Speech by SEC Staff:
Remarks at the Practising Law Institute's Ninth Annual Institute on Securities Regulation in Europe
David M. Becker
U.S. Securities and Exchange Commission
January 25, 2011
As many of you know, the Commission recently proposed rules to implement the whistleblower provisions of the Dodd-Frank Act. Some have said that the whistleblower rules may have the greatest impact on corporate governance of all the rules that will be promulgated under the Dodd-Frank Act. We have had many thoughtful comments in response. In broadest terms, the responses have fallen into two camps: (1) the first is concerned with undermining the efficacy of corporate compliance programs; (2) the second is concerned with placing barriers in the path of those who are considering coming forward to report corporate wrongdoing, but will do so only with some assurance that the considerable risks they take in so doing are ameliorated to some degree by a compensating financial reward.
I'm not here this morning to announce how we will resolve these issues. They can be resolved only by action of the Securities and Exchange Commission. The views I express here this morning are purely my own and are not necessarily those of the Commission, any Commissioner, or any other member of the Commission staff. Because the issues are complex, the trade-offs subtle, and the choices difficult, that standard disclaimer applies with particular strength to my remarks this morning.
I thought I'd talk briefly this morning about some of the conflicting views of the world that underlie the debate about whistleblowers and how they play out in differing views about what the Commission should be doing with its whistleblower rules.
While not new in other contexts, whistleblowers showed up in the federal securities laws by means of the Sarbanes Oxley Act of 2002. As everyone here recalls, the statute was prompted by the astonishing revelations that some of America's most prominent public companies — Enron and WorldCom, most prominently — were massive frauds.
The whistleblower provisions of the statute, principally Section 806, make it unlawful to for corporate issuers and various persons who work for them or do business with them to retaliate against persons reporting violations of various laws. These provisions also create a cause of action in favor of persons who have been subjected to such retaliation. The provisions were prompted by reports of frustration by whistleblowers at Enron and elsewhere who had sought unsuccessfully to come forward with reports of grave misconduct.
Other provisions of the Sarbanes-Oxley Act are important background as well. Section 301 of the statute (implemented by SEC rule 10A-3) requires audit committees to establish and maintain procedures for obtaining, retaining, and responding to complaints about financial reporting matters. The statute also enhanced the legal obligations of boards, audit committees, and most importantly, auditors to respond to reports of wrongdoing. And we all recall that the statute empowered the Commission to adopt rules to require lawyers to report information about wrongdoing to company management and if unsuccessful to the board of directors.
Taken together, these provisions bespeak — as of 2002 — a major loss of trust in the ability of corporate managers to run their corporations profitably without engaging in major violations of the law and a significant bet on the capacity of an elaborate mechanism of checks and balances to stop them from breaking the law and to pressure so-called "gatekeepers" into stopping them. So the law required principal executives to certify that they believed public filings were true and increased the adverse consequences if those filings turned out to be false. The Sarbanes-Oxley Act added duties on lawyers and accountants to find and report wrongdoing, required all public corporations to have audit committees to watch the auditors, and created a new body — the Public Company Accounting Oversight Board — to regulate the auditing profession. Accountability was the watchword — everyone was to bear some significant adverse consequence if things went wrong.
There are differing views as to how well all this has worked. Certainly, these changes — along with significant changes to the federal sentencing guidelines and the Department of Justice's policy as to when to indict corporations — have resulted in an enormous investment of time and resources in elaborate compliance mechanisms and procedures. Taken together, these changes make it much more likely that corporate issuers will learn about and pursue reports of wrongdoing within the corporation.
Auditors are, I think, acutely aware of the risks from an audit that overlooks misstatements in a company's financial statements. Audit partners are much more focused on audit quality and much less likely to take positions that aren't subject to review by the firms' national offices. Audit committees and boards of directors are much more sensitive to compliance issues, serious about going about their business, and well aware of the liability risks and risks of public humiliation if things go quite badly.
Of course, these mechanisms entail costs too. The notion that people respond to greater accountability — risk of harm if they perform poorly — by simply performing better doesn't tell the whole story. My sense is that people adopt a variety of stratagems to avoid those adverse consequences, only one of which is to perform better. So, for example, it is an article of faith among many corporate chief financial officers that auditors have become much more risk averse and prone to threaten to withhold their opinions if clients don't follow their guidance — even if the guidance is debatable or incorrect. They will also tell you that, when there are reports of potential wrongdoing, auditors will invariably insist on expensive and time-consuming internal investigations, which may prevent the company from getting timely financial information to shareholders. Auditors, of course, don't share this view. They will tell you that, in the wake of Sarbanes-Oxley they do a better job and clients may experience that as simply self-protective behavior.
Similarly, members of boards of directors will tell you that board meetings are much more devoted to legal and compliance matters than they used to be and that this detracts from their ability to use finite time to focus on issues of business strategies and management. They will also tell you they have spent much too much time and resources on various internal investigations. These investigations can be hugely disruptive — they turn de facto control of a corporation from its managers to its audit committee, lawyers, and auditors; they can easily cost millions of dollars; they spread anxiety; they hurt the company's reputation; and they can put major portions of a company's business effectively on hold until they are completed. Moreover, it's not at all clear — boards might say — that the Commission or other law enforcement bodies give the company adequate credit for these programs and investigations.
Many corporate managers share these views about the costs wrought by the Sarbanes-Oxley Act. They would add, I think, the distractions of having to defend the corporation, and in some circumstances themselves, from allegations of sometimes trivial instances of wrongdoing. Companies employ thousands — sometimes many thousands — of people. In any aggregation of thousands, at any time, someone is going to be doing something wrong. Sarbanes-Oxley and other pieces of the federal law, the critique goes, turn too many matters into federal cases. They threaten the careers of too many, cause them to look over their shoulders, and cause them to practice business defensively. With too much focus into avoiding getting into trouble comes too little focus on making money for the corporation, some have said. Performance suffers, and we cede an advantage to foreign competitors, many of which aren't worried about whether their audit committees keep adequate minutes.
Where do whistleblowers fit in the anti-fraud machine, what do they do, and what do they cost? I think those who speak for whistleblowers would tell you that whistleblowers are an indispensable source of vital information for senior managers, audit committees, and boards of directors. They would tell you that it takes extraordinary courage to be a whistleblower, because blowing the whistle on corporate misconduct invariably means, at a minimum, ostracism in the workplace. Often it means the loss of one's job, or at the very least the loss of one's ability to do one's job, and it may also mean the loss of one's friends. There is only a small prospect of vindication; if it comes, it comes only after many years.
I think whistleblower advocates would also tell you that the promise of protection for whistleblowers has not been realized, that agencies and the courts have been very reluctant to investigate reports of retaliation or interpret the law in a way that provides a firm response against those who retaliate. As a result, until the passage of Dodd-Frank there was little prospect that whistleblowers could be a persistently powerful in cleaning up corporate America.
The corporate community, I believe, has a different view. Under this view, whistleblowers are largely either eccentrics imagining ghosts or disaffected employees putting on a protective cloak to avoid disagreements with supervisors or accountability for their own sub-standard performance. They would complain that virtually every whistleblower complaint trips off a process that, once started, is extremely difficult to end. An allegation of any seriousness must be reported to the audit committee, which will make sure the auditors know about it. The auditors, to protect themselves, will insist that the allegation be investigated thoroughly, which means expensively. At a minimum, a company's internal auditors will have to search paper and electronic documents, conduct interviews, and report to the audit committee.
If that doesn't put the matter definitively to rest, the audit committee will require a more extensive investigation, one which may involve outside counsel independent from, and not knowledgeable about, the company, forensic auditors, outside consultants to handle documents, and often scores of interviews with company personnel. And, at the same time, the whistleblower is immune from disciplinary action that he may deserve, either for tying the company in knots for no reason or for his own substandard performance as an employee.
Well, who's got the right narrative? Are all these government-made mechanisms to ferret out fraud and abuse actually useful? Or are they just so much cost? And, in particular, are whistleblowers lonely heroes who occupy wind-swept hilltops before mustering the courage to take on corporate villains, or are they crackpots and incompetents trying to avoid their just desserts?
My view would be that it's all true — sometimes. The costs of a whistleblower programs are quite real. Corporate compliance programs can be quite expensive, and the manner in which corporations are required to respond to reports of wrongdoing can be an enormous diversion of resources. And the motivations of whistleblowers, in my experience, are as complex and as varied as the persons who blow the whistle. It is not always clear whether it is an unusual person or an unusual circumstance that prompts whistleblowing. I'm not quite sure it's relevant. Whistleblowers often have to go through a hellish ordeal for years. If rationality means the outcome of disinterested calculation, I'm not at all sure it's rational to be a whistleblower. But that hardly means that the claims made by whistleblowers are invariably untrue.
It's also clear to me that at times whistleblowers are quite aware of the leverage that they gain in declaring themselves whistleblowers, leverage that may simply enable one to make sense of an adverse employment decision, or to make money from it. And there are people to whom the notion of a good-faith disagreement of opinion is an oxymoron.
It is entirely possible that most whistleblower complaints don't have merit. But the ones that do can take your breath away, they are so dreadful. There is huge social benefit to rooting out and punishing corporate misconduct. It's a benefit that often accrues to the shareholders of a corporation — getting rid of incompetent or corrupt management and replacing them with more faithful stewards of the shareholders' interests. Complaints may let a corporation improve the ethical climate within the firm, improve business practices, and prevent serious problems from getting seriously worse, and even position itself in advance of government investigations and prosecutions that will come sooner or later.
Sometimes the benefits don't accrue to the corporation whose employee blows the whistle, but accrue more broadly as companies, their managers, and their enablers are reminded of the lessons of the wages of fraud.
I keep using the words "sometimes," but I should be clear that I don't know how much "sometimes" is in fact. And that is the key question: whether one thinks that whistleblower programs are worth it depends entirely on one's view as to the frequency with which complaints of serious wrongdoing have real merit.
I'm not sure there is any reliable information out there. In particular, we don't know how often whistleblower complaints turn out not to be true. From time to time, we read of deeply reprehensible misconduct that whistleblowers have reported, both with and without an appropriate reaction. These stories boil the blood, appropriately so. But we don't hear very much about the complaints that turn out to be baseless. Certainly, one doesn't read in the press headlines that say "whistleblower makes complaint but there's nothing to it." I'm not sure how to get at this information, because it is mostly — to mangle the multiple traditions — the equivalent of the sound of one dog not barking.
In any event, Congress has spoken. The Dodd-Frank Act not only preserves the whistleblower regime established by the Sarbanes-Oxley Act, it represents a doubling down on the bet. The statute does not only protect whistleblowers, it offers them the prospects of substantial rewards. And it not only encourages corporate whistleblowers, it takes the program in a new and expansive direction by rewarding them for going to the Commission.
For the Commission the challenge is to effectuate the goals specified by the Congress while not putting in jeopardy the substantial progress made in the years since 2002. The goal is to enhance the quantity, and more importantly, the quality of the information that the Commission gets upon which it can base enforcement cases. It is, of course, important not to undermine corporate compliance programs. When effective, they further corporate goals in a profound and efficient way, and they help protect the public from damage that might be caused by corporate misconduct. In proposing the whistleblower rules, the Commission intended to preserve incentives for whistleblowers to use their compliance programs and not to place obstacles in the path of those who wish to do so.
Some have asked us to require whistleblowers to go to corporations first, before coming to the Commission, in order to qualify for an award. It's not clear that the Commission could or should do that.
While substantial virtue resides among corporate stewards, it is not universal or inevitable. Not all corporate compliance programs work well. Some — no matter how elaborately conceived and extensively documented — exist only on paper. Some small number are shams. I once knew of an ostensibly anonymous employee hotline that actually rang on the desk of the CEO's secretary. I'm not at all sure that Congress intended that a whistleblower at this company would have to avail himself of this hotline before coming to the Commission and getting an award.
We also do not have a simple view about the motivations of whistleblowers. Even before the Dodd Frank Act, we had no shortage of complaints from members of the public. We have seen whistleblowers motivated by a genuine sense of public responsibility. We have seen whistleblowers motivated by genuine outrage — whether justified or not. And we have seen whistleblowers motivated by a desire to deflect responsibility from themselves. We have seen highly informed whistleblowers, along with the highly uninformed.
What we have not seen is whistleblowers coming to the Commission for financial gain. We do not know whether this will substantially change the number of whistleblowers we see or the mix of the information we get. Our hope is that the whistleblower program will yield not so much more complaints but better ones, ones that can more readily be turned into cases that will stick in the courts of law.
We expect to have this all sorted out sometime this Spring, though given the number of things on our plate, the precise schedule is uncertain. We hope to do so carefully and thoughtfully, with a balance that produces the maximum benefit for the investing public.
Thank you very much.