The Securities and Exchange Commission adopted a new rule today to reward a bounty to whistleblowers who provide regulators with information on securities law violations that leads to successful enforcement action in a 3 to 2 vote at the agency's open meeting. The Commission also voted to propose a rule that would disqualify securities offerings from registration exemption if felons or other “bad actors” are involved.

Whistleblower Final Rule Passed

The new rule, as mandated by Congress under the Dodd-Frank Act, would award any individual who voluntarily provides the government or a self-regulatory organization with original information based on independent knowledge or analysis that is not already known to the Commission up to 30 percent of the penalties collected in the enforcement action. Prior to this rulemaking, only insider trading cases warranted a bounty, which was capped at 10 percent of the collected sum.

Commissioner Kathleen Casey, who opposed the rule, said at the meeting that the rule “significantly underestimates the negative impact on the internal compliance programs” and, at the same time, “significantly overestimates our capacity to effectively triage and manage all the whistleblower complaints.” In response, the Division of Enforcement's Director Robert Khuzami and Associate Director Stephen Cohen said that they had reason to believe that whistleblowers would still be likely to report internally despite the bounty. They acknowledged that while there was already an “uptick” in the number of incoming submissions, that there wasn't yet the “flood” of new tips, as predicted by some comment letters. Furthermore, the quality in the information had already significantly improved, they said.

The SEC must continue to monitor the effects of the rule as it is implemented, said Comissioner Elisse Walter, who voted in its favor, at the meeting. When asked how the success of the new rulemaking would be tracked, Khuzami said, “Primarily we're going to have to hear from the companies as to how they view the impact, assessing the complaints themselves as to whether they were reported internally, and talking to the whistleblowers to find out why it is that they chose not to report internally.”

Modifications in the Final Rule

In consideration of the high volume of comments received on the proposed rule, and in particular, the worry expressed about the risk that internal corporate compliance functions would be negatively affected by incentivizing direct reporting to government, the SEC made certain modifications in the final version of the rule, said Khuzami. These changes include extending the grace period from 90 to 120 days, under which a company can investigate a tip internally before the whistleblower is required to report the same information to the agency in order still to be eligible for a bounty. A whistleblower could also be eligible for a more substantial reward by participating in a company's internal reporting system.

Contrary to many commenters' requests, however, the final rule does not require whistleblowers to notify companies of their submission, if they also notify regulators. This point has been a significant source of controversy.

Other changes apparent in the final version of the rule include a streamlining of the process by which whistleblowers submit tips to regulators, meaning a single form for submissions, in addition to a whistleblower website page, that will go up today, according to Khuzami. The rule's anti-retaliation protection was also clarified in the final version, making it unlawful to retaliate against a whistleblower who has a reasonable belief in the tip, or to obstruct the individual's ability to report that information to regulators. 

Certain parties are also excluded from being eligible whistleblowers, under the final rule. The most hotly contested of these are attorneys, including in-house counsel, who breach client-attorney confidentiality—unless the attorney-whistleblower has a reasonable basis to believe that disclosure of the information would significantly protect the financial interest or property of investors. “What the rule gives with one hand, it takes away with the other,” said Casey. “This exception literally swallows the rule.” Other excluded parties are those who are already obligated to report to the Commission, people who violate laws to obtain the information, as well as foreign government officials.

At the open meeting, the head of the Office of the Whistleblower Sean McKessy also announced that the office, which accepts incoming tips, works with whistleblowers, and helps the Commission determine the appropriate bounty, is now staffed and the Investor Protection Fund, which will pay the awards to whistleblowers, has been fully funded, also under Dodd-Frank.

‘Bad Actors' Rule Proposal

The Commission also voted 3 to 2 to propose a rule to disqualify securities offerings from registration exemption if they involve “felons or other bad actors,” at the meeting.

Commissioners Casey and Troy Parades, who voted ‘no' on both agenda items, objected to this proposal primarily because of its “impermissible retroactivity," which, they said, is not what Congress intended in its Dodd-Frank provision. In response, the Director of the Division of Corporation Finance Meredith Cross said, “We believe what we have proposed recognized Congress's clear intent.”

Public comment on the proposed rulemaking will be accepted through July 14.

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