In a vote split along partisan lines, the U.S. Securities and Exchange Commission today approved final rules for rewarding whistleblowers who provide the agency with tips that lead to successful prosecutions.
The agency attempted to strike a balance on the most controversial issue - whether to require workers to report possible wrongdoing to their employers first before going to the government. The business community argued vigorously that without such a provision, internal compliance programs would be decimated.
Under the final rules, workers are not required to use internal programs, but the SEC will offer incentives to those that choose to do so.
If whistleblowers make use of internal programs, the SEC will give them credit when determining the size of their reward—tipsters get 10% to 30% of the penalty collected in excess of $1 million. Conversely, those who don't use or interfere with internal programs will get less money from the SEC.
Also, if an employee reports a minor or non-specific violation internally—information that by itself might not be eligible for a whistleblower bounty—and the company investigates, finds a wider problem, and then tells the SEC, the whistleblower gets credit for all the information.
“I believe that incentivizing—rather than requiring—internal reporting is more likely to encourage a strong internal compliance culture,” said SEC Chairman Mary Schapiro at today’s meeting. “Our rules create incentives for people to report misconduct to their employers, but only if those companies have created an environment where employees feel comfortable that management will take them seriously—and where they are free from possible retaliation.”
The new whistleblower program is mandated by Section 922 of the Dodd-Frank financial reform legislation. The SEC released draft rules in November, triggering strong public debate.
SEC Commissioner Kathleen Casey, a Republican, voted against the new rules, which she described as favoring “a pound of cure over an ounce of prevention.”
Casey said she was “deeply concerned” that the rules didn’t do enough to “preserve the value of internal programs,” and that potential tipsters would be too tempted by SEC money to report violations in-house.
“By diverting a large portion of the flow of information, it impairs a company’s ability to step in,” she said. Because SEC investigations tend to be “more ponderous and time consuming,” the result may be to “permit violations to last longer and be more serious.”
Commissioner Troy Paredes shared Casey's concerns in voting against the rules, arguing that the final rule “unduly erodes the value of internal compliance programs.”
Enforcement Division head Robert Khuzami defended the rules. “An absolute requirement to report internally would be detrimental to the enforcement program and seemingly inconsistent with the statute’s goals,” he said. “It would place an undue burden on the whistleblower.”
Commissioners Luis Aguilar and Elisse Walter joined Schapiro in voting in favor of the rules.
The SEC also extended the period of time a whistleblower can wait after making an internal complaint before notifying the agency from 90 to 120 days.
To Randall Fons, who is co-chair of Morrison & Foerster’s securities litigation, one real-world result of the rules will be to change how companies deal with whistleblowers who make use of compliance programs.
“Historically, most companies have not gone back to whistleblowers and said, ‘Here’s what we’ve done,” he said. But now, companies are on notice that if the person feels the issue hasn’t been addressed within 120 days, he or she could still go to the SEC. “Public companies need to go back and look at their processes and procedures,” he said.
T. Markus Funk, a white collar partner at Perkins Coie, said the new rules may also make companies more inclined to come forward to the SEC when confronted with internal wrongdoing.
“An increase in tips breeds an increase in self-reporting,” he said. “If a problem is widely known within a company, that’s an additional reason to come forward rather than wait for the ax to drop.”