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When it pays to tattle
WASHINGTON, D.C.—On May 25, the U.S. Securities and Exchange Commission (SEC) adopted rules to create a whistleblower program that could result in big-ticket rewards for individuals who supply the government agency with information that leads to successful enforcement actions.
The strengthened SEC whistleblower program, implemented under Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, has as its focus early action to expose corporate violations that could negatively impact shareholders and the public. For the pharma industry, that means protecting the public from potentially hazardous products entering the market.
The rules also clarify anti-retaliation protection for whistleblowers and vocalize support for internal compliance programs.
"For an agency with limited resources like the SEC, it is critical to be able to leverage the resources of people who may have firsthand information about violations of the securities laws," says SEC Chairman Mary L. Schapiro.
Section 922 of the Dodd-Frank Act authorizes the SEC to pay rewards to individuals who provide the commission with original information that leads to successful SEC enforcement actions and certain related actions.
In passing the Dodd-Frank Act, Congress substantially expanded the agency's authority to compensate individuals who supply the SEC with information about violations of federal securities laws. Prior to the act, the agency's bounty program was limited to insider trading cases, and the amount of an award was capped at 10 percent of the penalties collected in the action.
To be considered for an award, the SEC's rules require that a whistleblower must voluntarily provide the agency with original information that leads to the successful enforcement of a federal court or administrative action. The payoff to the informant can only result from cases where the SEC successfully levies more than $1 million in penalties.
"While the SEC has a history of receiving a high volume of tips and complaints, the quality of the tips we have received has been better since Dodd-Frank became law," says Schapiro. "We expect this trend to continue, and these final rules map out simplified and transparent procedures for whistleblowers to provide us critical information."
Attorney Reuben Guttman, who chairs the whistleblower practice for shareholder and corporate governance law firm Grant & Eisenhofer in Washington, D.C., says in an interview and through his blog on whistleblowerlaws.com that the rules are welcome and just. He says that in just the last few years, whistleblower laws have been instrumental in holding pharmaceutical manufacturers responsible for off-label marketing of their drugs. These rules, he says, can add teeth to the process, and help ease the burden on a "David and Goliath" type of enforcement system.
The final rules define a whistleblower as a person who provides information to the SEC relating to a possible violation of the securities laws that has occurred, is ongoing or is about to occur. The rules also state that the disclosure by the whistleblower must be voluntary. The information provided must be sourced by that person, either through his or her direct knowledge or own independent review of the facts.
An individual official is deemed a whistleblower as of the date that employee reports the information internally—as long as the employee provides the same information to the SEC within 120 days.
A whistleblower's information can be deemed to have led to a successful enforcement action if the information provided is specific and credible and leads to the opening of a new enforcement case, or the reopening of an old case.
Even if there was an existing investigation, whistleblowers can still reap a reward if their information bolsters the government's case.
Significant to the new rules—and a bone of contention for those who remain skeptics—is the provision that the whistleblower must still use internal reporting procedures as outlined by the company in question. This can cause problems, according to some analysts, if a company is small enough that it has only a few executives who may serve in multiple roles.
The rules also specifically exempt certain people from benefiting from the reward program. For example, certain internal company officials with reporting responsibilities inherent in their jobs, as well as attorneys, cannot file reward claims. In addition, those who obtain information illegally or blow the whistle on themselves are likewise not eligible.
In very few instances and within carefully drawn boundaries, some internal agents can successfully become whistleblowers. Those exceptions include people who believe that only they can protect shareholders by revealing the information, or if the individual believes that corporate conduct could subvert an investigation.
Not everyone believes that the new rules will be beneficial. Immediately after the announcement, the U.S. Chamber of Commerce issued a statement in conjunction with the Institute for Legal Reform, condemning the new rules as a boon for trial lawyers.
David Hirschmann, president and CEO of the U.S. Chamber's Center for Capital Markets Competitiveness, and Lisa Rickard, president of the Institute for Legal Reform, together issued a strongly worded statement condemning the new rules:
"In approving this new whistleblower rule, the SEC has chosen to put trial lawyer profits ahead of effective compliance and corporate governance," the pair says. "This rule will make it harder and slower to detect and stop corporate fraud—by undermining the strong compliance systems set up under Sarbanes Oxley to ensure companies take whistleblowers seriously."
They continue: "Armed with trial lawyers and new large financial incentives to bypass these programs, whistleblowers will go straight to the SEC with allegations of wrongdoing and keep companies in the dark. This leaves expensive, robust compliance programs collecting dust, while violations continue to fester, eroding shareholder value."
Guttman begged to differ.
"Not requiring internal reporting before providing information to the SEC is a win for shareholders, consumers, and taxpayers," Guttman says. "In this regard, the SEC rule marks a conservative approach given that a few short months ago we were on the verge of an economic meltdown attributable to pervasive wrongful conduct that was unchecked by failed internal compliance programs."
The rules seek to protect informants from retaliation by the employer if the whistleblower thinks that the information he or she is providing relates to a possible securities law violation. In addition, the rules make it unlawful for anyone to interfere with a whistleblower's efforts to communicate with the commission, including threatening to enforce a confidentiality agreement.
Guttman has taken a vocal role in defending the Dodd-Frank whistleblower law.
"In practically every financial scandal that has rocked the corporate world, whistleblowers have been ignored or punished for their attempts to ward off catastrophe," he says.
The rules do strengthen incentives that had been proposed and add certain additional incentives intended to encourage employees to utilize their own company's internal compliance programs when appropriate to do so.
As an added incentive, investigators will take into account the whistleblower's participation in the voluntary compliance program when determining the amount of the cash payout. Using the internal system could increase the amount of the payout, and proof of interference with the internal process could diminish the amount of the award.
"We agree that the SEC should have access to the information it needs to detect and deter fraud," say Hirschmann and Rickard. "However, not requiring simultaneous reporting to both the company and the SEC prevents quick action to investigate and solve problems if they exist. Not informing the company of a potential fraud and waiting for the SEC to act is the equivalent of not calling the firefighters down the street to put out a raging fire and instead calling the lawyers from the next town to sue over the fire instead."