Is the SEC Trying to Head Congress Off at the Pass?

By Cydney Posner

The SEC is scheduled to adopt (or, in SEC parlance, "consider") final whistleblower provisions tomorrow, just a few days before a House subcommittee is scheduled to introduce legislation to rein in the proposed whistleblower rulemaking. It remains to be seen whether the SEC will have to revisit its rulemaking in the near future.

In November of last year, the SEC proposed rules to implement Section 21F of the Exchange Act, "Securities Whistleblower Incentives and Protection," which was added by Section 922 of Dodd-Frank. (See 11/9/10 article posting.) Section 21F directs the SEC to pay awards, subject to certain limitations and conditions, to eligible whistleblowers who voluntarily provide the SEC with original information about a violation of the federal securities laws that leads to a successful enforcement of a covered judicial or administrative action or a related action that results in monetary sanctions exceeding $1,000,000. The awards will be between 10% and 30% of the total monetary sanctions collected, with the possibility that the awards may well be divvied up among multiple whistleblowers.

The SEC's original proposal has been the subject of a lot of grousing on both sides among legislators and the business community. For example, this month, Senator Chuck Grassley (R-Iowa), apparently a strong whistleblower advocate, sent a letter to SEC Chair Mary Schapiro asking that the SEC reconsider its proposed rules because they would "unravel the good" sought by the financial reform legislation. After noting the SEC's embarrassing history of dealing with whistleblower claims -- only five claims paid in over 20 years -- the Senator argues that the SEC's proposal will hinder successful implementation of Section 21F and weaken its impact because it is overly complex, vague, overbroad, unduly burdensome for the whistleblower, too deferential to internal compliance programs, imposes too many limitations on eligibility -- you fill in the blank. Moreover, he argues, the proposal did not provide sufficient guidance for implementation of the anti-retaliation provisions. Apparently, SEC officials need an attitude adjustment, given their previous expressions of "hostility" and "skepticism" toward whistleblowers.

On the other hand, the business community and several other lawmakers have claimed that the SEC's proposal goes too far in the other direction. On May 11, the House Financial Services Capital Markets Subcommittee held a hearing to consider a draft bill that would substantially curtail the Dodd-Frank whistleblower provisions and the SEC's implementing proposal. The bill is anticipated to be introduced by the end of this month. Among other measures, the bill would: 

•  require whistleblowers to first report concerns through internal compliance processes to their employers to be eligible for a reward;
• eliminate the 10% minimum requirement under Dodd-Frank;
• give the SEC discretion to reward informants instead of making the bounty mandatory;
• eliminate contingency fee structures for counsel to whistleblowers;
• make whistleblowers who are found civilly liable in connection with the misconduct ineligible for a reward;
• make whistleblowers with legal, compliance or similar responsibilities and a fiduciary or contractual obligation to investigate or respond to internal reports of misconduct ineligible for a reward (note that the SEC proposed rules already limit the eligibility of those serving in compliance functions unless the company acts in bad faith);
• allow employers to enforce "established employment agreements, workplace policies, or codes of conduct against a whistleblower"; and
• require the SEC, before mounting an enforcement action in response to information provided by a whistleblower, to notify the company and allow it to investigate the matter and take remedial action.

At the hearing, business representatives urged the legislators to require the SEC to mandate preliminary company reporting, voicing their concerns that the same internal compliance processes encouraged by SOX would be undermined by the promise of a big payout from the SEC. (Business groups also think business can ease the burden on regulators by "screening" the complaints.) In addition, a whistleblower may "choose not to report internally because he or she believes that the company could then rectify the problem, and therefore be subject to lesser or no monetary sanctions upon which an award would be paid," said a Deloitte officer http://news.bna.com/srln/SRLNWB/split_display.adp?fedfid=20905710&vname=srlrnotallissues&fn=20905710&jd=a0c7u0m7y6&split=0. 

A representative of the U.S. Chamber of Commerce claimed that the proposal, "by not requiring informants to first approach their employers, creates a presumption that ‘all companies operate at the lowest possible level of ethical and illegal behavior.' The proposed program would penalize responsible companies that have spent millions of dollars investing in compliance programs and ‘building strong ethical corporate cultures.'" However, Senator Grassley has countered, "The SEC's primary purpose is to protect investors — not internal compliance programs." The CEO of the National Association of Corporate Directors urged lawmakers to delay the SEC's whistleblower program for one year to allow a comprehensive study of the effectiveness of corporate compliance programs. SEC officials told Reuters recently that the agency is not likely to agree to the demands for mandatory internal reporting.

The Washington Post reports that The Society of Corporate Secretaries and Governance Professionals has also sought changes to prevent "scorned husbands or wives from cashing in on secrets" and to make clear that companies could still fire whistleblowers for other reasons.