October 2014

The Securities and Exchange Commission (“SEC”) has announced that it will award over $30 million in its latest high profile payout to a whistleblower who provided key original information that led to a successful SEC enforcement action.

The award is getting a lot of attention for a number of reasons. This $30 million amount is the largest award to date under the SEC’s whistleblower program and the fourth time that the SEC has made such an award to a whistleblower living in a foreign country, confirming the program’s lucrative potential and international reach. Regardless of where the violation occurred geographically or where the whistleblower resides, the goal is to enhance SEC enforcement of violations involving U.S. securities law, as described by Sean McKessy, Chief of the SEC’s Office of the Whistleblower:

“This award of more than $30 million shows the international breadth of our whistleblower program as we effectively utilize valuable tips from anyone, anywhere to bring wrongdoers to justice.  Whistleblowers from all over the world should feel similarly incentivized to come forward with credible information about potential violations of the U.S. securities laws.”

It is also notable that the award could have been higher had it been reported more timely. Although the details were not disclosed in order to maintain the whistleblower’s anonymity, a lengthy reporting delay was reported to have caused a downward adjustment of the award amount. The SEC’s Order stated the adjustment was warranted since the delay caused investors to “continue to suffer significant monetary injury” that could have been avoided. Regardless, the information was of significant value, as described by Andrew Ceresney, Director of the SEC’s Division of Enforcement:

“This whistleblower came to us with information about an ongoing fraud that would have been very difficult to detect. This record-breaking award sends a strong message about our commitment to whistleblowers and the value they bring to law enforcement.”

The SEC’s whistleblower program rewards high-quality, original information that leads to an SEC enforcement action with sanctions exceeding $1 million.  The award is generally 10 percent to 30 percent of the money collected, but is sourced from an investor protection fund established by Congress at no cost to taxpayers or harmed investors.  It is instead financed through monetary sanctions paid by securities law violators to the SEC.  The SEC’s “fact sheet” for its implementation rules nicely summarizes the requirements for obtaining a whistleblower bounty, as follows:

“Voluntarily provide the SEC …

In general, a whistleblower is deemed to have provided information voluntarily if the whistleblower has provided information before the government, a self-regulatory organization or the Public Company Accounting Oversight Board …

… with original information

Original information must be based upon the whistleblower’s independent knowledge or independent analysis, not already known to the Commission and not derived exclusively from certain public sources.

… that leads to the successful enforcement by the SEC in a federal court or administrative action

A whistleblower’s information can be deemed to have led to a successful enforcement action if:

  1. The information is sufficiently specific, credible and timely to cause the Commission to open a new examination or investigation, reopen a closed investigation, or open a new line of inquiry in an existing examination or investigation.
  2. The conduct was already under investigation when the information was submitted, and the information significantly contributed to the success of the action.
  3. The whistleblower reports original information through his or her employer’s internal whistleblower, legal, or compliance procedures before or at the same time it is passed along to the Commission; the employer provides the whistleblower’s information (and any subsequently-discovered information) to the Commission; and the employer’s report satisfies prongs (1) or (2) above.

….The rules permit aggregation of multiple Commission cases that arise out of a common nucleus of operative facts as a single action [in fulfilling the requirement that the SEC obtains monetary sanctions totaling more than $1 million]. These may include proceedings involving the same or similar parties, factual allegations, alleged violations of the federal securities laws, or transactions or occurrences. “

The SEC has previously made it quite clear that their award program prioritizes reporting to the SEC and NOT improving corporate governance processes within registrants. Specifically:

“… a principal purpose of Section 21F is to promote effective enforcement of the federal securities laws by providing incentives for persons with knowledge of misconduct to come forward and share their information with the Commission. Although we acknowledge that internal investigations can be an important component of corporate compliance, and although there are existing incentives for companies to self-report violations, providing information to persons conducting an internal investigation, or simply being contacted by them, may not, without more, achieve the statutory purpose of getting high-quality, original information about securities violations directly into the hands of Commission staff.”

However, a whistleblower is still protected and may even be eligible for higher end awards when they demonstrate efforts to utilize internal compliance systems:

“A significant issue discussed in the Proposing Release was the impact of the whistleblower program on companies’ internal compliance processes…. [the rules] further incentivize whistleblowers to utilize their companies’ internal compliance and reporting systems when appropriate.

  • With respect to the criteria for determining the amount of an award, the final rules expressly provide: first, that a whistleblower’s voluntary participation in an entity’s internal compliance and reporting systems is a factor that can increase the amount of an award; and, second, that a whistleblower’s interference with internal compliance and reporting is a factor that can decrease the amount of an award.
  • The final rules contain a provision under which a whistleblower can receive an award for reporting original information to an entity’s internal compliance and reporting systems, if the entity reports information to the Commission that leads to a successful Commission action. Under this provision, all the information provided by the entity to the Commission will be attributed to the whistleblower, which means that the whistleblower will get credit — and potentially a greater award — for any additional information generated by the entity in its investigation.
  • The final rule extends the time for a whistleblower to report to the Commission after first reporting internally and still be treated as if he or she had reported to the Commission at the earlier reporting date. We proposed a “lookback period” of 90 days after the whistleblower’s internal report, but in response to comments, we are extending this period to 120 days in the final rules.”

Although the possibility of a reward will motivate some to report to the SEC regardless of the employer’s response, some employees are more interested in anonymously getting changes made. For these tipsters, it is increasing important for companies to quickly handle the complaints properly. To do this, companies should reevaluate the methods they are now using to collect complaints. Specifically:

  1. Obviously, companies would prefer to address these matters themselves, rather than being forced to deal with the additional inquiries and timetable of a government regulator such as the SEC. Companies should have an outside-sourced whistleblower system and encourage its use. Such systems make it easier for employees to address their concerns so that (i) the company has an opportunity to take preemptive action, and (ii) employees are not sufficiently frustrated that they seek resolution with government regulators. Many companies use internal collection means to comply with Sarbanes-Oxley Section 301(4).  While internal solutions continue to be legally permissible under the new whistleblower laws, internal solutions are not optimal.  Complainants are usually relieved to know that their anonymous complaints are being recorded and reported by someone independent of their employer. Further, such outside service is not cost prohibitive. For example, the vast majority of Fulcrum’s whistleblower clients pay only Fulcrum’s minimum annual cost (currently $800 annually).
  2. Not all external whistleblower programs are alike, and care should be exercised when selecting one. The majority of independently-provided whistleblower solutions are either (i) website-only forms that provide little (if any) feedback to the complainant, or (ii) “hotline” phone answering companies that use untrained personnel reading scripts. Neither forms nor scripts are sufficiently flexible to appropriately address complex financial issues.  These approaches are a mistake because they unnecessarily encourage complainants to believe their concerns are being treated with insufficient care and seriousness.
  3. Because the consequences of any securities law violation are less severe for self-reported violations, the SEC’s bounty program should push employers to provide more and quicker voluntary disclosures. Otherwise, whistleblowers might get the SEC involved before the company makes its own disclosure.

Employers should review their whistleblower reporting systems. While most registrants do not experience serious financial reporting complaints, just one such complaint that could have been addressed without an SEC investigation will certainly warrant changes to any laxness in the a registrant’s existing program.

For more guidance on what should be part of a company’s hotline and whistleblower process, see Best Practices in Whistleblower Systems.

Fulcrum Inquiry performs forensic accounting services, including fraud examinations. Fulcrum provides turnkey whistleblower reporting systems described in this article.