Speech by SEC Staff:
Remarks at Open Meeting — Whistleblower Program
Robert S. Khuzami, Director, Division of Enforcement
U.S. Securities and Exchange Commission
May 25, 2011
Thank you, Chairman Schapiro, and good morning Commissioners. I am very pleased to present for your approval today final rules that would establish the Commission’s new whistleblower program. This program is part of a broader initiative undertaken by the Division in the last two years to further strengthen our enforcement program by expanding our arsenal of investigative tools designed to detect and combat fraud and other violations of the securities laws. As with our Cooperation Initiative that we announced last year, the whistleblower program is designed to incentivize insiders and others who possess useful information regarding unlawful conduct to come forward early and assist the SEC with identifying and bringing enforcement actions against companies and individuals that have violated the securities laws.
The rules proposed by the Commission last November attempted to strike a balance between various policy considerations around implementation of a whistleblower program. To name just a few examples, among these policy considerations included —
- To what extent should the program award individuals who provide information about matters already under investigation by the SEC?
- Should the program exclude certain types of information; for example, information obtained through communications subject to the attorney-client privilege? and
- Should the rules require employees to first report possible violations through their employer’s internal compliance procedures before coming to the SEC?
Our proposal provoked strongly held and diverse views on these and a number of other significant topics. We received hundreds of comment letters expressing a range of views and ideas from various interested constituencies, including individual investors, whistleblower advocacy groups, public companies, corporate compliance personnel, academics, professional associations and audit firms. Perhaps the most vigorously-debated issue was the effect of the whistleblower program on internal corporate compliance processes. Many commenters recommended that the Commission require that whistleblowers report through their employers’ internal compliance systems before or at the same time they report to the SEC, in order to qualify for an award. The concerns expressed were that without mandatory internal reporting, the program would, among other things:
- Encourage whistleblowers to bypass internal compliance programs;
- Undermine the ability of an entity to detect, investigate and remediate securities violations, particularly as to those complaints over which the Commission has no jurisdiction or that are too small for the Commission to investigate;
- Create adverse incentives for whistleblowers to see their companies sanctioned or to delay reporting potential violations; and
- Reduce the incentive for corporations to establish and maintain effective internal compliance programs.
After much study, and even more discussion, we concluded that an absolute requirement that whistleblowers report internally to qualify for an award would be detrimental to the enforcement program, and seemingly inconsistent with the statute’s goal of motivating individuals to come to the Commission with evidence of securities law violations.
Four primary reasons supported our conclusion. First, we were not presented with, nor are we aware of, any empirical data supporting the view that the absence of mandatory internal reporting would undermine internal compliance programs. Second, companies that take their fiduciary obligations and corporate citizenship responsibilities seriously will design and implement effective compliance programs regardless of whether a whistleblower is required to internally report wrongdoers to qualify for an award — and, companies with effective compliance programs and cultures of compliance are actually more likely to attract whistleblower information as a result of the incentives in today’s rules, which I will outline shortly. Third, Congress intended the statute to incentivize insiders to provide the SEC with high-quality tips that reveal fraud and other wrongdoing, and to protect them from retaliation in the process. As such, it is, first and foremost, a tool designed to increase the effectiveness of the enforcement program.
The information from whistleblowers will allow us to build stronger cases and move more quickly, thus increasing the chance of stopping frauds early, of locating and returning more money to victim-investors, and of preventing small frauds from growing into bigger frauds with even more victims, more losses and more ruined lives. Fourth, there is nothing in the statute requiring internal reporting as a condition of eligibility, and an internal reporting requirement — particularly in situations where the compliance function is not effective or is controlled by managers that are the subject of the whistleblower’s claims — could easily undercut the purpose of the statute.
Consider boiler room operations where the principals are all running a “pump and dump” scheme. Requiring internal reporting in these situations, where the entity is entirely or largely corrupt, where the wrongdoers control the operation, would serve no beneficial purpose, and certainly would not undermine any legitimate corporate compliance programs. The same is true for Ponzi schemes, offering frauds and similar scams that we confront all too often. Some of the same considerations apply where the violation is carried out by principals that are largely law-abiding, working within an entity that takes compliance seriously. Requiring under all circumstances — and that is the key here, requiring — that the whistleblower first reveal the incriminating information to the same persons that the whistleblower is suggesting acted unlawfully, would create, in our view, an imbalance between the statutory mandate to incentivize whistleblowers to report wrongdoing to the SEC, and the desire not to undermine the efforts of internal compliance programs.
Mandating internal reporting as a condition of eligibility would, in our view, place an undue and additional burden on a whistleblower prior to presenting evidence of unlawful conduct to the SEC, and likely would deter others from coming forward to do the same. That is why our rules leave the decision as to whether or not to report internally in the hands of the person best equipped to make that decision — the whistleblower, considering the circumstances of his or her individual situation. But, because we recognize the extremely significant value that effective corporate compliance programs deliver in identifying, remediating, and deterring wrongdoers, we have refined and revised the proposed rules so that the whistleblower is incentivized — not mandated, but incentivized — to utilize their companies’ internal compliance and reporting systems, when appropriate.
First, as Chairman Schapiro noted, the rules contain a provision under which a whistleblower can receive an award for reporting original information to an entity’s internal compliance and reporting systems, if the entity then reports information to the Commission that leads to a successful enforcement action. Under this new provision, all the information provided by the entity to the Commission will be attributed to the whistleblower, which means that the whistleblower will get credit — and potentially a greater award — for any additional information generated by the entity in its investigation. In fact, because the whistleblower gets credited under this provision with the information generated by the entity, reporting internally to an effective compliance program may permit an individual to qualify for an award where they otherwise would not. We also hope that this powerful new incentive for employees to report internally will have the added benefit of incentivizing companies to implement robust compliance programs, as a whistleblower likely will only report internally where he or she believes the company will act promptly and responsibly.
Second, with respect to the criteria for determining the amount of an award, the final rules expressly provide that (1) a whistleblower’s voluntary participation in an entity’s internal compliance and reporting systems is a factor that can increase the amount of an award; and (2) a whistleblower’s interference with internal compliance and reporting is a factor that can decrease the amount of an award.
Third, the final rules extend from 90 to 120 days the time for a whistleblower to report to the Commission after first reporting internally and still be treated as if he or she had reported to the Commission at the earlier reporting date. The release makes clear, however, that the 120-day grace period applies only to whistleblowers, and that the final rules do not change the fact-based analysis that each entity should conduct when considering whether and when to report potential securities violations to the Commission. We will continue to expect companies to self-report on a timely and responsible basis.
We believe that these incentives sufficiently address the concerns raised in comments regarding the value of internal corporate compliance receiving information about possible violations of the law, but without discouraging the flow of insider tips that we believe will increase our agency’s ability to identify more frauds, and to move earlier and more quickly to stop them when we do.
The final rules also clarify the scope of the limitations on awards set forth in the proposed rules relating to persons with legal, compliance, audit, supervisory or governance responsibilities for an entity that receive information about a potential violation of the securities laws. This was another area that generated vigorous comments. The final rules retain the exclusion for certain individuals and certain categories of information from eligibility for whistleblower consideration. Information obtained through communications subject to the attorney-client privilege generally cannot be used, in order not to weaken the benefits that consultation with counsel often contributes to an effective compliance program and the development of corporate best practices. Nor can information be used to support a claim if it was obtained in the course of engagements required of independent public accountants under the securities laws and relating to the engagement client.
Lastly, certain categories of company officials also cannot qualify for whistleblower status, such as officers, directors, trustees or partners of an entity, if they are informed by another person of allegations of misconduct, or who learn the information in connection with the entity’s processes for identifying, reporting and addressing possible violations of law. This exclusion is necessary to ensure that persons most responsible for compliance are not incentivized to promote their own self-interest at the expense of an entity’s ability to detect, address and self-report wrongdoing.
Our proposal to allow awards to culpable whistleblowers is another area that elicited a substantial number of sharply-divided comments. Many commenters argued that the rules should not place any limits or restrictions on eligibility or award amounts for culpable whistleblowers beyond what is already contained in the statute for individuals who are criminally convicted. Many other commenters argued that culpable whistleblowers should be excluded completely from eligibility for awards. In our view, the rules as proposed represent the appropriate balance on this issue. The final rules therefore leave the proposed rules unchanged. The final rules substantially limit awards based on the conduct attributable to the culpable whistleblower — both the whistleblower’s own conduct as well as an entity’s conduct that the whistleblower directed, planned, or initiated. The final rules also provide that culpability of a whistleblower is a factor that can decrease the amount of an award.
At the same time, the final rules allow certain less-culpable whistleblowers to receive awards, assuming they otherwise satisfy the requirements set forth in the rule. This simply recognizes the established reality in law enforcement that often only those who are part of the fraud can provide evidence of unlawful conduct, and equally importantly can make the case against the biggest threats to investors — the organizers and leaders of a scheme who, if not pursued, will resurface in the future to commit new frauds.
Of course, the rulemaking, though a significant undertaking, is but one aspect of the creation of our whistleblower program. Since the enactment of Dodd-Frank, the Division has been hard at work creating the agency’s Office of the Whistleblower. In February, we welcomed back to the Commission Sean McKessy to oversee our whistleblower program. In a moment, you will hear from Sean, who will brief you on the status of the office and his vision for the program.
Before turning it over to Sean and to Steve Cohen, who will present additional details about our recommendation, I would like to thank Chairman Schapiro, Commissioner Casey, Commissioner Walter, Commissioner Aguilar and Commissioner Paredes for their valuable insights and input on these and other issues. I would also like to thank Commissioner’s Counsel Christian Broadbent, Anil Abraham, Scott Kimpel, and James Cappoli for their cooperation and assistance.
In addition, I want to echo the Chairman’s remarks and thank the Division staff, in particular the work of Steve Cohen, Sarit Klein, Sean McKessy, Jordan Thomas, and Sam Waldon. Their efforts have been in the finest tradition of the Agency — diligence, dedication and uncompromising professionalism. It is an honor to have them as colleagues.
I would also like to thank the staff from the Office of General Counsel who partnered with us, particularly Rich Levine, Brian Ochs and Brooks Shirey, on this very important initiative, for their tireless work on this recommendation.
I would also like to thank the staff from the Office of Risk, Strategy and Financial Innovation for their contribution and assistance, as well as staff from the Division of Corporation Finance; Office of Compliance, Inspections and Examinations; Division of Investment Management; Division of Trading and Markets; Office of the Chief Accountant; Office of International Affairs; and the Office of Legislative and Intergovernmental Affairs for their input and assistance.
And now, I’ll turn it over to Sean.