SEC's Proposed Regulations For New Whistleblower Program Will Have Material Effect On Fraud Detection

By James Eccleston

he Securities and Exchange Commission (SEC) has published proposed regulations to implement the whistleblower program established pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act"). The SEC has established a $451.9 million fund to make awards to whistleblowers who qualify by disclosing information about alleged violations of securities or commodities laws which subsequently lead to successful SEC of Commodity Futures Trading Commission (CFTC) enforcement actions. The proposed regulations also provide for new protections for employees who blow the whistle on employers. Let's examine the details of the proposed regulations and highlight the SEC's major concerns.

The details of the proposed regulations are revealed in the rather narrow definitions of terms that the SEC employs. Thus, simply stated, the Act authorizes the SEC and the CFTC to provide monetary awards to a "whistleblower" who "voluntarily" provides "original information" that "leads to successful enforcement" action under the securities laws in which the SEC or CFTC recovers monetary sanctions in excess of $1 million in the aggregate. A qualifying whistleblower will receive between 10% and 30% of the amounts obtained.

Moving to the precise definitions of terms, first, who is a "whistleblower"? A whistleblower can be any natural person, who does not fall within one of several disqualifying categories. Those categories include obvious exclusions such as SEC employees and those convicted of a criminal violation related to an enforcement action for which the person otherwise would be eligible to receive an award. Those categories also include some less obvious but sensible exclusions, such as lawyers, auditors, compliance personnel and other persons who have a duty to respond and provide information to the SEC. Importantly, the SEC has opined that a whistleblower need only provide information relating to a "potential violation" (not an actual violation) of the securities laws. This distinction is important in the early stages of the process because it triggers the SEC's duty under the Act to afford confidential treatment to the information provided, and it makes clear that the whistleblower anti-retaliation protections "do not depend on an ultimate adjudication, finding or conclusion that conduct identified by the whistleblower constituted a violation of the securities laws."

Second, what does a "voluntary" submission mean? The proposed regulations would define a submission as voluntary if the whistleblower provides information "before receiving any formal or informal request, inquiry or demand from the Commission [SEC], Congress, any other federal, state or local authority, any self-regulatory organization, or the Public Company Accounting Oversight Board about a matter to which the information in the whistleblower's submission is relevant." Notably, while the SEC states that a request, inquiry or demand directed to an employer also is considered to be directed to those employees who possess the documents or other information, employees nonetheless can meet the "voluntary" submission requirement if "the employer fails to provide the employee's documents or information to the requesting authority in a timely manner." Likewise, and as seen above regarding the definition of a "whistleblower", a disclosure should not be considered voluntary if the individual has "a clear duty to report violations of the type at issue."

Third, what is "original information"? The proposed rules define original information as being derived from either "independent knowledge" (not, for example, from court filings) or from "independent analysis" derived from a whistleblower's examination and evaluation of information that may generally be available to the public. Importantly, the SEC carves out seven exclusions to "original information", including information that is learned through: a) the attorney-client privilege; b) engagement as an independent public accountant; c) an illegal manner; and d) a company's legal, compliance, audit supervisory or governance functions, so long as the company discloses the information to the SEC within a "reasonable time".

Under the statutory definition of "original information", a whistleblower who provides information to the SEC which it knows already from another source has not provided original information, unless the whistleblower is the original source of that information. The SEC wrestled with this in the context of a whistleblower's first providing information to another authority, which thereafter notifies the SEC. As a solution, the SEC has proposed a 90-day period, during which time the whistleblower will be able to submit the necessary forms to the SEC and be deemed to have reported that information to the SEC on the earlier reporting date. Likewise, the SEC proposes to extend the same 90-day reporting accommodation to employees who first report to their company compliance departments.

Fourth, how does the SEC define "leads to successful enforcement" action under the securities laws? The SEC proposes a two-part test. First, the information "must have caused the staff to commence an examination, open an investigation, reopen an investigation that had been closed, or to inquire concerning new and different conduct as part of an open examination or investigation." Second, if the whistleblower's information caused the SEC staff to start looking at the conduct for the first time, the proposed rule would require that the information "significantly contributed" to the success of the enforcement action filed by the SEC. On the other hand, if the SEC already had been investigating or examining the conduct in question, then a "separate, higher standard" applies. In those circumstances, the whistleblower's information "would not have otherwise been obtained and was essential to the success of the action."

Fifth, while whistleblowers are entitled to between 10% and 30% of monetary sanctions in excess of $1,000,000, the SEC proposes to encourage whistleblowers first to utilize their company compliance programs. Accordingly, the SEC "will consider higher percentage awards for whistleblowers who first report violations through their compliance programs."

Sixth, the SEC has proposed regulations to provide protections to whistleblowers. Among them, the SEC proposes that it will not reveal the identity of a whistleblower or disclose other information that could reasonably be expected to reveal the identity of the whistleblower except under limited circumstances. The Act expressly excludes this information from the reaches of the Freedom of Information Act. Further, representation by an attorney is required in those situations in which the whistleblower wishes to remain anonymous.

Finally, the SEC proposes a detailed process to follow for an award and forms to complete along the way. Whistleblowers and attorneys representing them will need to familiarize themselves with those matters.

In conclusion, the SEC has proposed regulations to implement a far-reaching provision of the Act. Those regulations and the SEC's final regulations will have a dramatic impact on the detection of fraud!

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About the Author:
James J. Eccleston is the president of Eccleston Law Offices, P.C. The Chicago-based firm represents investors and advisers nationwide in securities and employment matters. 312-332-0000 www.EcclestonLaw.com.