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Preparing For And Responding To SECíS Whistleblower Program
Topic: Securities Regulation
Tonya Mitchum Grindon, Chair of the Corporate Governance/Securities Practice Group of the law firm Baker, Donelson, Bearman, Caldwell & Berkowitz, PC in Nashville, Tennessee.
Legal Opinion Letter, March 11, 2011, 2 pages
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WLF Legal Opinion Letter

Preparing For And Responding To SEC's Whistleblower Program

By Tonya Mitchem Grindon
March 11, 2011 (Vol. 20 No. 5)

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, which Congress intended to reform the U.S. financial regulatory system in response to the recent financial crisis.  To accomplish this goal, Dodd-Frank creates and expands protection and incentives for whistleblowers, among other provisions.

The Sarbanes-Oxley Act of 2002, as amended, required listed companies to create internal corporate reporting processes for whistleblowers.  Dodd-Frank, conversely, encourages voluntary reporting of original information concerning securities law violations to the Securities and Exchange Commission (SEC).  Specifically, whistleblowers may be entitled to 10% to 30% of the penalties collected by the SEC in excess of $1,000,000 under a newly-added Section 21F of the Securities Exchange Act.  Though these awards are higher than the previously available rewards for securities law violations, these amounts are roughly in line with those available for disclosure of fraudulent claims for U.S. government funds under the False Claims Act (30% of certain recoveries) or tax fraud (15% to 30% of certain recoveries).

The SEC issued proposed rules on whistleblowing in November 2010, and solicited public comments through December.  In response to the proposed rules, numerous public companies expressed concern that the newly-enhanced whistleblower rewards will disrupt and even undermine the internal reporting systems developed in compliance with Sarbanes-Oxley, encouraging employees to bypass the internal procedure in favor of direct reporting to the SEC.  There was additional concern that the new rewards will deprive management of important tools for uncovering and correcting abuses before the imposition of fines and penalties by the SEC.

The SEC's proposed release recognizes the concerns that the whistleblower provisions will undermine existing internal policies.  Specifically, in the proposed rules the SEC acknowledges that it seeks to "balance the need to encourage whistleblowers to come forward without promoting unintended consequences."  To address these concerns, the proposed rules encourage internal reporting by treating the date on which an employee reports information internally as the start date of his or her whistleblower status, so long as the information is provided to the SEC within 90 days.  This preserves a place in line for the employee if and when the information is subsequently disclosed to the SEC.  The proposed rules also permit the SEC to consider larger rewards for individuals who first report concerns internally.  These proposed rules do not require internal reporting as a first step, because apparently some companies lack robust reporting systems, making such a requirement impractical.

As another example of the SEC addressing the concerns raised by public companies, the proposed rules clarify that certain people would generally not be considered for whistleblower awards, including people who have a pre-existing legal or contractual duty to report their information; attorneys who attempt to use information obtained from client engagements to make whistleblower claims for themselves (unless disclosure is otherwise legally permitted); independent public accountants who obtain information through an engagement required under the securities laws; and people who learn about violations through a company's internal compliance program or who are in positions of responsibility for an entity, and the information is reported to them in the expectation that they will take appropriate steps to respond to the violation (unless the company does not disclose the information to the SEC within a reasonable time or acts in bad faith). 

In order to address Dodd-Frank's changes to whistleblower laws, public and private companies should consider changes to their compliance efforts.  First, they should undertake a risk assessment as to securities law exposure so as to better focus efforts on areas of high risk.  Second, clear and open lines of communication should be implemented (or, if already in existence, reinforced) for employees in these high risk areas, so that they have a receptive audience for relevant information.  Many of the internal reporting practices implemented under Sarbanes-Oxley will also be applicable, but efforts to further encourage internally reporting to the company first may be helpful.  Finally, in some cases, companies may wish to offer their own rewards for internal whistleblowing.  While none of these steps can obviate the possibility of whistleblowing liability, each will assist in balancing the company's interest in compliance against a potential whistleblower's self-interest in obtaining a lucrative reward.

Tonya Mitchum Grindon is Chair of the Corporate Governance/Securities Practice Group of the law firm Baker, Donelson, Bearman, Caldwell & Berkowitz, PC in Nashville, Tennessee.