Publications: Changes to Whistleblower Protections Under the Dodd-Frank Act

The Dodd-Frank Act (the “Act”) includes so-called “whistleblower” provisions regarding securities law violations. Under prior law, individuals who provided information on violations to the SEC were eligible for relatively modest financial rewards. Rather than rewarding whistleblowing, the focus was on internal corporate reporting processes. Instead, the Act emphasizes whistleblowing activities by substantially increasing available payouts. In reality, the changes are somewhat more nuanced, and the real consequences for corporate anti-fraud efforts will take time to develop.

The Act strongly encourages voluntary reporting of original information concerning securities law violations. Whistleblowers may be entitled to 10% to 30% of the penalties collected by the SEC in excess of $1,000,000 under a newly-added Section 21F of the Securities Exchange Act. These rewards are available to any individual (excluding wrongdoers and many professional advisors), whether or not affiliated with the issuer in question. Though substantially higher than the previously-available rewards for securities law violations, these amounts are roughly in line with those available for disclosure of fraudulent claims for U.S. government funds under the False Claims Act (30% of certain recoveries) or tax fraud (15% to 30% of certain recoveries).

Some public companies have expressed concern that the newly-enhanced whistleblower rewards may upend the intricate and costly internal reporting systems developed in response to the Sarbanes-Oxley Act (“SOX”), encouraging employees to bypass them in favor of direct reporting to the SEC. Private companies may share this concern. While not subject to the formal SOX internal reporting requirements, they too may feel that the new rewards will deprive management of important tools for uncovering and correcting abuses before the imposition of fines and penalties by the government.

The SEC issued proposed rulemaking on whistleblowing in November 2010, and solicited public comments through December. The November release demonstrates SEC awareness of the foregoing concerns, stating that the proposed rules seek to “balance[] the need to encourage whistleblowers to come forward without promoting unintended consequences.” As an example, the proposed rules encourage internal reporting by treating the date on which an employee reports information internally as the start date of his or her whistleblower status, so long as the information is provided to the SEC within 90 days. This preserves a place in line for the employee if and when the information is subsequently disclosed to the SEC (owing to management inaction or disinterest, for example). The proposed rules also permit the SEC to consider larger rewards for individuals who first report internally. These proposals do not, however, actually require internal reporting as a first step, apparently because some companies lack robust reporting systems, making such a requirement impractical.

In response to the Act’s changes to the whistleblower regime, both public and private companies should consider changes to their compliance efforts. First, they should undertake a risk assessment as to securities law exposure so as to better focus efforts on areas of high risk. Second, clear and open lines of communication should be implemented (or, if already in place, reinforced) for employees in these high risk areas, so that they have a receptive audience for relevant information. Many of the internal reporting practices implemented in response to SOX will be equally applicable here, but efforts to further encourage coming to the company first may be helpful. Finally, in some cases, companies may wish to offer their own rewards for internal whistle-blowing. While none of these steps can obviate the possibility of whistle-blowing liability, each will assist in balancing the company’s interest in compliance against a potential whistleblower’s self-interest in obtaining a lucrative reward.