September 10, 2011

Implementation of the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934

On August 12, 2011, the U.S. Securities and Exchange Commission (the “Commission”) adopted new rules¹ and forms² in order to implement Section 21F of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Specifically, Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act added new Section 21F to the Exchange Act, entitled “Securities Whistleblower Incentives and Protection.”

Who Can Be A Whistleblower?

The new rules define a whistleblower as any individual who provides information to the Commission regarding a possible violation that “has occurred, is ongoing, or is about to occur.” Subject to certain restrictions discussed below, a whistleblower can be any individual, including an employee, agent, or someone outside of the entity, who provides the Commission with relevant information. This standard does not does not require that the possible violation be material, probable, or even likely.

The new rules exclude certain individuals from eligibility to receive whistleblower status and thus, the ability to receive an award under the rules. These provisions were enacted to ensure that those responsible for an entity’s compliance lack the incentive to promote their own interests at the expense of the interests of the entity itself. The excluded individuals are as follows:

• officers, directors, trustees and partners of an entity, when such individuals became aware of or learned the information about the possible violation in question from another person or in connection with the entity’s internal compliance policies and procedures for identifying such conduct;
• employees of an entity when such individuals’ primary job function relates to compliance or internal auditing. This category also includes outside persons hired by an entity to (i) perform compliance or audit functions or (ii) investigate possible violations of law; and
• employees of a public audit firm performing an engagement of the entity required by the securities laws, when the information obtained relates to a violation by the entity or the entity’s officers, directors, or employees.

The exclusion of the categories of persons described above is, however, subject to the following caveats and, such persons may be eligible to receive an award if:

• such individuals have a reasonable belief that disclosure to the Commission is necessary to prevent the entity from engaging in conduct that would cause or result in substantial injury to investors or the financial interests of the entity itself;
• such individuals have a reasonable belief that the entity is impeding or interfering with an investigation of the violation; or
• 120 days has passed since the time at which such individual reported the possible violation to the appropriate internal compliance authority.³

The final rules also provide that attorneys who obtain information concerning a possible violation through communication subject to attorney-client privilege or as a result of other legal representation are generally not eligible for an award, unless disclosure of such information is permitted by the model rules of professional conduct for attorneys or applicable Commission rules.

Internal Reporting of Possible Violations

Under the final rules, it is not a requirement that the individual in possession of the information first report such possible violation to an entity’s appropriate internal compliance authority. Whistleblowers are, however, further incentivized to utilize the entity’s internal compliance authority, when appropriate. Such incentives include:

• a whistleblower who first reports information internally is deemed to have reported the violation to the Commission on the same date as the original internal report, provided that the whistleblower submits the same information to the Commission within 120 days of the initial disclosure.
• a whistleblower who reports information internally, which then results in the entity reporting a possible violation to the Commission, shall have all information subsequently disclosed by the entity to the Commission attributed to the whistleblower, potentially resulting in a higher monetary award.
• a whistleblower who cooperates with an entity’s internal compliance authority may receive a higher monetary award.⁴

Payment of Awards

The new rules direct that the Commission pay awards, subject to certain limitations and conditions, to whistleblowers who voluntarily provide the Commission with original information about a violation of (i) the federal securities laws⁵ or (ii) a rule or regulation promulgated by the Commission, that leads to a successful enforcement of an action brought by the Commission that results in monetary sanctions exceeding $1,000,000⁶. In such cases, whistleblowers are entitled to receive an award of between 10% and 30% of the monetary sanctions collected by the Commission.

Restrictions of Awards for Wrongdoers

For purposes of determining whether or not the required $1,000,000 threshold for an award has been met, the Commission does not include in such calculation any monetary sanctions that a whistleblower is ordered to pay, or that an entity is ordered to pay, if the entity’s liability is based substantially on conduct that the whistleblower directed, planned, or initiated. Further, the Commission will not include any such amounts in the total monetary sanctions collected for purposes of determining the amount of an award a whistleblower is to receive.

Anti-Retaliation Protections

The new rules prohibit retaliation by an employer when a whistleblower discloses possible violations by such entity to the Commission, provided that the whistleblower has a reasonable belief that such violations occurred. Further, the new rules provide potential whistleblowers with a private cause of action against the employer in the event that the reporting of such a violation results in discrimination or the whistleblower’s termination.

¹ Rules 21F-1 through 21F-17 of the Exchange Act.

² Forms TCR and WB-APP.

³ Such individual would also be entitled to an award if 120 days has passed since he or she received the information and the appropriate internal authority was already aware of such violation.

⁴ Conversely, if a whistleblower hinders an internal compliance authority’s process concerning the possible violation, the whistleblower’s monetary award can be reduced.

⁵ An individual who submits information that relates only to a state law or foreign law violation would not satisfy the whistleblower definition.

⁶ For purposes of making an award, the Commission will aggregate two or more smaller actions that arise from the same nucleus of operative facts.

If you have any questions regarding the matters described herein or should you wish to discuss these matters further, please do not hesitate to contact Joseph Lucosky (732-395-4400; jlucosky@lucbro.com), Seth Brookman (732-395-4400; sbrookman@lucbro.com), or the attorney with whom you regularly work

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