01 Nov 2011
Preparing for the impact of US Securities whistleblower reforms - employees become bounty hunters
by Nicholas Mavrakis, Michael Legg
Inhouse counsel and corporations should consider a range of measures to improve the operation of internal reporting mechanisms and make internal reporting more attractive to employees.
Australian entities dealing with US public companies, including investment banks, advisers and service suppliers, as well as US subsidiaries operating in Australia, should be aware of recent reforms which grant monetary rewards to individuals who report illegal conduct to the Securities Exchange Commission (SEC). The provisions took effect on 12 August 2011. The reforms give employees important rights to report illegal conduct directly to the SEC and thereby bypass internal reporting and compliance mechanisms.
On 21 July 2010, President Obama signed into United States law the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act is a response to the global financial crisis and contains extensive reforms to the US financial services industry. One of the remarkable changes introduced by these reforms is new direct reporting whistleblower provisions.
Role of whistleblowers
Whistleblowers play an important role in the detection of corporate and financial services misconduct. Whistleblowers frequently have access to information about illegal conduct which may otherwise remain undetected. It is well established that occupational misconduct is more likely to be detected by tip than by any other means. In the wake of the Sarbanes-Oxley Act of 2002 and the whistleblower provisions in the Corporations Act 2001 (Cth), companies sought to harness the ability of whistleblowers to detect and report misconduct to improve their internal controls.
In Australia, the Corporations Act protects whistleblowers who are employees, officers and contractors from recriminations. However according to Treasury in its 2009 Improving Protections for Corporate Whistleblowers: Options Paper these provisions have rarely been used. The provisions rely on the moral conscience of individuals to report improper conduct. Potential whistleblowers are not given any financial reward or incentive to encourage reporting.
The US has taken a different approach. Section 922 of the Dodd-Frank Act provides that the SEC shall pay awards to eligible whistleblowers who voluntarily provide the SEC with original information that leads to successful enforcement of a violation of US federal “securities laws” yielding monetary sanctions over $1 million. The award to the whistleblower must be between 10–30% of the total monetary sanctions collected in the SEC’s action or any related action such as a criminal prosecution. US federal securities law covers breaches of the Securities Act 1933, the Securities Exchange Act 1934, the Sarbanes-Oxley Act 2002 and the Investment Company Act 1940.
The Dodd-Frank Act prohibits retaliation by employers against whistleblowers. It also provides them with a private cause of action if they are discharged or discriminated against by their employers. This extends to obtaining double back-pay reparations.
This reward or bounty is quite an incentive. They would have yielded whistleblowers a small fortune if they applied to recent SEC prosecutions. For instance, whistleblowers would have been entitled to between $55–65 million from the recent $550 million SEC settlement with Goldman Sachs concerning its misleading investor claims. A whistleblower may also receive bountiful amounts in a Foreign Corrupt Practices Act cases as it forms part of the securities laws. Consider the award that could have applied in the US Department of Justice and SEC’s settlement of charges against Halliburton Company and its former engineering and construction unit, Kellogg, Brown & Root Inc, for $579 million or the German company Siemens AG for $800 million.
Reach of US whistleblower provisions
The Dodd-Frank whistleblower provisions may impact Australian entities dealing with US public companies, including investment banks, advisers and other service suppliers, and US subsidiaries operating in Australia. Employees of these entities may obtain information during the course of their employment which may reveal a breach of US federal securities laws. This would entitle them to report such conduct to the SEC directly and be eligible for the monetary award. The rules do not impose a requirement that whistleblowers report through internal compliance processes as a prerequisite to eligibility for an award.
For these reasons, public companies and directors in the US have raised concerns that internal compliance mechanisms will be undermined as employees race to be the first to blow the whistle to the SEC. The concern is that their internal compliance procedures may be sidelined by whistleblowers eager to secure a bounty.
The SEC rules attempt to deal with this by allowing an employee who reports wrongdoing internally first and, within 120 days reports the wrongdoing to the SEC, to maintain their place in the queue for providing original information and receive the benefit of all the information that the corporation obtains as part of its internal investigation.
Nevertheless due to the perverse nature of the incentive, the problem remains. Bounties get larger the greater the sanctions visited upon the company. Awhistleblower may consider that higher awards are more likely if the whistleblower promptly stakes their claim with the SEC but does not assist the corporation to take remedial steps to stop or limit the harm caused.
Tips for inhouse counsel
Whistleblowers are an important aspect of the detection and prevention of corporate and financial services misconduct but the Dodd-Frank bounties may increase litigation and sanctions without preventing corporate fraud. As the SEC’s Chief of the Office of the Whistleblower has observed:
"the [SEC] rules leave it to the employee to decide whether to report internally first — or to contact the SEC — and those companies that best ensure that their employees view internal reporting as a viable and credible option to address possible securities law violations are more likely to have the wrongdoing reported internally first."
Inhouse counsel and corporations should consider a range of measures to improve the operation of internal reporting mechanisms and make internal reporting more attractive to employees. These measures include:
- providing confidential and anonymous mechanisms for reporting potential misconduct;
- educating employees about the available methods of submitting complaints internally; and
- rewarding whistleblowers for providing the company with information that enables it to identify and address misconduct.
This article was first published in Inhouse Counsel, Vol 15 Nos 2&3, November/December 2011