Dodd Frank – Introduction

In an earlier posts here and here, we briefly discussed Dodd Frank. This week, we intend to get into the weeds a little bit with Dodd Frank. Our paper discusses Dodd Frank in great detail.

The whistleblower and bounty hunter provisions of Dodd-Frank make internal auditing, reporting and compliance programs a higher priority than ever for covered employers. The SEC regulations implementing Dodd-Frank, released on May 25, 2011, clearly reflect that the government’s objective is to stimulate reporting of violations of the federal securities laws through financial incentives to employees who discover such violations. The Dodd-Frank regulations are a law enforcement tool that signals a further progression in the SEC’s approach to rooting out corporate corruption. Ten years ago, Congress passed the Sarbanes-Oxley Act of 2002 (“SOX”) in response to the breakdown in internal corporate controls demonstrated most dramatically in the Enron prosecution. Dodd-Frank is a step farther on that continuum, by financially incentivizing employees to come directly to the SEC with information regarding shareholder fraud.

Dodd-Frank also provides enhanced employment protection for the whistleblower providing the information. In presenting the new regulations, SEC Chairperson Mary L. Schapiro stated that “for an agency with limited resources like the SEC, I believe it is critical to be able to leverage the resources of people who have first-hand information about potential violations” of the securities laws. Consistent with that goal, the final regulations:

• Broaden the range of people who may qualify as whistleblowers;
• Promise to pay informant/whistleblowers for “original source” information that leads to a successful enforcement action by the SEC;
• Require only a “reasonable belief” that the information provided “relates to a possible securities law violation”;
• Simplify the reporting process for whistleblowers; and
• Do not require an employee to make an internal complaint before reporting alleged unlawful conduct to the SEC, including complaints for unlawful retaliation.

As proof of its commitment to enforcing its new program, the SEC leased 900,000 square feet of space for its expanding offices and has staffed a newly created “Office of the Whistleblower.” The SEC has also allotted more than $450 million to its investor protection fund, out of which whistleblower awards will be paid.

The SEC also created the “Office of the Whistleblower” to administer the SEC’s whistleblower program under Dodd-Frank. The Chief Officer of the Office of the Whistleblower is Sean McKessy, a former in-house lawyer with Altria Group, Inc., AOL Inc., and Caterpillar, Inc. He had previously worked as Senior Counsel in the SEC’s Division of Enforcement from 1997 to 2000. McKessy has five lawyers working for his office, and a staff of investigators. McKessy has reported that he has been very encouraged by the percentage of high quality tips that his office has received through the portal his office opened to gather tips through the internet. Between the day his office opened in August 2011, and the end of the fiscal year, September 30, 2011, his office received 334 whistleblower complaints – an average of about seven per day. McKessy’s office is required by law to issue an annual report every November reflecting its activities, results, and bounties paid.

In August 2012, the SEC made its first award to an employee-informant pursuant to the whistleblower provisions of Dodd-Frank. According to the SEC, a whistleblower’s assistance led to court-ordered sanctions against an organization totaling more than $1 million, of which $150,000.00 has been collected thus far. The informant has been paid $50,000.00 to date and stands to gain more as the SEC collects additional money. The informant’s award derives from the DFA’s so-called “bounty” provisions. These provisions are described in further detail below. They authorize the SEC to award employee whistleblowers between 10-30% of a sanction that exceeds $1 million, if the SEC determines that the whistleblower’s information was high-quality, based on original information, and led to a successful SEC enforcement action.

According to the SEC’s announcement in August 2012, the whistleblower provided information and cooperation of the sort it hoped the bounty program would attract. In accordance with Dodd-Frank’s anti-retaliation and identity protection provisions, the SEC did not disclose the whistleblower’s identity. The SEC’s release is silent as to whether the sanctioned organization had an effective internal reporting (“hot-line”) process, whether the employee reported the matter internally, or whether the employee bypassed any internal reporting process at the organization. The Chief of the SEC’s Whistleblower Office, Sean McKessy, stated: “The fact that we made the first payment after just one year of operation shows that we are open for business and ready to pay people who bring us good, timely information.”

As the first award to a whistleblower illustrates, the financial incentives laid out in the SEC regulations suggest that covered employers are now and will continue to face some or all of the following:

• Increased use of their internal ethics and compliance reporting procedures, because the regulations reward the use of those procedures;
• A need for prompt and efficient corporate responses to internal complaints, because effective internal responses are rewarded by the SEC, the U.S. Department of Justice prosecution principles, and the Federal Sentencing Guidelines;
• An increase in SEC and DOL investigations generally, because the bounty hunter system does not discourage reporting of questionable claims of wrongdoing; and
• The need for prompt, proper, and well-documented Human Resources responses to employee complaints, because the Dodd-Frank whistleblower provisions can be used by employees as a shield against performance management and legitimate employer discipline.

On November 15, 2012, the Office of the Whistleblower issued its 2012 annual report on the Dodd-Frank whistleblower program. Key findings of the report included the following:

• 3,001 tips, complaints, and referrals were received by the SEC in fiscal 2012, and came from whistleblowers located in all 50 states, the District of Columbia, the U.S. territory of Puerto Rico, as well as 49 foreign countries.
• The most common whistleblower complaints involved corporate disclosures and financials (18.2%), offering fraud (15.5%), and manipulation (15.2%).
• Of the whistleblower tips, complaints, and referrals the SEC received, 143 resulted in enforcement judgments and orders that potentially qualify the whistleblower to receive funds under the program.
• As mentioned above, on August 21, 2012, the SEC issued its first award under the new program to an individual whose tip assisted the SEC in stopping an ongoing fraud scheme. The court in that case ordered the fraud perpetrators to pay more than $1 million in sanctions. During the 2012 fiscal year, approximately $150,000 of this amount was collected, giving the whistleblower an award of about $50,000.

Hat tip: An outstanding article that covers the law and final regulations in comprehensive fashion is Dodd-Frank and the SEC Final Rule: From Protected Employee To Bounty Hunter, ST001 ALI-ABA 1487 (July 28-30, 2011), which was written by Littler Mendelson, P.C. lawyers John S. Adler, Edward T. Ellis, Barbara E. Hoey, Gregory C. Keating, Kevin M. Kraham, Amy E. Mendenhall, Kenneth R. O’Brian, and Carole F. Wilder. This post is partially derived from that article.

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