134rd Year no.

25

RECORDER
www.therecorder.com

MondaY, JULY 11, 2011

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
be huge in light of recoveries in recent SEC actions, particularly those concerning the Foreign Corrupt Practices Act. The SECs 240-page adopting release, which accompanied the 65-page rule (17 C.F.R. 240.21F-1 through 21F-17), contains numerous complexities that may be resolved only by litigation and/ or further SEC guidance. A whistleblower for purposes of anti-retaliation provisions is an individual who has a reasonable belief that he or she is providing information that relates to a possible securities law violation or to a violation of the federal mail fraud, wire fraud, radio and television fraud or bank fraud statutes, that has occurred, is ongoing, or is about to occur. The reasonable belief standard is subjective and objective. The employee must hold a subjectively genuine belief that the information demonstrates a possible violation, and that this belief is one that a similarly situated employee might reasonably possess. The anti-retaliation protections apply regardless of whether the whistleblower is ultimately entitled to an award. These provisions encompass not only information provided to the SEC, but to any federal regulatory or law enforcement agency; Congress; or a supervisor. However, the anti-retaliation protections for internal reporting apply generally only to employees of public companies. An individual alleging retaliation may file an action in federal district court with a right to jury trial seeking reinstatement with the same seniority status, two times the amount of back pay and compensation for fees and costs. Employers may not require employees to waive or limit their anti-retaliation rights. Because the anti-retaliation provisions are codified in the Exchange Act, the SEC has enforcement authority. In the first judicial analysis of DoddFrank, issued prior to the final SEC rules, a court held that an employee who provided information to an outside law firm retained to conduct an internal investi-

Jared l. Kopel

Securities
This is the first of a two-part series explaining the SECs recently passed whistleblower rules. This part defines whistleblower and explains award eligibility.

WhiStlebloWer defined
The rules create two categories of whistleblowers one for purposes of receiving an award and the other for protection against retaliation. A whistleblower eligible for a reward is an individual who, alone or jointly with others, provides the SEC with original information that relates to a possible violation of the federal securities laws (including any rules or regulations thereunder) that has occurred, is ongoing, or is about to occur. A whistleblower must be an individual. Information that relates only to a state or foreign law violation would not suffice. However, it is important to remember that information concerning nonsecurities matters may implicate the federal securities laws. There is no requirement that the whistleblower be at a publicly traded company a whistleblower at a private company could provide information concerning purported fraud in the private placement of securities or the illegal sale of unregistered securities. A whistleblower is not limited to providing information concerning his own company, and the information need not relate to a material securities violation; the SEC believes that it should evaluate the significance of information.

On May 25, the SEC issued its final whistleblower rules as required by the DoddFrank Wall Street Reform and Consumer Protection Act passed by Congress last year. Section 922 of Dodd-Frank created a new 21F of the Securities Exchange Act of 1934, setting forth the basic structure of the whistleblower program, while 924 directed the SEC to issue implementing regulations. The SECs rules, which become effective Aug. 12, 2010, significantly modified the proposed rules issued last November. However, the SEC refused to require whistleblowers to report initially through a companys internal compliance processes as a prerequisite for receiving an award. In general, the new 21F and SEC rules provide that an individual, who voluntarily provides original information to the SEC that leads to a successful enforcement proceeding, is entitled to a reward of 10 to 30 percent of the resulting monetary sanctions. Such awards could
Jared L. Kopel is a partner at Wilson Sonsini Goodrich & Rosati in Palo Alto. He extends his appreciation to Nicki Locker and Caz Hashemi of Wilson Sonsini for their ideas and analysis.

gation was acting jointly with the law firm in reporting information to the SEC and therefore was protected by the antiretaliation provisions even if the employee himself had not contacted the SEC. Egan v. TradingScreen, (S.D.N.Y. 2011). The Ninth Circuit U.S. Court of Appeals recently held that the whistleblower protections provisions of SOX did not apply to disclosures of corporate misconduct to the media because such disclosures were not specifically protected by the statute. Tides v. The Boeing Co., 11 C.D.O.S. 5212. This holding should apply as well to Dodd-Frank.

AWArd eligibility
Whistleblowers are eligible for awards only when they voluntarily provide original information about possible securities law violations to the SEC. A submission will not be deemed voluntary if it occurs after any request, inquiry or demand for information that is directed to the individual (or the individuals attorney) that relates to the subject matter of the submission and is by the SEC or a number of other regulatory bodies. Information will not be considered voluntary after such a request even if a response is not compelled by subpoena. A submission also is not considered voluntary if the whistleblower was required to report the information to the SEC as a result of a pre-existing legal duty; a contractual duty owed to the SEC; or a duty arising out of a judicial or administrative order. An individual still would be eligible for an award after being contacted by the SEC so long as the submission was unrelated to the subject of the SECs inquiry. Only a request directed to the individual precludes a voluntary submission. Thus, a SEC request for information to the individuals employer does not prevent the employee from subsequently making a voluntary submission of information, although generally a whistleblower 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 after a request is directed to their employer will not face an easy path to an award. Further, the SEC suggests that information submitted after an employee is in-

terviewed by the SEC in connection with an investigation into the company will not be considered voluntary. To be considered original information, it must be 1) derived from the individuals independent knowledge or independent analysis; 2) not already known to the SEC from any source, unless the whistleblower is the original source of the information; 3) not exclusively derived from an allegation made in a judicial or administrative hearing, a governmental report, hearing, audit or investigation, or from the news media, unless the whistleblower is a source of the information; and 4) provided after the July 21, 2010, enactment of DoddFrank. Independent knowledge refers to factual information in the whistleblowers possession that is not derived from publicly available sources. A person may acquire independent knowledge from the experiences, communications and observations in business or social interactions. Thus independent knowledge is not limited to a persons direct, first-hand knowledge. Independent analysis involves an examination and evaluation of information that may be publicly available, but which reveals information that is not generally known or available to the public. Such an analysis must be more than merely pointing to disparate public information that the whistleblower assembled, but rather requires some additional evaluation, assessment, or insight. A classic example is the analysis by Harry Markopolos, who, based on publicly available information, unsuccessfully sought to alert the SEC that Bernie Madoff was operating a Ponzi scheme. Even if the SEC already possesses information about a matter, the whistleblowers submission will be considered original if she provides information that materially adds to the SECs knowledge. Thus, if B makes a submission based on information obtained from A, and A later makes her own submission of that information, A will be considered the original source of the information. However, B may still be eligible for an award because she submitted information derived from independent knowledge, i.e., whistleblower A. Further, because of being first-in-time, B might have an advantage over A if Bs submission

caused the SEC to open an investigation that led to a successful enforcement action, while A would share in any reward only if her subsequent information significantly contributed to the success of the SECs action.

PerSonS ineligible for An AWArd The SEC Rules preclude whistleblower awards to those corporate officials and third parties who have the principal responsibility for preventing and investigating possible securities law violations. However, the exclusions are complicated and likely will generate controversy. The following persons are not eligible whistleblowers: An officer, director, trustee or partner of an entity who learned of information concerning misconduct from another person or through the companys internal compliance mechanisms. Employees whose principal duties involve compliance or internal audit responsibilities, or persons employed by or associated with a firm retained to perform compliance or internal audit functions. Persons employed by or associated with a firm retained to conduct an inquiry or investigations into possible violations. Employees of or persons associated with a public accounting firm who learned through an audit engagement information relating to violations by the client or the clients, directors, officers or employees. The first exclusion does not prevent the designated persons from becoming eligible whistleblowers if they personally observed violations. Thus, the companys CFO could become an eligible whistleblower by discovering that the CEO was engaging in securities law violations. Further, these exclusions do not apply if 1) the person had a reasonable basis to believe that disclosing information to the SEC was necessary to prevent the company from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or investors; 2) there was a reasonable basis to believe that the company was impeding an investigation, such as destroying documents or influencing potential witnesses; or 3) at least 120 days had elapsed since the whistleblower provided the information to the

audit committee, the chief legal officer, the chief compliance officer, or a supervisor; or 120 days had elapsed since the whistleblower received the information under circumstances indicating that the audit committee, the CLO, CCO or the supervisor were already informed. Additionally, an outside auditor could make a whistleblower complaint that his or her accounting firm violated the securities laws or professional standards, and if that submission resulted in a successful action against the engagement client, the whistleblower could obtain an award for that action. The SEC will not consider information that was obtained through a communication that was subject to the attorney-client privilege or which was obtained by the legal representation of a client (whether as in-house or outside counsel) which the

attorney seeks to use for personal benefit. However, these exclusions do not apply if the attorney would be permitted to disclose the information under 17 C.F.R. 205.3(d)(2), applicable state attorney conduct rules, or otherwise. An important point for litigators is that a whistleblower is eligible for an award for providing information obtained through a breach of domestic or foreign law, or judicial or administrative protective orders. Indeed, the SEC stated that it would be against public policy for a protective order to prohibit the disclosure of information regarding violations to the SEC. A court may not favorably view a litigants explanation that it violated a protective order entered by the court because of language in the SECs adopting release. Nonetheless, litigators and their clients should be aware of the incentive

for an adverse party to provide information produced in discovery to the SEC despite a protective order. Furthermore, an employee will not be an eligible whistleblower if his information was obtained from a person subject to an exclusion. But what about an employee who is alerted to possible violations by an excluded person and subsequently conducts his own personal investigation that uncovers additional information that is provided to the SEC? Does a fruit of the poisonous tree principle apply so that the submission is not eligible for an award? Or does the additional information constitute original information based on the employees independent knowledge and/or analysis and is therefore not excluded?
Next week: internal reporting, award amounts and advice for affected companies.

Reprinted with permission from the July 11, 2011 edition of The Recorder. Copyright 2011. ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, call 415.490.1054 or cshively@alm.com.