Thad Guyer, a GAP Adjunct Attorney for the past two decades, and partner at T.M. Guyer and Ayers & Friends, has prepared an analysis of the whistleblower provisions of the Dodd-Frank Act, Final Dodd-Frank Whistleblower Rules: Are you prepared? The Whistleblower Perspective, (June 15, 2011). To date, I view this to be among the most comprehensive treatments of the law since the May 25, 2011 final regulations were issued, and it should serve as an aid to corporate whistleblowers and whistleblower advocates.
Under the new SEC Rule 21F, if a whistleblower has provided “information relate[d] to a possible violation of the federal securities laws (including any rules or regulations thereunder)” that results in penalties or recoveries by the SEC or agencies, then that whistleblower is eligible to receive from 10 to 30 percent of that penalty or recovery. The bulk of final Rule 21F sets forth the conditions, processes and exceptions of eligibility for these rewards, but Guyer explains that the very liberal whistleblower protections against retaliation are just as important to the whistleblower cause.
In the 30 page paper, Guyer makes the case that Dodd-Frank Section 922 protections are broader than the whistleblower provisions of Section 806 of the Sarbanes Oxley Act, since the whistleblower’s allegations need not be related to shareholder protection as many courts have held. Instead, a Dodd-Frank whistleblower may receive awards and anti-retaliation protections connected with “any judicial or administrative action” brought by the SEC, or specified “related actions” brought by the Department of Justice and other specified federal agencies, self-regulatory organizations, and even state attorney generals. These “related actions” for which a whistleblower may receive awards and protections include court or agency actions against corporations by the Attorney General of the United States, any appropriate regulatory authority, including self-regulatory organizations, or even a State attorney general in connection with any criminal investigation. Rule 21F will be effective 60 days after they are submitted to Congress or published in the Federal Register.
The Guyer & Ayers paper thoroughly analyzes (and extensively quotes from) not just the Rule 21F text and SEC’s explanations and public statements by Commissioners, including a strong dissent by a Republican member, but the materials submitted by industry and whistleblower advocates in the fierce battle for and against the proposed rules the SEC published last fall. Among the ten significant points Guyer makes, three really stand out. Section 1 examines the differences between the proposed and final rules and concludes that the SEC overwhelmingly sided with whistleblower advocates. First, the SEC rejected industry’s hard push to require whistleblowers to first use internal corporate reporting channels before going to the SEC. Instead, final Rule 21F merely added incentives to “encourage” employee-whistleblowers to at least simultaneously report violations internally, but made clear this is not a requirement, but just another factor the SEC will consider in setting any reward amount. Second, the SEC rejected industry’s advocacy that only “proven” or “legitimate” whistleblower disclosures should be protected to avoid what industry predicted would be an avalanche of “frivolous” claims. Industry wanted the SEC to narrow the standard in the proposed rules which would have protected a whistleblower for reporting “potential” violations of the securities laws. But under the final rules, the SEC went in the opposite direction and further liberalized the rule to require only a report of a “possible” violation that that may simply be “about to occur.” Similarly, the SEC accepted whistleblower advocates’ urging that such possible violations need not constitute “material” disclosures. On this the SEC comment states that “a facially plausible relationship to some securities law violation” is sufficient for whistleblower status. Third and perhaps most controversial, the SEC rejected industry arguments that its lawyers, auditing and compliance program personnel should not under any circumstances be accorded whistleblower status. Under the final rules, auditing, legal and compliance personnel can be protected if they had a reasonable belief that whistleblowing was necessary (a) to prevent substantial injury to the financial interests of the company or its shareholders; or (b) that that the company was about to impede an investigation of the misconduct; or (c) that 120 days had passed since the whistleblower reported (or officials already knew about) the possible violations. Guyer explains that this contrasted significantly from the proposed rules which denied these categories of whistleblowers awards unless the company failed to self-report “within a reasonable amount of time” or otherwise acted in bad faith.
Sections 4 through 7 of Guyer’s paper gives an in-depth and compelling account of how the SEC resolved in favor of whistleblowers the thorny policy, empirical and statistical arguments for and against the weight to be given to corporate internal compliance programs. This includes a look at how new federal criminal sentencing guidelines applicable when a corporation is convicted of securities fraud may well become the SEC standard in determining whether a compliance program is real or merely “smoke and mirrors.” The paper cites historical accounts of the corporate “ethics industry” which suggest that it may well be permeated with flim-flam programs staffed by compliance employees “hired from Craigslist.” Guyer quotes unflattering excerpts from comments to the SEC by the Association of Corporate Counsel (“ACC), a bar association for attorneys employed in the legal departments of over 10,000 organizations.
Guyer characterizes and documents the ACC’s views, rejected by the SEC, about “the selfish motivations of whistleblowers”, giving this ACC quote:
“From our perspective and based on the traditional understanding of the term, an individual who merely learns of a problem and heads for Door Number 1 to recover a large award is not a whistleblower. … The Commission should adopt a better definition of ‘whistleblower’ by requiring those who would wear the title to earn it by reporting internally first.”
He offers extensive excerpts from two “key studies” on the efficacy of compliance programs, one from each side of the debate. He concludes that “it appears that the SEC in the final rule found the study of whistleblower advocates to be more persuasive.”
As to the effect of federal criminal sentencing guidelines on evolving and defending corporate compliance programs, Guyer says that “the threat of criminal consequences has proven to be one of the most compelling drivers toward enhancement of corporate ethics and compliance programs.” Citing amendments to the sentencing guideline effective in late 2010, he contends that these were the result of “the views of courts and prosecutors that these [ethics and compliance] programs still require substantial improvement if they are to serve as sentence mitigators for corporate criminal punishment.” The paper suggests that the SEC was presumptively aware of this in having accorded compliance programs so little weight in the final Rule 21F.
Lastly, in Section 8, Guyer forecasts the expected defenses and “whistleblower control strategies” industry and its lawyers will deploy in response to final rules — and the expected counter strategies that whistleblower lawyers will likely use. He projects that “corporations can be expected to approach the SEC’s Dodd Frank initiatives with an offensive against the legality of the final rule, and with caution in their dealings with potential whistleblower employees.” The paper excerpts a December 2010 letter to Congress from the Committee on Capital Markets Regulation that asserts the SEC’s regulatory push “can be traced to the August pledge Secretary of the Treasury Geithner made in response to charges that regulatory uncertainty would hinder economic recovery.” The Committee’s letter asserts that the SEC’s final rule violated the Administrative Procedure Act requirement of “an informed rulemaking process that is transparent and responsive to the public and affected parties.” Guyer says this letter is a likely preview to court challenges by industry.
As to what Guyer calls expected “whistleblower control strategies” by corporations, he cites a recent corporate client education program by the Gibson Dunn law firm entitled “The New SEC Whistleblower Rules: How to Prepare Your Company.” Among the preparations the firm suggests its clients undertake, perhaps the most stark is that companies should be on the lookout for whistleblowers at the hiring stage and “screen prospective new hires to identify and properly vet any red flags,” with the caveat that this screening be “consistent with applicable federal and state laws.” Another strategy that Guyer views as a transparent hide and seek effort is that companies should “consider having an attorney conduct or participate in interviews… [so that] all information obtained through a communication that is subject to attorney-client privilege is not considered ‘original information’, and thus generally is not eligible for an award” by the SEC whistleblower program. Another Gibson Dunn suggested whistleblower control strategy is that all “employees should be required to promptly report internally all violations of code of conduct and be regularly reminded of this requirement.” Guyer contends that this and other strategies are neither benign or without legal risk. He argues that “screening prospective new hires to identify whistleblowers may be discriminatory;” and that having a company attorney conduct or participate in interviews is an obfuscation that “whistleblower lawyers and courts are alert to” and which will not pass the judicial test of whether “the attorney’s participation was for the purpose of, and actually involved, giving legal advice to and answering legal questions of managers.” As to suggested requirements that all employees must promptly report internally all violations of code of conduct, Guyer predicts both that this will likely result in disparate treatment of whistleblowers that is easy to prove, and “few companies and managers will actually want all employees to report all suspected violations,” and that fewer still “will have the resolve to uniformly enforce such a policy” — setting up disparate treatment claims by whistleblowers.
The Guyer & Ayers papers concludes with a section about “combining whistleblower initiated self-reporting and SOX 806 to obtain Dodd Frank awards” based upon the recent and perhaps first significant federal Dodd-Frank case, Egan v. TradingScreen, Inc. in New York (May 4, 2011). This case, Guyer says, is a preview of whistleblower plaintiff strategies that are sure to come based on arguments that any SOX-protected complaints fall within the scope of the Dodd-Frank Act’s whistleblower provisions, whether or not the employee reports to SEC, and that reporting of misconduct internally to the employer may be sufficient under the SEC eligibility criteria that rewards whistleblowers who “jointly provide information” to SEC. That is, where the employee makes an internal disclosure that the company then self-reports, the whistleblower may be considered a joint provider of the information, and eligible for an award if he applies for one.
I agree with Guyer’s concluding comments that it is “inspirational for whistleblower lawyers that the final Rule 21F provides that retaliation against whistleblowers is now in and of itself an independent “securities law violation”, enforceable by the SEC or by whistleblowers themselves in lawsuits under either SOX or Dodd Frank. Only future experience will tell if he is right in arguing that “whistleblowers can plead claims simply on the basis that they were retaliated against, without regard to any other allegations of securities fraud, internal controls, etc. violations.” GAP certainly intends to be in the forefront of making this future experience happen.
Tom Devine is Legal Director for the Government Accountability Project, the nation’s leading whistleblower advocacy organization.