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Summary of New SEC Whistleblower Rules

December 9, 2010

The Securities and Exchange Commission (SEC) recently proposed new whistleblower rules pursuant to its authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC is seeking comments to the proposed rules and has requested that all comments be submitted by December 17, 2010.

 

Summary of Proposed Rules

 

The proposed rules allow the SEC to grant a whistleblower an award of between 10 percent and 30 percent of any monetary recovery for providing the SEC with information about a potential violation of the federal securities laws that leads to a successful enforcement action. An individual will receive a monetary award if he:

  • voluntarily provides 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 sanctions totaling more than $1 million.

 

Certain individuals are not eligible for whistleblower awards, including individuals who obtained the relevant information through the entity’s legal, compliance, audit, supervisory or governance functions (unless the entity does not disclose the information to the SEC within a reasonable time or acts in bad faith).

 

Implications of Proposed Rules on Internal Reporting

 

Because the proposed rules give employees the potential to receive what could be an extremely large monetary reward if they are the first to provide the SEC with "original" information about possible violations of the securities laws, employees would have a significant financial incentive to report to the SEC before or instead of reporting to company management through established compliance or whistleblower programs.  The new rules may thus undermine the effectiveness of existing compliance programs and eliminate the many advantages that companies with such programs currently enjoy, including early identification of problems, heading off reputational harm and government investigations, and avoiding or limiting losses from fraudulent activities.

 

Noting the potential of monetary awards to encourage individuals to report to the SEC before or instead of reporting to internal compliance departments, the SEC did include provisions to encourage employees to report internally before reporting to the SEC. For example, the proposed rules:

  • permit the SEC to consider higher percentage awards for whistleblowers who first report internally to their compliance departments
  • treat an employee as a whistleblower as of the date they reported internally, as long as the employee reports the same information to the SEC within 90 days

 

The SEC noted that it considered requiring potential whistleblowers to report through internal channels, thus giving employers an opportunity to address misconduct, before being eligible for an award based on a whistleblower submission to the SEC.  It decided against this approach, however, because of its concern that, “while many employers have compliance processes that are well-documented, thorough, and robust, and offer whistleblowers appropriate assurances of confidentiality, others lack such established procedures and protections.” 

 

In light of the new proposed rules, companies may want to redesign their internal reporting mechanisms to minimize the possibility that employees will report problems to the SEC instead of raising issues directly with company management.