When it pays to tattle

SEC clarifies rules, compensates whistleblowers

Kimberely Sirk
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WASHINGTON, D.C.—On May 25, the U.S. Securities and ExchangeCommission (SEC) adopted rules to create a whistleblower program that couldresult in big-ticket rewards for individuals who supply the government agencywith information that leads to successful enforcement actions.
The strengthened SEC whistleblower program, implementedunder Section 922 of the Dodd-Frank Wall Street Reform and Consumer ProtectionAct, has as its focus early action to expose corporate violations that couldnegatively impact shareholders and the public. For the pharma industry, thatmeans protecting the public from potentially hazardous products entering themarket.
The rules also clarify anti-retaliation protection forwhistleblowers and vocalize support for internal compliance programs.
"For an agency with limited resources like the SEC, it iscritical to be able to leverage the resources of people who may have firsthandinformation about violations of the securities laws," says SEC Chairman Mary L.Schapiro.
Section 922 of the Dodd-Frank Act authorizes the SEC to payrewards to individuals who provide the commission with original informationthat leads to successful SEC enforcement actions and certain related actions.
In passing the Dodd-Frank Act, Congress substantiallyexpanded the agency's authority to compensate individuals who supply the SECwith information about violations of federal securities laws. Prior to the act,the agency's bounty program was limited to insider trading cases, and theamount of an award was capped at 10 percent of the penalties collected in theaction.
To be considered for an award, the SEC's rules require thata whistleblower must voluntarily provide the agency with original informationthat leads to the successful enforcement of a federal court or administrativeaction. The payoff to the informant can only result from cases where the SECsuccessfully levies more than $1 million in penalties.
"While the SEC has a history of receiving a high volume oftips and complaints, the quality of the tips we have received has been bettersince Dodd-Frank became law," says Schapiro. "We expect this trend to continue,and these final rules map out simplified and transparent procedures forwhistleblowers to provide us critical information."
Attorney Reuben Guttman, who chairs the whistleblowerpractice for shareholder and corporate governance law firm Grant &Eisenhofer in Washington, D.C., says in an interview and through his blog onwhistleblowerlaws.com that the rules are welcome and just. He says that in justthe last few years, whistleblower laws have been instrumental in holdingpharmaceutical manufacturers responsible for off-label marketing of theirdrugs. These rules, he says, can add teeth to the process, and help ease theburden on a "David and Goliath" type of enforcement system.
The final rules define a whistleblower as a person whoprovides information to the SEC relating to a possible violation of thesecurities laws that has occurred, is ongoing or is about to occur. The rulesalso state that the disclosure by the whistleblower must be voluntary. Theinformation provided must be sourced by that person, either through his or herdirect knowledge or own independent review of the facts.
An individual official is deemed a whistleblower as of thedate that employee reports the information internally—as long as the employeeprovides the same information to the SEC within 120 days.
A whistleblower's information can be deemed to have led to asuccessful enforcement action if the information provided is specific andcredible and leads to the opening of a new enforcement case, or the reopeningof an old case.
Even if there was an existing investigation, whistleblowerscan still reap a reward if their information bolsters the government's case.
Significant to the new rules—and a bone of contention forthose who remain skeptics—is the provision that the whistleblower must stilluse internal reporting procedures as outlined by the company in question. Thiscan cause problems, according to some analysts, if a company is small enoughthat it has only a few executives who may serve in multiple roles.
The rules also specifically exempt certain people frombenefiting from the reward program. For example, certain internal companyofficials with reporting responsibilities inherent in their jobs, as well asattorneys, cannot file reward claims. In addition, those who obtain informationillegally or blow the whistle on themselves are likewise not eligible.
In very few instances and within carefully drawn boundaries,some internal agents can successfully become whistleblowers. Those exceptionsinclude people who believe that only they can protect shareholders by revealingthe information, or if the individual believes that corporate conduct couldsubvert an investigation.
Not everyone believes that the new rules will be beneficial.Immediately after the announcement, the U.S. Chamber of Commerce issued astatement in conjunction with the Institute for Legal Reform, condemning thenew rules as a boon for trial lawyers.
David Hirschmann, president and CEO of the U.S. Chamber'sCenter for Capital Markets Competitiveness, and Lisa Rickard, president of theInstitute for Legal Reform, together issued a strongly worded statementcondemning the new rules:
"In approving this new whistleblower rule, the SEC haschosen to put trial lawyer profits ahead of effective compliance and corporategovernance," the pair says. "This rule will make it harder and slower to detectand stop corporate fraud—by undermining the strong compliance systems set upunder Sarbanes Oxley to ensure companies take whistleblowers seriously."
They continue: "Armed with trial lawyers and new largefinancial incentives to bypass these programs, whistleblowers will go straightto the SEC with allegations of wrongdoing and keep companies in the dark. Thisleaves expensive, robust compliance programs collecting dust, while violationscontinue to fester, eroding shareholder value."
Guttman begged to differ.
"Not requiring internal reporting before providinginformation to the SEC is a win for shareholders, consumers, and taxpayers,"Guttman says. "In this regard, the SEC rule marks a conservative approach giventhat a few short months ago we were on the verge of an economic meltdownattributable to pervasive wrongful conduct that was unchecked by failedinternal compliance programs."
The rules seek to protect informants from retaliation by theemployer if the whistleblower thinks that the information he or she isproviding relates to a possible securities law violation. In addition, therules make it unlawful for anyone to interfere with a whistleblower's effortsto communicate with the commission, including threatening to enforce a confidentialityagreement.
Guttman has taken a vocal role in defending the Dodd-Frankwhistleblower law.
"In practically every financial scandal that has rockedthe corporate world, whistleblowers have been ignored or punished for theirattempts to ward off catastrophe," he says.
The rules do strengthen incentives that had been proposedand add certain additional incentives intended to encourage employees toutilize their own company's internal compliance programs when appropriate to doso.
As an added incentive, investigators will take into accountthe whistleblower's participation in the voluntary compliance program whendetermining the amount of the cash payout. Using the internal system couldincrease the amount of the payout, and proof of interference with the internalprocess could diminish the amount of the award.
"We agree that the SEC should have access to the informationit needs to detect and deter fraud," say Hirschmann and Rickard. "However, notrequiring simultaneous reporting to both the company and the SEC prevents quickaction to investigate and solve problems if they exist. Not informing thecompany of a potential fraud and waiting for the SEC to act is the equivalentof not calling the firefighters down the street to put out a raging fire and insteadcalling the lawyers from the next town to sue over the fire instead."
Guttman has served as counsel to some of the largestrecoveries under the Federal False Claims Act, including representing one ofthe main whistleblowers in the recent $2.3 billion settlement with Pfizer Inc.over the illegal marketing of the drug Bextra.
The SEC's rules take effect on Aug. 12.

Kimberely Sirk

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