by Stephen Kohn
The SEC wasted no time in granting monetary rewards to compliance-related employees. The ninth whistleblower to receive a financial reward from the SEC worked as a compliance official. In the SEC’s press release announcing this award, it explained its policy behind permitting compliance officials to qualify for a reward: “Individuals who perform internal audit, compliance, and legal functions for companies are on the front lines in the battle against fraud and corruption. They often are privy to the very kinds of specific, timely, and credible information that can prevent an imminent fraud or stop an ongoing one.”
The Chief of the SEC’s Office of the Whistleblower explained how the 120-day rule works:
[Compliance officials] may be eligible for an SEC whistleblower award if their companies fail to take appropriate, timely action on information they first reported internally. . . . This particular whistleblower award recipient reported concerns of wrongdoing to appropriate personnel within the company, including a supervisor. But when the company took no action on the information within 120 days, the whistleblower reported the same information to the SEC. The information provided by the whistleblower led directly to an SEC enforcement action.
Thereafter, the Commission also awarded a “compliance professional” a $1.5 million award for reporting information for which the employee had a “reasonable basis to believe that disclosure to the SEC was necessary to prevent imminent misconduct from causing substantial financial harm to the company or investors.” The SEC explained that the company “failed to take steps” to prevent financial harm to investors after the whistleblower had disclosed the concerns. The Commission’s message was clear. The goal of the whistle-blower reward program was to protect investors, not prevent employees from becoming whistleblowers simply because they are auditors, attorneys, compliance professionals, or even members of the company’s Board of Directors who sit on the official Audit Committee.
If you perform a compliance function for a publicly traded company—whether you are an intake officer answering a company hotline, the Chief Compliance Officer, or the Chair of the Board of Director’s Audit Committee, you can qualify for whistleblower financial rewards so long as you follow SEC protocol.
One last note: There are no restrictions whatsoever on auditors or compliance officials qualifying for rewards under other programs, including the False Claims Act, the IRS tax whistleblower law, the Act to Prevent Pollution from Ships, and wildlife protection laws.
The SEC Rule Covering Employees Who Voluntarily Report to Compliance Officials, Supervisors, or Auditors before Making a Report to the SEC
The existence of corporate compliance programs raised an entirely different issue during the debate over whistleblower protections for corporate employees. Should employees be required to disclose fraud or misconduct internally before they reported these issues to the SEC? Should the SEC take steps to encourage internal reporting as a means to incentivize companies to create truly effective programs? These issues do not concern the rights of compliance professionals, but instead impact the procedures rank-and-file employees would use to report concerns
During the SEC’s Dodd-Frank Act’s rulemaking process, the U.S. Chamber of Commerce tried to persuade the Commission to require all employees to first report allegations of fraud internally in order to qualify for a reward. The Chamber depicted corporations as honest and willing to listen to their employees and claimed that financial rewards for whistleblowing would undermine good corporate governance. They alleged, with no empirical evidence, that by permitting employees to report allegations directly to the SEC and obtain a reward, employees would skip internal reporting. This argument had no credibility. As explained in Rule 17 (Beware of Hotlines), many companies had a history of firing employees who reported concerns internally and thereafter defending those terminations in court. Moreover, the nonprofit advocacy group National Whistleblower Center provided the Commission with detailed studies explaining how other reward laws (the False Claims Act) did not negatively impact corporate compliance programs.
The SEC rejected the Chamber’s argument that employees must report their concerns internally before they can qualify for a reward. The Commission reiterated that no employee would be required to report his or her concerns to the company first as a condition of obtaining a reward. The decision on where to report would be left up to the employee. If the employee trusted the company’s managers, they could report internally, if the employee feared retaliation or wanted complete confidentiality, they could go directly to the SEC.
As explained by the Chair of the Commission:
I believe that the final [rule] strikes the correct balance—a balance between encouraging whistleblowers to pursue the route of internal compliance when appropriate—while providing them the option of heading directly to the SEC. This makes sense as well, because it is the whistleblower who is in the best position to know which route is best to pursue. . . . I believe that incentivizing—rather than requiring—internal reporting is more likely to encourage a strong internal compliance culture. Our rules create incentives for people to report misconduct to their employers, but only if those companies have created an environment where employees feel comfortable that management will take them seriously—and where they are free from possible retaliation.
Under the SEC’s rules, employees can either report internally or go directly to the SEC. When they report to the SEC, they can qualify for a reward. But the SEC understood that many (or most) employees will report internally before approaching the government. The Commission crafted a rule that fully protected employees who initially reported their concerns internally to a compliance official or their supervisor, as long as they also report to the government in a timely manner.
Under the SEC’s whistleblower rules, if an employee discloses misconduct to his or her supervisor or the company’s internal compliance program, that employee enjoys the same rights as if he or she reported the allegations directly to the SEC. However, the employee is still required to file a claim with the SEC within 120 days of his or her internal report in order to fully qualify for a reward.
This rule is extremely significant, but it’s also confusing. It concerns how the SEC interprets the requirement that information provided to the Commission be “original” in order to qualify for a reward. The following scenarios should help explain the rule:
• An employee personally witnesses fraud and reports it to the SEC. S/he is the original source of that report.
• What if the same employee, instead of reporting the fraud to the SEC, reported the fraud to the company’s compliance department? The employee is given credit for the internal report. Even if others make the same report to the SEC, the employee is still the “original source” for purposes of qualifying for the reward, if s/he eventually reports the issue to the SEC within the 120-day grace period.
• What rights do the compliance officials for whom the report was made have? These officials cannot blow the whistle for 120 days. But if the employee who filed the original concern has not contacted the SEC, after 120 days expires, the compliance official can contact the SEC and be considered the original source.
The SEC rules implement the “first to file” rules that exist in all whistleblower-reward programs. If two whistleblowers give the same information to the government, the whistleblower who first provided the information gets credit for providing the “original” information for which the Commission is not aware. The whistleblower who is second in line gets no credit, as his or her information is already known to the SEC and is no longer “original.” The Commission already knows about the allegations from the first whistleblower. The “first to file” rule encourages early reporting. [Note: Under the Commission rules, if the second whistleblower “contributes” to an ongoing investigation, or provides information the first whistleblower did not have, he or she can still qualify for a reward.]
The SEC’s 120-day rule permits a whistleblower to give information to internal compliance
or a supervisor and still be the first to file, as long as he or she reports the concern to the SEC within 120 days of reporting the concern internally. Even if another employee went to the SEC during this 120-day period, the employee who initially raised his or her concerns with the company would still be the first to file and would qualify for the reward. This provides employees an opportunity to try to work out issues with their employer before taking the risky step of going outside the company and filing a claim with the government. The SEC’s goal was simple: Provide strong incentives for companies to establish independent and ethical compliance programs or risk an army of whistleblowers flooding directly to the SEC with allegations of corporate misconduct.
The SEC rules provide an additional benefit to reporting a concern internally. If an employee reported his or her concerns internally, and thereafter the company self-reported the violation, the employee could still qualify as the original source of the information provided he or she also reported the information within the 120-day grace period. In this scenario, if the information a company self-reports to the government results in a fine or penalty, the whistleblower who provided the information to the company that led to the self-reporting can still qualify for a reward. This is so, even if the penalty imposed on the company was triggered by the company’s self-reporting. Thus, if the employee was the original source of the fraud allegation, and the company acted on the employee’s allegation and self-reported the violation, the employee could still qualify for a reward.
This is the first time under any regulatory scheme that an employee could qualify for a reward even if the company self-reported the violation before the employee officially filed the fraud allegation with the government. The key to qualifying for the reward is to make sure that whatever information an employee provides to his or her supervisor or a compliance official is also disclosed to the SEC within 120 days of the initial report.
The Commodity Futures Trading Commission has an identical rule covering employees who report violations of the Commodity Exchange Act.
PRACTICE TIPS
• The SEC rule on compliance and director eligibility for rewards is set forth at 17 C.F.R. § 240.21F-4(b)(4)(iii) and (v).
• The SEC rule permitting employees to qualify as the original source for purposes of obtaining a reward if they report their concerns to the Commission within 120 days of providing information to a compliance officer is set forth at 17 C.F.R. § 240.21F-4(b)(7).
• The Commodity Futures Trading Commission’s rule on compliance and director eligibility is set forth at 17 C.F.R. § 165.2(g)(4), (5), and (7).
• The Commodity Futures Trading Commission’s rule permitting employees to qualify as the original source for purposes of obtaining a reward if they report their concerns to the Commission within 120 days of providing information to a compliance officer is set forth at 17 C.F.R. § 165.2(i)(3).
• To learn the origin of the SEC’s rules governing compliance departments, see The SEC’s Final Whistleblower Rules & Their Impact on Internal Compliance (West Law Publishing, October 2011).
• Ethics and Pressure, Balancing the Internal Audit Profession, an overview of the pressures facing auditors, was written by Dr. Larry Rittenberg for the Institute of Internal Auditors (IIA Research Foundation, 2016).
RULE 20Cautiously Use “Self-Help” Tactics
Whistleblowers have no choice but to engage in “self-help” tactics. They have to obtain evidence to prove their cases. But this can be extremely tricky. There are privacy rules, “trade secret” rules, rules governing the use of company computers, telephones, e-mail accounts, and even the use of copying machines. How does an employee balance the need to collect supporting information with various workplace rules that limit or prohibit evidence gathering?
When engaging in self-help tactics, whistleblowers have to be extremely careful. Judges will not sympathize with their plight simply because it is difficult for whistleblowers to obtain supporting witnesses, or because the company has an overwhelming advantage regarding access to documents. No matter how hard it is to obtain evidence of wrongdoing, courts continuously warn employees “not to engage in dubious self-help tactics or workplace espionage in order to gather evidence.” The law is clear on this issue: Engaging in protected activity does not immunize employees from being accused of “inappropriate workplace activities,” even if they are engaged in that conduct simply to document corporate wrongdoing.
To further complicate the matter, there is no clear rule on self-help tactics. The leading cases all apply a “balancing test” for determining whether an employee’s evidence-gathering tactics are protected. In one case widely followed by other courts, the U.S. Court of Appeals for the Fifth Circuit explained: “Courts have required that the employee conduct be reasonable in light of the circumstances, and have held that the employer’s right to run his business must be balanced against the rights of the employee to . . . promote his own welfare.”
Here are basic guidelines to follow when using self-help tactics, such as taping conversations or removing company documents.
Don’t Break the Law
Do not break the law. This is a basic rule that must be followed. If a court determines that an employee broke a criminal law in order to obtain evidence in the case, the employee will suffer a sanction. The case may be dismissed, the employee’s credibility will be attacked, and there may even be a referral for criminal prosecution. Even if dismissal is not imposed, the employee’s ability to introduce illegally obtained evidence in court may be blocked, and the defendants will capitalize on this conduct at every phase of the case: They will use it as grounds to have a case dismissed, they will use it to cross examine the employee at trial, and they will use it on appeal to justify having the case thrown out.
One-Party Taping of Conversations
Whistleblowers often tape conversations with their supervisors or coworkers. In numerous cases employees have testified regarding their fear that no one will believe their story, and that they need to document the oral admissions of witnesses or wrongdoers in order to prove their case. Without a doubt these fears are well-founded. Taped conversations have often proven to be key evidence in a whistleblower’s case. They can be the difference between winning and losing a case.
Also, tapes can be powerful evidence proving wrongdoing. When Linda Tripp taped her coworker at the Pentagon, she obtained admissions that directly led to unprecedented sanctions against a sitting president of the United States, including a contempt citation, disbarment, an adverse finding in a sexual harassment case, and a vote by the House of Representatives for impeachment (only the second time in history). The tapes provided irrefutable evidence. They documented oral admissions that would have been denied under oath by all the other witnesses.
The Tripp case is not without precedent. Many other whistleblowers have successfully used taped conversations to document serious wrongdoing. But is taping legal or ethical?
The rule on one-party taping traces back to a 1961 incident on which IRS agent Roger S. Davis interviewed German Lopez, the owner of Clauson’s Inn in North Falmouth, Massachusetts. Lopez paid Davis a bribe. Davis promptly reported the pay-off to his supervisors and returned to Clauson’s Inn to collect more evidence. But when he returned to the inn, he had a pocket tape recorder and another taping device on his body. This time he taped the conversation with the inn’s owner, and the tape was key evidence in convicting Lopez. However, Davis never obtained a search warrant.
Davis’s taping would become the landmark federal decision on the legality of “one-party” taping (when one party to a conversation tapes the conversation without telling the other party), whether done by federal agents or private persons. When the case of Lopez v. the United States wound its way up to the Supreme Court three years later, Justice John Harlan upheld the legality of one-party taping. He reasoned that the “electronic device” was not used to document “conversations” the IRS agent “could not otherwise have heard. Instead, the dev
ice was used only to obtain the most reliable evidence possible of a conversation” in which the person using the hidden tape recorder “was a participant” and was “fully entitled to disclose.”
The IRS agent was a party to the conversation and the person making the criminal admissions knew that the agent could hear him. The court drew a strict distinction between using a tape recorder when you are a party to a conversation and planting a listening device (that would have been illegal if a search warrant for the device had not been obtained).
Chief Justice Earl Warren, one of the Supreme Court’s most vocal supporters of a right to privacy, supported the decision. But to ensure that there was no misunderstanding as to why he fully joined in a ruling that may appear counter to his strong support of an individual’s right to privacy, Justice Warren wrote a separate concurring opinion. For Chief Justice Warren, permitting one-party taping was a simple matter of fairness. It would be wrong for the court to render Davis “defenseless” against attacks on his own “credibility.” How else could someone defend themselves against countercharges that during the conversation they attempted to obtain a bribe or they acted to illegally entrap a defendant? Chief Justice Warren understood that no matter what the outcome of the court trial may be, the IRS agent had his reputation to defend. As he explained:
[When] faced with situations where proof of an attempted bribe will be a matter of their word against that of the tax evader and perhaps some of his associates [IRS agents such as Mr. Davis] should not be defenseless against outright denials or claims of entrapment, claims which, if not open to conclusive refutation, will undermine the reputation of the individual agent for honesty and the public’s confidence in his work. Where confronted with such a situation, it is only fair that an agent be permitted to support his credibility with a recording as Agent Davis did in this case.
