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New Dodd-Frank rules made easy

New Dodd-Frank rules made easy

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Published by: jkopel6221 on Jul 12, 2011
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134rd Year no. 25 www.thc.cm MondaY, JULY 11, 2011
This is the first of a two-part series explain-ing the SEC’s recently passed whistleblower rules. This part defines “whistleblower” and explains award eligibility.
On May 25, the SEC issued its final whistle-blower rules as required by the Dodd-Frank Wall Street Reform and ConsumerProtection Act passed by Congress last year. Section 922 of Dodd-Frank created anew §21F of the Securities Exchange Act of 1934, setting forth the basic structure of the whistleblower program, while §924 direct-ed the SEC to issue implementing regula-tions. The SEC’s rules, which become ef-fective Aug. 12, 2010, significantly modifiedthe proposed rules issued last November.However, the SEC refused to require whis-tleblowers to report initially through acompany’s internal compliance processesas a prerequisite for receiving an award.
In general, the new §21F and SECrules provide that an individual, who voluntarily provides original informa-tion to the SEC that leads to a successfulenforcement proceeding, is entitled to areward of 10 to 30 percent of the resultingmonetary sanctions. Such awards couldbe huge in light of recoveries in recentSEC actions, particularly those concern-ing the Foreign Corrupt Practices Act.The SEC’s 240-page adopting release, which accompanied the 65-page rule(17 C.F.R. §§240.21F-1 through 21F-17),contains numerous complexities thatmay be resolved only by litigation and/or further SEC guidance.
‘WhiStlebloWer’ defined
The rules create two categories of  whistleblowers — one for purposes of receiving an award and the other for pro-tection against retaliation. A “whistleblower” eligible for a rewardis an individual who, alone or jointly  with others, provides the SEC with origi-nal information that relates “to a pos-sible violation of the federal securitieslaws (including any rules or regulationsthereunder) that has occurred, is ongo-ing, or is about to occur.” A whistleblowermust be an individual. Information thatrelates only to a state or foreign law vio-lation would not suffice. However, it isimportant to remember that informa-tion concerning nonsecurities mattersmay implicate the federal securities laws.There is no requirement that the whistle-blower be at a publicly traded company — a whistleblower at a private company could provide information concerningpurported fraud in the private place-ment of securities or the illegal sale of unregistered securities. A whistlebloweris not limited to providing informationconcerning his own company, and theinformation need not relate to a “materi-al” securities violation; the SEC believesthat it should evaluate the significance of information. A “whistleblower” for purposes of an-ti-retaliation provisions is an individual who has a reasonable belief that he orshe is providing information that relatesto a possible securities law violation or toa violation of the federal mail fraud, wirefraud, radio and television fraud or bank fraud statutes, that has occurred, is on-going, or is about to occur.The “reasonable belief” standard issubjective and objective. The employeemust hold “a subjectively genuine belief that the information demonstrates a pos-sible violation, and that this belief is onethat a similarly situated employee mightreasonably possess. The anti-retaliationprotections apply regardless of whetherthe whistleblower is ultimately entitledto an award. These provisions encom-pass not only information provided tothe SEC, but to any federal regulatory orlaw enforcement agency; Congress; or asupervisor. However, the anti-retaliationprotections for internal reporting apply generally only to employees of publiccompanies. An individual alleging retaliation may file an action in federal district court witha right to jury trial seeking reinstatement with the same seniority status, two timesthe amount of back pay and compensa-tion for fees and costs. Employers may not require employees to waive or limittheir anti-retaliation rights. Because theanti-retaliation provisions are codifiedin the Exchange Act, the SEC has en-forcement authority.In the first judicial analysis of Dodd-Frank, issued prior to the final SEC rules,a court held that an employee who pro- vided information to an outside law firmretained to conduct an internal investi-
New Dodd-Frank rules made easy 
The recently adopted whistleblower provisions set forth in detail who can make a report and the type of information rewarded 
 Jared L. Kopel is a partner at Wilson SonsiniGoodrich & Rosati in Palo Alto. He extends hisappreciation to Nicki Locker and Caz Hashemiof Wilson Sonsini for their ideas and analysis.
Ja l. Kp
gation was “acting jointly” with the law firm in reporting information to the SECand therefore was protected by the anti-retaliation provisions even if the employ-ee himself had not contacted the SEC.
Egan v. TradingScreen
, (S.D.N.Y. 2011).The Ninth Circuit U.S. Court of Appealsrecently held that the whistleblower pro-tections provisions of SOX did not apply to disclosures of corporate misconductto the media because such disclosures were not specifically protected by thestatute.
Tides v. The Boeing Co.
, 11 C.D.O.S.5212. This holding should apply as wellto Dodd-Frank.
AWArd eligibility
 Whistleblowers are eligible for awardsonly when they “voluntarily” provideoriginal information about possible se-curities law violations to the SEC. A sub-mission will not be deemed voluntary if it occurs after any request, inquiry ordemand for information that is directedto the individual (or the individual’s at-torney) that relates to the subject mat-ter of the submission and is by the SECor a number of other regulatory bodies.Information will not be considered “vol-untary” after such a request even if a re-sponse is not compelled by subpoena. Asubmission also is not considered vol-untary if the whistleblower was requiredto report the information to the SEC as aresult of a pre-existing legal duty; a con-tractual duty owed to the SEC; or a duty arising out of a judicial or administrativeorder. An individual still would be eli-gible for an award after being contactedby the SEC so long as the submission wasunrelated to the subject of the SEC’s in-quiry.Only a request directed to the individ-ual precludes a “voluntary” submission.Thus, a SEC request for information tothe individual’s employer does not pre- vent the employee from subsequently making a voluntary submission of in-formation, although generally a whistle-blower will not be eligible for an award if his information was derived exclusively from a SEC or internal investigation(subject to exceptions discussed below).The SEC warned that individuals who wait to make their submission until aftera request is directed to their employer“will not face an easy path to an award.”Further, the SEC suggests that informa-tion submitted after an employee is in-terviewed by the SEC in connection withan investigation into the company willnot be considered voluntary.To be considered “original informa-tion,” it must be 1) derived from the in-dividual’s independent knowledge orindependent analysis; 2) not already known to the SEC from any source, un-less the whistleblower is the originalsource of the information; 3) not exclu-sively derived from an allegation madein a judicial or administrative hearing,a governmental report, hearing, audit orinvestigation, or from the news media,unless the whistleblower is a source of the information; and 4) provided afterthe July 21, 2010, enactment of Dodd-Frank.“Independent knowledge” refers tofactual information in the whistleblow-er’s possession “that is not derived frompublicly available sources.” A personmay acquire independent knowledgefrom the “experiences, communicationsand observations in” business or socialinteractions. Thus “independent knowl-edge” is not limited to a person’s direct,first-hand knowledge.“Independent analysis” involves an“examination and evaluation of infor-mation that may be publicly available,but which reveals information that isnot generally known or available to thepublic.” Such an analysis must be morethan merely pointing to disparate pub-lic information that the whistleblowerassembled, but rather requires “someadditional evaluation, assessment, or in-sight.” A classic example is the analysis by Harry Markopolos, who, based on pub-licly available information, unsuccess-fully sought to alert the SEC that BernieMadoff was operating a Ponzi scheme.Even if the SEC already possesses in-formation about a matter, the whistle-blower’s submission will be consideredoriginal if she provides information that“materially” adds to the SEC’s knowl-edge. Thus, if B makes a submissionbased on information obtained from A,and A later makes her own submissionof that information, A will be consideredthe “original source” of the information.However, B may still be eligible for anaward because she submitted informa-tion derived from “independent knowl-edge,” i.e., whistleblower A. Further, be-cause of being first-in-time, B might havean advantage over A if B’s submissioncaused the SEC to open an investigationthat led to a successful enforcement ac-tion, while A would share in any rewardonly if her subsequent information “sig-nificantly contributed” to the success of the SEC’s action.
PerSonS ineligible for An AWArd
The SEC Rules preclude whistleblowerawards to those corporate officials andthird parties who have the principal re-sponsibility for preventing and investi-gating possible securities law violations.However, the exclusions are complicatedand likely will generate controversy.The following persons are not eligible whistleblowers:
• An officer, director, trustee or partner
of an entity who learned of informationconcerning misconduct from anotherperson or through the company’s inter-nal compliance mechanisms.
• Employees whose principal duties
involve compliance or internal audit re-sponsibilities, or persons employed by or associated with a firm retained to per-form compliance or internal audit func-tions.
• Persons employed by or associated
 with a firm retained to conduct an in-quiry or investigations into possible vio-lations.
• Employees of or persons associ
-ated with a public accounting firm wholearned through an audit engagementinformation relating to violations by theclient or the clients, directors, officers oremployees.The first exclusion does not preventthe designated persons from becomingeligible whistleblowers if they personally observed violations. Thus, the company’sCFO could become an eligible whistle-blower by discovering that the CEO wasengaging in securities law violations.Further, these exclusions do not apply if 1) the person had a reasonable basisto believe that disclosing informationto the SEC was necessary to prevent thecompany “from engaging in conductthat is likely to cause substantial injury to the financial interest or property of the entity or investors”; 2) there was areasonable basis to believe that the com-pany was impeding an investigation,such as destroying documents or influ-encing potential witnesses; or 3) at least120 days had elapsed since the whistle-blower provided the information to the

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