Washington D.C. Employment Law Update : Washington D.C. Employment Lawyer & Attorney : Littler Mendelson Law Firm : Virginia, Tyson's Corner

• The 3,001 tips, complaints, and referrals the SEC received in 2012 came from whistleblowers located in all 50 states, the District of Columbia, the U.S. territory of Puerto Rico, as well as 49 foreign countries.
• The most common whistleblower complaints involved corporate disclosures and financials (18.2%), offering fraud (15.5%), and manipulation (15.2%).
• Of the whistleblower tips, complaints, and referrals the SEC received, 143 resulted in enforcement judgments and orders that potentially qualify the whistleblower to receive funds under the program.
• On August 21, 2012, the SEC issued its first award under the new program to an individual whose tip assisted the SEC in stopping an ongoing fraud scheme. The court in this case ordered the fraud perpetrators to pay more than $1 million in sanctions. During the 2012 fiscal year, approximately $150,000 of this amount was collected, giving the whistleblower an award of about $50,000.

In a press release, SEC Chairman Mary L. Schapiro said: "the whistleblower program already has proven to be a valuable tool in helping us ferret out financial fraud," adding, "When insiders provide us with high-quality road maps of fraudulent wrongdoing, it reduces the length of time we spend investigating and saves the agency substantial resources."

Other Whistleblower Efforts

Whistleblower protection has been – and will likely continue to be – a legislative and regulatory priority for this administration. Last week, the Senate approved the Whistleblower Protection Enhancement Act (WPEA) of 2012 (S. 743), a measure that strengthens whistleblower protections for federal employees. Because the House of Representatives approved this bill in September, it now passes to the President for his signature.

Earlier this year, the Department of Justice (DOJ) announced the creation of a new position of Whistleblower Ombudsperson within the DOJ’s Office of the Inspector General (OIG), and the Occupational Safety and Health Administration (OSHA) launched an alternative dispute resolution pilot program for resolving whistleblower complaints filed with the agency. 

Moreover, several private-sector whistleblower bills were introduced in recent months, including one that would extend whistleblower protections to employees who provide information to the DOJ regarding criminal antitrust violations, and others that would expand and strengthen whistleblower protections in the private sector. In addition to these standalone bills, lawmakers introduced other legislation this term, including the Robert C. Byrd Mine and Workplace Safety and Health Act of 2012, that incorporates anti-retaliation provisions applicable to whistleblowers. Now that the President has been reelected, it is likely that one or more of these bills will be reintroduced in the 113th Congress, and whistleblower protection initiatives and programs will continue.

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The contract clause would apply to all service contracts with the Department above the simplified acquisition threshold, which is currently $150,000. The proposed clause would read as follows:

Contractor confirms its commitment to equal opportunity in employment and contracting. To implement this commitment, the Contractor shall ensure, to the maximum extent possible consistent with applicable law, the fair inclusion of minorities and women in its workforce. The Contractor shall insert the substance of this clause in all subcontracts under this Contract whose dollar value exceeds $150,000. Within ten business days of a written request from the contracting officer, or such longer time as the contracting officer determines, and without any additional consideration required from the Agency, the Contractor shall provide documentation, satisfactory to the Agency, of the actions it (and as applicable, its subcontractors) has undertaken to demonstrate its good faith effort to comply with the aforementioned provisions. For purposes of this contract, “good faith effort” may include actions by the contractor intended to identify and, if present, remove barriers to minority and women employment or expansion of employment opportunities for minorities and women within its workforce. Efforts to remove such barriers may include, but are not limited to, recruiting minorities and women, providing job-related training, or other activity that could lead to those results.

Treasury interprets “good faith efforts” to mean efforts consistent with the Equal Protection Clause of the Constitution and Title VII of the Civil Rights Act of 1964, such as the identification and elimination of employment barriers, the widespread publication of employment opportunities, and other forms of outreach to minorities and women. Documentation that would demonstrate a contractor’s “good faith effort” might include the total number of contractor’s or subcontractor’s employees, and the number of minority and women employees, by race, ethnicity, and gender; a list of subcontract awards under the contract that includes: dollar amount, date of award, and subcontractor’s race, ethnicity, and/or gender ownership status; and/or the contractor’s plan to ensure that minorities and women have appropriate opportunities to enter and advance within its workforce, including outreach efforts.

The proposed rule notes that a failure to comply with these hiring efforts could result in termination of the contract, referral to the Office of Federal Contract Compliance Programs, or other appropriate action.

Comments on the proposal must be received by October 22, 2012. Comments may be submitted electronically through the federal eRulemaking Portal or via mail to: Department of the Treasury, Office of Minority and Women Inclusion, Attention: Contractor Clause, Room 2438, 1500 Pennsylvania Avenue, NW, Washington, DC 20220.

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As outlined in an SEC press release and fact sheet, the rule will require exchange listing standards to address the following:

• The independence of the members on a compensation committee
• The committee’s authority to retain compensation advisers
• The committee’s consideration of the independence of any compensation advisers and
• The committee’s responsibility for the appointment, compensation, and oversight of the work of any compensation adviser.

No later than 90 days after the new rule and rule amendments become effective, each exchange that lists equity securities must propose listing standards that comply with the new rule. The new listing standards must be approved by the SEC within one year of the new rule becoming effective.

According to SEC Chairman Mary L. Schapiro, “This rule will help to enhance the board's decision-making process on executive compensation matters, particularly the selection, engagement and oversight of compensation advisers, and will provide more transparency with respect to conflicts of interest of consultants engaged by boards.”

A detailed analysis of this rule and its implications is forthcoming.

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The Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) signed into law on July 21, 2010, contains a provision that requires federal agencies that deal with financial firms, including the CFPB, to create an OMWI within their agency. This office will impose certain diversity requirements on businesses in the financial industry. Section 342 of Dodd-Frank stipulates that each director of an OMWI will develop and implement standards for ensuring “to the maximum extent possible, the fair inclusion and utilization of minorities, women, and minority-owned and women-owned businesses in all business and activities of the agency at all levels, including in procurement, insurance, and all types of contracts.”

Ishimaru was appointed to the EEOC in 2003 by former President Bush, and serviced as the Commission’s acting chair from January 20, 2009 until April 7, 2010. In a press release announcing Ishimaru’s new position with the CFBP, the agency explains that its OMWI will develop standards for:

• Equal employment opportunity and the racial, ethnic and gender diversity of the workforce and senior management of the agency;
• Increased participation of minority-owned and women-owned businesses in the CFPB’s programs and contracts; and
• Assessing the diversity policies and practices of the CFPB’s regulated entities.

The SEC also intends to issue a proposed rule governing various pay disclosures under Sections 953 and 955 of Dodd-Frank, and a proposal regarding the recovery of certain executive compensation – commonly referred to as “claw-back” policies – under Section 954. Specifically, Section 953 of the Act requires that certain covered entities disclose to the SEC various compensation matters including pay-for-performance policies and the ratio between the CEO’s total compensation and the median total compensation for all other company employees. Section 955 mandates additional disclosures regarding whether directors and employees are permitted to hedge any decrease in market value of the company’s stock. Section 954, the claw-back provision, prohibits exchanges from listing the securities of a company that has not developed, implemented and disclosed a policy relating to the recoupment of incentive-based compensation when that compensation was based on performance criteria of reported financials and the company restates its financials due to material noncompliance with financial reporting requirements.

According to the SEC chart, the agency aims to issue final rules on these provisions by the end of 2012.

In January of 2011, the SEC adopted a final rule governing shareholder approval of executive compensation and “golden parachute” compensation arrangements required under Dodd-Frank. For more information on these and other corporate governance provisions set forth in the Dodd-Frank Act, see Littler’s ASAP: Executive Compensation and the Wall Street Reform and Consumer Protection Act.

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Neither rule requires employees to first report violations through their company’s internal channels in order to qualify for the award, although they do create incentives for employees to do so. Critics of the rules have claimed that the incentives to report internally are insufficient, leading many to bypass an employer’s legitimate internal reporting system. To remedy this occurrence, the bill would deny any award granted under the whistleblower protection program to employees who fail to first report information constituting possible securities fraud internally before reporting such information to the Commissions. In addition, the whistleblower would be required to report such information to the SEC or CFTC no later than 180 days after providing the information to the employer. The bill would create an exception to the internal reporting requirement if (1) the SEC or CFTC determines that the employer lacks either a policy prohibiting retaliation for reporting potential misconduct or an internal reporting system allowing for anonymous reporting, or (2) the SEC or CFTC determines in a preliminary investigation that an employer’s internal reporting system would not have been a viable option based on evidence that the alleged misconduct was committed by or involved the complicity of the highest level of management, or other evidence of bad faith on the part of the employer.

An award under this program would also be denied to a whistleblower:

who has legal, compliance, or similar responsibilities for or on behalf of an entity and has a fiduciary or contractual obligation to investigate or respond to internal reports of misconduct or violations or to cause such entity to investigate or respond to the misconduct or violations, if the information learned by the whistleblower during the course of his or her duties was communicated to such a person with the reasonable expectation that such person would take appropriate steps to so respond.

This legislation also would eliminate the minimum award requirement, and instead give the agencies discretion in granting any award up to 30% of the sanctions imposed.

Additionally, the bill would insert a new requirement that the agencies notify the employer of the whistleblower’s allegations prior to commencing any enforcement action against the employer in order to give it time to investigate the alleged misconduct and take remedial action. In the event the employer responds in good faith and takes appropriate corrective action, the agency would treat the employer as having self-reported the alleged violations. This option would not apply if, during its preliminary investigation, not to exceed 30 days, the agency determines that notification would jeopardize its overall investigation into the securities law violation allegations, based on evidence that the misconduct was committed by or involved complicity of the highest level of management or bad faith by the entity.

During the legislation’s markup session, the committee approved two amendments to the initial bill. The first amendment (pdf) offered by Rep. Michael Grimm (R-NY), who sponsored the underlying legislation, would clarify that an employee would need to report the information to “a person at his or her employer with legal, compliance, financial reporting, or similar responsibilities, or to the board of directors, or a committee thereof, of such employer.” In addition, the amendment permits the SEC to share any information it receives from the whistleblower with the employer.

The second amendment (pdf) offered by Reps. Maxine Waters (D-CA) and Rep. Keith Ellison (D-MN) orders the Government Accountability Office to expand the scope of its study on the whistleblower programs to include the impact on “market integrity, taxpayer protection, mitigation of harms posed to investors, and the Commission’s ability to successfully pursue enforcement actions.” The original bill calls for a study on the programs’ impact on shareholder value only.

The bill will now be referred to the full Financial Services Committee for additional markup and consideration. A link to a webcast of the subcommittee’s bill markup session can be found here.

For more information on this legislation, see Littler's ASAP: The Whistleblower Improvement Act: New Legislation Takes Aim at Dodd-Frank Whistleblower Bounty Provisions by Ilyse Schuman and Gregory Keating.

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According to OSHA – which is charged with enforcing the whistleblower provisions contained in 21 separate statutes – the new interim regulations “clarify and improve” the procedures for handling Sarbanes-Oxley whistleblower complaints, and make them consistent with the procedures in place for handing similar complaints under the other statutes over which OSHA has jurisdiction. In September, OSHA revised its Whistleblower Investigations Manual  to reflect these new case handling procedures.

Among other revisions, OSHA’s interim final rule does the following:

• Changes certain terms for consistency (i.e., actions will be filed for “retaliation” instead of for “discrimination).
• Describes the activities that are protected under Sarbanes-Oxley and the conduct that is prohibited in response to any protected activities.
• Revises the statute of limitations for filing complaints from 90 to 180 days.
• Eliminates the requirement that whistleblower complaints to OSHA under Sarbanes-Oxley be detailed and in writing. Under the new regulations, “consistent with OSHA’s procedural rules under other whistleblower statutes, complaints filed under Sarbanes-Oxley need not be in any particular form. They may be either oral or in writing.”
• Describes the procedures that apply to the investigation of Sarbanes-Oxley complaints;
• With respect to the burdens of proof necessary to sustain a claim, the regulations state that the complaint will be dismissed unless the complainant has made a prima facie showing that protected activity was a contributing factor in the alleged adverse action. The preamble to the regulations explains that it is the Secretary’s position that complainant must prove by a “preponderance of the evidence” that his or her protected activity contributed to the adverse action; otherwise the burden never shifts to the employer to establish its defense by “clear and convincing evidence.”
• Explains that once the complainant establishes that the protected activity was a contributing factor in the adverse action, the employer can escape liability only by proving by clear and convincing evidence that it would have reached the same decision even in the absence of the prohibited rationale. The “clear and convincing evidence” standard is a higher burden of proof than a “preponderance of the evidence” standard.
• Explains that among other remedies, “in appropriate circumstances, in lieu of preliminary reinstatement, OSHA may order that the complainant receive the same pay and benefits that he received prior to his termination, but not actually return to work. Such ‘economic reinstatement’ is akin to an order of front pay. According to OSHA, “economic reinstatement is designed to accommodate situations in which evidence establishes to OSHA’s satisfaction that reinstatement is inadvisable for some reason, notwithstanding the employer’s retaliatory discharge of the employee.” The agency notes, however, that “there is no statutory basis for allowing the employer to recover the costs of economically reinstating an employee should the employer ultimately prevail in the whistleblower adjudication.”
• Outlines the various litigation steps, rules of and process for appealing decisions, and the roles of federal agencies involved.

The new interim procedures are effective as of November 3, 2011. Comments on these regulations are due within 60 days of the procedures’ publication in the Federal Register, which is scheduled for November 3. Comments may be submitted electronically through the federal eRulemaking portal; via fax to (202) 693-1648 (if comments do not exceed 10 pages); or by mail or hand-delivery to: OSHA Docket Office, Docket No. OSHA-2011-0126, U.S. Department of Labor, Room N-2625, 200 Constitution Avenue, N.W., Washington, D.C. 20210.

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In May 2011, the Securities and Exchange Commission (SEC) issued its final rule on the whistleblower bounty program under Section 922. As discussed in the Littler Report: Dodd-Frank and The SEC Final Rule: From Protected Employee to Bounty Hunter, the SEC final rule provides a monetary incentive of 10 to 30% of any recovery by the SEC for employees who contribute original information that leads the SEC to recover monetary sanctions of $1,000,000 or more. Based on certain factors whistleblowers may recover between 10% and 30% of any recovery by the SEC. The final rule does not require employees to follow internal reporting procedures before reporting suspected violations to the SEC, but reporting internally is a factor that may increase the whistleblower’s award.

The Dodd-Frank provision applicable to the CEA also creates monetary incentives for whistleblowers, and prohibits employers from discharging, demoting, suspending, threatening, harassing (directly or indirectly) or otherwise discriminating against an employee for: (1) providing information to CFTC in accordance with the commodity whistleblower incentive program; or (2) assisting in an investigation or judicial or administrative action relating to the information provided. Employees alleging violations of this new law may bring an action in the appropriate federal district court. Such claims may not be brought more than two years after the violation complained of by the whistleblower. Relief for prevailing employees under this new private right of action includes reinstatement, backpay plus interest, and special damages, including attorneys' fees, expert witness fees and litigation costs. As discussed in Littler’s Insight: Cementing a Trend: Financial Reform Act Dramatically Expands Whistleblower Protections, one notable difference between sections 748 and 922 of Dodd-Frank is the ability of a commodity whistleblower to appeal any determination regarding an award made by the CFTC, not just awards outside of the 10 to 30 percent range, within 30 days.

According to a fact sheet (pdf) and a Q&A document (pdf) on the final rule, the CFTC-approved regulations are substantially similar to the agency’s proposed rule, but include minor changes to “ensure consistency and promote harmonization” with the SEC’s final rule and program. Other provisions of the rule include the following:

• A whistleblower may appeal certain Commission decisions including award denials and amounts to the appropriate U.S. Circuit Courts of Appeal;
• Whistleblowers may receive an award based upon violations that occurred prior to the date of enactment of the Dodd-Frank Act (July 21, 2010);
• Whistleblowers who submit original information after the date of enactment of the Dodd-Frank Act but before these proposed rules become effective, will also be eligible for an award provided they comply with the Commission’s procedures within one hundred and twenty (120) days of the rules’ effective date;
• A whistleblower who has submitted information after July 16, 2011 may have a private cause of action for employment retaliation of whistleblower activities. Whistleblowers who ultimately are not entitled to an award are still protected by the anti-retaliation provisions;
• The determination of the amount of the award will be in the Commission’s discretion and based upon certain criteria;
• Those not entitled to receive an award under the program include employees of certain listed government, law enforcement and regulatory agencies; a person convicted of a criminal violation related to the underlying judicial or administrative action; a person who submits information that is based on facts underlying a covered action already submitted by another whistleblower; and any whistleblower who fails to submit information to the Commission in the form the Commission requests;
• Whistleblowers will not be eligible for an award if they knowingly and willfully make any false, fictitious, or fraudulent representations to the Commission or another authority in connection with a related action.

These regulations will be effective 60 days after they are published in the Federal Register.

Like the SEC final rule, the CFTC rule does not require employees to first avail themselves of their organization’s internal reporting process. The CFTC acknowledged that a number of comments to the proposed rule criticized the ability of a whistleblower to by-pass an employer’s internal reporting process. Commissioner Jill E. Sommers expressed disappointment regarding this failure during the Agency’s opening meeting to discuss the rule. In a statement, Sommers emphasized:

The primary purpose of a Whistleblower program is not to pay awards to whistleblowers. The primary purpose is to prevent, detect and remedy violations of the Commodity Exchange Act as efficiently and cost-effectively as possible. In order to be efficient and cost-effective in this regard, I believe robust internal compliance programs and thorough internal investigations are absolutely necessary to successfully prevent, detect and remedy violations, particularly given the Commission’s resource restraints. I believe that this rule does not sufficiently address the potential for thousands of new tips or complaints and how this new office will prepare for this outcome. . . . Setting up a Whistleblower program that allows all Whistleblowers to by-pass internal compliance programs will likely deprive such programs of the very information they need in order to be robust and effective. . . . I believe a better approach to our Whistleblower program would have been to require internal reporting as the norm, with the ability for a Whistleblower to bypass internal reporting upon a good faith showing that such reporting would be impracticable or unsafe for the Whistleblower. Another potential approach would have been to require simultaneous reporting internally and to the Commission. This would have ensured that any internal investigation could be conducted under the watchful eye of the Commission, and would have made certain that the Whistleblower knew that the Commission was watching. We did not explore these options, and I believe we should have.

The outcry over the SEC’s similar position on this practice has led to the recent introduction of legislation that would require employees to first report potential misconduct through the company’s internal reporting system before being eligible to cash in on the monetary rewards offered under the Dodd-Frank Act SEC and CFTC whistleblower bounty programs.

More information on the CFTC’s opening meeting and rule can be found here.

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As discussed in Littler’s Report: Dodd-Frank and The SEC Final Rule: From Protected Employee to Bounty Hunter, the SEC’s rule does not require employees to first report violations through their company’s internal channels in order to qualify for the award, although it does create incentives for employees to do so. For example, the rule makes whistleblowers eligible for an award if they report internally and the company informs the SEC about the violations. Therefore, all information provided by the employer to the SEC is to be attributed to the whistleblower for award purposes. Additionally, a whistleblower’s voluntary participation in the company’s internal compliance and reporting system would constitute a factor that could increase the amount of the award, while the whistleblower’s interference with the company’s reporting process could decrease the amount of the award.

The Whistleblower Improvement Act of 2011 (H.R. 2483), introduced by Rep. Michael Grimm (R-NY), seeks to preserve the integrity of a company’s internal reporting system and prevent employees whose job it is to investigate misconduct from being considered whistleblowers. Specifically, the bill would deny any award granted under the whistleblower protection program to employees who fail to first report information constituting possible securities fraud to their employers before reporting such information to the SEC. In addition, the whistleblower would be required to report such information to the SEC no later than 180 days after providing the information to the employer. The bill would create an exception to the internal reporting requirement if 1) the SEC determines that the employer lacks either a policy prohibiting retaliation for reporting potential misconduct or an internal reporting system allowing for anonymous reporting, or 2) the SEC determines in a preliminary investigation that an employer’s internal reporting system would not have been a viable option based on evidence that the alleged misconduct was committed by or involved the complicity of the highest level of management, or other evidence of bad faith on the part of the employer.

An award under this program would also be denied to a whistleblower:

who has legal, compliance, or similar responsibilities for or on behalf of an entity and has a fiduciary or contractual obligation to investigate or respond to internal reports of misconduct or violations or to cause such entity to investigate or respond to the misconduct or violations, if the information learned by the whistleblower during the course of his or her duties was communicated to such a person with the reasonable expectation that such person would take appropriate steps to so respond.

This legislation also would eliminate the minimum award requirement, and instead give the SEC discretion in granting any award up to 30% of the sanctions imposed.

Finally, the bill would insert a new requirement that the SEC notify the employer of the whistleblower’s allegations prior to commencing any enforcement action against the employer in order to give it time to investigate the alleged misconduct and take remedial action. In the event the employer responds in good faith and takes appropriate corrective action, the SEC would treat the employer as having self-reported the alleged violations. This option would not apply if, during its preliminary investigation, not to exceed 30 days, the SEC determines that notification would jeopardize its overall investigation into the securities law violation allegations, based on evidence that the misconduct was committed by or involved complicity of the highest level of management or bad faith by the entity

This bill has been referred to the House Committees on Financial Services and Agriculture.

For more information on this legislation, see Littler's ASAP:  The Whistleblower Improvement Act: New Legislation Takes Aim at Dodd-Frank Whistleblower Bounty Provisions by Ilyse Schuman and Gregory Keating.

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For example, the rule makes whistleblowers eligible for an award if they report internally and the company informs the SEC about the violations. In essence, all information provided by the employer to the SEC will be attributed to the whistleblower for award purposes. Second, a whistleblower’s voluntary participation in the company’s internal compliance and reporting system would constitute a factor that could increase the amount of the award, while the whistleblower’s interference with the company’s reporting process could decrease the amount of the award. In addition, the final rule extends the amount of time from 90 to 120 days in which the employee can report the information to the SEC after first reporting it internally and still be considered a whistleblower. According to the SEC, this would allow an employee to report the information through company channels while still preserving his “place in line” for a possible award.

One significant change from the proposed rules is that the SEC will allow the aggregation of smaller actions that arise from the same “nucleus of operative facts” to go towards the $1 million threshold entitling the whistleblower to an award. Under the proposed rule, awards would have only been available if the SEC brought a single judicial or administration action in which it obtained sanctions of more than $1 million.

In addition, the final rule clarifies who would be excluded from award eligibility. As stated in the rule, the final regulations “provide greater clarity and specificity about the scope of the exclusions applicable to senior officials within an entity who learn information about misconduct in connection with the entity’s processes for identifying, reporting, and addressing possible violations of law.”

For example, as discussed in a fact sheet on the final rule, those people who will not be considered whistleblowers eligible for awards include:

• People who have a pre-existing legal or contractual duty to report their information to the SEC.
• Attorneys (including in-house counsel) who attempt to use information obtained from client engagements to make whistleblower claims for themselves (unless disclosure of the information is permitted under SEC rules or state bar rules).
• People who obtain the information by means or in a manner that is determined by a U.S. court to violate federal or state criminal law.
• Officers, directors, trustees or partners of an entity who are informed by another person (such as by an employee) of allegations of misconduct, or who learn the information in connection with the entity’s processes for identifying, reporting and addressing possible violations of law (such as through the company hotline).
• Compliance and internal audit personnel.
• Public accountants working on SEC engagements, if the information relates to violations by the engagement client.

Notably, however, in some instances a company’s compliance and internal audit personnel as well as public accountants could become whistleblowers when:

• The whistleblower believes disclosure may prevent substantial injury to the financial interest or property of the entity or investors.
• The whistleblower believes that the entity is engaging in conduct that will impede an investigation.
• At least 120 days have elapsed since the whistleblower reported the information to his or her supervisor or the entity’s audit committee, chief legal officer, chief compliance officer – or at least 120 days have elapsed since the whistleblower received the information, if the whistleblower received it under circumstances indicating that these people are already aware of the information.

The final rule also clarifies that employees are protected from retaliation if they possess a reasonable belief that the information they are providing relates to a possible securities law violation that has occurred, is ongoing, or is about to occur. Under the rule it is also unlawful for anyone to interfere with a whistleblower’s efforts to communicate with the SEC, including threatening to enforce a confidentiality agreement.

The final rule will become effective 60 days after it is published in the Federal Register.

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• Requiring financial institutions with $1 billion or more in assets to annually report the structure of their incentive compensation arrangements to their federal regulator to determine whether the structure provides “excessive compensation, fees, or benefits” or “could lead to material financial loss” to the institution.. This report would include a narrative description of the components of the firm’s incentive-based compensation arrangements; a brief description of the firm’s policies and procedures governing the incentive-based arrangements, and an explanation as to why the entity believes the structure of its incentive-based compensation arrangement will help prevent it from suffering a material financial loss or does not provide certain executives with excessive compensation. Under the Proposed Rule, incentive-based compensation for a covered person would be considered excessive when amounts paid are unreasonable or disproportionate to, among other things, the amount, nature, quality, and scope of services performed by the covered person.
• Providing additional requirements for financial institutions with $50 billion or more in assets, including deferral of incentive-based compensation of executive officers and approval of compensation for people whose job functions give them the ability to expose the firm to a substantial amount of risk. Among other requirements, these larger financial institutions would have to defer at least 50 percent of the incentive compensation of certain officers for at least three years. Moreover, the rule stipulates that any incentive-based compensation payments must be adjusted for losses incurred by the covered financial institution after the compensation was initially awarded.
• Requiring covered institutions to develop policies and procedures that ensure and monitor compliance with requirements related to incentive-based compensation. In essence, a covered financial institution would be barred from establishing an incentive-based compensation arrangement unless the arrangement has been adopted under policies and procedures developed and maintained by the institution and approved by its board of directors.

A fact sheet on these requirements can be found here.

Comments on this proposed rule must be submitted within 45 days of the rule’s publication in the Federal Register, which is scheduled for April 14, 2011, and may be submitted electronically through the SEC’s webpage, through the federal eRulemaking portal, or via email to: rule-comments@sec.gov (include File Number S7-12-11 on the subject line). Alternatively, written copies may be sent in triplicate to: Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549 All submissions should refer to File Number S7-12-11.

Listing Standards for Compensation Committees and Advisers

The second proposed rule (pdf) would implement the section of the Dodd-Frank Act governing listing standards for a company’s compensation committees and advisers. Section 952 of the new law directs national securities exchanges/associations (e.g., NYSE, NASDAQ) to establish listing standards requiring publicly traded companies to have their compensation committee participants be members of the board of directors and meet a heightened standard of independence in order for their shares to continue trading on those exchanges. In addition, this section of the Act requires the SEC to adopt new disclosure rules for companies to report the use of compensation consultants and conflicts of interest.

With respect to the independence of compensation committee members, a fact sheet on the SEC’s proposal explains that in developing a definition of “independence,” exchanges would need to take into consideration such factors as:

• The sources of compensation of a director, including any consulting, advisory or compensatory fee paid by the company to such member of the board of directors.
• Whether a member of the board of directors of a company is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company.

As for the authority and funding of the compensation committees, the proposed rule would require the exchanges to develop listing standards permitting compensation committees to, in their discretion, retain or obtain the advice of a compensation adviser, and be directly responsible for their appointment, payment and oversight.

The listing standards to be developed by the exchanges would need to articulate that in choosing compensation consultants, legal counsels or other advisers, exchanges must take into account a number of considerations These factors include, but are not limited to:

• Whether the compensation consulting company employing the compensation adviser is providing any other services to the company.
• How much the compensation consulting company that employs the compensation adviser has received in fees from the company, as a percentage of that person’s total revenue.
• What policies and procedures have been adopted by the compensation consulting company employing the compensation adviser to prevent conflicts of interest.
• Whether the compensation adviser has any business or personal relationship with a member of the compensation committee.
• Whether the compensation adviser owns any stock of the company.

The proposed rule also provides certain exemptions of companies from the independence requirements, such as controlled companies and limited partnerships.

The added disclosure requirements for publicly traded companies include proxy statement disclosures listing whether the company’s compensation committee has retained or obtained the advice of a compensation consultant, and if so, whether the work has triggered any conflict of interest. As noted in the fact sheet, the proposal “would eliminate the current disclosure exception for services that are limited to consulting on broad-based plans and the provision of non-customized benchmark data, but would retain the fee disclosure requirements, including the exemptions from those requirements.”

Comments on this proposal must be received on or before April 29, 2011, and may be submitted electronically through the SEC’s comment page, via email to: rule-comments@sec.gov; or through the federal eRulemaking portal. Alternatively, written comments may be submitted in triplicate to Elizabeth M. Murphy, Secretary, U.S. Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. All submissions should refer to File Number S7-13-11.

For more information on the executive compensation provisions of the Dodd-Frank Act, see Littler’s ASAP: Executive Compensation and the Wall Street Reform and Consumer Protection Act by Nick Linn, Ilyse Schuman and Ellen Sueda.  

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Specifically, Section 922 of the Act adds Section 21 F to the Exchange Act, entitled “Securities Whistleblower Incentives and Protection.” This program provides monetary rewards to those who voluntarily contribute original information that leads the SEC to recover monetary sanctions of $1,000,000 or more in criminal and civil proceedings in federal court or through administrative action. Whistleblowers would be eligible for amounts between 10% and 30% of the monetary sanctions that are collected, based on the original information provided by the whistleblower.

Some commentators have questioned whether the monetary incentives provided to whistleblowers would reduce the effectiveness of a company’s existing compliance, legal, audit and similar internal processes for investigating and responding to potential violations of the federal securities laws. With this possible tension in mind, the SEC stated that they: “included provisions in the proposed rules intended not to discourage whistleblowers who work for companies that have robust compliance programs to first report the violation to appropriate company personnel, while at the same time preserving the whistleblower’s status as an original source of the information and eligibility for an award.” At the same time, according to the SEC, the proposed rules would not prohibit a whistleblower in a compliance function from reporting information to the Commission where the company did not provide the information to the Commission within a reasonable time or acted in bad faith.

In determining whether a company acted in bad faith, the SEC will, among other things, consider whether the entity or any personnel who were responsible for responding to allegations of misconduct took affirmative steps to hinder the preservation of evidence or a timely and appropriate investigation. For example, an effort by company officials to destroy documents or to interfere with witnesses would constitute bad faith conduct. Similarly, if a company engaged in a sham investigation of allegations, then the company’s response would constitute bad faith according to the SEC. The proposed rule does not set a fixed time frame for what is considered “reasonable”. Instead, the SEC states that a “reasonable time” in this context will necessarily be a flexible concept that will depend on all of the facts and circumstances of the particular case.

As discussed in an SEC fact sheet, the proposal includes provisions designed to encourage employees to avail themselves of their company’s internal compliance programs. For example, an employee who reports information through internal company channels would still be considered a whistleblower by the SEC, so long as the employee provides the same information to the agency within 90 days. The proposal also allows the SEC to consider higher percentage awards for whistleblowers who first report their information through effective company compliance programs. Accordingly, the SEC “does not expect our receipt of whistleblower complaints to minimize the importance of effective company processes for addressing allegations of wrongful conduct.”

The proposal includes additional definitions of phrases contained in the definition of “original information” so as to further describe when a whistleblower provides such information. Original information is that which is derived from the whistleblower’s independent knowledge or analysis; is not already known to the Commission, and is not exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report, hearing, audit, or investigation, or from the news media, unless the whistleblower is a source of the information. The proposed rule defines “independent knowledge” as factual information in the whistleblower’s possession that is not obtained from publicly available sources. According to the SEC, this proposed definition does not require that a whistleblower have direct, first-hand knowledge of potential violations. Thus, a whistleblower could have “independent knowledge” of information even if that knowledge derives from facts or other information that has been conveyed to the whistleblower by third parties.

In contrast, the SEC will not consider information to be derived from independent knowledge or independent analysis if the would-be whistleblower obtained the knowledge or information:

• Through a communication that was subject to the attorney-client privilege (unless disclosure of that information is otherwise permitted under SEC rules or state bar rules);
• As a result of the legal representation of a client on whose behalf the whistleblower’s services, or the services of the whistleblower’s employer or firm, have been retained, and the person seeks to make a whistleblower submission for his or her own benefit (unless disclosure of that information is otherwise permitted under SEC rules or state bar rules);
• Through the performance of an engagement required under the securities laws by an independent public accountant, if that information relates to a violation by the engagement client or the client’s directors, officers or other employees;
• Because the individual is a person with legal, compliance, audit, supervisory, or governance responsibilities for an entity, and the information was communicated to the individual with the reasonable expectation that they would take steps to cause the entity to respond appropriately to the violation, unless the entity did not disclose the information to the SEC within a reasonable time or proceeded in bad faith;
• Otherwise from or through an entity’s legal, compliance, audit or other similar functions or processes for identifying, reporting and addressing potential non-compliance with law, unless the entity did not disclose the information to the SEC within a reasonable time or proceeded in bad faith;
• By a means or in a manner that violates applicable federal or state criminal law; or
• From any of the individuals described above.

The SEC has attempted to maximize the submission of high-quality tips and to enhance the utility of the information reported to the SEC. Toward this end, the proposed rules would impose certain procedural requirements designed to deter false submissions, including a requirement that the information be submitted under penalty of perjury and requiring an anonymous whistleblower to be represented by counsel who must certify to the SEC that he or she has verified the whistleblower’s identity.

The proposed rule clarifies a number of definitions and program requirements, as well as describes the procedures for submitting information to the SEC and for making an award claim after an action is brought. For example, the proposal defines a whistleblower as “an individual who, alone or jointly with others, provides information to the Commission relating to a potential violation of the securities laws.” This definition differs from that set forth in the Act in that it includes the phrase “potential violation.”

One of the SEC’s rationales for including the word “potential” is that it clarifies that the whistleblower anti-retaliation protections set forth in Section 21F(h)(1) of the Exchange Act do not depend on an ultimate adjudication, finding or conclusion that conduct identified by the whistleblower constituted a violation of the securities laws. In other words, even if the whistleblower provides information to the SEC that is not ultimately found to constitute an SEC violation, that individual is still protected from any adverse employment actions as a result. The proposed rule further explains that an individual need not satisfy all of the procedures and conditions to qualify for an award under the Commission’s whistleblower program in order to be protected against retaliation. As stated in the preamble to the proposed rule, the SEC “believe[s] the statute extends the protections against employment retaliation in Section 21F(h)(1) to any individual who provides information to the Commission about potential violations of the securities laws regardless of whether the whistleblower fails to satisfy all of the requirements for award consideration set forth in the Commission’s rules.”

The proposed rule considers the provision of information “voluntary” if it is provided before receiving any formal or informal request, inquiry, or demand from the Commission, Congress, any other federal, state or local authority, any self-regulatory organization, or the Public Company Accounting Oversight Board about a matter to which the information in the whistleblower’s submission is relevant. According to the SEC, this is to encourage whistleblowers to provide information about possible SEC violations as soon as possible.

With respect to the investigation process, the Act permits the SEC to communicate directly with the whistleblower without first obtaining the consent of the company’s counsel. The proposed rule further clarifies that it is allowed to do so even if the whistleblower at issue is a director, officer, member, agent, or employee of the entity.

Although the SEC invites comment on any aspect of the proposed rule, the agency’s proposal lays out 43 separate areas of inquiry for public comment. For example, the SEC is seeking input on whether it should promulgate rules regarding the interpretation or implementation of the anti-retaliation provisions of the Exchange Act. If so, the agency asks, should these anti-retaliation provisions be applied broadly to any person who provides information to the Commission concerning a potential violation of the securities laws, or should they be limited by the various procedural or substantive prerequisites to consideration for a whistleblower award? In addition, the SEC asks whether it should consider promulgating a rule to exclude frivolous or bad faith whistleblower claims from the protections afforded by the anti-retaliation provisions. The SEC is also inviting comments on whether it should promulgate rules to ensure that the anti-retaliation provisions are not used to protect employees from otherwise appropriate employment actions (i.e., employment actions that are not based on reporting potential securities law violations).

Comments on the proposal must be submitted on or before December 17, 2010, and contain the File Number S7-33-10. Written comments should be sent in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. Alternatively, comments may be submitted electronically through the SEC’s Internet comment form; the federal eRulemaking portal; or via email to: rule-comments@sec.gov. The file number: S7-3310 should be included in the subject line.

Photo credit: Lkmorlan

Speaking on behalf of the Society of Corporate Secretaries and Governance Professionals, Darla Stuckey (pdf) generally agreed that the changes imposed by the Dodd-Frank Act would help companies manage and oversee risk, but laid out a number of concerns she had with certain sections of the Act. Stuckey’s concerns and suggestions include the following:

• The “say-on-pay” provision of the Act, Section 951, requires companies to provide their shareholders with a non-binding vote on the compensation of their executives. The Act also mandates that employers provide their shareholders with a non-binding vote on how often the say-on-pay vote should occur. Such votes are required for all shareholder meetings held after January 21, 2011. The Securities Exchange Commission (SEC) intends to issue rules implementing these provisions between January and March or 2011. Stuckey testified that the SEC should instead issue its proposed rules in October of 2010 so that the final rules can be implemented before the 2011 proxy season. In addition, she argued that when the say-on-pay votes should be held should be influenced by the company’s board of directors’ recommendation, as members of the board “are in the best position to recommend the frequency of the vote, to ensure that the timing of the vote is aligned with the compensation program and the duration of the incentive structure.”
• Section 953(a) requires that companies disclose the relationship between executive compensation paid and financial performance. Stuckey urged the SEC to issue rules “with enough flexibility to allow compensation committees to explain their decisions, to explain when compensation is ‘actually paid,’ over which period performance is measured, and how performance is measured.”
• Section 953(b) mandates that companies disclose the median of the annual total compensation of all employees (other than the CEO) of the company, the compensation of the CEO, and a comparative ratio. The witness testified that the SEC should clarify that the calculation should take into consideration only U.S.-based, full-time employees, and that “total compensation” should exclude pension accrual.
• Section 954 requires certain companies to develop policies to recapture (“clawback”) excessive incentive compensation that should not have been awarded in light of the company’s financial situation. The witness claimed that company boards should have the discretion to determine whether to “claw back” and how to recoup funds.
• Finally, with respect to the whistleblower provisions contained in Section 922 of the Act that create a financial incentive program to encourage individuals to report SEC violations, Stuckey expressed concern that these provisions “will so significantly incentivize and encourage employees to report concerns of potentially improper conduct directly to the SEC that employees will bypass the extensive compliance programs that companies already have in place, and thus undermine their effectiveness. The unintended consequence of the Act may be that companies will have a more difficult time detecting and investigating misconduct and taking prompt corrective action when violations are found.”

A complete list of panelists and copies of their written testimony, in addition to a link to the hearing’s webcast, can be found here.

For more information on the Dodd-Frank Act’s executive compensation provisions, see Littler’s ASAP: Executive Compensation and the Wall Street Reform and Consumer Protection Act by Nick Linn, Ilyse Schuman, and Ellen Sueda.

Photo credit:  MBPHOTO, Inc.

Executive Compensation

The conference report retains the numerous “say on pay” provisions previously discussed. These terms provide for a shareholder vote on executive compensation disclosures, and require that each member of the company’s compensation committee be an independent member of the board of directors. As explained in a summary (pdf) of the conference report, sections 951 through 957 of the bill – Accountability and Executive Compensation – provide for the following:

• Vote on Executive Pay and Golden Parachutes: Shareholders are given a say on pay with the right to a non-binding vote on executive pay and golden parachutes.
• Nominating Directors: The Securities and Exchange Commission (SEC) is provided the authority to grant shareholders proxy access to nominate directors.
• Independent Compensation Committees: These terms stipulate that standards for listing on an exchange will require that compensation committees include only independent directors and have authority to hire compensation consultants in order to strengthen their independence from the executives they are rewarding or punishing.
• No Compensation for Lies: These provisions require that that public companies set policies to take back executive compensation if it was based on inaccurate financial statements that do not comply with accounting standards.
• SEC Review: The SEC is directed to clarify disclosures relating to compensation, including requiring companies to provide charts that compare their executive compensation with stock performance over a five-year period.
• Enhanced Compensation Oversight for Financial Industry: Provisions require federal financial regulators to issue and enforce joint compensation rules specifically applicable to financial institutions with a federal regulator.

Arbitration

Certain sections of the Dodd-Frank bill seek to regulate the use of mandatory arbitration in specific instances:

• Section 921 – Authority to restrict mandatory pre-dispute arbitration. This section gives the SEC the authority to conduct a rulemaking to prohibit, or impose conditions or limitations on the use of, agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any dispute between them.
• Section 1028 – Authority to restrict mandatory pre-dispute arbitration. This section gives the Bureau of Consumer Financial Protection (CFPB or “Bureau”) – an independent consumer entity within the Federal Reserve created by the legislation – the authority to restrict mandatory pre-dispute arbitration in certain circumstances. Specifically, the Bureau would be required to conduct a study and provide a report to Congress on the use of mandatory pre-dispute arbitration agreements as they pertain to the offering or provision of consumer financial products or services. The Bureau would be vested with the authority to prohibit or impose conditions and limitations on certain arbitration agreements between a covered person and a consumer consistent with the results of the study if it is in the public interest and for the protection of consumers. The Bureau would not be able to restrict consumers from voluntarily entering into post-dispute arbitration agreements.

Whistleblower Protections

Several provisions implement a new whistleblower program designed to motivate people who are aware of securities law violations to report these violations. The bill also expands existing whistleblower laws.

• Section 922 – Whistleblower protection. This section establishes the new whistleblower protection program. In essence, it provides monetary rewards to those who contribute original information that leads to recoveries of monetary sanctions of $1,000,000 or more in criminal and civil proceedings. This program awards whistleblowers with between 10% and 30% of any monetary sanctions that are collected based on the original information provided by the whistleblower. “Original information” is defined as information that is derived from the independent analysis or knowledge of the whistleblower and is not derived from an allegation in court or government reports nor exclusively from news media. The SEC has discretion in determining the amount and whether or not a whistleblower is to be awarded. This section also includes various protections for whistleblowers, including a prohibition on discharging, demoting, suspending, threatening, harassing (directly or indirectly) or otherwise discriminating against an employee for providing information to the SEC or assisting in an investigation or judicial or administrative action relating to the information provided. The bill would allow one who has been retaliated against to bring an action against his or her employer in federal court for reinstatement, double back pay plus interest, and attorneys’ fees and litigation costs.
• Section 929A – Protection For Employees of Subsidiaries and Affiliates of Publicly Traded Companies. This section extends the whistleblower protection provisions in the Sarbanes-Oxley Act of 2002 (SOX) to employees of subsidiaries and affiliates of publicly-traded companies. Section 806 of the Sarbanes-Oxley Act creates protections for whistleblowers who report securities fraud and other violations.
• Section 748 – Commodity Whistleblower Incentives And Protection. This section would amend the Commodity Exchange Act by adding a “Commodity Whistleblower Incentives and Protection” section that provides whistleblower incentives protections similar to those set forth in Section 922.
• Section 1057 – Employee Protection. This section provides protection against firings of or discrimination against employees who provide information or testimony to the Bureau. Specifically, this section stipulates that:

No covered person or service provider shall terminate or in any other way discriminate against, or cause to be terminated or discriminated against, any covered employee or any authorized representative of covered employees by reason of the fact that such employee or representative, whether at the initiative of the employee or in the ordinary course of the duties of the employee (or any person acting pursuant to a request of the employee), has –

(1) provided, caused to be provided, or is about to provide or cause to be provided, information to the employer, the Bureau, or any other State, local, or Federal, government authority or law enforcement agency relating to any violation of, or any act or omission that the employee reasonably believes to be a violation of, any provision of this title or any other provision of law that is subject to the jurisdiction of the Bureau, or any rule, order, standard, or prohibition prescribed by the Bureau;

(2) testified or will testify in any proceeding resulting from the administration or enforcement of any provision of this title or any other provision of law that is subject to the jurisdiction of the Bureau, or any rule, order, standard, or prohibition prescribed by the Bureau;

(3) filed, instituted, or caused to be filed or instituted any proceeding under any Federal consumer financial law; or

(4) objected to, or refused to participate in, any activity, policy, practice, or assigned task that the employee (or other such person) reasonably believed to be in violation of any law, rule, order, standard, or prohibition, subject to the jurisdiction of, or enforceable by, the Bureau.

A “covered employee” would include any individual performing tasks related to the offering or provision of a consumer financial product or service. Any predispute arbitration agreement seeking to resolve a complaint under this section would be deemed invalid and unenforceable.

An employee aggrieved under this section would have 180 days to file a complaint with the Secretary of Labor. An employee would have a viable cause of action if the Secretary determines that any of the employee’s actions described in paragraphs (1) – (4), above, constituted a “contributing factor” to the alleged adverse employment action. In its defense, an employer would have to demonstrate “by clear and convincing evidence” that it would have taken the same adverse actions regardless of the employee’s conduct.

Miscellaneous Provisions

Section 731 – Registration and Regulation of Swap Dealers and Major Swap Participants.  This section provides that a swap dealer or major swap participant that acts as an advisor to a special entity, including an employee benefit plan, has a duty to act in the best interest of the special entity.

Final votes on the Dodd-Frank bill could occur as early as this week. More information on this bill can be found at the House Committee on Financial Services’ web page.

Photo credit:  Ramy Majouji