The Dodd-Frank Whistleblower Program: An Analysis of the SEC’s Second Annual Report, Best Practices for Dealing with Whistleblowers, and Recent Cases Interpreting the Scope of the Anti-Retaliation Provisions of the Dodd-Frank Act

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[author: Raymond Banoun]

I. Introduction

On November 15, 2012, the Securities and Exchange Commission ("SEC" or "the Commission") issued its Second Annual Report on the Dodd-Frank Whistleblower Program ("the Report"), covering the period between October 1, 2011, and September 30, 2012. The Report, which satisfies congressional reporting obligations found in sections 922(a) and 924(d) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 922(a), 924(d), 124 Stat. 1841 (2010) ("the Dodd-Frank Act", the "Act", or "Dodd-Frank"), provides insight into the effectiveness of the Commission's whistleblower bounty program,1 the activities of the office charged with administering the program, and the Investor Protection Fund from which bounty payments are made. The issuance of the Report offers an opportunity for companies to understand the focus of the Commission's whistleblower program and to reevaluate their own compliance and internal reporting systems.

II. Highlights of the Second Annual Report

In what is perhaps the most significant development in the whistleblower program's short history, the SEC made its first award in Fiscal Year 2012. According to the Report, the whistleblower received the maximum award of 30% for helping the SEC stop an "ongoing multi-million dollar fraud."2 The Report indicates that fines in the judicial action already exceed $1 million, with further judgments and sanctions possible.3 Because the government collected approximately $150,000 by the end of the fiscal year, the SEC was able to pay nearly $50,000 to the whistleblower.4 While the percentage awarded was the maximum of 30%, the total dollar amount is relatively modest considering that most securities cases involve hundreds of millions of dollars in fines and penalties, and thus the potential remains for far greater awards than the one discussed in the Report.5 Because few details about the whistleblower, the fraudulent activity involved, or the company have been provided due to confidentiality provisions in the Dodd-Frank Act,6 the larger significance of the award is hard to ascertain.7 Interestingly, the SEC also denied another tipper in the same matter an award, reportedly because that person's information did not contribute significantly to the SEC's investigation.

As it did last year, the Report also provided information on the number of whistleblower tips, complaints, and referrals ("TCRs") made during Fiscal Year 2012. According to the Report, 3,001 TCRs were received by the SEC's Office of the Whistleblower during the reporting period.8 Nearly 50.0% of those TCRs fell within three complaint categories: Corporate Disclosures (18.2%), Offering Fraud (15.5%), and Manipulation (15.2%).9 The 3,001 TCRs came from not only the United States (including all fifty states, the District of Columbia, and Puerto Rico), but forty-nine other countries as well.10 With respect to domestic TCRs, of which there were 2,507, nearly 50.0% came from six states: California (17.4%), Florida (8.1%), New Jersey (4.1%), New York (9.8%), Texas (6.3%), and Washington (4.1%).11 As for foreign TCRs, nearly 60.0% of the 324 came from Commonwealth countries,12 with another 8.0% from the People's Republic of China.13

Although only one award was paid out in Fiscal Year 2012, the SEC's Office of the Whistleblower posted 143 Notices of Covered Action-notices of enforcement judgments and orders that imposed monetary sanctions of $1 million or more.14 According to the Report, the Office of the Whistleblower continues to review and process applications for whistleblower awards based on those notices received during Fiscal Year 2012.15

III. Best Practices for Companies Dealing with Whistleblowers

The Report provides a reminder to public companies of the critical importance of establishing and maintaining a tailored compliance and internal reporting program. Although off-the-shelf programs may be a useful start, they are unsuitable as a final form for most public companies. Indeed, guidance from both the Department of Justice ("DOJ") and the SEC stress the importance of having a compliance program tailored to specific risks and nuances of a company and its industry.16

Companies should strive to encourage employees to report any suspected violations of law or the company's code of conduct to company compliance, internal audit, or legal personnel. Company culture-including "tone at the top"-is an important factor not only in encouraging employees to make use of internal reporting systems but also in demonstrating a commitment to compliance with the laws. Companies should ensure that employees are trained on the company's code of conduct and on the requirement to comply with applicable laws, including the Foreign Corrupt Practices Act ("FCPA").17 During the training, appropriate emphasis should be placed on encouraging employees to utilize internal reporting channels, such as hotlines, and on the importance of reporting violations of the code of conduct or laws. Such training programs are critical to reducing violations of law, to mitigating any sanctions for the company if employees violate the law,18 and to encouraging internal reporting of suspected misconduct.

A critical component of every corporate compliance program, especially now, is a formalized process to identify and promptly respond to potential violations of federal securities laws. Companies must have anonymous reporting hotlines for employees and vendors and should develop a system in which tips and complaints can be prioritized based on risk. A pre-identified outside counsel should be engaged to investigate more serious allegations such as alleged misconduct by management, violations of the FCPA, and significant accounting violations. With the potential for employees to go straight to the SEC with allegations, companies must treat every allegation seriously and promptly investigate potential violations of federal securities laws so that the company can be in a position to remediate the wrongdoing and to self-report the possible violations to the SEC and, where appropriate, to the DOJ.

Companies face additional challenges in situations where a whistleblower complaint is brought to their attention in the first instance by the SEC. In those instances, companies should recognize that the SEC Enforcement Staff nonetheless will welcome a credible and thorough internal investigation, even after having received a whistleblower tip or complaint.19

Given the Dodd-Frank Act's anti-retaliation provisions,20 companies should consider whether and to what extent they want to take steps to identify the individual who reported to the Commission. If a company has uncovered the identity of the whistleblower, then it must determine whether and to what extent it wants to keep the whistleblower informed of the status (but not the findings) of the internal investigation.

IV. Other Developments in Whistleblower Cases

Although not addressed in the Report, there have been several significant judicial developments regarding the anti-retaliation provisions of the Dodd-Frank Act. Dodd-Frank significantly expands protections for whistleblowers and explicitly makes it illegal for a company to retaliate in any way against a whistleblower.21 The statute also contains a private cause of action for whistleblowers alleging retaliatory discharge or other discrimination22 and provides that retaliation can be criminal.23 However, thus far, courts have applied the anti-retaliation provisions of Dodd-Frank narrowly.

In Asadi v. G.E. Energy (USA), LLC, 33 I.E.R. Cas. (BNA) 1837, Fed. Sec. L. Rep. (CCH) ¶ 96929 (S.D. Tex. Jun. 28, 2012), a federal district court in Texas held that the Dodd-Frank anti-retaliation provisions do not apply extraterritorially. All the alleged retaliatory conduct against the plaintiff, including negative reviews and a demotion, took place outside of the United States, as did the conduct about which the plaintiff reported. Under those circumstances, the court held that the Dodd-Frank Act protections were inapplicable because the protections were not intended to apply outside the United States. Additionally, the court stated that the plaintiff did not have a cause of action for retaliation under Dodd-Frank because (1) he reported the alleged FCPA violations internally, but never to the SEC; and (2) his internal disclosures were not required or protected by securities laws.

In Egan v. TradingScreen, Inc., 32 I.E.R. Cas. (BNA) 418, Fed. Sec. L. Rep. (CCH) ¶ 96307 (S.D.N.Y. May 4, 2011), the court left open the possibility that internal reporting of a violation could qualify for protection under the anti-retaliation provisions, but found that the complaint as drafted did not adequately plead anti-retaliation. In Egan, the plaintiff made an internal report that the company's CEO was diverting company resources to another business that the CEO solely owned. An internal investigation supported the plaintiff's allegations. The CEO fired the plaintiff and did not provide him with the company's customary severance package. The plaintiff sued under the anti-retaliation provisions, and the defendants moved to dismiss, arguing that, because the plaintiff did not report the violations to the SEC, but rather only internally, he could not be a protected whistleblower under the statute. The court held that to have a successful claim under the anti-retaliation provisions of the whistleblower provisions of Dodd-Frank, a plaintiff must either allege that his information was reported to the SEC, or that his disclosures fell under one of the four categories of disclosures delineated by 15 U.S.C. § 78u-6(h)(1)(A)(iii) that do not require such reporting-i.e., those under the Sarbanes-Oxley Act, the Securities Exchange Act, 18 U.S.C. § 1513(e), or other laws and regulations subject to the jurisdiction of the SEC. The court also held that a plaintiff can invoke the anti-retaliation protections of the Dodd-Frank Act if, rather than reporting personally and directly to the SEC, he or she does so jointly with another party, such as an investigating law firm, and can establish that a report to the SEC actually was made. The court gave the plaintiff narrow leave to amend his complaint to allege that a joint report was actually made to the SEC, because it held that the plaintiff could not establish that his internal disclosures met the requisites of any of the four categories delineated under prong (iii).

In Nollner v. Southern Baptist Convention, Inc., 852 F. Supp. 2d 986 (M.D. Tenn. 2012), the court cited Egan in interpreting prong (iii) of the Dodd-Frank Act's anti-retaliation provisions to cover an employee who suffers an adverse employment action based on the employee's internal disclosure that is "required or protected" by the securities laws. In other words, an employee who reports internally, rather than directly to the Commission, may be protected under Dodd-Frank's anti-retaliation provisions so long as the employee's internal reporting is "required or protected" by the securities laws. To guide its analysis, the court identified four factors that an employee would need to prove to qualify for protection: (1) that the plaintiff was retaliated against for reporting a violation of the securities laws; (2) that the plaintiff reported that information to the SEC or to another entity, including internal reporting; (3) that the disclosure was made pursuant to a law, rule, or regulation subject to the SEC's jurisdiction; and (4) that the disclosure was "required or protected" by that law, rule, or regulation. The court ultimately denied the plaintiffs' anti-retaliation claim, holding that their internal disclosure of a potential FCPA violation was not "required or protected" by the securities laws because their employer was not an "issuer."

While companies must take care to ensure that they have thorough and clear anti-retaliation policies and guidelines regarding how to address whistleblower complaints, the cases interpreting these new provisions thus far suggest that courts will conduct thorough and searching fact-driven inquiries before allowing anti-retaliation claims to proceed.

1 For more information on the SEC's whistleblower bounty program and best practices for companies dealing with whistleblowers, please see Bradley J. Bondi, Jodi Avergun, Thomas Kuczajda & Steven D. Lofchie, Cadwalader, Wickersham & Taft LLP, "The Dodd-Frank Whistleblower Provisions: Considerations for Effectively Preparing for and Responding to Whistleblowers," Business Fraud Alert, May 26, 2011, http://www.cadwalader.com/PDFs/newsletters/201105263321_BusinessFraudAlert_May_26.pdf.
2 U.S. Sec. & Exch. Comm'n, Annual Report on the Dodd-Frank Whistleblower Program Fiscal Year 8 (2012) [hereinafter "Annual Report"].
3 Id.
4 Id.
5 Indeed, the amount pales in comparison to the whistleblower award of $104 million announced by the Internal Revenue Service ("IRS") on September 11, 2012, in connection with the government's investigation of tax evasion by a Swiss bank.  See David Kocieniewski, "Whistle-Blower Awarded $104 Million by I.R.S.," N.Y. Times, Sept. 11, 2012, available at http://www.nytimes.com/2012/09/12/business/whistle-blower-awarded-104-million-by-irs.html.  The whistleblower, who was involved in that offense and who served two and a half years in prison, assisted the IRS in collecting over $780 million in fines and penalties from the bank.  Id.  By contrast, the SEC's whistleblower bounty rules do not permit a whistleblower to recover a bounty where the whistleblower was convicted of a related crime.
6 15 U.S.C. § 78u-6(h)(2).
7 Annual Report at 8.
8 Id. at 4.
9  Id. at 4-5.
10 Id. at 5.  One hundred and seventy (170) TCRs received in Fiscal Year 2012, representing 5.7% of the total received, were submitted without any geographical information provided.  Annual Report at Appendix B: Whistleblower Tips Received by Location - United States and its Territories - Fiscal Year 2012.
11 Id. at Appendix B: Whistleblower Tips Received by Location - United States and its Territories - Fiscal Year 2012.
12 While the relatively high percentage of TCRs from Commonwealth countries may suggest a common culture that encourages whistleblowing activity, the number probably reflects the more mundane fact that residents of those countries are more likely to speak English, the language in which Form TCR and the Commission website are written.
13 The relatively high percentage of TCRs from China may be due to the SEC's significant focus on issuers from China, and in particular Chinese reverse merger companies listed on U.S. exchanges.  See, e.g., Press Release, U.S. Sec. & Exch. Comm'n, SEC Charges N.Y.-Based Fund Manager and Others With Securities Laws Violations Related to Chinese Reverse Merger Company (July 30, 2012), available at http://www.sec.gov/news/press/2012/2012-146.htm; Press Release, U.S. Sec. & Exch. Comm'n, SEC Charges China-Based Company and Others with Stock Manipulation (Apr. 11, 2012), available at http://www.sec.gov/news/press/2012/2012-59.htm; Press Release, U.S. Sec. & Exch. Comm'n, SEC Approves New Rules to Toughen Listing Standards for Reverse Merger Companies (Nov. 9, 2011), available at http://www.sec.gov/news/press/2011/2011-235.htm; Luis A. Aguilar, Comm'r, U.S. Sec. & Exch. Comm'n, Facilitating Real Capital Formation (Apr. 4, 2011), available at http://www.sec.gov/news/speech/2011/spch040411laa.htm; Scott Eden, "China Reverse Mergers Continue Wild Ride," The Street, June 23, 2011, http://www.thestreet.com/story/11083003/1/china-reverse-mergers-continue-wild-ride.html.
14 Annual Report at 6, 8-9.  Individuals have ninety (90) days to apply for an award based on the posted notices of covered action.
15 Id. at 9.
16 See U.S. Dep't of Justice & U.S. Sec. & Exch. Comm'n, A Resource Guide to the U.S. Foreign Corrupt Practices Act, 56-66 (2012), available at http://www.sec.gov/spotlight/fcpa/fcpa-resource-guide.pdf (explaining that "[w]hen it comes to compliance, there is no one-size-fits-all program"); U.S. Sentencing Comm'n, Guidelines Manual, § 8B2 (Nov. 1, 2012), available at http://www.ussc.gov/Guidelines/2012_Guidelines/Manual_PDF/2012_Guidelines_Manual_Full.pdf (describing qualities of an "effective compliance and ethics program" for purposes of reducing an organization's culpability score).
17 Peter B. Clark, Bradley J. Bondi & James A. Treanor, Corruption and the Arab Spring: Compliance Implications for International Companies, FCPA Report, July 25, 2012, available at http://www.cadwalader.com/assets/article/072512BondiClarkFCPAReport.pdf.
18 Lanny Breuer, Assistant Att'y Gen., U.S. Dep't of Justice, Address at the American Conference Institute's 28th National Conference on the Foreign Corrupt Practices Act (Nov. 16, 2012), available at http://www.justice.gov/criminal/pr/speeches/2012/crm-speech-1211161.html (highlighting a financial services firm's "rigorous compliance program" as one reason why the Department of Justice declined to bring a case against the firm when its former employee conspired to circumvent its internal controls).
19 Emmanuel Olaoye, "Companies Will be Treated Favorably if They Report Violations First, SEC Enforcer Tells Lawyers," The Knowledge Effect, Oct. 24, 2012, http://blog.thomsonreuters.com/index.php/companies-will-be-treated-favorably-if-they-report-violations-first-sec-enforcer-tells-lawyers/; see also Press Release, SEC Charges Johnson & Johnson With Foreign Bribery, Apr. 7, 2011, available at http://www.sec.gov/news/press/2011/2011-87.htm (emphasizing the company's voluntary disclosures and "thorough internal investigation").
20 See 15 U.S.C. § 78u-6(h)(1).  Relief for an employee who successfully brings a retaliation action could include reinstatement, two times the amount of back pay owed, including interest, and compensation for costs, expert witness fees, and reasonable attorneys' fees. 15 U.S.C. § 78u-6(h)(1)(C).
21 Id. at § 78u-6(h)(1)(A).
22 Id. at § 78-6(h)(1)(B).
23 Under § 78u-6(h)(1)(A)(iii), an employer may not take a retaliatory action against an employee that makes a disclosure that is required or protected by 18 U.S.C. § 1513(e).  By taking such action, the employer could face fines, imprisonment, or both.