In the days of the old Wild West in the United States, when the local sheriff or townspeople wanted to capture a “bad guy” they posted a sign offering a reward for the capture or demise of the outlaw. While the days of “Wanted Dead or Alive” are long gone, the principle of the hunt is alive and well today.
In late August, the Securities and Exchange Commission disclosed that it had paid $50,000 to an anonymous tipster who provided information that led to the closure of what the agency described as an ongoing stock fraud. That tip gave the evidence leading to a court order imposing $1 million in penalties against unknown defendants. The SEC did not release the names of the defendants, or the related enforcement action. With the announcement of the first reward under its fledgling whistleblower program, the SEC is seeking to ensure that reporting financial criminals is almost as lucrative as the reported crimes themselves.
The payout is 30% of the $150,000 the SEC has collected to date in the case. That is the maximum percentage of recovery permitted under the Dodd-Frank Act, which authorized the whistleblower program in July 2010.
Coming one year after the SEC launched its program in August 2011, the first reward signals the SEC is acting quickly and aggressively to encourage whistleblowers, says Erika Kelton, an attorney specializing in representing whistleblowers at Phillips & Cohen, in Washington, DC.
“This payout is critical to show whistleblowers that this is a robust, functioning program,” Kelton says, “and it’s operating very well. A one-year turnaround is exceptional.”
SEC is now receiving much information from whistleblowers
The SEC is no stranger to whistleblowers. It had already been receiving thousands of tips a year prior to the passage of Dodd-Frank, and for nearly 2 decades had maintained a limited reward program focusing solely on insider trading violations. The new program has been expanded to cover all securities violations, including violations of the Foreign Corrupt Practices Act. It also increases rewards to 10 percent to 30 percent of the amount collected in enforcement actions involving more than $1 million in penalties.
Contrary to what some critics had predicted, the whistleblower program has not produced a flood of “garbage” information, says Jordan Thomas, chair of the whistleblower representation practice at Labaton Sucharow in New York, and former Assistant Director of the SEC’s Enforcement Division. Thomas notes that the reward program has led to roughly 3,000 tips to the SEC last year, which is roughly a ten percent increase over the prior year. However, the program has triggered a fundamental shift in the nature and value of information coming to the agency, he says.
“In the past, the tips the SEC was receiving were of inconsistent quality at best,” Thomas says. “Tips are much stronger now, and have more corroboration. They have a much higher pass-through rate from tip-off to inquiry by the agency. “
“You now have whistleblowers stepping forward with key internal documents, audio recordings, e-mail chains,” he continues. “You also have senior people coming to the program now. None of that happened in the past. It’s made SEC investigations more effective and efficient than ever before.”
SEC program joins other federal whistleblower initiatives
The SEC’s program is one of several federal whistleblower programs that have been revamped or inaugurated in recent years. The Internal Revenue Service Whistleblower Office, which was created in 2006, made headlines this month when it paid a record $104 million reward to Bradley Birkenfeld, who helped expose how UBS had lured as many as 52,000 US persons to open secret accounts in Switzerland to evade US taxes.
The Commodities Futures Trading Commission, which was also required to establish a whistleblower program by the Dodd-Frank Act, launched it in January of this year. It has received only 46 tips in the first eight months.
The widespread adoption of whistleblower programs as potent new regulatory and enforcement tools has been motivated in part by past failures, says Kelton. “The Madoff scandal had a lot to do with inspiring [the SEC program],” she says. “The SEC had a whistleblower knocking on its door, and they just kept missing it. In the wake of that, [SEC Chairman] Mary Schapiro pushed hard for a whistleblower program.”
One of the SEC’s stated goals is to capture information on securities violations in progress, which in many cases only whistleblowers can provide.
“The SEC is very interested in stopping frauds before they fully blossom,” Kelton says. “They want to intervene before the harm is done, not just enforce after the fact.”
Agency plans fast action on tips to nip violations early
That may prompt the SEC to be react more rapidly than other regulators. “[The whistleblower programs of some agencies] are completely different statutory regimes,” says Kelton. Nevertheless, I think the SEC is proving they’re more nimble in moving on whistleblower tips.”
“When you look at cases under the False Claims Act, the turnaround tends to be much longer,” she continues, “It was nine years in the GlaxoSmithKline case,” which ended in July with a record $3 billion penalty for health care fraud violations. “With the IRS program, none came in the first few years. That office has said it expects a 6-7 year turnaround in its cases.”
Under the SEC program, rewards will be paid only for information brought voluntarily that leads to the opening of a new investigation, re-opens a closed one, or “significantly contributes” to the success of an enforcement action. In its first reward payment, the SEC rejected a claim from a second whistleblower on the grounds that the furnished information did not substantially further the investigation of the fraud.
The SEC has seven attorneys assigned to reviewing whistleblower tips, and plans to add four more soon. The agency has already set aside $452 million from past penalties and fines to fund future whistleblower payouts.
Large penalties make whistleblower claims alluring
With so much money at stake, Thomas says a wave of whistleblower-triggered enforcement actions is likely in the next one to three years. “The SEC in the last two years levied $2.8 billion in penalties, and brought many cases in excess of $100 million [in penalties],” he notes. “There’s clearly the potential for enormous rewards.”
In addition to monetary payments, the program offers two other key provisions to make whistleblowing more palatable to persons who wish to come forward. One is the ability to remain anonymous. The second offers legal protection to safeguard against retaliation by employers. Under the Dodd-Frank Act, the SEC may take enforcement action against companies that dismiss or otherwise retaliate against informants.
“Staying anonymous is absolutely crucial for whistleblowers,” says Thomas, who notes that the SEC anonymity provision is unique among federal whistleblower programs. “For them, it’s no longer a choice between their career and doing the right thing.”
Sound internal programs give companies chance to mitigate whistleblowing risks
For companies, the elevation and visibility of federal whistleblower programs at regulatory agencies increases the importance of developing effective internal reporting mechanisms, says Kelton.
“The vast majority of whistleblowers raise concerns internally first,” she notes. “After their concerns are dismissed, or they themselves are dismissed, that’s when they go to regulators.” The key point for companies, she says, is ensuring that “compliance has an independent seat at the management level.”
“Don’t have reporting go through business lines,” she emphasizes. “Make sure it’s an open door, it’s welcoming, and that employees feel the information is being considered and acted on in a meaningful way.”
It would be wise for companies to note that employees consistently report a preference for internal whistleblowing, if they believe an effective program exists.
“There was lots of chest-pounding during the construction of the [SEC program] over concerns that it would circumvent internal reporting. Surveys and experience say that really hasn’t happened,” Kelton says. “The SEC wants concerns addressed internally just as much as companies do.”
But now, there is a financial lure for the internal whistleblower who is ignored.