Compensation and Governance Committees: Sharing the Hot Seat in 2016


hot-seat-11-19-15.pngThe compensation committee has been on the hot seat for several years. Outrage regarding executive pay and its perceived role in the financial crisis has put the spotlight on the board members who serve on this committee. Say-on-pay, the non-binding shareholder vote on executive compensation practices, was one of the first new Securities and Exchange Commission (SEC) requirements implemented as part of the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010. Since that time, public companies have responded to shareholder feedback and changed compensation programs and policies to garner support from shareholders and advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis & Co. In recent years, only 2 percent of public companies have “failed” their say-on-pay vote. The significant majority of public companies (approximately 75 percent of Russell 3000 companies) received shareholder support of 90 percent or greater during the 2015 proxy season. Today, companies with less than 90 percent should increase their shareholder outreach, as a dip below that level is often an indicator of emerging concerns.

Compensation committees can’t sit back and relax on these results. The SEC’s proposed rule for pay versus performance disclosure (published in April) and the final rule for the CEO pay ratio (published in August) will further intensify the focus on executive pay and require compensation committees to dedicate much more time and energy to evaluate and explain their pay decisions in light of these new disclosures. Fortunately, implementation of the CEO pay ratio is delayed until the 2018 proxy season while the SEC has not yet adopted final rules for the pay versus performance disclosure (as of September). It is hard to predict what influence these additional disclosures will have on shareholders’ say-on-pay votes. What is clear is that boards will need to monitor these and other pending Dodd-Frank Act rules (i.e. mandatory clawback, disclosure on hedging policies, incentive risk management) in the coming year.  

In the meantime, however, boards may face increased shareholder scrutiny in key governance areas.

Proxy access, the ability of significant shareholders to nominate board members on the company’s proxy ballot, achieved momentum in 2015 when New York City Comptroller Scott Singer submitted proxy access proposals at 75 public companies as part of his 2015 Boardroom Accountability Project. We expect proxy access proposals will remain a focus among activist shareholders during the 2016 proxy season. Dissatisfaction with executive compensation and board governance are often the reasons cited by shareholders seeking proxy access.

Institutional shareholders and governance groups have also started to focus on board independence, tenure and diversity. Institutional investors such as Vanguard and State Street Global Advisors consider director tenure as part of their voting process and ISS includes director tenure as part of their governance review process. This could lead to a push for term and/or age limits for directors in the near future. While many companies use retirement age policies as a means to force board refreshment, it is unclear if that will be enough. Boards would be wise to start reviewing their board composition and succession processes in light of their specific business strategies but also in consideration of these emerging governance and shareholder perspectives.

The intense scrutiny by investors and proxy advisors of public companies’ compensation and governance practices shows no signs of abating. Bank boards will need to develop their philosophies, programs and policies with an acknowledgement of emerging regulations and perspectives. Board composition and processes such as member education, evaluation, nomination and independence will gain focus. Executive pay levels and performance alignment will continue to be scrutinized based on new disclosures mandated by Dodd-Frank. The spotlight on pay and governance is not winding down, but rather widening and both the compensation and governance committees will need to spend more time addressing these issues in the years to come.

Taking the Fear out of Phantom Stock


The use of equity compensation has increased in the banking industry in recent years, coinciding with enhanced compensation guidelines from the Securities and Exchange Commission (SEC), bank regulators, and the Dodd-Frank Act. These parties recommend that some executive compensation be deferred and tied to long-term performance. Equity programs typically accomplish both of these goals. A recent study of 177 public banks from Blanchard Consulting Group’s internal database found that the use of equity grants as a percentage of total compensation increased two to three times from 2009 to 2013, depending on the asset size of the bank.

Asset Size 2009 Proportion of Equity to Total Compensation 2013 Proportion of Equity to Total Compensation
Over $1B 15% 26%
$500M to $1B 4% 12%
Under $500M 4% 7%

Most publicly traded banks will use compensation plans tied to the organization’s stock to distribute long-term incentives in the form of stock options or restricted stock. Some private or thinly traded banks will use these types of “real” stock programs; however, many of these banks have limited availability of actual stock. As an alternative, private banks may use synthetic equity, such as phantom stock or stock appreciation rights, which are settled in cash.

Phantom stock programs are modeled to look and feel like restricted stock, where the participant receives the full value of the share plus any appreciation over time. The value of phantom stock is typically linked to the company’s stock price or book value per share. In addition, dividends could be factored into the phantom stock value during the vesting period, typically 3-5 years. Ultimately, the phantom stock awards will be settled in cash.

Advantages to Synthetic Equity
Banks concerned with equity dilution often prefer phantom stock, which provides a value comparable to that of restricted stock, but does not result in actual equity dilution. The value of the phantom stock is paid out in cash upon vesting, so the officer still receives value commensurate with having a real share of stock. Because phantom stock is settled in cash, it does not receive equity-based accounting treatment (value fixed at grant date). Instead, the expense is adjusted over time to reflect changes in the bank’s stock price or book value. The advantage of using phantom stock is the absence of any share dilution.

Stock Appreciation Rights (SARs) are another form of synthetic equity that are settled in cash. Cash SARs work similarly to stock options, as SARs give the participant the right to any appreciation in stock price or book value between the grant date and settlement. The appreciation value is paid in cash and taxed as ordinary income. Similar to phantom stock, cash SARs do not receive equity-based accounting treatment. The SARs are re-valued periodically, and the expense is adjusted to reflect the changes in value throughout the vesting period. This could lead to expensive accruals if the underlying stock price increases dramatically. Similar to phantom stock, there is no share dilution.

Other Considerations
Before implementing any type of equity or long-term incentive plan, a bank should consider a number of factors, such as the following:

  1. Performance-based awards: In today’s environment, equity awards are typically based on the achievement of bank-wide, department and/or individual goals.
  2. Service vesting: We typically see three to five-year vesting schedules within the banking industry. The vesting schedule may vary by grant or employee based on the bank’s retention goals.
  3. Dividends: The board should determine when and if the plan participant will receive value for dividends. This provision can be customized by the bank for each eligible employee.
  4. Termination of employment: If a participant voluntarily terminates employment during the plan term, the employee typically forfeits any unvested awards.
  5. Death or disability: Most banks will accelerate vesting and allow the participant or beneficiary to exercise shares in the event of a disability or executive’s death. All early disbursements will need to comply with Internal Revenue Service (IRS) restrictions (section 409A).
  6. Change-in-control: Shares will typically vest immediately and be paid upon the acquisition or merger of the bank if an employee is terminated as a result, also known as a “double trigger”.
  7. Clawback provision: This allows the bank to recoup incentive compensation payments made to plan participants in error from any unvested phantom stock or SAR grant.

In order to retain and attract talent, private banks need to ensure that they have the compensation tools available to compete with public banks that use real stock compensation. By using phantom stock or SARs settled in cash, private banks can help ensure that they are competitive with the market.

Trends Emerging in Compensation Policies for Bank Executives


Governance policies related to executive compensation are on the rise as a result of increased influence of bank regulators, shareholders and the Securities and Exchange Commission (SEC). These policies are intended to reduce compensation-related risk, encourage a long-term perspective and align executives with shareholder interests.

Meridian’s 2015 proxy research of banks with $10 billion to $400 billion in assets illustrates the prevalence of “standard” and “emerging” practices. Standard practices tend to be common regardless of asset size. Emerging practices are more prevalent at larger banks, but are likely to cascade to community banks over time.

Policies on Risk Adjusting Payoutsrisk-adjustment.PNG
Standard: Clawback Policies
Clawback policies allow the recovery of incentive compensation that has already been paid or vested when there has been a financial restatement and/or significant misconduct. Most banks currently have clawback policies; however, these may need to be revisited once the SEC issues final clawback rules. While many existing policies allow compensation committee discretion to seek recovery, the proposed rules (July 2015) would require a mandatory clawback of “excess” incentive pay in the event of an accounting restatement.

Emerging: Forfeiture Provisions
While clawback policies seek to recover awards already paid, forfeiture provisions provide for the reduction of incentive payouts and/or unvested awards based on negative risk outcomes such as  a lack of compliance with risk policies. While these provisions are standard at large banks that have faced significant regulatory scrutiny, they are only beginning to be used at smaller banks.

Policies on Use of Company Stockcompany-stock.PNG
Standard: Anti-Hedging Policies
Anti-hedging policies prevent executives and directors from participating in transactions that protect against or offset any decrease in the market value of company stock. Such transactions could create misalignment between shareholders and executives since executives would not suffer the same losses as shareholders if the share price drops.

The SEC’s proposed rule (issued February 2015) requires companies to disclose the types of hedging transactions (if any) allowed and the types prohibited for both employees and directors. As seen in our study, most banks already disclose formal anti-hedging policies.

Emerging: Pledging Policies
Pledging policies prevent or limit executives’ and directors’ ability to pledge company shares as collateral for loans. Pledged company stock creates a risk that executives may be forced to sell shares at a depressed stock price in order to raise cash to cover the loan margin, which could further the decline in stock price.

However, some companies allow limited pledging with pre-approval. Pledging enables executives to monetize share holdings without selling company stock. Since 2006, public companies have been required to disclose the amount of company stock pledged by executives and directors. Proxy advisory firms and shareholders typically criticize only significant levels of pledging.

Policies on Retention of Stock AwardsStock-retention.PNG
Standard: Stock Ownership Guidelines
Over 80 percent of banks in our study have stock ownership guidelines that require executives to maintain a minimum level of ownership. Ownership guidelines are typically defined as a multiple of base salary. For CEOs, the most common ownership requirement is five times base salary, while other executives range between one times and three times base salary.

Emerging: Post-Vesting Stock Holding Requirements
Many investors and shareholder advisory firms have started pushing for additional stock holding requirements. Holding requirements restrict executives from selling stock earned from equity awards or option exercises for a period of time after vesting or exercise. Some holding requirements require executives to hold a percentage of shares until ownership guidelines are met. More rigorous policies require executives to hold a percentage of shares for a set period of time (e.g., one year after vesting) or until (or even after) retirement.

Banks have been ahead of many industries in adopting these governance practices as a result of the regulatory scrutiny on compensation programs, and we expect the emerging practices will continue to gain in prevalence across banks of all sizes.

The Current Status of Dodd-Frank Act Compensation Rules


dodd-frank-8-17-15.pngWe have waited for five years since the Dodd-Frank Act became law and we are now seeing consistent movement to finalize several compensation provisions of the law.  

Meetings started in October with President Barack Obama gathering the heads of U.S. financial regulators and urging them to finish the Dodd-Frank rules. To date, we have already adopted Securities and Exchange Commission (SEC) rules that include shareholder votes on executive compensation (Section 951 on say-on-pay and so-called golden parachutes), and on independence of compensation committees (Section 952). Remaining Dodd-Frank provisions, designed to regulate behavior encouraged by compensation structures, are Sections 953, 954, and 956. Already, many institutions have implemented more stringent variable pay plans since 2010, with more compensation tied to longer term performance. The current status of the rules is highlighted below.

Pay Versus Performance Disclosure, Section 953(a)
The proposal for section 953(a) is intended to provide compensation information to augment the say-on-pay vote for public companies. The proposal highlights a new form of realized pay versus reported pay as well as a comparison of the company and peer group total shareholder return (TSR) over several years. The proposed disclosure reflects the SEC’s attempt to help shareholders gain a better understanding of how executive pay compares to company performance by comparing named executive officers’ total compensation as described in the summary compensation table to what the SEC is now defining as compensation actually paid. As an example, the vested value of equity will be incorporated into the actually paid definition versus the value of equity at grant date. Also, the new rule uses total shareholder return (TSR) as the performance measure comparing performance to compensation “actually paid,” and using TSR of a company’s peer group to provide additional context for the company’s performance. In addition, companies will be required to provide a clear description of the relationship between the compensation actually paid and cumulative TSR for each of the last five completed fiscal years.

Current Status of Rulemaking: We expect either a final, or re-proposed rule, by fall, 2015.

Pay Ratio Disclosure, Section 953(b)
The SEC finalized this rule in August, 2015, with implementation deferred to fiscal years beginning on or after January 1, 2017. The rule requires that public companies disclose the ratio of the CEO’s total compensation to the total compensation of all other employees. For example, if the CEO’s compensation was 45 times the median of all other employees, it can be listed as a ratio (1 to 45) or as a narrative. Total compensation for all employees has to be calculated the same way the CEO’s is calculated for the proxy. All employees means all full-time, part-time, temporary and seasonal employees.

Current Status of Rulemaking: The SEC finalized the rule on August 5, 2015. The first disclosure is expected for 2017 fiscal year as shown in proxy statements filed in 2018.

Clawbacks, Section 954
Section 954 is often referred to as the “clawback” provision of Dodd-Frank and applies to all public companies. The proposal requires companies set policies to revoke incentive-based compensation from top executives with a restatement of earnings if the compensation was based on inaccurate financial statements. The company has to take back the amount of compensation above what the executive would have been paid based on the restated financial statements. This rule applies to public company Section 16 officers, generally any executive with policy making powers. Variable compensation that is based upon financial metrics as well as total shareholder return would need to be clawed back, and there is a three year look-back for current and former executives.

Current Status of Rulemaking: Expect final rules in fall, 2015; once final from SEC, stock exchanges will create the listing rule and an effective date (expected late 2016 or early 2017).

Enhanced Compensation Structure Reporting, Section 956
This rule was proposed in April, 2011—more than four years ago. This rule applies to financial institutions, specifically banks greater than $1 billion in assets. The rule is primarily a codification of the principles as found in joint regulatory Guidance on Sound Incentive Compensation Policies, which stated that compensation needs to be:

  • Balanced to both risk and reward over a long-term horizon
  • Compatible with effective controls and risk management, and
  • Supported by strong corporate governance.

In addition, there is an annual reporting requirement and for large banks (greater than $50 billion in assets), there is a mandatory deferral of incentive pay. Given that there have been four years since the original proposal, we are expecting a number of changes as the global regulatory structures have changed greatly since 2011.

Current Status of Rulemaking: Originally proposed in April 2011, changes are expected to be re-proposed in 2015.

Are Your Board Communications Secure in a Changing Regulatory Landscape?


risk-assessment-process-7-15-15.pngAs recently as March 2015, Hillary Clinton’s use of private email on multiple devices while serving as secretary of state hit the media. Clinton commented, “. . . I opted for convenience to use my personal email account, which was allowed by the State Department, because I thought it would be easier to carry just one device for my work and for my personal emails instead of two.”

Every board member can fall prey to the Clinton communication example—take the necessary steps to educate your board.

We continue to live in a changing business environment with a backdrop of increasing regulatory pressures and a heightened focus on improving board oversight and communication. Current guidance and regulatory policies and practices are designed to force improvement in risk management and compliance. Along with that comes the responsibility of how we securely communicate and exchange confidential information at the board and committee level.

Technology and security are playing an important role in this change as leadership demands more mobility, flexibility and speed. Armed with multiple mobile devices and an “on-the-go” attitude, some stakeholders, who may not have grown up in the world of IT, are constantly exposing company information to risk.

Practices for managing board communication suggest we may not be keeping up with the requirements for security and compliance.

Take into account the following:

The Organization

  • Think about how many board members are still receiving board and committee information in their personal email accounts. Then layer in the amount of changes and document version control that need to be communicated before the actual meeting. This information often is not encrypted.
  • Interactions with management and the board is continuous. Monthly, quarterly and annual meetings give the board and committee members an opportunity to review company performance, and provide a forum for governance. Information is still being printed, exposing huge amounts of confidential information as directors travel between meetings and between locations.
  • Unsecure dissemination of confidential documents from regulators, investors and management flows from administrators to the board.

The Individual

  • Critical documents are still being stored and shared on a variety of personal devices – computers, tablets and phones.
  • Directors and committee members are still sending their packets to their personal emails so they can print the materials, thereby breaching security.

What do you do?
Security issues continue to be on the front page of the news. How do you prevent a perfect storm from happening where directors with personal communication devices are not handling confidential information in a proper format? Below are four practical steps to address this.

Education: Board members should be educated on a periodic basis as to what their roles and requirements are, from a board and a bank perspective. If you are public, Securities and Exchange Commission regulations should also be reviewed often.

Process: To help prevent damage from occurring, it is also important to setup a process whereby the directors are getting the necessary information in a secure fashion. There should be sufficient documentation of the process in establishing and monitoring board members. Appropriate personnel, including risk-management and IT personnel, should have input.

Review: The risk department should conduct a review and test the entire process to ensure the loop is secure. This should include management, committee members and the entire board.

Evaluate: Evaluate the risk factors affecting the current process. How does it impact the organization overall?

As technology continues to evolve at breakneck speed, the race is on for leaders to move fast enough to deliver a secure environment. It is clear that not enough attention is being focused on the process that is necessary to foster this environment. Board members will need to think ahead before they communicate, and leaders will need to make sure director communications are secure. And there is no magic formula for creating this—it is an ongoing, “live” process that you will need to keep reviewing. While the process needs to constantly be monitored and refreshed, it also must reflect new behaviors and new preferences: look to the success of the Apple Watch. 

This real-time process will aim to keep you secure at all times. And that may end up in your favor as regulators may soon turn their focus to communication within the board room.

CEO Pay Ratio: How It Will (And Won’t) Work


11-15-13-Pearl.pngThe Securities and Exchange Commission (SEC) is now accepting comments on proposed rules that would require public companies to disclose the ratio of the CEO’s pay to that of their median worker. Proponents say it will serve to better highlight excessive pay practices and shame those companies into adopting more shareholder-friendly programs. Detractors argue that the cost and complexity of implementing the new disclosure outweighs the benefits to investors and may actually ramp up pay levels.

The rules would require public companies to disclose:

  • the median employee annual total compensation, excluding the CEO;
  • the annual total compensation of the CEO and
  • the ratio between the two.

Companies exempt from the rules include:

  • emerging growth companies (those who completed their IPO after 12/8/11 and have less than $1 billion in total annual gross revenues);
  • smaller reporting companies (less than a $75 million float); and
  • foreign private issuers (50 percent or less of outstanding voting securities are held by U.S. residents).

Interestingly, the SEC provided flexibility in terms of how median employee compensation would be calculated: Companies can use either the entire employee population, or a statistical sampling. Companies would be able to choose their own methodology, as long as it is clearly outlined in their proxy and is “appropriate to the size and structure of their own businesses and the way they compensate employees.” We anticipate that the methodologies available for calculating this new pay standard will be front and center in the public debate—perhaps even more than the pay ratios themselves.

So how beneficial would this new disclosure really be in determining the appropriateness of CEO pay within the banking industry? We already know that ratios will vary widely across industries, especially among global versus domestic companies and those with a high number of part-time, temporary and/or seasonal workers. Within the banking industry, there also will be a lot of noise to deal with: Banks’ business models, ownership structures, and operational sizes (e.g., number of branches) will influence the CEO pay ratio, making it difficult to make meaningful comparisons. On top of that, pay ratio disclosures would be based on inconsistent methodologies and different definitions of “total annual compensation.” That number could be established using the Summary Compensation Table in the annual proxy, or any consistently used compensation measure such as amounts reported in payroll or tax records.

Given the wide variations in how companies arrive at these ratios, they are likely to be of limited value in helping shareholders assess banks’ pay programs. In some circumstances, however, pay ratios might provide some additional perspective for bank directors. The following serve as examples:

  • How has the relationship between pay for our CEO and other employees changed over time?
  • Are increases/decreases in the ratio commensurate with our performance?
  • Should the ratio remain constant in good and bad times, meaning that there is an equitable distribution of rewards or cost-cutting measures between the CEO (or management team) and the general employee population—or should there be variation?

Fortunately, there is time to consider various options. However, we recommend banks begin now to investigate the methodologies best suited to their own business and prepare a preliminary pay ratio calculation based on the SEC’s current proposal.

Assuming the final rules become effective in 2014, calendar year companies won’t need to provide pay ratio data until the 2015 fiscal year, and they can provide it in the annual report, proxy or information statement that might not get filed until 2016.

A more detailed client alert that addresses the SEC’s proposed CEO pay ratio rules is available by clicking here.

Being Public: Is It Worth It?


Six months after the JOBS (Jumpstart our Business Startups) Act went into effect, making it easier for banks to remain private, we asked lawyers their opinion on the advantages and downsides of public ownership. Although all raise good points, many believe the expense is just not worth it for that size bank. But if the bank is looking at acquisitions and access to capital that the public markets provide, public ownership is a good idea.

Does it make sense for banks with less than $500 million in assets to be public companies? 

Mark-Nuccio.jpgWith increasing needs for capital and a desire to grow, some smaller banks may want to become or remain public companies, in spite of the significant burdens imposed on smaller public company issuers. Access to the public markets and shareholder liquidity, in the right situation, are worth the price of admission. Without a growth agenda, however, small, publicly held banks would be well-advised to privatize.

—Mark Nuccio, Ropes & Gray LLP 

Peter-Weinstock.jpgIt is hard to see many benefits for companies with less than $500 million in total assets to have their shares registered with the Securities and Exchange Commission (SEC) under the Exchange Act.  The accounting costs associated with public company status continue to increase, as do legal and regulatory check-the-box exercises. Perhaps it is worthwhile for boards to consider the issue again at $1 billion in assets, which is when the requirements for Federal Deposit Insurance Corp. Improvement Act certifications and the Federal Reserve’s enterprise risk assessments kick in. It is clear how smaller, publicly traded banking organizations view this issue. After the JOBS Act, the pace of such companies going dark has resembled Pamplona’s Running of the Bulls.

—Peter Weinstock, Hunton & Williams LLP 

Gregory-Lyons.jpgFor many banks with less than $500 million of assets, the burdens of operating as a public company likely outweigh the benefits. The reporting obligations themselves are substantial. Moreover, particularly as many community banks continue to feel the burdens of the financial crisis, the need to satisfy the short-term view of many investors can impede the pursuit of the long-term objective for a return to health. And the public markets often place a discount on the stock price of banks this size, thereby limiting the upside potential of an offering. Despite having said that, if a bank of this size is in comparatively good health, there are many opportunities for acquisitions in the marketplace now.  For these banks, the publicly traded stock can still be a useful currency in a growth strategy.  

—Greg Lyons, Debevoise & Plimpton LLP 

Schaefer_Kim.pngAfter the JOBS Act increased thresholds for registration from 500 shareholders to 2,000 and deregistration from 300 shareholders to 1,200, many banks have been closely examining the practicality of being a public company, especially considering the tremendous expense and additional regulation. However, the sensibility of that decision truly rests in the bank’s strategic plans for its future. How does the bank want to position itself? If a bank wants to expand its market or services, or if it wants (or needs) to raise capital, its prospects for doing so are much brighter as a public company. Some banks also enjoy the prestige and attention that they receive as a public company. Being a public reporting company may add significant expense, but the visibility and flexibility for raising capital is certainly enhanced for a public company, which may turn those expenses into a valuable investment for future growth.

—Kim Schaefer, Vorys, Sater, Seymour and Pease LLP               

John-Gorman.jpgThere is no one-size-fits all response to this question.  For the institution that sees itself generating enough capital to pay dividends and sustain growth and does not see itself expanding its footprint, then it should seriously consider deregistering with the SEC.  There is a unique ability for a bank or bank holding company (and a savings bank and savings and loan holding company) to continue to trade on the bulletin board without having to be registered with the SEC. This is not available for non-financial institutions.

For many small-cap banks, bulletin board trading may provide as much liquidity as NASDAQ OMX, and provides insiders with an outlet for their shares, which is one of the major downsides of deregistering (i.e., it is difficult for insiders to sell their shares).  For an institution that sees itself accessing the public markets for additional capital or expanding through mergers and acquisitions, continuing with an SEC registration could prove critical, despite the costs and burdens. And as the market cap of a bank/holding company increases, the need to maintain a trading alternative is also important for shareholders. 

—John Gorman, Luse Gorman Pomerenk & Schick PC

The Dodd-Frank Whistleblower Program: What Publicly-Traded Banks Should Know


whistle.jpgOn August 12, 2011, the Securities and Exchange Commission’s (“SEC”) final rules implementing the sweeping whistleblower program in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) became effective.  Like all entities within the SEC’s jurisdiction, publicly-traded banks and their compliance officials should take the time now to understand the whistleblower provisions and the new challenges they pose.

The Dodd-Frank Whistleblower Provisions

The Dodd-Frank whistleblower provisions are quite broad.  They extend to people who share information with the SEC or the Commodity Futures Trading Commission (“CFTC”) concerning misconduct that falls within the jurisdiction of these agencies — including accounting fraud, insider trading, stock manipulation, and violations of the Foreign Corrupt Practices Act. 

The whistleblower provisions authorize cash rewards to whistleblowers for original information leading to a recovery exceeding $1 million.  A key condition is that the tip is “derived from the independent knowledge or analysis of the whistleblower.”  The SEC and CFTC have discretion to decide the exact amount of the award based on the “significance” of the information and the level of assistance provided by the whistleblower, as long as the award is between 10 and 30  percent of total recovery.

The Final Rules

The SEC’s final rules  exclude certain individuals from receiving awards, including:

  • officers, directors, trustees, or partners of an entity who learn information about misconduct from another person or in connection with the company’s processes for identifying misconduct;
  • employees whose main duties involve compliance or internal audit, or persons associated with a firm hired to perform similar functions; and
  • employees of public accounting firms performing an engagement required by the securities laws, when the information relates to a violation by the client or its officers, directors or employees.

However, these individuals are still eligible for a reward under Dodd-Frank if:

  • they have a reasonable belief that (a) disclosure to the SEC is necessary to prevent the company from engaging in conduct that could cause substantial injury to investors, or (b) the company is acting in a way that would interfere with an investigation of the misconduct; or
  • one hundred twenty days have passed since they escalated the information to their company’s audit committee, legal/compliance officer, or supervisor, or since they received the information and the circumstances indicate that the audit committee, legal/compliance officer, or supervisor was aware of the information.

The Dodd-Frank whistleblower provisions do not impact the obligation of publicly-traded banks under certain circumstances to report suspected wrongdoing, such as in connection with suspicious activity reports or when the bank is notified by its outside auditors under Section 10A of the Exchange Act of a suspected illegal act that has not been adequately remediated.

Although the final rules do not require that employees report suspected wrongdoing through internal corporate compliance channels before disclosing information to the SEC in return for a bounty, the rules do try to encourage internal reporting:

  • A whistleblower who reports wrongdoing to the SEC within 120 days of lodging a complaint internally will be deemed to have reported to the SEC as of the date of the internal disclosure.
  • If a whistleblower reported original information internally before or at the same time that the whistleblower reported it to the SEC, and the company discloses the whistleblower’s information or the results of an investigation initiated by the whistleblower’s information to the SEC leading to a successful enforcement action, the whistleblower will receive credit for the information provided by the company and will be eligible for an award.
  • When deciding whether to increase the amount of a whistleblower’s award, the SEC will consider whether the tipster reported through internal channels and assisted with any internal investigation.

Dodd-Frank prohibits retaliation not only against whistleblowers who provide information under the award program but also against employees engaged in offering consumer financial products who provide information about what they reasonably believe to be a violation of federal consumer protection laws, even if these employees are not pursuing a Dodd-Frank whistleblower award.

Looking Ahead

Beyond enhancing existing internal compliance measures designed to identify potential misconduct (such as employee ethics hotlines), the Dodd-Frank whistleblower rules make it more important than ever for publicly traded banks to promptly review all claims of wrongdoing.  Doing so will increase the opportunity to remediate any problems and self-report the conduct to bank regulators and other authorities before a whistleblower contacts the SEC first.