November 9, 2010

Dodd-Frank Section 922

The governance, risk and compliance (GRC) industry has worked hard over the past six years to help corporate America implement effective ethics and compliance programs. GRC procedures have become part of the viable business processes that drive decision making at the highest level of most public corporations.

In response to the most recent financial meltdown, the US Government introduced the Dodd-Frank Act. The critical task for the Dodd-Frank Act is to address the increasing propensity of the financial sector to put the entire system at risk to eventually be bailed out at taxpayer expense. In doing so, it attempts to: identify and regulate systemic risk, propose an end to too-big-to-fail, expand the responsibility and authority of the Federal Reserve, restrict discretionary regulatory interventions, reinstate a limited form of Glass-Steagall (the Volcker Rule) and regulate the transparency of derivatives. As part of the identification and regulation of systematic risk, the Act's Section 922 attempts to protect, encourage and incent whistleblowers to come forward, a tactic that could have decreased the risk of the impending meltdown had whistleblower claims been adequately explored in the years previous.

Dodd-Frank section 922 mandates the establishment of a government-sponsored program to pay awards of up to 30 percent to eligible whistleblowers who voluntarily provide original information about potential securities law violations that lead to sanctions of $1 million or more. While solidifying the value of corporate whistleblowers is certainly important, the requirement potentially undermines the value of internal ethics & compliance departments. This process will create profitable association with the voicing of ethical violations and therefore competition for this vital information. The question then becomes, “How is an internal department expected to keep pace with the promise of millions of dollars in reward money from the SEC?”

As a tax payer, investor, business leader and responsible corporate citizen, I fully appreciate the need for the regulatory environment to evolve in order to protect the stakeholders. Financial fraud has run amok and no one wants a continuation of the current economic turmoil due to deceit performed by the few, but impacting the many. Whistleblower provisions should help protect those bringing misconduct or neglect to light, but provisions under Section 922 tacitly bypass companies who are working diligently to preserve open channels to report wrongdoing internally and create competition to externally report without the careful exploration and care that would be provided by the company itself.

If this appears to be a plea to decrease the avenues open to whistleblowers, consider this: all public entities are under consent decree to report any allegations of wrongdoing, so the corporation is legally bound to be the first reporter of accusations of ethics & compliance violations to the Federal Government already. However, accusations made by whistleblowers under Section 922 are public record, meaning that every complaint lodged with the SEC is publicly available when it’s filed, whether valid or not.

Not only does Dodd-Frank create a competition between the internal compliance department and the whistleblowers to be the "original" reporter of the violation to the SEC (another existing regulatory requirement), but this information also allows Wall Street to react to reported violations without the benefit of due process. Historically the number of whistle blowing complaints that are maliciously filed have been very low. Internal ethics and compliance departments investigate all allegations, and report wrongdoing when they move beyond the allegation phase to a valid complaint. Hard working compliance and legal officers diligently protect their companies and officers from these reports from achieving their intentional harm.

Remember, under Dodd-Frank whistleblowers are under no obligation to report to the ethics and compliance departments before taking their complaints to the SEC. Wall Street has never reacted well to good governance. Good governance requires transparency and Wall Street tends to react to the false perception of risk created by allegations - regardless of proven conduct. It remains to be seen how the SEC will answer these questions and concerns; they are currently taking comment on the whistleblower provisions and a final decision is expected in April 2011. In the meantime, we continue advising clients on the most robust programs to increase trust and dialogues internally.

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