Among the many innovations introduced in the massive Dodd-Frank Wall Street Reform and Consumer Protection Act
enacted this past July are the new whistleblower provisions, designed to
encourage employees and others to report securities law violations to the SEC.
The bounty award provided for in the whistleblower provisions seem likely to
encourage fraud reporting, but many observers are voicing concerns about these
provisions. And as noted below, there may be other concerns above and beyond
those generally noted, particularly with respect to potential D&O insurance
Section 922 of the Dodd Frank Act specifies that a person
who provides "original information" to the SEC of fraud within the
company that leads to an enforcement penalty of $1 million or more may be
entitled to collect between 10 and 30 percent of the penalties of $1 million or
more. The provision also provides substantial retaliation protections for
An article in the November 1, 2010 Wall Street Journal
article (here) notes a number of concerns about the new
whistleblower provisions, the first and foremost of which is that the bounty
provisions provide incentives for prospective whistleblowers to race to the SEC
in order to be the first to report violations, which in turn encourages prospective
whistleblowers to bypass internal fraud detection mechanisms mandated by the
Sarbanes Oxley act. Bruce Carton previously discussed many of these same
concerns on his Securities Docket blog, here.
There is little doubt that the bounty provisions are
likely to encourage fraud reporting. As I have noted elsewhere, penalty awards, for example, have skyrocketed in
recent years, with many recent awards in the hundreds of million dollars.
Whistleblowers potential rewards are enormous.
To put this into perspective, and as noted in the Journal
article, the whistleblower whose tip resulted in the recently announced $750
million settlement between GlaxoSmithKline and the Justice Department stands to get an award of $96 million, under similar
whistleblower provisions in the False Claims Act.
In recognition of the likelihood of substantial
whistleblower awards, the SEC has already established a fund of approximately
$452 million to fund the payments to whistleblowers, according to the SEC's Annual Report to Congress on the Whistleblower Program,
which was released last week. (The congressional report was mandated by the
Dodd Frank Act.)
Under these circumstances, it seems highly likely that
whistleblower actions will proliferate, and so the concerns noted in the Journal
article and elsewhere seem warranted. In addition to the items noted
elsewhere, there are a couple of other issues arising from the new
whistleblower provisions that are worth considering as well.
The first is that the threat of legal proceedings from
the whistleblower action is not limited just to the possible SEC enforcement
action. A related and accompanying threat is the possibility of a follow-on
civil litigation, brought on behalf of the target company's investors, in which
the plaintiffs will claim that the company's senior managers failed to take
appropriate steps to ensure that proper controls were in place, or that
investors were misled by the company's statement about the company's controls.
These kinds of follow-on civil actions have been a
frequent accompaniment of FCPA enforcement actions, as I have often noted on this blog. It seems probable that as
whistleblower actions mount in response to the Dodd-Frank Act provisions, that
there will be a parallel increase in civil actions following on after the
whistleblower enforcement action.
The fines and penalties associated with a whistleblower
enforcement action would likely not be covered under a D&O insurance
policy, although the fees incurred in defending against the action potentially
could be covered, at least as to individual defendants.
The follow-on civil actions would likely be covered under
the typical D&O insurance policy, subject to all of the applicable policy
terms and conditions. However, one potential D&O insurance coverage issue
that might arise concerning the follow-on civil actions has to do with the
possibility that the individual whistleblower could be an insured person under
the D&O policy. This might arise, for example, if the whistleblower is also
an officer of the company. The risk is that either the enforcement action or
the follow on civil proceeding might run afoul of the insured v. insured
exclusion typically found in most D&O insurance policies.
Following the enactment of the Sarbanes Oxley
whistleblower provisions a few years ago, many D&O insurance policies were
amended to ensure that a claim related to a Sarbanes-Oxley whistleblower action
would not run afoul of the insured v. insured exclusion. Many of these
amendments were written sufficiently broadly that the coverage carve back for
whistleblower claims would preserve coverage not only for Sarbanes-Oxley
whistleblower claims, but would also preserve coverage under other types of
whistleblower claims. Many of these amendments were written sufficiently
broadly that they would likely preserve coverage for Dodd-Frank whistleblower
claims as well.
However, not all of the whistleblower carve back
amendments are equally broad, which may raise the question about the potential
applicability of the insured v. insured exclusion to Dodd Frank whistleblower
claims, whether with respect to the initial enforcement action or even the
possible follow-on civil action. Given the high likelihood of future Dodd Frank
whistleblower claims, the review of the applicable D&O insurance policy
language, seems like a critical next step.
In any event, the range of possibilities seems to include
the likelihood of an increase both in enforcement actions and follow-on civil
lawsuits, which has important implications far beyond the narrow provisions of
the policy's exclusionary provisions.
More Securities Suits Against For-Profit
Educational Companies: One of the most distinctive securities
class action lawsuit filing trends in the second half of 2010 has been the
sudden arrival of a multitude of securities suits against for-profit education
companies. As I noted in an earlier post, these suits follow a congressional
investigation in to the companies' practices involving student loans.
In recent days, plaintiffs have added two more companies to
the growing list of for-profit education companies that have been hit with
securities lawsuits. First, on October 28, 2010, plaintiffs' lawyers initiated a securities suit against The
Washington Post Company and certain of its directors and offices, in
connection with the companies Kaplan, Inc. education subsidiary. Second, on
November 1, 2010, plaintiffs' lawyers initiated a securities suit against DeVry,
Inc. another for-profit education company.
These two latest suits brings the number of securities
suits filed against for-profit education companies so far this year to nine,
which represents about 6% of the approximately 145 securities lawsuit filed
Though the Washington Post Company is obviously a media
company, it actually carries the 8200 SIC Code (Educational Services),
reflecting the relative importance of the Kaplan Inc. subsidiary's revenues to
the company's overall financial picture.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
For More Information:
"These two latest suits brings the number of securities suits". Must be a lot of suits there