Will proposed SEC whistleblower rules prevent the undermining of corporate compliance programs?

White Collar Crime Update

The US Securities and Exchange Commission has proposed new rules to implement the whistleblower provisions of the recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Among other things, the proposed rules, announced on November 3, 2010, attempt to address the substantial incentives for employees to bypass their own company’s internal compliance programs.

The proposed whistleblower rules

The significant incentives under the whistleblower provisions of Dodd-Frank are bound to result in increased whistleblower activity, which may lead to action by US law enforcement authorities. Since the passage of the Dodd-Frank Act, parties potentially affected by whistleblower activity, including public companies, have expressed concerns regarding the scope of the new law. As written, the whistleblower law could undermine a company’s internal compliance program. Additional concerns have been raised regarding the eligibility requirements for bounties and the claims process.

In presenting the proposed rules, the SEC acknowledged these legitimate concerns, stating, “[t]he proposed rule reflects the consideration of a number of potentially competing interests, and balances the need to encourage whistleblowers to come forward without promoting unintended consequences.”

One unintended consequence may be the erosion of internal compliance programs. The SEC attempts to address this issue by proposing rules that apply specifically to employees who report internally first. The proposed rules would treat an employee as 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 90 days. The SEC’s intent is to preserve an employee’s “place in line” for a possible award from the SEC where the employee reports their information internally first. The proposed rules also permit the SEC to consider higher percentage awards for whistleblowers who first report their information through effective company compliance programs.

While well-intentioned, the proposed rules stop short of requiring whistleblowers to utilize internal complaint and reporting procedures before making a whistleblower submission to the SEC. The SEC considered this requirement, but rejected it out of concern that not all companies have robust compliance procedures and protections. Thus, whistleblowers are free to bypass internal compliance programs, and their eligibility for a bounty is not affected by pursuing a path that leads to the SEC first.

The SEC acknowledges the difficulty in balancing the need for a strong and effective whistleblower program, and the importance of preserving corporate structures for self-policing and self-reporting. As a result, the SEC has asked for public comment on whether the SEC should consider other ways to reconcile corporate compliance with the whistleblower law, whether the rules should require whistleblowers to utilize employer-sponsored complaint and reporting procedures and for guidance on how to minimize the potential negative impact on compliance programs.

Less controversial are proposed rules that exclude certain people from eligibility for awards, including those who have a pre-existing legal or contractual duty to report information, attorneys and independent public accountants who attempt to use information obtained from client engagements to make whistleblower claims for themselves, foreign government officials, and people who learn about violations through a company’s internal compliance program. In addition, the proposed rules outline a detailed claims process. The proposed rules are available on the SEC’s website.

Practical considerations

The SEC is seeking public comment on the proposed whistleblower rules through December 17. Entities at risk of increased whistleblower activity should consider submitting comments to the SEC, particularly on the issue of whether the proposed rules go far enough to protect internal compliance programs. Well-framed comments, including alternative rule proposals and follow-up communications with the SEC, may result in necessary revisions to the proposed rules.

For further information about the impact of the new whistleblower law on your business and guidance on the SEC’s comment process, please contact:

Patrick J. Smith 

See our reports on breaking developments around Dodd-Frank here.