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

SEC commissioners voted 3-2 today in Washington to establish awhistle-blower program to “reward individuals who provide theagency with high-quality tips that lead to successful enforcementactions.” The program, part of the SEC's rulemaking under theDodd-Frank Act, expands a bounty system that was previously limitedto insider-trading cases.

In setting the rules, the SEC rejected appeals to require thatwhistle-blowers make reports through companies' internal complianceprograms before going to the agency. Instead, the regulatorincreased incentives for internal complaints by permitting bountiesfor people whose tips are passed along on to the agency andexpanding the time whistle-blowers can maintain their place in lineat the SEC while reporting to the company.

“Incentivizing — rather than requiring — internal reporting ismore likely to encourage a strong internal compliance culture,” SECChairman Mary Schapiro said in prepared remarks before thevote.

Commissioner Kathleen Casey, who joined fellow Republican TroyParedes in opposing the final rule in today's vote, said it“significantly underestimates the negative impact on internalcompliance systems” and could lead to a flood of complaints theagency would be unprepared to handle.

Madoff Tips
Dodd-Frank called for the SECto establish the expanded bounty system after the agency wasfaulted by lawmakers for fumbling tips about Bernard Madoff'smultibillion-dollar fraud. Commissioners voted unanimously on Nov.3 to seek comment on the program, which will cover whistle-blowercomplaints dating from the enactment of the regulatory overhaullast July.

The rule approved today allows the SEC to consider awards forwhistle-blowers ranging from 10 percent to 30 percent of penaltiescollected in case where sanctions exceed $1 million. To qualify,tipsters must voluntarily provide information based on their ownindependent knowledge before it is requested by the SEC or otherregulators.

SEC commissioners and staff members received 1,210 commentletters through yesterday and held more than 50 face-to-facemeetings trying in vain to assuage concerns that the program wouldundermine internal systems that were mandated by the Sarbanes-OxleyAct of 2002.

'In the Dark'
“Armed with trial lawyersand new large financial incentives to bypass these programs,whistle-blowers will go straight to the SEC with allegations ofwrongdoing and keep companies in the dark,” the U.S. Chamber ofCommerce said in a statement after the vote. “This leavesexpensive, robust compliance programs collecting dust.”

In a step aimed at bolstering internal programs, the SEC measureincludes a provision for saving a whistle-blower's place in linefor 120 days if they chose to report to their company first. Itwill also consider participation in a company program indetermining the percentage of sanctions awarded as a bounty.

The rules were endorsed by the Securities Industry and FinancialMarkets Association, which released a statement applauding “theSEC's willingness to work with the industry and make important andnecessary changes to the internal reporting provisions and theprovisions on who can collect monetary awards.”

Grimm Legislation
U.S. RepresentativeMichael Grimm, a New York Republican who serves on the HouseFinancial Services Committee, said he may propose legislation thatwould reverse the SEC's action by barring whistle-blowers frombypassing internal programs.

“The SEC's ruling will do more harm than good as potentialvictims may go months or years waiting for relief from unscrupulousemployees,” Grimm said in a statement after the vote. “I lookforward to introducing legislation to correct the overreachingwhistleblower provisions in Dodd-Frank and today's SEC ruling, in away that catches criminal activity early while protectingwhistleblowers from retaliation.”

The SEC rules contain provisions designed to protectwhistle-blowers against retaliation, which has been the focus of alawsuit in U.S. District Court for the Southern District of NewYork. A May 4 opinion from Judge Leonard Sand held that Dodd-Franksays a person has to report wrongdoing to the SEC — or be able toseek protection under other laws — before receiving legalsanctuary.

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

Separately, commissioners voted 3-2 today to propose limits onthe involvement of “bad actors” in Rule 506 securities sales andofferings. The measure, open for comment until July 14, woulddisqualify people barred from the securities business or convictedof a securities-related felony from exemptions that let issuersraise unlimited capital from accredited investors.

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