Posts Tagged ‘Internal compliance’

Understanding the New Whistleblower Rules

May 27th, 2011 | By

On May 25th, the SEC approved a final rule implementing the whistleblower provisions of the Dodd-Frank Act. The rule adds section 21F to the Exchange Act and directs the SEC to pay awards to whistleblowers who voluntarily provide the Commission with original information about a securities law violation leading to the successful enforcement of an action that results in monetary sanctions exceeding $1,000,000.

The rule, proposed on November 3, 2010, garnered significant attention from governance groups, corporations, trade associations, and audit firms. Perhaps most in contention was the provision allowing potential whistleblowers to bypass internal compliance systems and go straight to the SEC and inform them of securities violations. Over the objections of some organizations, including NACD, the SEC’s final rule does not mandate utilizing a company’s internal compliance system prior to or simultaneously with reporting to the SEC. Instead, the SEC has increased the potential amount of award for those who use a company’s internal systems. Whistleblowers may also claim a reward when they report to the company and the company subsequently reports to the SEC. In this case, any information provided by the company will be attributed to the whistleblower, potentially increasing the amount of reward.

The final rule also extends the time frame for whistleblowers to inform the SEC after reporting internally. For purposes of award eligibility, the SEC will treat an employee as a whistleblower as of the date that the employee reports the information internally – as long as the employee provides the same information to the SEC within 120 days. Through this provision, employees are able to report their information internally first while preserving their “place in line” for a possible award from the SEC. This additional time was provided to allow a company to identify, correct, and self-report securities violations.

Certain employees of a company are excluded from being considered for a reward under the new rule. Those unable to claim the award include:

  • Those who obtain the information through a communication that was subject to attorney-client privilege, unless disclosure of the information would prevent an issuer from committing a material violation of securities law or perpetrating a fraud upon the Commission.
  • Those who obtain information in connection with the legal representation of a client on whose behalf the whistleblower or the whistleblower’s firm are providing services, unless disclosure would be permitted in the instances referenced above
  • Individuals who obtain the information in a manner that violates federal or state criminal law
  • An officer, director, trustee, or partner of an entity and another person who informed the whistleblower of allegations of misconduct
  • The whistleblower, if the whistleblower learned about the information in connection with the entity’s processes for indentifying, reporting, and addressing possible violations of law
  • Any persons employed by or associated with a firm retained to conduct an inquiry or investigation into possible violations of law
  • An employee of a public accounting firm if the information was obtained through the performance of an engagement required by SEC

However, internal audit and/or compliance personnel as well as public accountants could become whistleblowers in the following situations:

  • The whistleblower has a reasonable basis to believe that disclosure of the information to the Commission 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
  • The whistleblower has a reasonable basis to believe that the company is engaging in conduct that will impede an investigation of the misconduct
  • At least 120 days have elapsed since the whistleblower provided information to the company’s audit committee, chief legal officer, chief compliance officer, or the whistleblower’s supervisor, or since the whistleblower received the information, if it was received under circumstances indicating that the entity’s audit committee, chief legal officer, chief compliance officer, or the whistleblower’s supervisor was already aware of the information

Prior to passage of the final rule, NACD staff submitted a comment letter to the SEC and met with SEC officials to express their concerns. NACD stressed the need for whistleblowers to utilize the internal compliance systems prior to going to the SEC. The systems required by the Sarbanes-Oxley Act (SOX) were established with great expense to companies in the United States. NACD believes these systems are working and we requested a postponement of the whistleblower rules to have the SEC conduct a study on the effectiveness of current whistleblower programs such as those required under SOX.

Another major concern for NACD is the use of consultants. Consultant use is rising and is an important means of acquiring outside third-party information. In certain situations, a consultant may discover information about a securities violation and bring it to the SEC in order to claim a reward. The final rule does not extend the exclusions to outside consultants because the SEC believes that additional exclusions for such outside professionals would too broadly preclude individuals with possible inside knowledge of violations from coming forward to assist the Commission in identifying and prosecuting persons who have violated securities laws.

The new rules will become effective sixty days after they are submitted to Congress or published in the Federal Register.

NACD will continue to monitor any developments involving the whistleblower rules. Despite the passage of the new rules at the SEC, one notable development has occurred. Recently, Congressman Michael Grimm introduced draft legislation amending the Dodd-Frank Act to require whistleblowers to first use a company’s internal compliance systems. Potential whistleblowers may still bypass internal systems if the Commission determines in a preliminary investigation that internal reporting is not a viable option based on evidence that the alleged misconduct was committed by or involved the complicity of the highest level of management, or evidence of bad faith on the part of the employer. NACD will continue to monitor any developments involving the whistleblower rules.

To view the SEC’s summary of the rule, click here.

To read the SEC’s full explanation of the rule, click here.

To read NACD’s comment letter, click here.

To view an NACD webcast regarding the whistleblower rules, click here.