Expanded SEC Whistleblower Program Is Likely
A little-noticed provision in the financial regulatory overhaul legislation currently before Congress provides for a significantly expanded SEC whistleblower program. We explain the proposed law, the IRS’s results with a similar program, and practical suggestions of what to do.
A little-noticed provision in the financial regulatory overhaul legislation currently before Congress allows whistleblowers who report securities violations to recover part of any settlement that exceeds $1 million. Similar legislative provisions are contained in both the House and Senate versions. Although currently part of the broader financial regulation changes, the whistleblower provisions have sufficient Congressional support that they will likely become law through another proposal even if the broader regulatory changes are unable to pass.
The Senate version of the bill (section 922), would award whistleblowers between 10 and 30 percent of any recovery. Under the House bill passed in December (section 7203), a whistleblower could receive no more than 30 percent. In both cases, the award would be determined by the Securities and Exchange Commission (SEC) based on the cooperation provided by the whistleblower, and the significance of the information provided. The whistleblower may appeal an award to the appropriate U.S. Circuit Court. No award is allowed if the whistleblower is convicted of a criminal violation in connection with the reported crime.
The summary of the Senate version of the whistleblower provision follows:
“(1) In General.—In any covered judicial or administrative action, or related action, the Commission, under regulations prescribed by the Commission and subject to subsection (c) [the limitations summarized above], shall pay an award or awards to 1 or more whistleblowers who voluntarily provided original information to the Commission that led to the successful enforcement of the covered judicial or administrative action, or related action, in an aggregate amount equal to -
(A) not less than 10 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions; and
(B) not more than 30 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions.”
The measure applies to any securities violation. Payments can also be made for “related actions”, such as administrative or judicial actions brought by the Department of Justice (DOJ) or other agencies, state regulatory authorities, and foreign law enforcement authorities.
The proposed SEC program is similar to the IRS whistleblower program. The IRS whistleblower program generated substantially increased information once the program was enhanced.
The Madoff fraud was reported to the SEC by Harry Markopolos years before the SEC took any action. In response to the SEC’s failed oversight and reaction to Markopolos’ reports of the Madoff fraud, he testified before the U.S. House of Representatives Committee on Financial Services on February 4, 2009 about his experience. He used the successful IRS whistleblower program as an illustration of what should be done, and justified an expanded SEC whistleblower program as follows:
“I would add one more Directorate, the Office of the Whistleblower, to centralize the handling and investigation of whistleblower tips. Currently, the SEC’s eleven (11) Regional Offices handle whistleblower complaints on an individualized, ad hoc basis. Every whistleblower who comes in with a tip is handled differently and no one tracks the whistleblower with the particular complaint she has brought with the object of the complaint, a particular company or individual. One would think that if ABC Company has received five complaints this year and its nearest competitors received no complaints this year, that this would be meaningful information and merit close scrutiny. Complaints from within industry or by investors have got to be the cheapest, most effective way to identify fraudsters, yet this valuable resource is currently ignored by the SEC. There can be no good reason for dismissing this valuable tool….
The Internal Revenue Service (IRS) started its Office of the Whistleblower in December 2006 and in two short years has grown this office to a staff of 17. The IRS now receives the largest cases with the absolute best quality of evidence in its history. Consider the cost of 17 IRS employees versus the billions in additional tax revenues they’ll be responsible for bringing into the US Treasury….
I recommend that the SEC expand and reinvigorate its almost never used whistleblower bounty program. Section 21A(e) of the 1934 Act allows the SEC to pay a bounty of up to 30% to whistleblowers but only for insider-trading theory cases….Unfortunately, unlike the IRS’s Whistleblower Program and the False Claims Act, the SEC’s reward payments are not mandatory and the SEC can refuse to pay these rewards without explanation. If Congress would expand this program to include all forms of securities’ violations and make the reward payments mandatory, hundreds of cases would likely walk in the door each year, and many of these would be high quality cases that would lead to billions in investor recoveries similar to the billions that the False Claims Act (31 USC Sections 3729-3733) already provides each year.
We have two major government agencies, the Department of Justice and the Internal Revenue Service, that use whistleblower programs to identify cases that they would otherwise know nothing about. To date False Claims Act recoveries total over $22 Billion since 1986. For every $1 spent in enforcement, the False Claims Act returns $15 in recoveries from fraudsters. This proves that such a program works and is not a speculative enterprise on the part of the government. . We need the SEC to become as effective as the Department of Justice and the Internal Revenue Service at fraud enforcement.
In a June 30, 2009 letter, the SEC’s Inspector General also recommended that Congress expand the SEC’s whistleblower program.
The SEC’s current insider trading program has involved only a handful of payments since 1998, and none of the payments have been substantial. However, since the SEC program will include the Foreign Corrupt Practices Act (FCPA), whistleblower bounties could be quite lucrative.
The FCPA makes it illegal to give anything of value to a foreign government official in order to obtain or retain business, or to secure an improper business advantage. In some countries, nearly every aspect of the approval, manufacture, import, export, pricing, sale, or marketing of a product will involve a "foreign official" as defined by the FCPA. Since 2005, the DOJ has brought over 60 FCPA cases. At the end of 2009, the DOJ and SEC were pursuing over a hundred FCPA investigations. The FCPA recently generated enormous fines that could make whistleblowing potentially quite lucrative. For example:
1. The combined monetary sanction assessed against Siemens in 2008 totaled $1.6 billion, including an approximate $450 million fine by the DOJ, $350 million disgorgement to the SEC, and $850 million in penalties assessed by the German government.
2. The combined monetary sanction assessed against Kellogg Brown & Root and former parent company Halliburton in 2009 totaled approximately $580 million, including a $400 million fine and the $180 million in disgorgement.
3. The combined monetary sanction assessed against BAE Systems in 2010 totaled approximately $450 million to the U.S. and British authorities.
4. The proposed law also reiterates the applicability of whistleblower protection to anyone involved in a legitimate complaint. While this may seem expected, the provision undoes the Department of Labor’s narrow interpretation of the applicability of Sarbanes-Oxley whistleblower protection.
Practical Implementation Impacts
The likely passage of an SEC expanded whistleblower reporting system has the following practical ramifications for registrants:
1. Obviously, companies would prefer to address these matters themselves, rather than having the additional inquiries and timetable of a government regulator. Companies should have an outside-sourced whistleblower system, and encourage its use. Such systems make it easier for employees to address their concerns internally so that (i) the company has an opportunity to take preemptive action, and (ii) employees are not sufficiently frustrated to investigate resolution outside their employer’s programs. For more guidance on what should be part of a company’s system, see Best Practices in Whistleblower Systems.
2. Because the consequences of violation are less severe for self-reported violations, the SEC’s bounty program (once implemented) could lead to more and quicker voluntary disclosures. Companies face greater risks by delaying self-reporting to the SEC since the proposed law will make it easier for whistleblowers to get the SEC involved before the company makes its own disclosure.
Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials: CPA, MBA, CMA and ASA.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.