The SEC’s Tricky Balancing Act

By Shruti Shah and Robert N. Walton

How the controversial whistleblower incentive provisions in the Dodd Frank Act will be implemented became slightly clearer last Wednesday. The SEC’s proposed new rules, available here, set the stage for the issuance of final rules next spring.

The legislative intent behind the provisions is to create incentives to report wrongdoing and protect whistleblowers. These objectives, while laudable, present a significant regulatory challenge. As it formulates its rules, the SEC needs to strike the right balance between incentivizing and protecting whistleblowers and, at the same time, not undermining good corporate compliance programs.

The proposed rules mark the first attempt by the SEC to achieve this balance and address some of the outcry over the provisions. Significant among the many concerns raised are (1) the potential for whistleblowers to bypass a company’s existing compliance procedures, (2) the possibility that those complicit in improper conduct might benefit from their own wrongdoing, and (3) the inefficient use of SEC resources that might result from processing the potential multitude of claims.

In response to the first concern, the proposed rules emphasize that the absence of a requirement for a whistleblower to use internal compliance processes does not necessarily mean that such processes will be bypassed. The rules indicate that SEC staff, upon receiving a whistleblower’s complaint, will reach out to the company where appropriate, describe the nature of the allegations, and give the company an opportunity to investigate the matter and report back. What happens next is an open question, as is the impact such a process will have on internal reporting mechanisms.

The rules also provide that company personnel with legal, compliance, audit, supervisory, or governance responsibilities cannot be whistleblowers unless the company fails to disclose the information to the SEC within a reasonable time, or if the company proceeds in bad faith.

With respect to the second concern, the SEC also proposes that whistleblowers not be paid awards based on monetary sanctions arising from their own misconduct. The SEC seeks comment as to whether the term “whistleblower” should be defined “to expressly state that it is an individual who provides information about potential violations of the securities laws ‘by another person.’” This seems like a commonsense approach.

Finally, in an effort to address the potential strain on the SEC (and, it might be added, on the companies concerned), the proposed rules would impose procedural requirements in order to deter false submissions.  In applying those requirements, the SEC will need to ensure that it carefully balances the burden on the SEC and the companies concerned with that on the whistleblowers.

If the comments posted to date in the blogosphere are any indication, neither the companies expressing concerns, nor the provisions’ proponents, are entirely satisfied with the proposed rules. They’re likely to provide plenty of comments to keep the SEC rulemakers busy in the coming months.
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Shruti Shah and Rob Walton are senior policy directors at Transparency International-USA and can be contacted here.