SEC Chair Signals Intent to Unwind Whistleblower Award Limitations
On August 2, 2021, the Chair of the US Securities and Exchange Commission (SEC or Commission), Gary Gensler, issued a “Statement in Connection with the SEC’s Whistleblower Program” (Statement). In his Statement, Chair Gensler noted that he has directed SEC staff to prepare potential revisions to certain of the whistleblower rule amendments that were adopted by the Commission last year by a narrow 3-2 margin. Chair Gensler stated that these particular rule amendments, as written, could discourage whistleblowers from coming forward to provide information to the SEC. The Statement comes on the heels of Chair Gensler’s speech for National Whistleblower’s Day on July 30, 2021 (NWD2021), and the continuing output of whistleblower awards from the Commission.
This Advisory (i) explains the background of the relevant SEC whistleblower provisions, (ii) discusses Chair Gensler’s pro-whistleblower stance, including through his call for potential revisions to the whistleblower rule amendments, (iii) surveys recent whistleblower awards where internal reporting was a factor, and (iv) identifies some key takeaways for companies to consider.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) amended the Securities Exchange Act of 1934 (Exchange Act) by, among other things, adopting Section 21F, entitled “Securities Whistleblower Incentives and Protection.” 15 U.S.C. § 78u-6. Section 21F directs the Commission to make monetary awards to eligible individuals who voluntarily provide original information that leads to successful SEC enforcement actions resulting in monetary sanctions over $1 million.
In addition to awards based on successful SEC enforcement actions, the Commission is also directed to pay awards based on amounts collected in certain “related actions.” Exchange Act Rule 21F-3(b)(1) defines “related actions” to include judicial or administrative actions brought by certain other federal and state authorities, such as the Department of Justice, the Comptroller of the Currency, an exchange such as NASDAQ, or a state Attorney General in a criminal case. 17 C.F.R. §§ 240.21F-3. Awards range between 10% and 30% of the money collected in the SEC action and any related action. In addition to providing monetary awards to certain whistleblowers, Dodd-Frank and the Commission’s implementing rules create confidentiality protections for whistleblower submissions and prohibit employers from retaliating against whistleblowers for providing information to the SEC. 17 C.F.R. §§ 240.21F-7; 15 U.S.C. § 78u-6(h)(1).
On September 23, 2020, the SEC voted—by a 3-2 margin—to adopt amendments to the rules governing the whistleblower program. The sweeping amendments included provisions, as applicable here, clarifying that a law-enforcement or separate regulatory action does not qualify as a “related action” and, thus not an eligible action for a whistleblower award, if the Commission determines that there is a separate whistleblower award program that more appropriately applies to the action. The Commission’s Adopting Release explains the rationale behind the rule amendment to be three-fold: (1) allowing multiple awards with respect to a single action may result in an aggregate award above the 30% threshold imposed by Congress; (2) the related action award is intended to allow whistleblowers to receive an award for matters not otherwise covered by another program; and (3) whistleblowers would receive multiple “bites at the apple” on a whistleblower claim based on the same original information. 17 CFR § 240.21F-3(b).
At the same time, the SEC also adopted amendments to Exchange Act Rule 21F-6, which sets the criteria for determining where an award falls within the 10% to 30% range. The Rule identifies seven award factors (four positive and three negative) that the Commission considers in setting the award amount, consisting of: (1) the significance of information provided by the whistleblower; (2) the assistance provided by the whistleblower; (3) the law enforcement interest in deterring violations by making whistleblower awards; (4) participation in internal compliance systems; (5) culpability; (6) unreasonable reporting delay; and (7) interference with internal compliance systems. In its Adopting Release, the Commission noted that it has broad discretion in applying the award factors, and that it can consider and apply them in terms of percentages, dollars, or some combination of the two. To codify this discretion, the SEC added new language to Rule 21F-6 that makes clear that the Commission can consider the potential dollar amount that corresponds to each factor, thereby giving the Commission a mechanism to reduce—in its sole discretion—a large dollar amount award. 17 CFR § 240.21F-6.
Chair Gensler’s Pro-Whistleblower Stance
Chair Gensler’s Statement on August 2, 2021 addressed potential revisions to both rules discussed above. With respect to the rule regarding related actions, Chair Gensler stated that the rule as written would preclude the Commission in some instances from making an award where an alternative whistleblower award program might also apply to the action. With respect to the rule that provides the Commission with discretion to consider an award in terms of dollar amounts and/or percentages, Chair Gensler noted that the provision “could be used by a future Commission to lower an award because of the size of the award in absolute terms.”
To address the concerns that the amendments will discourage whistleblowers from coming forward, Chair Gensler directed SEC staff to consider whether the rules should be revised to permit the Commission to make awards for related actions that might otherwise be covered by an alternative whistleblower program that is not comparable to the SEC’s own program, and to clarify that the Commission will not lower an award based on its dollar amount. If implemented, these revisions would in effect unwind two of the amendments adopted less than a year ago and would further incentivize whistleblowers to come forward, by potentially allowing them to recover from multiple government award programs and by relaxing perceived award thresholds.
The Statement is just one example of Chair Gensler being a vocal supporter of the whistleblower program in his short tenure so far. In addition to announcing the possibility of these pro-whistleblower rule changes, he made a speech in support of whistleblowers and their value to the SEC’s enforcement efforts in honor of National Whistleblower Day at the NWD2021 event on July 30, 2021. At the event, Chair Gensler expressed a commitment to reduce processing times in SEC whistleblower award determinations. This change would further incentivize would-be whistleblowers to come forward.
Recent Whistleblower Awards and a Continuing Trend Toward Internal Reporting
While the Commission is actively reviewing its rules to further support whistleblowers, it has continued to issue awards at a record-breaking pace. On August 2, 2021, the same day that Chair Gensler issued his Statement, the SEC announced awards of $4 million to four whistleblowers in two separate matters. See Rel No. 24-92541; Rel No. 34-92542. Of note, in both award orders, the Commission highlighted that certain of the whistleblowers reported their concerns internally, and, in one case, the whistleblower “raised concerns multiple times at the Company in efforts to remedy the relevant misconduct.”
In the first order, the Commission awarded more than $2 million to a whistleblower who provided information that resulted in the initiation of an investigation, identified key individuals, and provided several interviews and reported internally multiple times. The Commission also awarded more than $150,000 to another whistleblower, whose information prompted SEC staff to expand its investigation into other alleged conduct at the relevant company.
In the second order, the Commission awarded more than $1.1 million to a whistleblower who, after reporting the misconduct internally, provided “significant” information to the SEC that resulted in a successful action. The Commission also awarded a second whistleblower more than $500,000. In explaining the disparity between the two award amounts, the Commission noted the following (among other reasons): “Claimant 2 unreasonably delayed by waiting several years to report the conduct to the Commission, during which time Claimant 2 did not take any steps to report or remediate the conduct. By contrast, Claimant 1 repeatedly raised concerns internally about the conduct.” Notably, in response to Claimant 2’s claim that it would have been futile to report internally because the company’s management was aware of the issue but was not taking steps to address it, the Commission stated that this “underscores the urgency of timely reporting to the Commission if claimant believed the company was unlikely to address the issue itself.”
Implications and Practical Considerations
Chair Gensler’s recent Statement and speech both signal his intent to strengthen the SEC’s whistleblower program, and the Commission’s recent award orders highlight the need for companies to take action promptly once they receive an internal report of potential misconduct. As reported by the SEC in its 2020 Annual Report to Congress on the Whistleblower Program, 81% of SEC whistleblower awardees reported their concerns internally, including in many instances to a direct supervisor, before or at the same time that they reported to the Commission. The orders issued Monday continue to support this trend. Because of this, while every situation is different, companies would be well-advised to consider the following:
- Whistleblower Communications. Early acknowledgement and frequent appropriate communications with a whistleblower are important if the whistleblower has not reported anonymously. Lack of communication after a tip is submitted can result in misunderstandings and may result in whistleblowers believing internal reporting is futile. As noted by the second whistleblower order discussed above, if a whistleblower reports internally and no concrete steps are taken by the company to remediate, then the Commission expects prompt reporting to the authorities.
- Risk Assessments. Consider conducting risk assessments related to internal reporting structures to make sure that all reports—not just those going to an internal hotline—are captured, triaged, and investigated if appropriate. Use internal whistleblower information to get ahead of a potential problem with regulators or law enforcement. Companies that are able to conduct thorough internal investigations showing a clear, robust response to an internal tip will be better able to effectively self-correct and have a defensible position if regulators or law enforcement get involved.
- Annual Training. Consider if annual training is appropriately robust and targeted to middle management to ensure that tips received outside of the employee hotline or formal reporting mechanisms are identified, logged, and triaged. If all tips are not identified and centrally reviewed, it is a lost opportunity for a company to self-correct an issue.
- Internal Reporting Mechanisms for a Remote and Hybrid Workforce. Record-breaking numbers of tips were reported to the SEC during the pandemic. Consider how to communicate with remote and hybrid workers to not only encourage internal reporting, but to interact with such workers if they do submit an internal report.
- Anti-Retaliation Policies and Training. Ensure that whistleblower anti-retaliation policies and training are up-to-date. Annual training should be conducted to ensure that everyone understands what retaliation is and knows the steps that can and cannot be taken once someone reports internally or to the government. Zero tolerance policies that are advertised to the workforce can help employees get comfortable reporting internally rather than straight to the governmental authorities.
- Domestic and International Policies. Review and update both domestic and international policies. Companies should be aware that whistleblower tips may arise from and with respect to any part of their business, including activity overseas.
- Review Documents for Language that May Impede Government Reporting. The Commission has now settled 14 cases against companies for language that impedes voluntary communications with the SEC. Thorough and expansive reviews should be conducted to ensure the company is not using documents that could be read to limit or impede an individual’s right to communicate with the SEC, including documents such as (i) compliance manuals, (ii) training materials, (iii) codes of ethics, (iv) employment manuals, (v) codes of conduct, (vi) employment agreements, (vii) separation agreements, (viii) employee incentive plans and related agreements, and (ix) confidentiality agreements, including those used during an internal investigation.
The high number of tips, the high value and frequency of awards, and the willingness of the SEC to adopt pro-whistleblower rules all indicate that the Commission views whistleblower tips as an important source of information in assessing wrongdoing in the markets. Companies should take note and be proactive—whistleblowers are here to stay, and incentives to report are stronger than ever under this new administration.
If you are seeking advice related to a whistleblower issue, please reach out to any author of this Advisory or your regular Arnold & Porter contact. Arnold & Porter is continuing to monitor developments in this area and will continue to issue client advisories related to whistleblowing and best practices for companies. Past advisories by the authors related to whistleblowing can be found here and here.
*On August 5, 2021, after this Advisory was published, the Commission issued a statement to “clarify how the SEC will proceed when addressing certain issues under Exchange Act Rule 21F-3(b)(3) and Exchange Act Rule 21F-6 while the staff is preparing and the Commission is considering potential amendments to those rules.” In other words, as the SEC staff fulfills Chair Gensler’s direction to prepare potential revisions to the recently-amended rules discussed in this advisory, the Commission decided to formally announce changes to certain procedures relating to such rules. In response, two Commissioners appointed by the prior administration, Hester Peirce and Elad Roisman, released their own statement asserting that the new procedures are “designed to ensure that two rule provisions, which are subject to litigation, are substantively ignored while proposed amendments are formulated and considered,” which “effectively nullifies standing Commission rules under the guise of changes to ‘agency procedures.’” We are preparing an additional advisory regarding the Commission’s new procedures as well as the separate statement released by Commissioners Peirce and Roisman.
© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.