleblower rules are designed to encourage internal reporting, they do not require an employee to report internally. Employees can report only to the SEC. From the company’s point of view, it is beneficial to the company if the complaint of wrongdoing is made internally, even if the employee dual reports. To increase the likelihood that an employee will report internally, companies are often advised to encourage employees to use the internal reporting mechanisms. The SEC noted that “[n]on-monetary incentives that often motivate individuals to whistleblow include: (i) cleansing the conscience, (ii) punishing wrongdoers (in some cases out of spite), (iii) simply ’doing the right thing‘ for the sake of a general increase in social welfare, or (iv) motive for self-preservation.”
Unfortunately, the SEC’s hopes are unlikely to persuade may whistleblowers to report internally since monetary rewards are likely to override any of the above-cited incentives. Realistically, even given the availability of anonymous whistleblowing internally or to the government, the anti-retaliation provisions in Section 21F and the Sarbanes-Oxley Act, while helpful, are not nearly enough to assuage concerns of some potential whistleblowers about the likelihood of being identified as a whistleblower and suffering adverse effects. Companies also need to be careful to avoid creating any appearance of a prohibition against reporting wrongdoing to the SEC or claiming the benefits of the SEC whistleblower rules.