New efforts by states to incentivize whistleblowers financially underscore the importance of comprehensive corporate compliance programs that effectively address all internal reports of potential misconduct that may constitute violations of state or federal securities laws.
The North American Securities Administrators Association ("NASAA") recently released two proposed Model Acts—a Model Whistleblower Award and Protection Act ("Model Act") and a Model Act to Create a Restitution Assistance Fund for Victims of Securities Violations ("Model Restitution Fund Act")—for adoption by the 48 states that have not yet enacted such programs. According to NASAA, the intent of the Model Act "is to incentivize individuals who have knowledge of potential securities law violations to report it to state regulators in the interest of investor protection."
The Model Act closely tracks the whistleblower award programs established by the Securities and Exchange Commission ("SEC") and Commodities Futures Trading Commission ("CFTC") under the Dodd‑Frank Wall Street Reform and Consumer Protection Act of 2010. Like those programs, the Model Act provides incentives to, and protections for, individuals who report potential violations of state securities laws. Both Dodd‑Frank and the Model Act authorize awards ranging from 10% to 30% of the total monetary sanctions imposed by regulators to individuals who provide original information leading to a successful enforcement action. However, the Model Act differs from Dodd‑Frank in several important ways. First, a whistleblower under Dodd‑Frank is not eligible for a financial award unless the amount recovered in a successful enforcement action exceeds $1 million while the Model Act contains no such minimum threshold. Second, the Model Act withholds retaliation protections from whistleblowers who knowingly provide state agencies with false information. Finally, unlike the federal programs that permit an individual to remain eligible for whistleblower status so long as they provide the information to the SEC or CFTC within 120 days of their internal report, the Model Act encourages potential whistleblowers to proceed directly to state authorities.
State whistleblower awards are rare. Although Indiana and Utah have enacted whistleblower statutes modeled on Dodd‑Frank, each state has made only one award. Most notably, Indiana's Securities Division awarded $95,000 to a whistleblower based on civil penalties imposed on a multinational financial services firm. The whistleblower provided executive‑level information regarding the firm's policy not to disclose its preference to invest its high-net-worth clients in proprietary hedge funds rather than cheaper available options. In contrast, the SEC continues to increase its financial awards to whistleblowers and recently announced that it has awarded $500 million to 90 whistleblowers since the program's inception, including 15 awards totaling $115 million in the first half of 2020.
One potential hurdle for states considering adoption of the Model Act is likely to be the source of funding. The federal, Indiana, and Utah programs all have established funding sources while the Model Act leaves the issue up to each state. Notably, the Model Restitution Fund Act is based partly on Indiana's Securities Restitution Fund, the vehicle through which Indiana funds its whistleblower awards, and other states may choose a similar structure by enacting both model Acts. Given the continuing success of the SEC whistleblower program, which reports receiving more than 5,000 tips per year and imposing $2.5 billion in financial remedies of which $750 million was earmarked for investors since inception, it is likely that some states will be incentivized to enact a the Model Whistleblower Act.
Given the financial incentives for whistleblowers to report to the government, companies should review and update their policies and procedures to provide for prompt and effective handling of all internal reports or complaints about conduct that might constitute fraud or violation of the securities laws regardless of the source.
