S.E.C. Whistleblower Program: Overview and Analysis

S.E.C. Whistleblower Program: Overview and Analysis

University of Maryland University College

ACCT 630 – Fall 2015

April 26, 2015

Abstract

Amidst the corporate scandals, fraud, and securities laws violations that have made headlines, Congress passed laws to change corporate practices and increase accountability with the intent of protecting investors and regaining investor confidence. Two of such laws enacted were the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. While each law has different emphasis, both have whistleblower protection and anti-retaliation provisions. They are similar in context but the Dodd-Frank Act provides additional rules and it is also responsible for the creation of the U.S. SEC Whistleblower Program.

The establishment of the program, however, did not happen without debate. The SEC received many letters and comments concerning the program rules. Some provided support while others, opposition. This paper seeks to examine the laws from which the program is derived as well as to dissect and analyze the primary concerns that were debated prior to the SEC producing the final rules[D1][D2].

Introduction

In light of the highly publicized corporate scandals and financial crisis, such as the massive fraud cases of Enron and WorldCom and the 2008 financial crisis, Congress enacted laws to protect investors through changes in the corporate setting and the financial industry. On July 30, 2002, the Sarbanes-Oxley Act of 2002 (“SOX”) was passed. Through its strict reforms, this law intended to protect investors, particularly with respect to corporate governance and changes to financial practices (Sarbanes-Oxley Act of 2002, 2002). The next major reform happened eight years later. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law (Sweet, 2010). With an emphasis on the financial industry, this law intended to restore confidence in the financial system through increased regulations that are meant to prevent financial crisis by detection of any financial bubbles (Sweet, 2010).

Of the various provisions of SOX and the Dodd-Frank Act, the ones in focus are Section 806 of SOX – Protection for employees of publicly traded companies who provide evidence of fraud – which is under Title VIII – Corporate and Criminal Fraud Accountability – and Section 922 of the Dodd-Frank Act – Whistleblower Protection. The SOX whistleblower provisions were the first to provide relief to whistleblowers while the Dodd-Frank Act further refined such relief to include an expanded definition of covered employees as well as an extended filing date for violation complaints. Together, these sections of the Acts provide protection for covered employees that are considered whistleblowers. The Dodd-Frank Act, in particular, provide the basis for the Securities and Exchange Commission’s (“SEC”) highly debated and recently established Whistleblower Program (Sarbanes-Oxley Act of 2002, 2002).

SOX – Section 806 Overview

SOX, particularly the Section 806 provisions, addresses the protection for employees who divulge information as to the fraud activities of a firm. It is the building block for whistleblower protection against anti-retaliation from which Section 922 Dodd-Frank Act addressed and enhanced in its whistleblower protection provisions. Overall, this section of SOX addresses the role of a whistleblower in providing information about company violations as well as the damages that can be sought if it can be proven that a whistleblower was discriminated against in the process of providing such information (Sarbanes-Oxley Act of 2002, 2002).

Section 806 of SOX offers protection to employees of publicly traded firms or firms that have securities registered under the Securities Exchange Act of 1934 against company retaliation when they “blow the whistle” on fraud or fraudulent reporting committed by the company (Sarbanes-Oxley Act of 2002, 2002). According to this section, an employee is covered under the protection of SOX if he or she is or was employed at the time by a public company and when such person discloses information about violations of SEC rules and regulations or other types of Federal law, particularly regarding “fraud against shareholders.”

Information Provided

The type of information provided by an employee that is covered under this section of SOX is any information on the conduct of the company where the employee “reasonably believes” that anti-fraud laws and regulations were violated (Sarbanes-Oxley Act of 2002, 2002). Such information offered could be as straightforward as the employee providing an initial tip, providing assistance in an investigation, or could be by providing testimony for or participation in a proceeding filed or to be filed. In addition, the information covered is one given to a Federal regulatory agency, law enforcement agencies, members or committees of Congress, or any official with “supervisory authority over the employee” (Sarbanes-Oxley Act of 2002, 2002).

In a nutshell, information relating to a firm’s activities meant to defraud shareholders that are shared with government officials or authorities at any stage by an employee of the firm – initial disclosure of knowledge, disclosure throughout investigations, or disclosure at final stages such as court proceedings – are protected from discrimination and retaliation. According to this section, a firm may not discriminate against the employee for any lawful act of protecting shareholders. Discrimination in this case includes “discharge, demotion, suspension, threat, harassment, or any other manner…in the terms and conditions of employment” (Sarbanes-Oxley Act of 2002, 2002).

Remedies

If an employee of a firm was discriminated against by the firm, an officer of the firm, another employee, a contractor, subcontractor, or an agent of the firm because he or she presented information to agencies and officials mentioned above relating to fraud, that employee is afforded remedies under this section of SOX. Remedies include compensatory damages and retained rights (Sarbanes-Oxley Act of 2002, 2002). Compensatory damages that could be awarded under this section include the following:

• Reinstatement of position held with the firm – the employee would be given back the same job status as before the discrimination occurred and would not be given a reduced job status or demotion of any kind.
• Retro-pay with interest tacked on – the employee would be given back pay for the period when the discrimination occurred, if it involved some sort of loss of income. In addition, interest would be assessed on the income withheld.
• Additional monetary compensation for special damages – the employee would be reimbursed for costs incurred to defend against the discrimination. Such special damages would include litigation costs, attorney fees, or any other fees incurred as a result of the discrimination (Sarbanes-Oxley Act of 2002, 2002).

An employee who has been discriminated against, as it applies to this section, can seek these remedies within ninety days of the violation by first filing a formal complaint with the Secretary of Labor and if no decision was made within 180 days as to the action to be taken, then the employee can bring about a lawsuit with the relevant district court (Sarbanes-Oxley Act of 2002, 2002). In the latter case, the district court would have full jurisdiction to preside over the discrimination case “without regard to the amount in controversy.”

As can be conceived, Section 806 of SOX is aimed at providing protection so that whistleblowers, if in the event of discrimination, can be made whole as if the discrimination did not occur. Although the primary emphasis on SOX was to encourage investor confidence through changes to practices primarily in financial reporting and corporate governance, it also included provisions relating to the welfare of employees. With this section of the Act in place, whistleblowers should be able to speak up about the corporate wrongdoing on behalf of shareholders sans fear of retaliation.

Dodd-Frank Act – Section 922 Overview

As an enhancement to the SOX whistleblower provisions that were enacted eight years prior, the Dodd-Frank Act of 2010 took the SOX a few steps further by providing expanded protection to whistleblowers. In addition, it was the law that established the SEC. Office of the Whistleblower, and in the process, it was also the law responsible for the creation of the SEC Whistleblower Program (U.S. Securities and Exchange Commission, n.d.).

Section 922 of the Dodd-Frank Act amended the Securities and Exchange Act of 1934’s Section 21F – Securities Whistleblowers Incentives and Protection – by addressing the whistleblower’s protection under the Act (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010). It expands beyond the whistleblower scope of SOX provisions by broadening the definition of an “employee” and including stipulations for the (1) payment of awards, (2) denial of awards, (3) Investor Protection Fund establishment, and (4) the various means of whistleblower protection that both supplement and enhance the provisions covered under SOX – those which are mentioned above (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010).

Payment of Awards to Employee

Under Section 922, the definition of a covered employee is expounded to include not only an employee of those mentioned under “Remedies” above, but also to include an employee of affiliates and subsidiaries of the firm in question. This enhanced the SOX’s definition of an employee as it allows for more people to be eligible for protection under the Dodd-Frank Act and it reduces the doubt as who to may qualify as a covered employee.

In addition to adding to the categories of covered employees, Section 922 also enhances SOX by explicitly stating the range of monetary awards that can be given to whistleblowers. Under this section, whistleblowers can be awarded monetary compensation for original information provided to the SEC in a value range from 10 percent to no more than 30 percent of what is collected from the firm in question (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010). Such payment to a whistleblower would be derived from monetary sanctions credited to the SEC Investor Protection Fund (“Fund”) which was set up with the Treasury of the United States, as required by the Act. The amount to be determined as award to the whistleblower is at the discretion of the SEC and is based on due consideration for the following:

• Value of the information in relation to the success of the actions taken against the firm in question
• Degree of participation in relation to the judicial and administrative processes
• Extent to which the award to the whistleblower would serve as a deterrence for other securities laws violations
• Other factors that the SEC may deem relevant such as when established by new rules or regulations (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010).

In addition, since the payment of awards would come from the Fund exclusively, the Dodd-Frank Act explicitly states that the amount of award determined for payout should not be affected by the balance of the Fund(Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010). In other words, irrespective of the amount of monies in the Fund at the time of award, the SEC should calculate a payout amount and “make good” on its promise to pay.Any payout in excess of the balance of the Fund would be covered by the sanctions from which the award is derived.

Denial of Awards

On the other hand, as equally as it is important to stipulate the payment of awards, the denial of awards was also addressed in this section of the Dodd-Frank Act. Whistleblowers could be denied an award if the following applies to the individual(s):

• Employed by related agencies – the SEC other regulatory agencies, Department of Justice, the Public Company Accounting Oversight Board, a self-regulating organization, or any law enforcement agencies.
• Convicted of criminal violations related to the judicial and administrative action in question
• Obtained the information through financial statement audits that are required under the securities laws
• Failed to provide information to the SEC as deemed by the SEC through its rules and regulations.

If any of the above applies to the whistleblower, he or she cannot receive awards for the information provided. In addition, the information that leads to successful prosecution can only be granted consideration for award if it is new and original information or that which was not already known to the SEC (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010).

Whistleblower Protection

Apart from the monetary awards that can be given to whistleblowers, the Dodd-Frank Act also defines the areas of protection afforded to whistleblowers that extend beyond the scope of the SOX provisions. The protection provisions stipulated in the Dodd-Frank Act are similar to that stipulated in SOX except that it adds to the amount of compensatory damages that can be collected and it extends the statute of limitations on the whistleblowing coverage period.

As it relates to the changes to compensatory damages, if an employee was terminated for whistleblowing reasons, under Section 922 of the Dodd- Frank Act, such employee can be awarded double the amount of back pay, including interest (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010). The other forms of compensatory damages remain the same as named in the SOX provisions.

As it relates to the changes to the statute of limitations, an employee has 180 days to file a complaint under the Dodd-Frank Act, as opposed to the 90 days under SOX (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010). The lengthened statute of limitations for complaints provides for more protection under the Act as well as allows for more time for the objectives under the Act to be effective. In other words, fewer whistleblowers would be denied protection as there would be additional time to file a complaint.

As can be envisioned, the provisions under the Dodd-Frank Act provide enhanced reforms from the precursor Act – SOX. While SOX laid the foundation for many reforms for overall corporate accountability, certain elements of the Dodd-Frank Act improved SOX, particularly with respect to its whistleblowing provisions. Also, in additional to the major elements stated above, the Dodd-Frank Act provisions also include other elements not included in SOX such as confidentiality, a study on the effectiveness of the whistleblower protection program, description of award payouts and Fund balances, and the requirement for audited financial statements of the Fund (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010). [D3]

SEC Whistleblower Program Overview

Prior to the enactment of the Dodd-Frank Act, in particular, the SEC had limited authority to take action against corporate wrongdoers. The agency’s “bounty program” could only be used for insider trading and the monetary awards it was allowed to pay out had a ceiling of only 10 percent of the monetary sanctions collected (U.S. SEC, 2011). This means that the SEC now has expanded authority, through the SEC Whistleblower Program set up by the Dodd-Frank Act, to compensate whistleblowers for information provided, not only for insider trading, but now for other federal securities laws violations. In addition, the payout amount increased from a maximum of 10 percent to a range from 10 percent to 30 percent.

As explained in the preceding paragraphs on the SOX and the Dodd-Frank Act overview, SOX provided the foundational elements for anti-retaliation provisions of whistleblowers that provide information leading to judicial action and the Dodd-Frank Act further enhanced such provisions by expanding the scope of what is covered under federal law primarily through the creation of the SEC Office of the Whistleblower and the SEC Whistleblower Program. (Other significant improvements include a broader definition of covered employees and the amplified consequences for retaliation against such employees).

Program Objectives

The SEC Whistleblower Program is directed by the Dodd-Frank Act to enforce the provisions under Section 922 (U.S. SEC, n.d.). According to the official SEC website, the primary intent for the creation of the SEC Whistleblower Program is to “reward individuals who act early to expose violations and who provide significant evidence that helps the SEC bring successful cases” (U.S. SEC, 2011). This goes in line with one of the primary missions of the SEC – to protect investors. The SEC is focused on exposing fraud against shareholders; however, not at the expense of those providing the information that exposed the fraud. If an employee blows the whistle on fraudulent acts, under SOX and the Dodd-Frank Act provisions, the SEC must protect the individual from retaliation. In addition, it is instructed to also provide awards for successful actions, as required by the Dodd-Frank Act and through the SEC Whistleblower Program (U.S. SEC, 2011).

Debate and Controversy[D4]

The creation and implementation of the SEC Whistleblower Program, however, did not arise without debate and controversy. Prior to creating the final rules of the program, the SEC received more than 240 comment letters and about 1,300 “form letters” specifically addressing concerns and support for the proposal (U.S. SEC, 2011). The letters received were from commenters that range from individuals to lawyers and law firms, public entities, professional organizations, audit firms, compliance personnel, whistleblower advocacy groups, academics, and not-for-profit organizations who all chimed in on what they feel would be the impact of the proposal (U.S. SEC, 2011).