Whistleblowers and Clawbacks
Securities class actions may see a shot in the arm from a number of changes brought about by the Dodd-Frank Act (the "Act"). This is particularly true regarding fraud exposed by whistleblowers. As Kramer Levin Naflalis & Frankel LLP writes (here), Section 922(a) of the Act seeks to entice whistleblowers to expose fraudulent behavior by providing incentives and protections to individual whistleblowers who provide "original information" voluntarily to the SEC. Specifically, where whistleblower information leads to subsequent enforcement action resulting in sanctions greater than $1,000,000, whistleblowers are entitled to recover 10 to 30 percent of the monetary sanctions. Such awards will be funded by the SEC Investor Protection Fund, which itself will be funded by the sanctions collected by the SEC. The SEC has reported (here) that the Investor Protection Fund is already fully funded at just under $452 million.
In addition to allowing whistleblowers who qualify potential recovery from SEC sanctions, the Act creates for them a private right of action against retaliation from employers. The remedy has a six year statute of limitations and the action can be brought directly in federal court. No longer will whistleblowers be required to file a complaint with the Secretary of Labor prior to filing in federal court. The remedies available are broad and include reinstatement, double back-pay, with interest, and compensation for litigation costs and attorneys fees.
The Dodd-Frank whistleblower provisions reach far and wide with additional provisions aimed specifically at the financial industry. Section 748 of the Act provides new whistleblower protections involving products under the jurisdiction of the Commodities Futures Trading Commission. And, Section 1057 establishes a new private right of action and whistleblower remedies to financial services industry employees for reporting violations under the jurisdiction of the new Bureau of Consumber Financial Protection. (See Bloomberg Law Report for more information).
In addition to the expanded incentives and protections for whistleblowers, the Act also provides new provisions for executive incentive-based compensation. The Act requires that the SEC prohibit securities exchanges from listing any company that does not disclose incentive based compensation. And, its "clawback" provision under Section 954 requires that executive incentive-based compensation based on false financial data be returned to the company. The Act's clawback provision covers all executive officers and applies to all incentive-based compensation going back three years from the date of a misstated financial filing. This is in contrast to Sarbanes Oxley, which only allowed a one year look-back and which only covered the issuer's current CEO and CFO.
The Dodd-Frank Act's clawback provision could spawn a number of derivative law suits to recover ill gotten executive bonuses obtained in connection with fraudulent misstatements. The Act's whistleblower provisions could have the same effect for securities class actions. The bounty potential in some whistleblower cases could be extremely high, especially for Foreign Corrupt Practices Act claims where sanctions can be hundreds of millions of dollars. In his analysis of the whistleblower provision Kevin LaCroix of the D&O Diary blog notes (here) that "[t]here is little doubt that the bounty provisions are likely to encourage fraud reporting." Naturally, if such a trend occurs it will almost certainly have the effect of encouraging spin-off securities class action suits.
SEC Request for Comments: Private Right of Action Against Non-US Issuers
As Securities Litigation Watch reported (here), the Dodd-Frank Act codified the SEC and DOJ's power to enforce federal antifraud securities legislation with respect to fraudulent conduct abroad. Federal courts will have jurisdiction to hear such actions where (1) "conduct within the United States...constitutes significant steps in furtherance of the violation," or (2) conduct occurring outside of the United States...has foreseeable substantial effect within the United States. However, the Act did not go so far as to codify extraterritorial application of federal securities fraud laws for private parties. Yet, it does take some steps in this direction. Under Section 929Y, the SEC is charged with soliciting public comment and conducting a study on whether the federal antifraud laws should be extended to cover conduct outside the U.S. A report of the study with recommendations is to be submitted to Congress within 18 months after the date of enactment. Pursuant to Section 929Y, the SEC is now requesting comments on the "Extraterritorial Private Right of Action." A copy of the request for comments as well as details for how to make a submission are available here.
By way of background, in Morrison v. NAB the Supreme Court established the "transactional test," which turned on its head decades of circuit court jurisprudence involving multi-national securities class action litigation. The Court chose to adopt a black letter test that has since been applied by lower courts to bar both f-squared and f-cubed securities fraud litigants from suit. In other words, the test has been applied to eliminate the private right of action under federal securities fraud laws to investors who traded their securities on a foreign stock exchange (here for more information). The implications for private plaintiffs as well as the SEC seem far reaching. But, the ultimate outcome on this issue is far from certain. Two high profile transnational cases currently pending in U.S. lower courts are the Vivendi and Porsche cases, both of which are likely to be impacted by the Morrison transactional rule.
If the SEC's study on the extraterritorial private right of action results in a recommendation to Congress to allow such actions, it could open the door to an Exchange Act amendment that would in effect overrule Morrison. Morrison's transactional rule would likely be replaced by a test similar to that currently available to the SEC under the Dodd-Frank Act, which is very similar to the conduct and effects test applied by many of the circuit courts prior to Morrison. However, given the looming November elections, if Republicans gain a majority in the House of Representatives as polls predict, Congressional approval of an Exchange Act amendment overturning Morrison could be less likely.