Whistleblower Program Demonstrates Clout But Some See Problems
Not everyone is happy with the SEC’s whistleblower program – except perhaps the SEC and the whistleblowers.
Recent developments involving the SEC’s four-year old program that allows some informers to become rich make the case that, like it or not, the whistleblower program is here to stay:
The number of whistleblowers approaching the SEC is high and getting higher. The agency received more than 3,600 tips in fiscal year 2014 – about 10 per day – and that was up from 3,200 tips in 2013, said SEC chair Mary Jo White in an April 30 speech, "The SEC as the Whistleblower’s Advocate," in Chicago. "In the first quarter of this year, we have seen the numbers increase again – by more than 20 percent over the same quarter last year," she said, adding that the tips have come from all 50 states and "span the full spectrum of federal securities laws violations."
The quality of tips and whistleblower assistance is improving. The SEC is receiving "higher quality tips that are of tremendous help to the Commission in stopping ongoing and imminent fraud, and lead to significant enforcement actions on a much faster timetable than we would be able to achieve without the information and assistance from the whistleblower," White said. Whistleblowers, she said, "have provided us with original information leading to the opening of new investigations, ‘insider’ views as to how a company approaches its disclosures to investors and highly technical analyses of rapidly evolving fraud schemes."
First award in retaliation case. A whistleblower will receive more than $600,000, which represents the maximum 30 percent award payment, for aiding the SEC’s June 2014 settlement with Paradigm Capital Management, in part for retaliating against the whistleblower (ACA Insight, 6/23/14), which was the first such award, the agency announced on April 28. "My hope is that the award … encourages potential whistleblowers to come forward in light of our demonstrated commitment to protect them against retaliatory conduct and make significant financial awards to whistleblowers who suffer employment hardships as a result of reporting possible securities law violations," said SEC Office of the Whistleblower chief Sean McKessy.
Second award to a compliance professional. The SEC on April 22 said it would present a compliance officer with between $1.4 million and $1.6 million by coming forward to help prevent "imminent misconduct" from causing substantial financial harm to a company or investors. The name of the entity involved was not released, but the award was the second given under the program to an employee with internal audit or compliance responsibilities, the agency said.
More than $50 million in awards. This amount is the total of the awards given out since the program’s inception in 2011, with 17 whistleblowers receiving awards. Three individual awards were in excess of $1 million, White said. "In the last fiscal year, the Commission issued more awards to more people for more money than in any previous year – and that trend is expected to accelerate."
The whistleblower program, "while still developing, has proven to be a game changer," White said.
A whistleblower can receive an award if he or she voluntarily provides the SEC with original information that leads to a successful agency enforcement action or related action with monetary sanctions exceeding $1 million. Awards can range between 10 percent and 30 percent of the amount collected, depending on a number of factors. Those factors include the significance of the volunteered information, assistance provided by the whistleblower, the importance of the law enforcement interest advanced, the culpability of the whistleblower, and whether there was a delay in reporting.
Pluses and minuses
"Many in-house lawyers, compliance professionals and law firms representing companies have told us that since the implementation of our program, companies have taken fresh looks at their internal compliance functions and made enhancements to further encourage their employees to views internal reporting as an effective means to address potential wrongdoing without fear of reprisal or retaliation," White said.
This represents, at least to some degree, an evolution in the way the whistleblower program was initially viewed by compliance professionals. At that time, "concerns were raised about undermining companies’ internal compliance programs," White said. The SEC, at least partially in response to these concerns, established a framework to incentivize employees to report internally first. As the program currently works, a whistleblower’s participation in internal compliance systems is a factor considered in determining the size of an award.
But the incentive program really doesn’t solve the problem, said Mayer Brown attorney Adam Kanter. "There is no requirement to inside-report before going to the SEC. Consequently, firms can still run into situations where the progress of an ongoing internal investigation is actually impeded by the SEC showing up ‘early’—before the investigation is concluded—due to a whistleblower tip, which can ultimately delay final resolution of the problem."
"Beyond that," Kanter said, "if the SEC acts on a concurrently-reported whistleblower tip before the company’s own internal investigation has had time to make any progress, the information asymmetry between the SEC and the company can lead to problems. The SEC may believe that the firm is being recalcitrant by failing to be forthcoming with additional information, when in fact it simply hasn’t had enough time to properly investigate the alleged conduct."
Firms can still run into situations where they conclude an internal investigation and fix the problem, then voluntarily report it to the SEC, only to find that the SEC already knows of the problem because a whistleblower reported to the agency first. Or the SEC might pay a firm a visit in response to a whistleblower report, not knowing that the firm was already conducting an investigation of it and planning to fix it.
"White focuses on the positive aspects of the Dodd-Frank whistleblower bounty programs while ignoring the downsides," said Zaccaro Morgan partner Nicolas Morgan. He noted the nearly 7,000 tips the program reportedly generated in fiscal years 2013 and 2014. "That sounds like an unadulterated success until you see that only 17 people have received awards since the inception of the program. The overwhelming majority of the tips pouring in do not result in awards."
"These non-award tips impose a cost," he said. "The SEC staff spends scarce time and resources pursuing tips. Companies spend time and resources investigating allegations. When the tips and allegations have merit, those are resources well spent. When the tips and allegations are not meritorious, the resource expense is wasteful at best, and certainly in some situations a diversion from more effective compliance efforts. To truly evaluate the value of the Dodd-Frank whistleblower program, the SEC should be transparent about the costs imposed by ‘false positives.’"
Compliance officers and whistleblowers
There are strict requirements as to the conditions under which compliance and audit professionals, as well as officers and directors, are eligible to receive awards. Generally, they are not eligible to receive them, "but the rules provide an exception to the general prohibition if the information is reported to the SEC at least 120 days after providing it to the employer’s audit committee, chief legal officer, chief compliance officer, or a supervisor," White said. These excluded personnel can also receive an award when there is a reasonable basis to believe that disclosure to the SEC was necessary to prevent imminent misconduct from causing substantial harm to the company or investors. Awards have, in fact, been made under both of these exceptions, she said.
Compliance officers are a particular challenge for firms when it comes to the whistleblower program, said Morgan Lewis partner Thomas Linthorst. They "are privy to a tremendous amount of information." Compliance officer are hired to ensure compliance with laws and regulations, but "you can have people misusing the role."
The Commission itself has had some problems with the whistleblower program.
Among these are what White called "serial submitters" who file a claim "for virtually every case in which over $1 million in sanctions is awarded when there is no connection between their tip and the case."
Nonetheless, the SEC staff is required to "thoroughly assess" every claim and make recommendations, even in cases where the award claims turn out to have no basis, she said.