Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The SEC has issued a final rule repealing former Section 21A(e) of the Securities Exchange Act of 1934, pursuant to which the SEC had been empowered to make monetary awards to persons that provided information relating to insider trading violations where investigations into such violations led to the collection of civil penalties.  You might ask why, in the wake of the Dodd-Frank Act,  the SEC would repeal rules relating to insider trading bounties; the answer is because the Dodd-Frank Act replaces the old monetary awards regime with a new, more expansive program.

Under the former Section 21A, penalties were imposed, and monetary whistleblower awards were available, only for insider trading violations, defined as transactions in which a person purchased or sold a security or security-based swap agreement on a national securities exchange while in possession of material, non-public information.  Penalties could also be imposed for the communication of such material, non-public information in connection with a securities transaction. 

The Dodd-Frank Act significantly expands the scope of violations that could give rise to monetary awards for whistleblowers, and also expands whistleblower protections and anti-retaliatory measures.  Under the new Section 21F of the Exchange Act, the SEC will pay monetary awards to whistleblowers who provide the agency with “original information” that leads to the successful enforcement of a “covered judicial or administration action.”  

A “covered judicial or administrative action” is broadly defined as “any judicial or administrative action brought by the Commission under the securities laws that results in monetary sanctions exceeding $1,000,000” (my emphasis).  Under this provision, the monetary awards previously available to whistleblowers in insider trading actions are now available to whistleblowers in connection with any violation of the securities laws.  The breadth of potential actions leading to monetary awards for whistleblowers will be limited, as a practical matter, by the $1,000,000 sanctions requirement, but even so, this is a significant expansion of whistleblower compensation and protection.

The amount of the award will range from 10-30% of what has been collected of the monetary sanctions imposed in the action, and the award will be paid out of the Investor Protection Fund established by the Dodd-Frank Act.  To be eligible for an award, a whistleblower must provide “original information,” defined as information that is:1) derived from the independent knowledge or analysis of the whistleblower; 2) not known by the SEC from any other source; and 3) not exclusively derived from an allegation already made in a proceeding or investigation.

Certain types of whistleblowers are ineligible to receive monetary awards, such as members, officers, or employees of “an appropriate regulatory agency,” the department of justice, a self-regulatory organization, the Public Company Accounting Oversight Board, or a law enforcement organization.  Further, awards are not available to whistleblowers who are convicted of criminal violations in the judicial or administrative action that would otherwise have led to the award, nor are awards available to whistleblowers that fail to provide the information to the SEC “in such form as the Commission may, by rule, require.” 

The most interesting exception to eligibility for the monetary whistleblower awards applies to registered public accounting firms, though.  New Section 21F(c)(2)(C) prohibits monetary awards to whistleblowers who gain the information in the course of performing audits required by the securities laws “and for whom such submission would be contrary to the requirements of section 10A of the Securities Exchange Act of 1934.”  Section 10A provides, among other things, that if a registered public accounting firm discovers evidence of an illegal act during an audit of financial statements, it has a duty to make a report to the audit committee or board of directors of the company being audited.  The accounting firm is prohibited, on threat of civil penalties, from directly reporting the evidence of illegal acts until after the company itself has been given a chance to self-report and has failed to do so.

Check back here frequently at as we continue to monitor the implementation of the Dodd-Frank Act and comment on its effects.

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