United States: The New SEC Whistleblower Program: What the SEC Has Learned (at Least For Now) From the False Claims Act About Avoiding Whistleblower Abuses

INTRODUCTION

The sweeping overhaul of the financial system in the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank" or "Act") included a provision to encourage more "whistleblowers" to disclose alleged wrongdoing by publicly traded companies, financial services institutions, and other covered entities by rewarding those who come forward with substantial monetary awards.¹ This concept, initially proposed by University of Alabama Law School Professor Pamela (Bucy) Pierson in a seminal article published eight years ago, is based upon the view that so-called "qui tam enforcement" had worked so well in the enforcement of the civil False Claims Act ("FCA") that it should be imported to securities enforcement.²

Congress's thought process is understandable. There can be little question that the revised whistleblower provisions in the FCA have helped to significantly increase recoveries under the FCA. The FCA, originally passed in 1863 to punish fraud on the Union Army, has always included a unique enforcement mechanism ("qui tam" enforcement) which rewards insiders for disclosing and prosecuting fraud on the federal government. The law was rarely used before watershed amendments to the FCA were passed in 1986. Since those amendments, annual FCA recoveries have skyrocketed from $86 million in 1987 to $3 billion in the just concluded fiscal year. Total FCA recoveries since the 1986 amendments have been over $27 billion, and two thirds of that amount ($17.6 billion) was recovered in FCA cases originally brought by qui tam relators.

Good arguments can be made that other factors since 1986 were more significant to this dramatic rise in recoveries: the large increase in DOJ and U.S. Attorney personnel devoted to FCA enforcement; the increased power of agency inspector general offices to conduct investigations and obtain documents; the reduction in the FCA intent standard to mere "recklessness"; the oppressively punitive nature of the FCA's treble damages and per-claim civil penalties; and the debilitating adverse collateral consequences (debarment and exclusion) of a final FCA judgment, which make trials a "bet the company" adventure. These and other developments since 1986 were all significant in the increase in FCA recoveries.

Nonetheless, qui tam enforcement has been important. Even though most qui tam cases do not result in any significant recoveries (the DOJ has intervened in only 25 percent of all qui tam cases, and DOJ controlled cases account for almost 98 percent of all FCA recoveries), paying whistleblowers for information about alleged fraud increases the number of reports regarding fraud and the recoveries that naturally follow from those that have merit.³ After all, greed is an element of human nature, and large whistleblower rewards feed that natural inclination.

Thus, one understands the Dodd-Frank provisions establishing the payments to whistleblowers, but―in a remarkable (and rare) display of intelligence and good sense―Congress for the most part did not dictate the rules implementing the SEC whistleblower program. Instead, Congress left it to the SEC to draft them. And the SEC has clearly considered the history of qui tam enforcement under the FCA in developing those draft rules.

The SEC's proposed rules were published on November 3, 2010, with comments due on December 17, 2010.⁴ While public companies, other entities regulated by the SEC, and interested parties will have other comments and criticisms of the rules, the SEC should not be criticized for recognizing that the new whistleblower program was based on the False Claims Act's qui tam mechanism and for reviewing qui tam enforcement under the FCA in drafting the rules. Most importantly, the SEC should be commended for recognizing that current qui tam enforcement is subject to substantial abuse by qui tam relators and their counsel, and for drafting proposed rules which will eliminate, or at least attempt to avoid, many of those FCA abuses in the SEC whistleblower program. One hopes that the SEC will be able to withstand the political pressures that are almost certain to be mounted by the qui tam bar, its Washington lobbyists, and qui tam advocates in Congress, and keep those abuses out of the SEC whistleblower program.

THE SEC WHISTLEBLOWER PROGRAM AND THE FCA

The Dodd-Frank Act, enacted on July 21, 2010, authorized a whistleblower program that requires the SEC to pay an award to eligible whistleblowers who provide original information about securities laws violations that leads to a successful enforcement action. The Act also prohibits retaliation against these whistleblowers by their employers. Several elements of Dodd- Frank's SEC whistleblower provisions derive from the FCA's qui tam enforcement mechanism (for example, the 10-30% whistleblowers' share, the "original information" requirement, and the "voluntarily" provided requirement are based on similar requirements in the FCA), and the SEC noted in its proposed rules that the FCA provided "helpful guidance" on the legal standards for whistleblowers. However, the SEC's rules reflect a more balanced approach to the competing interests of whistleblowers, companies with internal compliance programs, and governmental enforcement than currently exists under the FCA. And the SEC's proposal shows that it has learned important lessons from abuses by qui tam relators under the FCA.

1. The Dodd-Frank Act Itself Prohibits Independent Enforcement of the Securities Laws by Whistleblowers

The most significant distinction between the SEC's whistleblower provisions and the FCA's qui tam mechanism, of course, is that the SEC is not forced to yield its authority to investigate potential violations of the securities laws and to bring administrative or court actions to enforce these laws to whistleblowers. Perhaps that is an indication that at least some in Congress are beginning to learn a valuable lesson about qui tam enforcement: paying whistleblowers for information about wrongdoing makes economic sense, but allowing those same whistleblowers to exercise Article II power to enforce the laws without DOJ intervention and involvement is a bad investment. Less than three percent of FCA recoveries―and almost all adverse case law―come from qui tam cases which are litigated without DOJ involvement.⁵ Under Dodd-Frank's SEC whistleblower provisions and the SEC's proposed rules, an administrative process is established under which the SEC pays awards to whistleblowers who voluntarily provide original information that leads to the successful enforcement of a federal court or administrative action by the SEC. Rather than allowing whistleblowers to become involved in enforcement, the SEC maintains complete control of the government's enforcement of the securities laws. The SEC's award to the whistleblower is dependent upon the submission of information in accordance with the procedures and conditions set forth in the SEC's rules and on the success of the action.

Essentially, under the proposed rules, the SEC pays awards to whistleblowers⁶ who:

1. voluntarily provide the SEC
2. with original information
3. that leads to the successful enforcement of a federal court or administrative action
4. in which the SEC obtains monetary sanctions totaling more than $1 million.⁷

There are a number of key requirements and exclusions to the SEC's awards that reflect a more balanced approach and an interest in preventing the abuses that have occurred under the FCA's qui tam enforcement mechanism.

2. The SEC's Relation-Back Provision Reflects an Attempt to Minimize Conflict with Internal Corporate Compliance Programs

The SEC rules attempt to encourage continued use and expansion of internal corporate compliance programs by allowing a whistleblower's disclosure to the SEC to relate back to the date of the whistleblower's internal corporate disclosure. This provision means that an SEC whistleblower is not necessarily precluded from receiving a reward by his or her previous attempt to disclose the information as part of an internal corporate compliance program. The proposed rule provides a relatively short period for the company to investigate―90 days―but it also requests comment on this issue and thus appears open to expanding that time frame. Some have argued that requiring internal reporting would better align the whistleblower rules with the policies of the Sarbanes-Oxley Act that favor encouraging companies to maintain robust reporting programs.⁸ There is no such requirement or encouragement under the FCA. The SEC also prohibits awards to those who obtain information in a manner that violates federal or state criminal law, and perhaps anticipating the "self-discovery" issues found in FCA cases, it requests comment on how violations of judicial or administrative orders in private litigation should be treated.⁹

3. The SEC Rules Define the "Voluntarily" Requirement

The SEC rules ensure that the whistleblower's information is submitted "voluntarily" by requiring its submission "before you or anyone representing you (such as an attorney) receives any request, inquiry, or demand from the Commission, the Congress, any other Federal, State, or local authority, any self-regulatory organization, or the Public Company Accounting Oversight Board."¹⁰ The rules also provide that a request directed to an employer is also considered to be directed to the employee who possesses the documents for purposes of the definition of "voluntarily," and thus this employee would not generally be eligible for an award (unless the employer failed to disclose the information or documents in a timely manner). By defining "voluntarily" in this way, the SEC has sought to eliminate one of the major abuses in qui tam enforcement, and by providing a specific definition, it has attempted to limit rewards to true whistleblowers. Unfortunately, the FCA has left the interpretation of the term "voluntarily" in Section 3730(e)(4)(B) to the courts, with unsatisfactory and conflicting results that in many cases reward parasitic relators with large financial recoveries.¹¹

4. The SEC Rules Expressly Prohibit Awards to Government Employees and Those with a Pre-Existing Duty to Report Violations

Under the Dodd-Frank Act, no award may be given to any whistleblower who acquired the information submitted to the SEC through employment at a regulatory agency, the DOJ, the PCAOB, a self-regulatory organization, a law enforcement organization, or by one who gained the information through an audit required under the securities laws.¹² The SEC rules implement this statutory prohibition by specifically providing that, in order to be considered "original information," the information must be derived from the person's "independent knowledge" or "independent analysis," neither of which may derive from one's employment in any of the groups listed in the statute.¹³

The rules expand on this statutory list by prohibiting an award to one who gained knowledge or information "because you were a person with legal, compliance, audit, supervisory, or governance responsibilities for an entity, and the information was communicated to you with the reasonable expectation that you would take steps to cause the entity to respond appropriately to the violation."¹⁴ The rules explain that these prohibitions reflect the SEC's attempt to balance the potentially competing interests in providing monetary awards to whistleblowers and in supporting "the effectiveness of a company's existing compliance, legal, audit and similar internal processes for investigating and responding to potential violations."¹⁵ The SEC rules carve out a limited exception to its expanded prohibitions for an entity that does not disclose the information within a reasonable time or proceeds in bad faith, and the SEC requests comment on whether this provision for the entity's disclosure within a reasonable time strikes the appropriate balance.¹⁶

Under the FCA, on the other hand, there is no such express prohibition on awards to government employees or those with a pre-existing duty to report fraud, such as in-house counsel, auditors, and compliance officers.¹⁷ Indeed, while the government has argued vigorously against awards to government employee whistleblowers, many courts have continued to allow recoveries to government employee relators.¹⁸ In United States ex rel. Fine v. Chevron, U.S.A., Inc., the government pointed out how permitting employees of the Office of the Inspector General to act as relators created undesirable incentives:

Rather than leaving this critical issue vague or unresolved, the explicit prohibition on government employee whistleblowers reflects an effort to ensure that the integrity of the government's regulatory process is maintained by preventing those in charge of that process from pursuing personal monetary gain or adopting conflicting roles. Further, the SEC's proposal would avoid other conflicts of interest invited under the FCA by excluding those with a pre-existing duty to report violations from receiving awards.

5. "Original Information" is Defined to Exclude Publicly Available Information

The SEC rules specifically provide that, in order to be considered "original information," the information must derive from the person's "independent knowledge" or "independent analysis," both of which are defined to require information that is not publicly known or available to the public^.20 Dodd-Frank and the SEC's rules provide that "original information" does not exclusively derive from an allegation in a judicial or administrative hearing, a governmental report, hearing, audit, or investigation, or from the news media, unless the person is a source of the information.²¹ These sources of disclosure are not limited to federal sources―as a recent amendment to the FCA's public disclosure bar provides.²² The SEC rules focus on the type of knowledge and information a whistleblower must provide rather than on restricting the sources from which public disclosures occur. Thus, the SEC describes a FOIA response as "generally available to the public" and therefore not a basis for "independent knowledge."²³ Under the less precise terminology of the FCA's public disclosure bar, this issue has resulted in a circuit split and is now before the Supreme Court in Schindler Elevator Corp. v. United States ex rel. Kirk.²⁴

6. The SEC Requires Information that Leads to Successful Enforcement

The SEC rules require the information to lead the Commission to either commence an investigation or reopen a closed investigation and find that the information "significantly contributed to the success of the action," or, if the matter was already under investigation, the information must "not otherwise have been obtained and [must be] essential to the success of the action."²⁵ Thus, the SEC rules emphasize the view that awards should generally be limited to cases where a whistleblower provides new information about violations not already under investigation, and the accompanying explanation of the "essential to success" standard confirms this view: "[w]e anticipate applying [the rule] in a strict fashion, . . . such that awards under this standard would be rare."²⁶

The SEC's interpretation tries to prevent whistleblowers from seeking a monetary share of the government's recovery when they provide no new information on allegations or transactions that the government is already investigating. However, a qui tam relator could do just that under the First Circuit's clearly faulty interpretation of the "original source" standard in United States ex rel. Duxbury v. Ortho Biotech Products, L.P., despite the government's vigorous arguments to the contrary.²⁷ The PPACA amendments to Section 3730(e)(4) do not fix this problem in the FCA's public disclosure bar because they continue to allow the relator this option in addition to the option of reporting the fraud prior to a public disclosure. The SEC's "essential to success" standard is far more direct and effective than the FCA's "materially adds" standard in preventing parasitic suits by relators while encouraging whistleblowers to provide their information about fraud to the government prior to the government's initiation of an investigation.

7. SEC Awards Are Based on Monetary Sanctions in a Commission "Action"

An award under the SEC's rules is between 10 and 30 percent of the monetary sanctions collected in the "action," which is calculated based on the recovery in a "single captioned judicial or administrative proceeding."²⁸ This award could cover claims that were not included in a whistleblower's original disclosure, and thus it could potentially allow a greater award to the SEC whistleblower than under the FCA, where treble damages and civil penalties attach to each false or fraudulent "claim," and are calculated using a claim-by-claim approach.²⁹

8. Anti-Retaliation and Confidentiality

Dodd-Frank provided that an individual alleging retaliation under the Act may bring an action in the appropriate federal district court, much like a similar provision in the FCA.³⁰ Unlike the FCA's retaliation provision as amended by Dodd-Frank, however, the SEC's antiretaliation provision specifically extends only to retaliation by an "employer."³¹

In addition, under the SEC rules, the whistleblower's identity and submissions are kept confidential prior to the filing of an action.³² Under the FCA, the entire qui tam complaint is kept under seal until the DOJ either intervenes or seeks court approval to partially unseal the complaint to seek the defendant's comments. That is a cumbersome process, and the SEC's anonymity and confidentiality concern is more focused and its effect more limited than the FCA's broad seal requirements. This should allow for better communication between the SEC and target companies.

9. Sworn Declarations, Criminal Conduct, and False Statements by Whistleblowers

The SEC rules exhibit a concern for the integrity of the investigation, trial, and award processes―a concern that is equally important but far less protected under the FCA. For example, the SEC requires the whistleblower's submission to be signed under penalty of perjury in order to deter the submission of false and misleading information to the Commission and to "mitigate the potential harm to companies and individuals that may be caused by false or spurious allegations of wrongdoing."³³ Like the FCA, the SEC rules provide that whistleblowers are not eligible for an award if they are convicted of a criminal violation that is related to an action,³⁴ but the SEC further provides that whistleblowers are ineligible for an award if they make false or fraudulent statements or representations in connection with a related action.³⁵ No such provision exists in qui tam enforcement under the FCA, even though requiring and ensuring truthfulness on the part of whistleblowers is equally appropriate in FCA actions.

A FINAL WORD

Comments on the SEC's proposals are due December 17, 2010. Only then will the political pressure really begin. The whistleblower bar has very powerful friends in Congress and is a very effective lobbying group. The FCA amendments in 2009 and 2010, which dramatically increased the scope and power of the FCA, are proof of that lobbying power. Congress was told that the FCA was being "weakened" by pro-defense court decisions (almost all in qui tam cases in which the DOJ declined to intervene), yet FCA recoveries have continued to skyrocket in recent years. One can expect that they will lobby both the SEC and Congress to thwart the SEC's efforts to eliminate the abuses seen in FCA qui tam enforcement. One hopes that the False Claims Act will one day be amended to eliminate the abuses it currently allows.

Footnotes

1. See Pub. L. No. 111-203, 124 Stat. 1376 (2010).

2. See Pamela H. Bucy, Private Justice, 76 S. Cal. L. Rev. 1 (2002). A similar whistleblower program was added to the tax laws in 2006. See Tax Relief and Health Care Act of 2006, Pub. L. No. 109-432, § 406, 120 Stat. 2922, 2958 (2006).

3. See DOJ's 2010 FCA Statistics.

4. See Proposed Rules for Implementing the Whistleblower Provisions of Section 21 F of the Securities Exchange Act of 1934, Exchange Act Release No. 63, 237, 75 Fed. Reg. 70488 (Nov. 17, 2010).

5. See John T. Boese, Civil False Claims and Qui Tam Actions, § 1.04[H] n. 99 (Aspen Publishers, Wolters Kluwer Law & Business) (3d ed. 2006 & Supp. 2010-1) ("The vast majority of qui tam recoveries . . . came from cases with federal government intervention) ("Boese"). The forthcoming Fourth Edition of this treatise is to be published in late December 2010.

6. Recognizing that a "whistleblower" should not be able to profit from his or her own fraud, the SEC is considering changing the definition of "whistleblower" in the rule to an individual who provides information relating to a potential violation of the securities laws "by another person." See 75 Fed. Reg. 70489 (request for comment on definition of a whistleblower). See also 75 Fed. Reg. 70509 ("we are preliminarily of the view that it would not be consistent with the purposes of the statute to pay awards to persons based on monetary sanctions arising from their own misconduct"). This would directly exclude recoveries by a person who participates in perpetrating the violation, which the FCA only addresses indirectly. See 31 U.S.C. § 3730(d)(3) (court may reduce share of relator who planned and initiated a violation). See also United States v. Resnick, 594 F.3d 562 (7th Cir. 2010) (action brought by the United States under the Federal Debt Collection Procedure Act to recover money from insolvent qui tam relator sentenced for wire fraud and check kiting scheme).

7. 75 Fed. Reg. 70520.

8. See Memorandum, Wachtell, Lipton, Rosen & Katz, New SEC Whistleblower Rules Fall Short, at p.2 (Nov. 19, 2010).

9. 75 Fed. Reg. 70495. See United States ex rel. Rigsby v. State Farm Ins. Co., No. 1:06-CV-0433 LTSRHW, 2008 WL 2130314 (S.D. Miss. May 19, 2008) (ruling that documents illegally taken by the relators from their employer would be excluded from evidence unless produced in discovery). The reader should note that the author is counsel to a number of the defendants in the Rigsby case. See also Boese, §§ 4.01[B][1], [B][2].

10. 75 Fed. Reg. 70520.

11. See, e.g., United States ex rel. Maxwell v. Kerr-McGee Oil & Gas Corp., 540 F.3d 1180 (10th Cir. 2008) (finding that relator 's qui tam suit was not barred even though, as a federal auditor, he was required to disclose the alleged fraud to his government superiors).

12. Dodd-Frank, § 922, 124 Stat. 1843.

13. See 75 Fed. Reg. 70520.

14. Id. (§ 240.21F-4(b)(4)(iv)).

15. 75 Fed. Reg. 70488.

16. See 75 Fed. Reg. 70495.

17. See, e.g., X Corp. v. Doe, 805 F. Supp. 1298 (E.D. Va. 1992, aff'd sub nom. Under Seal v. Under Seal, 17 F.3d 1435 (4th Cir. 1994) (inhouse corporate counsel allowed to use privileged information to bring qui tam case against his client).

18. See, e.g., Maxwell, 540 F.3d 1180 (government auditor allowed to bring qui tam case); United States ex rel. Williams v. NEC Corp, 931 F.2d 1493 (11th Cir. 1991) (Air Force attorney allowed to bring case); United States ex rel. Hagood v. Sonoma County Water Agency, 929 F.2d 1416 (9th Cir. 1991) (same). Other courts have used the "original source" bar to dismiss qui tam cases brought by government employees. See, e.g., United States ex rel. Biddle v. Board of Trs. of the Leland Stanford, Jr. Univ., 161 F.3d 533 (9th Cir. 1998) (government employee obliged to alert superiors to wrongdoing by contractor could not "voluntarily" provide information to the government for purposes of bringing a qui tam suit); United States ex rel. Schwedt v. Planning Research Corp., 39 F. Supp. 2d 28 (D.D.C. 1999) (same).

19. 72 F.3d 740, 745 (9th Cir. 1995).

20. 75 Fed. Reg. 70520.

21. Dodd-Frank, § 922, 124 Stat. 1376, 1841-42; 75 Fed. Reg. 70520.

22. See Patient Protection and Affordable Care Act, Pub. L. No. 111-148, § 10104(j), 124 Stat. 119, 901-02 (2010) (amending 31 U.S.C. § 3730(e)(4) ("PPACA").

23. See 75 Fed. Reg. 70492.

24. No. 10-188 (petition granted Sept. 28, 2010).

25. 75 Fed. Reg. 70497-98. In addition, if the information was already in the possession of the Commission, in order to be considered an "original source" eligible to receive an award, the whistleblower must either show that he or his representative furnished the information to the Commission's source, or that his information "materially adds" to the Commission's information. See 75 Fed. Reg. 70521.

26. See 75 Fed. Reg. 70498.

27. 579 F.3d 13 (1st Cir. 2009) (holding that, despite the government's long-standing investigation of fraud allegations and multiple public disclosures about it, the timing of relator's qui tam filing was not a factor to be considered under the FCA's "original source" standard). See FraudMail Alert Nos. 10-02-23, 09- 08-19.

28. 75 Fed. Reg. 70521.

29. See Rockwell Int'l Corp. v. United States ex rel. Stone, 549 U.S. 457 (2007).

30. Dodd-Frank, § 922, 124 Stat. 1376, 1846. See also 75 Fed. Reg. 70514 n.104.

31. See Dodd-Frank, Pub. L. No. 111-203, § 1079A(c), 124 Stat. 1376, 2079 (2010) (amending 31 U.S.C. § 3730(h) by striking the word "employer" and expanding coverage to an "employee, contractor, or agent . . . discriminated against in the terms and conditions of employment").

32. See Dodd-Frank, § 922, 124 Stat. 1376, 1843-44 (disclosure of identity prior to payment of award); 75 Fed. Reg. 70521-22 (confidentiality of submissions).

33. 75 Fed. Reg. 70502.

34. 75 Fed. Reg. 70522 .

35. Id. (eligibility).

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