Dodd-Frank Broadly Expands SEC Whistleblower Program (Part 1 of 2)

By James K. Hein and Craig A. Foster

The Securities and Exchange Commission recently issued final rules implementing a whistleblower program designed to encourage reporting of potential violations of the federal securities laws to the SEC to enhance its success in enforcement actions. The rules became effective August 12, 2011. The SEC also announced the creation of its new whistleblower program and its newly created “Office of the Whistleblower,” whose website may be found by clicking here.

Section 922(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, enacted in July 2010, requires the SEC to pay awards to whistleblowers who voluntarily provide the SEC with original information that leads to a successful enforcement action by the SEC in which more than $1 million is recovered. This new provision substantially broadens the SEC’s authority to compensate whistleblowers. Before Dodd-Frank, the SEC’s authority to pay whistleblowers was capped at 10% of the recovery, was discretionary, and was limited to insider trading violations. Awards under Dodd-Frank range from 10% to 30% of the total monetary sanctions recovered, are mandatory, and apply to violations of all federal securities laws. Dodd-Frank also created a parallel program for the Commodity Futures Trading Commission, which regulates commodity futures and option markets under the Commodities Exchange Act.

Significant Increase in Whistleblower Tips Expected

In the past 20 years, only $160,000 was awarded to a handful of whistleblowers through the SEC’s earlier whistleblower program. Industry experts predict that Dodd-Frank’s large, mandatory awards will result in a significant increase in tips. The SEC has already experienced an uptick in the year since Dodd-Frank was passed, and it has set aside $450 million for the whistleblower fund. This amount is 50% more than the minimum level required by Congress. Just after the passage of Dodd-Frank, the SEC also announced that it was making a $1 million award to a whistleblower under the earlier whistleblower program, signaling a renewed focus on this enforcement tool.

The SEC whistleblower provisions are modeled after an IRS whistleblower program. The IRS whistleblower office was created in 2007; that year, it received 83 claims alleging underreported income of $8 billion. The following year, the IRS received 1,890 claims alleging underreported income of $65 billion. The IRS whistleblower program even spawned an industry of law firms specializing in tax whistleblower claims. There are already indications that a similar trend is unfolding with firms hoping to specialize in Dodd-Frank whistleblower claims.

Who Is Eligible for a Whistleblower Award?

Whistleblowers must be individuals – tips are not eligible for awards if they are submitted by a company or other type of entity. Furthermore, as described below, certain individuals are disqualified for policy reasons (subject to some exceptions), such as internal compliance personnel, in-house and outside counsel, and outside auditors. Individuals who participated in the wrongdoing may be eligible, but, as described below, they should expect that their degree of culpability will be taken into account in determining the potential award.

What Are the Informational Requirements for a Whistleblower Award?

Under the new rules, the SEC must pay awards to whistleblowers who: (a) voluntarily provide the SEC with (b) original information about a possible violation of the federal securities laws (c) that leads to a successful enforcement action by the SEC (d) in which the SEC obtains monetary sanctions totaling more than $1 million.

  • Voluntary: Information is provided voluntarily if it is submitted before a government authority or self-regulatory organization has requested it. Information is not voluntarily provided if the whistleblower is under a preexisting legal or contractual duty to report the violation to a regulatory authority, or a duty that arises out of a judicial or administrative order.
  • Original information: The information must be: (a) derived from the whistleblower’s “independent knowledge or independent analysis”; (b) not already known to the SEC from another source; (c) not exclusively derived from allegations in a hearing, report, audit, or investigation, or from the news media; and (d) provided to the SEC for the first time after July 21, 2010 (the date Dodd-Frank was enacted). The inclusion of “independent analysis” in the definition of “original information” means that whistleblowers will not always be corporate insiders. This provision is presumably intended to capture informants such as Harry Markopolos, who approached the SEC on numerous occasions about Bernard Madoff’s growing Ponzi scheme.
  • Leads to a successful enforcement action: The whistleblower’s information must cause the SEC to commence an examination, open an investigation, reopen a closed investigation, or inquire concerning new or different conduct as part of a current examination or investigation, with the whistleblower’s information significantly contributing to the success of the action.
  • Results in collection of monetary sanctions totaling more than $1 million: This threshold includes penalties, disgorgement and interest, and it applies to each separate action. Nevertheless, for purposes of making an award, the SEC will treat as a single “action” two or more administrative or judicial proceedings brought by the SEC if those proceedings arise from the same set of facts.
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