The SEC Whistleblower Incentives Program

If a whistleblower satisfies all of these elements, he or she is guaranteed the above-mentioned bounty. And he or she may also be entitled to a share of any penalties recovered by certain other government or regulatory agencies that bring enforcement or criminal proceedings while relying on the same original information provided by the whistleblower.

Encouraging Whistleblowers to Report Internally

The SEC unveiled a working set of whistleblower rules in November 2010 and requested public comment on the scheme. Over the next six months, no issue related to the proposed rules was more vigorously debated than their potential impact on internal compliance and reporting programs. Proponents of the rules argued there is no value in requiring whistleblowers to report alleged violations internally before informing the Commission. Such a mandate, they insisted, has a chilling effect on would-be whistleblowers who fear retaliatory termination, as well as those who work in environments where the only recourse is reporting up to the alleged wrongdoer.

Meanwhile, detractors argued that a set of rules without an internal reporting requirement would undermine internal audit, compliance, and reporting policies and procedures already in place (and required by the Sarbanes-Oxley Act of 2002). The promise of a substantial bounty, they maintained, would only encourage whistleblowers to bypass internal compliance mechanisms altogether ' so the proposed rules provided no real incentive to report internally.

Having weighed these differing viewpoints, the SEC in its final whistleblower rules elected not to require whistleblowers to report internally before submitting tips and complaints to the SEC. In the adopted scheme, however, the SEC sought a compromise designed to promote internal reporting through corporate compliance procedures. Simply stated, rather than requiring would-be whistleblowers to report potential securities law violations in-house, the Commission devised a scheme that “encourages” employees to blow the whistle internally, principally by putting more money on the table for internal whistleblowers. According to SEC Chairman Mary Schapiro, the final rules “expand upon the incentives for whistleblowers to report internally” in three significant ways. (Chairman Mary L. Schapiro, SEC Chairman, Opening Statement at SEC Open Meeting: Item 2 ' Whistleblower Program (May 25, 2011), available at http://162.138.185.32/news/speech/2011/spch052511mls-item2.htm (“Schapiro Opening Statement”).)

First, the rules lengthen the period of time a whistleblower can wait after reporting a suspected violation internally before submitting the same information to the SEC. For the purposes of determining his or her “place in line” for a bounty, an individual is regarded as a “whistleblower” from the date he or she reports internally. The rules proposed in November 2010 granted whistleblowers a 90-day “grace period” after making an internal report to come forward to the Commission and claim a place in line. The final rules extend the grace period, giving internal whistleblowers a 120-day window before they must submit the same original information to the Commission.

Second, the program offers internal whistleblowers a higher award than those who report only to the Commission. The rules make clear that a whistleblower's use of a regulated entity's internal compliance or reporting program(s) is a factor the Commission will consider in determining the amount of an award. Participation in internal reporting procedures cuts in favor of an award at the upper end of the 10%-30% range.

Third, and most significantly, the program provides bounties for certain internal whistleblowers even if they never make a formal complaint to the SEC. Stated differently, in its final rules, the Commission devised a system that rewards whistleblowers for internal reporting. The final rules make an internal whistleblower eligible for an award, regardless of whether he or she separately submits the same original information to the SEC, if his or her employer subsequently self-reports to the Commission related information that leads to a successful enforcement action. Importantly, the internal whistleblower is entitled to an award based on ' and commensurate with ' all the information the company provides to the Division of Enforcement, not just the information the whistleblower reported internally. The effect, says the Commission, is a strong incentive for would-be whistleblowers to report internally before turning to the SEC.

The Commission believes that an internal reporting requirement would be of no use in many circumstances, and may have a detrimental effect. SEC Enforcement chief Rob Khuzami believes that requiring whistleblowers to report internally would “place an undue and additional burden on a whistleblower” and would likely deter persons with knowledge of fraud from coming forward. (Robert S. Khuzami, Director, Division of Enforcement, Remarks at Open Meeting ' Whistleblower Program (May 25, 2011), available at www.sec.gov/news/speech/2011/spch052511rk.htm.) Khuzami argues that in “boiler rooms,” “pump-and-dump,” Ponzi schemes and similar frauds, there is no point in requiring internal reporting. (Id.) Entities engaged in such practices typically do not have a legitimate compliance program or internal reporting mechanism available; the whistleblower would effectively be required to report directly to the alleged wrongdoer.

Thus, though it declined to require internal reporting, according to Chairman Schapiro the final rules strike “a balance between encouraging whistleblowers to pursue the route of internal compliance when appropriate ' while providing them the option of heading directly to the SEC.” (Schapiro Opening Statement) It is essential, she says, to leave both avenues open to potential whistleblowers who are “in the best position to know which route is best to pursue.” (Id.)

Harvesting Whistleblower Tips and Complaints

From the day the Dodd-Frank Act was signed into law, the SEC experienced an appreciable uptick in whistleblower tips and complaints. Because of the extraordinary bounties available to SEC whistleblowers under the final rules, many believe the Commission will experience a prohibitively large increase in complaints. The program's critics ' SEC Commissioner Casey chief among them ' insist that the Commission is ill-equipped to handle the avalanche of tips. According to Commissioner Casey, the Commission does not have sufficient staff or systems to “triage and manage” incoming tips, and the final rules do too little to prepare the Commission for a high volume of tips.

For its part, the Commission is adamant it can effectively separate the wheat from the chaff. Not only does it believe it can handle an ever-increasing volume of tips, the Commission insists the whistleblower program is already having a positive impact on its ability to identify and stop violations of the federal securities laws. According to the Commission, in sifting through thousands of complaints, the enforcement staff has already unearthed a number of high-quality tips. Chairman Schapiro has highlighted “stories from [SEC] investigators about how whistleblowers have [already] saved [the Commission] weeks of investigation time because of the specific, credible and timely information they provided.” (Schapiro Opening Statement.) Other SEC representatives echo Schapiro's remarks, pointing out a matter in which a whistleblower's cooperation saved the Commission an estimated six to 12 months of investigation. (Stephen Cohen, SEC, Remarks at SEC Open Meeting (May 25, 2011).)

While the SEC's preliminary success is owed to an effective use of existing resources, the future of the program is in the hands of the newly created Office of the Whistleblower. The Dodd-Frank Act required the SEC to establish a separate whistleblower office within the Division of Enforcement. The Office of the Whistleblower, headed by Sean McKessy, is now staffed and operational. The group's mandate is to triage whistleblower tips and complaints, work with whistleblowers to cultivate leads, and help the Commission determine the amount of an award in appropriate cases. To that end, the Office has developed an online system designed to harvest and analyze whistleblower tips and complaints.

How Companies Should Respond

Whether the Office of the Whistleblower will be able to handle the volume of tips it receives is yet to be seen but, rest assured, the number of tips will increase. Regulated entities that want to take advantage of the whistleblower program's allure need to design and implement (or improve) their own compliance programs to attract internal reports. Reporting programs should emphasize the increased bounty available to internal whistleblowers through the SEC's incentives program. Equally, programs should emphasize corporate anti-retaliation policies and stress that the company takes internal reporting seriously. Most importantly, perhaps, reporting programs should be capable of acting swiftly and decisively. Investigating tips internally and self-reporting to the Commission in a timely fashion will be of paramount importance in a world where whistleblowers have the ability to bypass internal compliance programs on their way to the SEC.

Kurt Wolfe is an attorney in McGuireWoods LLP's Washington, DC, office. He is a member of the firm's Government, Regulatory and Criminal Investigations Department.

he U.S. Securities and Exchange Commission (SEC or the Commission) is implementing a new whistleblower incentives program required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). Legal and compliance personnel at public companies, companies making non-public offerings, brokers and dealers, investment advisers, and mutual funds that have not yet familiarized themselves with the whistleblower program should take note: The rules are effective Aug. 12, 2011, and they significantly transform the whistleblower landscape. This article examines how the SEC plans to use the powerful new incentives to draw out would-be whistleblowers, and how it plans to sort through and make use of whistleblower complaints.

The SEC's New 'Securities Whistleblower Incentives Protection' Program

On May 25, the SEC adopted rules implementing the “Securities Whistleblower Incentives and Protection” program, codified in Section 21F of the Securities Exchange Act of 1934 (17 C.F.R. ” 240.21F-1to -17 (2011)). The rules offer people who supply the Commission high-quality tips regarding suspected violations of the federal securities laws a bounty of 10%-30% of all assessed sanctions that result from the tip. To qualify for a whistleblower bounty, a person must: 1) voluntarily come forward to the Commission; 2) with original information (a “tip” or “complaint”) about a suspected violation of the federal securities laws; 3) that leads to a successful judicial or administrative enforcement action brought by the SEC; 4) in which the SEC obtains monetary sanctions totaling more than $1 million.

If a whistleblower satisfies all of these elements, he or she is guaranteed the above-mentioned bounty. And he or she may also be entitled to a share of any penalties recovered by certain other government or regulatory agencies that bring enforcement or criminal proceedings while relying on the same original information provided by the whistleblower.

Encouraging Whistleblowers to Report Internally

The SEC unveiled a working set of whistleblower rules in November 2010 and requested public comment on the scheme. Over the next six months, no issue related to the proposed rules was more vigorously debated than their potential impact on internal compliance and reporting programs. Proponents of the rules argued there is no value in requiring whistleblowers to report alleged violations internally before informing the Commission. Such a mandate, they insisted, has a chilling effect on would-be whistleblowers who fear retaliatory termination, as well as those who work in environments where the only recourse is reporting up to the alleged wrongdoer.

Meanwhile, detractors argued that a set of rules without an internal reporting requirement would undermine internal audit, compliance, and reporting policies and procedures already in place (and required by the Sarbanes-Oxley Act of 2002). The promise of a substantial bounty, they maintained, would only encourage whistleblowers to bypass internal compliance mechanisms altogether ' so the proposed rules provided no real incentive to report internally.

Having weighed these differing viewpoints, the SEC in its final whistleblower rules elected not to require whistleblowers to report internally before submitting tips and complaints to the SEC. In the adopted scheme, however, the SEC sought a compromise designed to promote internal reporting through corporate compliance procedures. Simply stated, rather than requiring would-be whistleblowers to report potential securities law violations in-house, the Commission devised a scheme that “encourages” employees to blow the whistle internally, principally by putting more money on the table for internal whistleblowers. According to SEC Chairman Mary Schapiro, the final rules “expand upon the incentives for whistleblowers to report internally” in three significant ways. (Chairman Mary L. Schapiro, SEC Chairman, Opening Statement at SEC Open Meeting: Item 2 ' Whistleblower Program (May 25, 2011), available at http://162.138.185.32/news/speech/2011/spch052511mls-item2.htm (“Schapiro Opening Statement”).)

First, the rules lengthen the period of time a whistleblower can wait after reporting a suspected violation internally before submitting the same information to the SEC. For the purposes of determining his or her “place in line” for a bounty, an individual is regarded as a “whistleblower” from the date he or she reports internally. The rules proposed in November 2010 granted whistleblowers a 90-day “grace period” after making an internal report to come forward to the Commission and claim a place in line. The final rules extend the grace period, giving internal whistleblowers a 120-day window before they must submit the same original information to the Commission.

Second, the program offers internal whistleblowers a higher award than those who report only to the Commission. The rules make clear that a whistleblower's use of a regulated entity's internal compliance or reporting program(s) is a factor the Commission will consider in determining the amount of an award. Participation in internal reporting procedures cuts in favor of an award at the upper end of the 10%-30% range.

Third, and most significantly, the program provides bounties for certain internal whistleblowers even if they never make a formal complaint to the SEC. Stated differently, in its final rules, the Commission devised a system that rewards whistleblowers for internal reporting. The final rules make an internal whistleblower eligible for an award, regardless of whether he or she separately submits the same original information to the SEC, if his or her employer subsequently self-reports to the Commission related information that leads to a successful enforcement action. Importantly, the internal whistleblower is entitled to an award based on ' and commensurate with ' all the information the company provides to the Division of Enforcement, not just the information the whistleblower reported internally. The effect, says the Commission, is a strong incentive for would-be whistleblowers to report internally before turning to the SEC.

The Commission believes that an internal reporting requirement would be of no use in many circumstances, and may have a detrimental effect. SEC Enforcement chief Rob Khuzami believes that requiring whistleblowers to report internally would “place an undue and additional burden on a whistleblower” and would likely deter persons with knowledge of fraud from coming forward. (Robert S. Khuzami, Director, Division of Enforcement, Remarks at Open Meeting ' Whistleblower Program (May 25, 2011), available at www.sec.gov/news/speech/2011/spch052511rk.htm.) Khuzami argues that in “boiler rooms,” “pump-and-dump,” Ponzi schemes and similar frauds, there is no point in requiring internal reporting. (Id.) Entities engaged in such practices typically do not have a legitimate compliance program or internal reporting mechanism available; the whistleblower would effectively be required to report directly to the alleged wrongdoer.

Thus, though it declined to require internal reporting, according to Chairman Schapiro the final rules strike “a balance between encouraging whistleblowers to pursue the route of internal compliance when appropriate ' while providing them the option of heading directly to the SEC.” (Schapiro Opening Statement) It is essential, she says, to leave both avenues open to potential whistleblowers who are “in the best position to know which route is best to pursue.” (Id.)

Harvesting Whistleblower Tips and Complaints

From the day the Dodd-Frank Act was signed into law, the SEC experienced an appreciable uptick in whistleblower tips and complaints. Because of the extraordinary bounties available to SEC whistleblowers under the final rules, many believe the Commission will experience a prohibitively large increase in complaints. The program's critics ' SEC Commissioner Casey chief among them ' insist that the Commission is ill-equipped to handle the avalanche of tips. According to Commissioner Casey, the Commission does not have sufficient staff or systems to “triage and manage” incoming tips, and the final rules do too little to prepare the Commission for a high volume of tips.

For its part, the Commission is adamant it can effectively separate the wheat from the chaff. Not only does it believe it can handle an ever-increasing volume of tips, the Commission insists the whistleblower program is already having a positive impact on its ability to identify and stop violations of the federal securities laws. According to the Commission, in sifting through thousands of complaints, the enforcement staff has already unearthed a number of high-quality tips. Chairman Schapiro has highlighted “stories from [SEC] investigators about how whistleblowers have [already] saved [the Commission] weeks of investigation time because of the specific, credible and timely information they provided.” (Schapiro Opening Statement.) Other SEC representatives echo Schapiro's remarks, pointing out a matter in which a whistleblower's cooperation saved the Commission an estimated six to 12 months of investigation. (Stephen Cohen, SEC, Remarks at SEC Open Meeting (May 25, 2011).)

While the SEC's preliminary success is owed to an effective use of existing resources, the future of the program is in the hands of the newly created Office of the Whistleblower. The Dodd-Frank Act required the SEC to establish a separate whistleblower office within the Division of Enforcement. The Office of the Whistleblower, headed by Sean McKessy, is now staffed and operational. The group's mandate is to triage whistleblower tips and complaints, work with whistleblowers to cultivate leads, and help the Commission determine the amount of an award in appropriate cases. To that end, the Office has developed an online system designed to harvest and analyze whistleblower tips and complaints.

How Companies Should Respond

Whether the Office of the Whistleblower will be able to handle the volume of tips it receives is yet to be seen but, rest assured, the number of tips will increase. Regulated entities that want to take advantage of the whistleblower program's allure need to design and implement (or improve) their own compliance programs to attract internal reports. Reporting programs should emphasize the increased bounty available to internal whistleblowers through the SEC's incentives program. Equally, programs should emphasize corporate anti-retaliation policies and stress that the company takes internal reporting seriously. Most importantly, perhaps, reporting programs should be capable of acting swiftly and decisively. Investigating tips internally and self-reporting to the Commission in a timely fashion will be of paramount importance in a world where whistleblowers have the ability to bypass internal compliance programs on their way to the SEC.

Kurt Wolfe is an attorney in McGuireWoods LLP's Washington, DC, office. He is a member of the firm's Government, Regulatory and Criminal Investigations Department.