SEC Lets Whistleblowers Bypass Internal Programs

New rules will provide award of up to 30% of penalties for tips on financial wrongdoing

The U.S. Securities and Exchange Commission will let corporate whistle-blowers collect as much as 30 percent of penalties when they report financial wrongdoing, even when they bypass companies’ internal complaint systems.

SEC commissioners voted 3-2 today in Washington to establish a whistle-blower program to “reward individuals who provide the agency with high-quality tips that lead to successful enforcement actions.” The program, part of the SEC’s rulemaking under the Dodd-Frank Act, expands a bounty system that was previously limited to insider-trading cases.

In setting the rules, the SEC rejected appeals to require that whistle-blowers make reports through companies’ internal compliance programs before going to the agency. Instead, the regulator increased incentives for internal complaints by permitting bounties for people whose tips are passed along on to the agency and expanding the time whistle-blowers can maintain their place in line at the SEC while reporting to the company.

“Incentivizing -- rather than requiring -- internal reporting is more likely to encourage a strong internal compliance culture,” SEC Chairman Mary Schapiro said in prepared remarks before the vote.

Commissioner Kathleen Casey, who joined fellow Republican Troy Paredes in opposing the final rule in today’s vote, said it “significantly underestimates the negative impact on internal compliance systems” and could lead to a flood of complaints the agency would be unprepared to handle.

Madoff Tips
Dodd-Frank called for the SEC to establish the expanded bounty system after the agency was faulted by lawmakers for fumbling tips about Bernard Madoff’s multibillion-dollar fraud. Commissioners voted unanimously on Nov. 3 to seek comment on the program, which will cover whistle-blower complaints dating from the enactment of the regulatory overhaul last July.

The rule approved today allows the SEC to consider awards for whistle-blowers ranging from 10 percent to 30 percent of penalties collected in case where sanctions exceed $1 million. To qualify, tipsters must voluntarily provide information based on their own independent knowledge before it is requested by the SEC or other regulators.

SEC commissioners and staff members received 1,210 comment letters through yesterday and held more than 50 face-to-face meetings trying in vain to assuage concerns that the program would undermine internal systems that were mandated by the Sarbanes-Oxley Act of 2002.

‘In the Dark’
“Armed with trial lawyers and new large financial incentives to bypass these programs, whistle-blowers will go straight to the SEC with allegations of wrongdoing and keep companies in the dark,” the U.S. Chamber of Commerce said in a statement after the vote. “This leaves expensive, robust compliance programs collecting dust.”

In a step aimed at bolstering internal programs, the SEC measure includes a provision for saving a whistle-blower’s place in line for 120 days if they chose to report to their company first. It will also consider participation in a company program in determining the percentage of sanctions awarded as a bounty.

The rules were endorsed by the Securities Industry and Financial Markets Association, which released a statement applauding “the SEC’s willingness to work with the industry and make important and necessary changes to the internal reporting provisions and the provisions on who can collect monetary awards.”

Grimm Legislation
U.S. Representative Michael Grimm, a New York Republican who serves on the House Financial Services Committee, said he may propose legislation that would reverse the SEC’s action by barring whistle-blowers from bypassing internal programs.

“The SEC’s ruling will do more harm than good as potential victims may go months or years waiting for relief from unscrupulous employees,” Grimm said in a statement after the vote. “I look forward to introducing legislation to correct the overreaching whistleblower provisions in Dodd-Frank and today’s SEC ruling, in a way that catches criminal activity early while protecting whistleblowers from retaliation.”

The SEC rules contain provisions designed to protect whistle-blowers against retaliation, which has been the focus of a lawsuit in U.S. District Court for the Southern District of New York. A May 4 opinion from Judge Leonard Sand held that Dodd-Frank says a person has to report wrongdoing to the SEC -- or be able to seek protection under other laws -- before receiving legal sanctuary.

The final rule won’t provide protections to those who don’t report to the SEC, reinforcing the court’s interpretation.

Separately, commissioners voted 3-2 today to propose limits on the involvement of “bad actors” in Rule 506 securities sales and offerings. The measure, open for comment until July 14, would disqualify people barred from the securities business or convicted of a securities-related felony from exemptions that let issuers raise unlimited capital from accredited investors.


Bloomberg News

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