Jenner & Block's Robert R. Stauffer
Jenner & Block's Andrew D. Kennedy
Editor's note: This article has been modified since its original online publication, with a correction made to a dollar amount.
On July 21, 2010, upon signing the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (pdf), President Barack Obama announced that "unless your business model depends on cutting corners or bilking your customers, you've got nothing to fear from reform." In the real world of companies operating in highly regulated industries, what one person defines as bilking customers may be viewed by another as staying within the chalklines. Moreover, despite even the best efforts to promote compliance, all companies face a risk that employees will engage in behavior that subjects the company to liability.
One aspect of the Dodd-Frank Act that may increase the risk of government enforcement for companies covered by the act is the incentive it creates for whistleblowers. The act entitles individuals who bring violations of securities and commodities laws to the attention of the Securities and Exchange Commission or the Commodities Futures Trading Commission to between 10 percent and 30 percent of any recovery in excess of $1 million. This "bounty," as some are calling it, can be expected to prompt a dramatic increase in complaints of accounting misconduct, corrupt practices, and other violations.
In this article, we will provide some context by highlighting some of the other whistleblower provisions already in effect, describe the whistleblower provisions in the Dodd-Frank Act, and discuss the steps public corporations should be taking in light of these new provisions.
EXISTING STATUTES ENCOURAGING WHISTLEBLOWING
Three noteworthy statutes already on the books provide incentives or protections to whistleblowers.
First, the Sarbanes-Oxley Act provides protection for whistleblowers at public companies. Section 302, 15 U.S.C. §7241, mandates that corporations establish procedures to allow for confidential reporting of accounting or auditing irregularities. Section 806, 8 U.S.C. 1514A, prohibits a company from taking any retaliatory action against a whistleblower who has brought wrongdoing to the attention of either a supervisor or a regulatory or law enforcement official, and entitles an employee who has been subjected to retaliation to reinstatement, back pay and legal fees. In addition to the civil penalties for retaliation, Section 1107, 18 U.S.C. 1513(e), provides criminal penalties of up to 10 years imprisonment for an individual found to have retaliated against a whistleblower. Sarbanes-Oxley does not, however, provide for a financial reward to a whistleblower or otherwise incentivize parties to provide information to outside authorities. The Dodd-Frank Act extends the limitations period in which an employee may pursue a claim for retaliatory discharge under Sarbanes-Oxley and allows an employee to receive double back pay after a retaliatory discharge.
Second, the Securities Exchange Act, 15 U.S.C. 78u-1(e), provides for a financial reward to an individual who provides information to the SEC regarding insider trading. However, this provision has been underutilized and has proven ineffective. Rather than require that a whistleblower receive a portion of any recovery if the whistleblower's report leads to a successful prosecution, the statute vests the SEC with complete discretion over whether to provide an award. The statute also caps the whistleblower's share of any award at 10 percent. The whistleblower recovery provision in the Securities Exchange Act is not well-known, and during the 20 years since the provision was enacted, only five individuals have received awards under the program, totaling a mere $159,537.[FOOTNOTE 1]
Third, the False Claims Act (FCA), 31 U.S.C. §3729, provides a strong incentive to individuals who report fraud on the government, entitling them to between 15 percent and 30 percent of any award that the government may receive. The amount of any award that is allocated to an FCA "relator" may be determined as part of a settlement or allocated by the court and is based on the value of the information provided by the relator and the level of participation that the relator had in the litigation. If, upon being presented with the allegations, the government refuses to pursue the claim, the relator may pursue it on his or her own and, while the government remains the real party at interest, the relator's share of any resultant award increases. Although economics may often dictate that few cases are brought under the FCA that are not substantial in nature, there is no limit on how large an award must be before an FCA relator can share in an award.
The large awards that have been received under the FCA and the dream of a big payday have incentivized employees and plaintiffs lawyers to look for potential causes of action. In the 2009 fiscal year, the Department of Justice recovered more than $2.4 billion under the FCA, nearly $2 billion of which came from qui tam cases.[FOOTNOTE 2] The total recovered since the FCA was amended and its whistleblower protections were augmented in 1986 now exceeds $24 billion, with the bulk of those awards coming through whistleblower-initiated claims.[FOOTNOTE 3] Those claims have expanded drastically in recent years, with awards having only crossed the $10 billion threshold in 2002.[FOOTNOTE 4] Recoveries were at their highest in the 2006 fiscal year, when they exceeded $3.1 billion.[FOOTNOTE 5]
THE DODD-FRANK ACT'S WHISTLEBLOWER PROVISIONS
The Dodd-Frank Act requires the SEC and the CFTC to pay between 10 percent and 30 percent of any award received by the government to whistleblowers who voluntarily provide original information regarding a violation of securities or commodities laws leading to a government recovery. A whistleblower may only recover if the whistleblower is the original source of the allegations. Specifically, the allegation must contain information "derived from the independent knowledge of the whistleblower" that is not otherwise known to the regulatory agency and is not based exclusively on allegations or reports made by another party including both formal reports and proceedings or news reports.
Although the FCA contains a similar restriction, the Dodd-Frank Act's definition of original source is more specific. Under the FCA, it is doubtful that, if a relator provided new analysis of information that the government already had without providing at least some new facts, the relator would qualify as an original source. The Dodd-Frank Act, on the other hand, specifically allows for a whistleblower providing new "knowledge or analysis" to qualify as an original source.
The Dodd-Frank Act also expands the original source rule by providing that the claims may be partially contained in allegations already made public as long as they are not exclusively derived from the public allegations. Thus, while the government may already know some of the facts, if a whistleblower provides information that helps complete the picture, the whistleblower is still entitled to share in the recovery. Again, such an outcome would be unlikely under the FCA.
In some regards, though, the Dodd-Frank Act's original source rule is more restrictive than that contained in the FCA. The FCA only requires that a relator be an original source if the allegations have already been made public through the news media. If the relator learned of the activity at issue from a third party but it has not been made public or known by relevant government officials, the relator may still proceed with the FCA claim. The Dodd-Frank Act, on the other hand, requires that any claim be "derived from the independent knowledge or analysis of the whistleblower." Although the meaning of that language may be subject to varying interpretations, it is likely that a whistleblower would be denied a bounty under the Dodd-Frank Act if the allegations are based on knowledge learned solely from a third party, regardless of whether or not it was public.
The Dodd-Frank Act limits the universe of individuals who may recover a bounty. In order for a whistleblower to be entitled to recovery, the information provided cannot be gathered through the performance of an SEC-mandated audit. Furthermore, employees of regulatory agencies, the Department of Justice, a self-regulatory organization, the Public Company Accounting Oversight Board or any law enforcement organization are ineligible to obtain a portion of the award. As under the FCA, the whistleblower is ineligible to participate in the award if he or she is convicted of a criminal violation in connection with the alleged activity. It is noteworthy that individuals conducting internal audits are excluded from recovery under the Dodd-Frank Act if the audit is required by the SEC. The FCA contains no such prohibition on individuals responsible for internal audits participating in a recovery.
The universe of claims for which a whistleblowing party may potentially receive a bounty under the Dodd-Frank Act is expansive. A whistleblower may recover a reward obtained by the government as part of any action brought by the SEC "under the securities laws" or brought by the CFTC under the Commodity Exchange Act. This is far more expansive than the previous provision in the Securities Exchange Act, which applied exclusively to issues of insider trading.
The Dodd-Frank Act does impose two significant limitations on potential recoveries that are not present in the FCA and could prevent the act from having the same consequences as the FCA has had. First, a whistleblower may only recover under the Dodd-Frank Act if the award exceeds $1 million. The FCA, in contrast, does not mandate that an award meet any threshold before a relator can share in the award. Second, the Dodd-Frank Act does not provide a whistleblower with a private cause of action, unlike the FCA, which allows a whistleblower to initiate litigation and to continue that litigation if the government declines to participate. Thus, there may be little incentive for a whistleblower to present a claim under the Dodd-Frank Act unless he or she is confident that the evidence is convincing enough for the government to take up the case and that any award could exceed $1 million.
In determining what percentage of an award to allocate to a whistleblower, the act requires the SEC to consider a number of factors, including the significance of the information, the degree of assistance provided by the whistleblower and the interest of the government in deterring such violations. The allocation process is very similar to that contained in the FCA, which provides for a relator to receive 15 percent to 25 percent of the government's award if the government pursues the claim and 25 percent to 30 percent of the award if the government declines to intervene. The FCA requires that the same factors be considered in determining how to allocate the award. However, while allocations under the FCA are made by the court or the parties through a settlement, allocations under the Dodd-Frank Act will be performed solely by the SEC or the CFTC, with no right to appeal an award that is within the range prescribed by the statute. Under the prior provisions of the Securities Exchange Act, a whistleblower was only entitled to the percentage of a recovery that the SEC "deems appropriate" and that percentage was not to exceed 10 percent. The SEC's decision was final and there was no right to appeal.
The act allocates a substantial amount of money into funds to pay out potential bounties, suggesting that Congress anticipates that a great deal of enforcement activity will be prompted by the passage of the act. For violations of commodities laws, the fund may grow as large as $100 million and, for violations of securities laws, it may grow to as large as $300 million.
The Dodd-Frank Act also provides substantial protections to whistleblowers to prevent an employer from retaliating against an employee who has filed a report of wrongdoing, either internally or with the government. The act provides an independent cause of action for a whistleblower who has been retaliated against, under which the whistleblower may recover double back pay with interest and attorney fees. The whistleblower is also entitled to reinstatement to the position he or she would have held but for the retaliation. This is very similar to the whistleblower protection provision contained in Sarbanes-Oxley, with two key distinctions. First, while both provide for reinstatement, back pay and litigation costs, Sarbanes-Oxley previously did not entitle the employee to double back pay. Thus, while the civil right of action created by Sarbanes-Oxley may have been effectively crafted to put the parties back where they would have been but for the retaliation, there was no punitive or deterrent aspect of the right of action. Rather, Sarbanes-Oxley relied on potential criminal penalties to deter retaliation. Additionally, under Sarbanes-Oxley, a whistleblower had to first present the claim to the Department of Labor and could only bring a lawsuit after the Department of Labor has declined to intervene.
IMPLICATIONS OF THE DODD-FRANK ACT'S WHISTLEBLOWER PROVISIONS
In light of the new financial incentives for whistleblowers, the Dodd-Frank Act makes it more important than ever for corporations to establish and maintain first-rate compliance programs. This is a good time for companies to evaluate their compliance and auditing programs and update them to ensure that they adequately address the various legal risks those companies face and adequately inform employees of the substantive compliance policies and the channels for internally reporting suspicious activity or raising questions. If improper activity is identified, the Dodd-Frank Act provides another incentive to report the activity to the relevant government agency, as the act increases the likelihood that the agency will eventually hear about the matter from other sources. While self-reporting typically will not save the company from liability, the company should be better off after making voluntary disclosure than it will if the government first hears of the wrongdoing from a whistleblower. It should also be noted that the new whistleblower incentives are not limited to information concerning post-Dodd-Frank Act conduct; an employee who reports pre-act conduct may still qualify for a substantial award.
Both portions of the statute mandate that the responsible agency issue necessary rules within nine months, so it may take some time for the ramifications of the new provisions to become apparent. However, based on the allocation of the funds, it is clear that Congress anticipates a substantial number of whistleblower claims will be brought under the Dodd-Frank Act. One thing is clear, however, and that is that corporations subject to the commodities and securities laws need to be cognizant of, and prepared for, the increased scrutiny that their past and present activities may face, even if they are not "cutting corners" or "bilking their customers."
Robert R. Stauffer is a partner in Jenner & Block's litigation department. He is a member of the firm's white-collar defense and investigations, class action and health care litigation practices. Andrew D. Kennedy is an associate in Jenner & Block's litigation department.
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FN1 "Assessment of the SEC's Bounty Program," (pdf) Office of Inspector General, U.S. Securities and Exchange Commission, Report No. 474 (March 29, 2010)
FN2 Press Release, U.S. Department of Justice, "Justice Department Recovers $2.4 Billion in False Claims Cases in Fiscal Year 2009; More than $24 Billion Since 1986" (Nov. 19, 2009)
FN3 Id.
FN4 Press Release, U.S. Department of Justice, "Justice Department Recovers Over $1 Billion in FY 2002: False Claims Act Recoveries Exceed $10 Billion Since 1986" (Nov. 16, 2002)
FN5 Press Release, U.S. Department of Justice, "Justice Department Recovers Record $3.1 Billion in Fraud and False Claims in Fiscal Year 2006" (Nov. 21, 2006); Press Release, U.S. Department of Justice, "Justice Department Recovers $2.4 Billion in False Claims Cases in Fiscal Year 2009; More than $24 Billion Since 1986" (Nov. 19, 2009) ("FY 09 Recovery is Second Largest in History").
