UNDERSTANDING THE NEW SEC WHISTLEBLOWER PROGRAM. Lyle Roberts Michael Herring

Transcription

1 1 UNDERSTANDING THE NEW SEC WHISTLEBLOWER PROGRAM Lyle Roberts Michael Herring Cooley LLP Prepared February 2013 If you find this article helpful, you can learn more about the subject by going to to view the on demand program or segment for which it was written. 71

2 In December 2008, Bernard Madoff confessed to a giant Ponzi scheme that ran into the tens of billions of dollars, one of the largest financial frauds in United States history. 1 Widespread outrage followed the subsequent revelation that the Securities and Exchange Commission ( SEC or the Commission ) had failed to detect Madoff s fraud despite having received numerous complaints about his operations dating as far back as 1992, as well as having conducted multiple investigations into Madoff and his associates. 2 While the crimes of Madoff and other fallen investment advisers such as R. Allen Stanford did not cause the 2008 financial crisis, fraud and lax oversight by regulatory agencies have become intimately connected in the minds of the public and Congress with the economic damage wrought during that period. 3 There also is a widespread belief that fraud often is accompanied by warning signs that are known to potential whistleblowers who could alert the relevant authorities to the wrongdoing. 4 Of course, in the Madoff case itself, the SEC s Office of the Inspector General found that tipsters had come forward and raised significant red flags, but that the Commission had never conducted a competent and thorough examination or investigation. 5 Despite these now-infamous failures, the fact that whistleblower tips could have stopped Madoff s fraud years before it was ultimately uncovered 6 served to highlight the value of such tips in rooting out fraud in the future. Indeed, according to testimony provided during Congressional hearings 1. Madoff Confessed $50 Billion Fraud Before FBI Arrest, BLOOMBERG (Dec. 12, 2008), available at sid=atuk.qnxavzy (visited February 26, 2013). 2. H. David Kotz, Oversignt of the SEC s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance: Hearing Before the S. Comm. On Banking, Housing, and Urban Affairs, at 7-8, 11 th (2009) ( Kotz Testimony ). 3. See generally, e.g., Wall Street and the Financial Crisis: Anatomy of a Financial Collapse, Majority and Minority Staff Report, S. Permanent Subcommittee on Investigations, (Apr. 13, 2011) /html/CHRG-112shrg57323.htm (citing throughout fraud and failure of oversight as causes of the crisis). 4. The Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub L. No , 124 Stat (2010) ( Dodd-Frank ) includes in its definition of whistleblower any individual providing information relating to a violation of the securities laws. Id. 922(a)(6). 5. Kotz Testimony at See Kotz Testimony at 8 ( had [] a proper examination or investigation been conducted, the SEC would have been able to uncover the fraud ). 5 75

3 following the crisis, whistleblower tips led to more than half of all cases in which fraud was uncovered within public companies. Whistleblowers, in fact, led to the detection of thirteen times as many fraudulent schemes as external audits. 7 All of this put significant pressure on Congress to find legislative means to enhance the likelihood of whistleblowers coming forward, culminating in the 2010 creation of a new SEC whistleblower program as part of the Wall Street Reform and Consumer Protection Act ( Dodd- Frank ). This article examines the mechanics of the SEC whistleblower program, the results of its first full year in action, and the judicial treatment of the anti-retaliation provisions. MECHANICS OF THE SEC S WHISTLEBLOWER PROGRAM: THEN AND NOW Prior to Dodd-Frank, the SEC s whistleblower program was limited to tips relating to insider trading violations, and had only made payouts to five whistleblowers between its inception in 1989 and the passage of Dodd-Frank. 8 Further, in Congress s view, the SEC s program did not adequately incentivize individual employees to take the enormous risk of blowing the whistle in calling attention to fraud, by presenting them with a guaranteed minimum payment to weigh against that risk. 9 The Senate report on Dodd-Frank drew a parallel between the SEC s whistleblower program and a similar program within the Internal Revenue Service that had been overhauled in Like the original SEC program, the pre-2006 IRS program included no required minimum 7. Harry Markopolos, Oversight of the SEC s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance: Hearing Before the S. Comm. On Banking, Housing and Urban Affairs, at 33, 111 th Cong. (2009). See also S. Rep at (Apr. 30, 2010). The Senate Banking, Housing, and Urban Affairs Committee held 79 separate hearings on topics surrounding the housing and economic crisis and financial regulatory reform between 2007 and April Id. at U.S. Securities and Exchange Commission, Office of Inspector General, Office of Audits, Assessment of the SEC s Bounty Program, Rep. No. 474 at 5, Mar. 29, 2010 ( OIG Report 474 ); S. Rep at S. Rep at 111. The prior SEC program had no minimum payout and a maximum payout of 10% of the recovery. OIG Report 474 at ii. In requesting authority to give higher awards, then-chairman Mary Schapiro said that the main benefit most whistleblowers received was the good feeling you get of having done something important, rather than money. Id. at

4 payment for eligible tips, and while the Senate called the earlier IRS program largely ineffective, it said the program had been reinvigorated by the rule change. 10 Modeled after the IRS whistleblower program, Section 924(d) of Dodd-Frank directed the SEC to establish a separate office to administer the whistleblower program. 11 This office, established in 2011, is called the Office of the Whistleblower ( OWB ). OWB is staffed by approximately fifteen employees, and is charged with, inter alia, publicizing the program both within the SEC and among the general public, 12 communicating with potential whistleblowers, 13 and fielding calls and submissions received via regular mail, , and fax. 14 Dodd-Frank mandated that monetary awards be available to eligible individuals providing voluntary, original information leading to enforcement actions resulting in the imposition of over $1 million in sanctions. 15 Original information must be derived from the whistleblower s own independent knowledge or analysis, and cannot be already known to the SEC or exclusively derived from an allegation in a lawsuit, government document, or news story. 16 Whistleblowers who are employees of regulatory agencies or organizations, who gain the information while performing an audit required by the securities laws, who are convicted in a related criminal case, or who make any false statement or knowingly 10. S. Rep at U.S. Securities and Exchange Commission, Annual Report on the Dodd-Frank Whistleblower Program, Fiscal Year 2012, at 1 (Nov. 2012), about/offices/owb/annual-report-2012.pdf; Dodd-Frank 924(d). 12. OWB s publicity efforts include a website and instructional videos uploaded to the SEC s YouTube channel. See (visited Feb. 27, 2013); (visited Feb. 27, 2013). 13. Neither OWB nor SEC Enforcement staff may confirm or deny whether an investigation has been initiated as a result of a whistleblower tip. Nevertheless, OWB staff may, on a discretionary basis, inform the whistleblower that the complaint has been assigned to Enforcement staff, or that the Enforcement Division has decided to take no further action in response to the tip. U.S. Securities and Exchange Commission, Office of Inspector General, Evaluation of the SEC s Whistleblower Program, Report No. 511 ( OIG Report 511 ) at 3-4 (Jan. 18, 2013) SEC Whistleblower Report at Dodd-Frank 922(a)(1), (b)(1). Even if the case does not itself result in over $1 million in sanctions, the tipster might still be eligible for an award if the case is later aggregated with related SEC actions and the aggregate sanctions exceed the threshold. OIG Report 511 at Dodd-Frank 922(a)(3). 7 77

5 submit any false document are ineligible for awards. 17 Tips and tipsters identities are to be held confidential by the Commission unless and until a public proceeding by the Commission requires disclosure, although this requirement does not bar sharing the information with federal, state, foreign, or certain nongovernmental regulators or law enforcement agencies (all of whom are themselves bound by the same confidentiality requirement). 18 When a final judgment or order results in sanctions over the $1 million threshold, OWB posts a Notice of Covered Action. After the Notice is posted, the whistleblower has ninety calendar days to apply for an award. 19 If an application is timely submitted, OWB prepares a recommendation regarding the appropriate award, if any. The staff in the SEC s Enforcement Division and Office of General Counsel considers OWB s recommendation and make its own proposed determination for consideration by the Commissioners. 20 Awards can vary between 10% and 30% of the sanctions recovered. 21 In deciding where in this range to set individual awards, Dodd-Frank grants the SEC wide discretion as long as the agency takes into consideration the significance of the information provided to the success of the enforcement proceeding, the degree of assistance provided, and the programmatic interest of the Commission in deterring violations of the securities laws Awards are to be paid from the Securities and Exchange Commission Investor Protection Fund, established by Dodd-Frank and funded by the SEC s 17. Dodd-Frank 922(c)(2), (i). 18. Dodd-Frank 922(h)(2). 19. SEC Whistleblower Report at 6. OWB will contact the whistleblower to inform him or her of approaching deadlines and of any deficiencies in an application for an award. OIG Report 511 at SEC Whistleblower Report at 6-7. Applicants may request reconsideration of any preliminary determination by the SEC staff. Id. 21. Because payments are made based on actual recoveries (i.e., collections) but eligibility is based on the mere imposition of sanctions, individual payments to whistleblowers can, in practice, be smaller than $100,000 (10% of $1 million). See Dodd-Frank 922(a)(1), (b)(1); SEC Whistleblower Report at 8 (reporting an August 2012 payment of under $50,000 to the first qualifying whistleblower based on recoveries of approximately $150,000 at that time). 22. Dodd-Frank 922(c)(1). Other factors considered include whether the whistleblower cooperated or interfered with his or her employer s internal compliance system in connection with the alleged wrongdoing, whether the whistleblower had any culpability, and whether there was an unreasonable delay in reporting. OIG Report 511 at

6 monetary recoveries. 23 Whistleblowers who are denied an award or are unsatisfied with the amount of their award may appeal to a federal Court of Appeals within thirty days of the adverse SEC determination. 24 FIRST FULL YEAR OF THE PROGRAM: BY THE NUMBERS OWB began receiving tips in August 2011 and received 334 tips during the remainder of the fiscal year. 25 In fiscal year 2012, the first full year of the program, the office received 3,001 tips from eligible individuals seeking awards. 26 The vast majority of tips were submitted online as opposed to having been faxed or mailed. 27 Tips came in from every single state, the District of Columbia, and Puerto Rico. California led the nation, generating over 17% of domestic reported tips, followed by New York at 10% and Florida at 8%. 28 Tips also came in from forty-nine foreign countries. The United Kingdom led the way, accounting for seventy-four tips, which is far more than most individual United States jurisdictions generated. Canada, India, China, and Australia also accounted for significant numbers of tips: 46, 33, 27, and 21 respectively. 29 The SEC has reported that the most common complaints concerned corporate disclosures and financials (18% of tips in fiscal year 2012), offering fraud (16%), and manipulation (15%). Other categories used to characterize the subject matter of complaints included insider trading (6%), trading and pricing (5%), Foreign Corrupt Practices Act (4%), unregistered offerings (3%), market event (3%), and 23. Dodd-Frank 922(g). 24. Dodd-Frank 922(f). As of January 2013, no such appeals had yet been filed. OIG Report 511 at vi. 25. The federal government s fiscal year ends on September An undisclosed additional number of tips were submitted by individuals who either did not wish to seek an award or were not eligible to receive one. U.S. Securities and Exchange Commission, Annual Report on the Dodd-Frank Whistleblower Program, Fiscal Year 2011, at 5 (Nov. 2011) gov/about/offices/owb/whistleblower-annual-report-2011.pdf. 27. OIG Report 511 at 15 (showing 85% of a statistical sample of seventy-four submissions as having been submitted online). 28. SEC Whistleblower Report at Appendix B. 29. SEC Whistleblower Report at Appendix C. 9 79

7 municipal securities and public pension (2%). (Twenty-eight percent of tipsters did not indicate that their complaints fell within any particular category.) 30 As part of a review mandated by Dodd-Frank, the SEC s Office of Inspector General audited the 3,335 tips submitted between the beginning of the program and the end of the 2012 fiscal year, and tracked smaller samples of tips through the system. 31 The review found that the average tip is either referred to a point of contact for potential investigation or designated as NFA ( no further action ) within approximately one month. 32 Thirty-one percent of tips resulted in referrals, while the remaining 69% resulted in NFAs. 33 The review also found that 96% of voic s left on OWB s hotline were returned within twenty-four business hours. 34 The first whistleblower program award to a tipster was made in August 2012, in the amount of nearly $50,000. In a November 2012 press release, the SEC stated that tips relating to 143 enforcement judgments and orders potentially qualified for an award (i.e., a Notice of Covered Action was generated by OWB) under the program during fiscal year Given that it can take many months (even a number of years) for SEC enforcement proceedings to reach a final resolution, the tips received by the SEC in fiscal years 2011 and 2012 may continue to lead to judgments and orders for a number of years to come. DODD-FRANK S STRONG ANTI-RETALIATION PROVISIONS AND THE SCOPE OF THOSE PROVISIONS Dodd-Frank protects whistleblowers from retaliation (including, but not limited to, firing, suspension, threats, and harassment) by their employers. 36 This protection covers the initial tip to the Commission, any 30. SEC Whistleblower Report at Appendix A. 31. OIG Report 511 at iv, OIG Report 511 at 16. Tips took as little as one day or as long as 249 days to reach these stages. Id. 33. OIG Report 511 at 16. A tip designated as NFA is not necessarily categorized as such due to a finding that it lacks merit. Tips might also be designated for no further action because they duplicate an existing investigation or because the SEC determines that a different agency should investigate the allegation. Id. at 16 n OIG Report 511 at SEC Release (Nov. 15, 2012). 36. Dodd-Frank 922(h)(1)(A)

8 later assistance or testimony related to the information provided, and the making of any disclosures required or protected by the Sarbanes-Oxley Act ( Sarbanes-Oxley or SOX ), the Securities Exchange Act, or any statue or regulation within the Commission s jurisdiction. 37 Individuals who believe they have been the victim of retaliation may immediately file suit in a United States District Court, and, if successful, may be reinstated and recover double back pay, interest, attorneys fees, and other litigation costs. 38 Dodd-Frank also gave whistleblowers generous statutes of limitation and repose. Whistleblowers have either six years from the alleged retaliation or three years from the time they knew or reasonably should have known of the alleged retaliation to bring suit. 39 The protection under this program is therefore much stronger than that of other anti-retaliation statutes. For example, the whistleblower protections of the Sarbanes-Oxley impose a ninety-day deadline for retaliation claims, require the whistleblower to file a complaint with the Department of Labor, and only allow suit in federal court in cases where the Department fails to issue a final ruling within six months. 40 There is no requirement that the tipster be eligible for an actual award under the whistleblower program in order to hold the employee liable for retaliation, so an employer could potentially face damages for retaliation even if the initial tip reported to the Commission was meritless. 41 Actually, that understates employers potential exposure, because according to the SEC and a number of federal district courts, the Dodd- Frank protections kick in even for certain employees who never actually contact the SEC. This result is at first counterintuitive because Dodd- Frank protects whistleblowers and the Act defines a whistleblower as someone providing information to the Commission. 42 But 37. Dodd-Frank 922(h)(1)(A). 38. Dodd-Frank 922(h)(1)(B)(i), (h)(1)(c). 39. Dodd-Frank 922(h)(1)(B)(iii). In any case, any retaliation claim must be brought within ten years of the alleged violation. Id. 922(h)(B)(iii)(II). 40. Sarbanes-Oxley Act of (b). The Sarbanes-Oxley protections also do not provide for double damages for back pay. Id. 41. The employee, however, must have possessed a genuine and objectively reasonable belief that the tip had merit. See SEC Release at (June 13, 2011) Dodd-Frank 922(a)(6), (h)(1)(a) (emphasis added). To be more precise, a whistleblower is someone providing information to the Commission in a manner established... by the Commission. So the definition would also seem to exclude someone reporting to the SEC in a manner other than that mandated by Commission rules. Nevertheless, at least one court has held that Dodd-Frank s 11 81

9 Dodd-Frank also protects disclosures that are mandated or protected by Sarbanes-Oxley and other statutes and regulations within the Commission s jurisdiction. 43 That broader class of protected disclosures includes disclosures made to only one s supervisor, a different federal agency, or a member or committee of Congress, in addition to disclosures made to the SEC. 44 The first court to address this issue was the United States District Court for the Southern District of New York, in Egan v. TradingScreen, Inc. 45 In that case, the court recognized a contradiction between the statutory definition limiting whistleblowers to those that report to the SEC and the retaliation provisions seeming protection of whistleblowers who only report elsewhere. The court decided to construe the retaliation provision as an exception to the definition of whistleblower, stating: [t]he contradictory provisions... are best harmonized by reading [Dodd-Frank s] protection of certain whistleblower disclosures not requiring reporting to the SEC as a narrow exception to [the statute] s definition of a whistleblower as one who reports to the SEC. Therefore, Plaintiff must either allege that his information was reported to the SEC, or that his disclosures fell under the four categories of disclosures... that do not require such reporting. 46 In its release adopting rules implementing the anti-retaliation provisions, the SEC took a similar approach, stating the statutory antiretaliation protections apply to three different categories of whistleblowers, and the third category includes individuals who report to persons or whistleblower protections extend to individuals providing tips via procedures other than those established by the SEC. See Kramer v. Trans-Lux Corp., 2012 WL , at *3-5 (D. Conn. Sept. 25, 2012) (holding that even though SEC regulations require that a particular form be used, an individual mailing a letter to the SEC that did not include the required form qualified as a whistleblower). 43. Dodd-Frank 922(h)(1)(A)(iii). 44. See, e.g., SOX 806(a)(1) (protecting reporting, including internal-only reporting, of employees suspecting violations of laws against defrauding shareholders) WL , at *3 n.1 (S.D.N.Y. May 4, 2011) ( This is an issue of first impression in the federal courts. ). 46. Id. at *5 (emphasis added). Ultimately, the court found that the plaintiff had not made a disclosure protected by SOX or another statute and could therefore not avail himself of this exception. But the court allowed the claim to survive, holding that Egan had adequately alleged that he acted jointly with other individuals and could amend his complaint to allege that those individuals reported the potential violation to the SEC. Id. at *

10 governmental authorities other than the Commission. 47 Courts in Connecticut and Tennessee have agreed with the holding of Egan and the interpretation of the SEC. 48 Finally, where the employer is the potential target of an SEC investigation or enforcement action, treating whistleblowers poorly could have consequences for the company beyond the possibility of a civil suit by the aggrieved employee. SEC officials have stated that management must take all complaints seriously, even if the source is an employee who seems unreliable, has an axe to grind, or has a personnel file full of black marks. In December 2012, David Bergers, Director of the SEC s Boston Regional Office, advised firms to separate an employee s allegations from the opinion the firm has about the employee. Not only does this advice ensure that all allegations receive adequate attention, but Mr. Bergers noted that the SEC will scrutinize a company s whistleblower policy and its execution of that policy when deciding whether to file an enforcement action. We want to see that the company is taking their concerns seriously, and how they are talking about them, said Mr. Bergers. 49 In other words, treating a whistleblower poorly increases a company s potential exposure regarding the subject of the tip, as well as its liability for treatment of the tipster. CONCLUSION The SEC has expressed optimism about the ongoing results of its whistleblower program. As noted by Sean McKessey, Director of OWB, [w]e are getting very, very high-quality information from 47. SEC Release at 17. The SEC went on to say that the third category provides anti-retaliation protections for employees of public companies, subsidiaries whose financial information is included in the consolidated financial statements of public companies, and nationally recognized statistical rating organizations when these employees report to (i) a federal regulatory or law enforcement agency, (ii) any member of Congress or committee of Congress, or (iii) a person with supervisory authority over the employee or such other person working for the employer who has authority to investigate, discover, or terminate misconduct. Id. at Protection for employees of other types of entities is more limited, but still present in certain circumstances. Id. at 18 & n See Nollner v. Southern Baptist Convention, Inc., 852 F.Supp. 2d 986, (M.D. Tenn. 2012); Kramer, 2012 WL , at * JD Supra Law News, The SEC Wants To Know About Your Whistleblower Policy (Dec. 19, 2012), available at (visited Feb. 26, 2013)

11 whistle-blowers... I was girding myself for what we were promised, which was an avalanche of nonsense, and I ve been very pleased. 50 Whether these tips will turn into a slew of enforcement actions remains to be seen, but there appears little doubt that the sheer volume of tips alone suggests that the whistleblower program presents a challenge for corporate entities, who must manage employee complaints both internally and (potentially) externally. Indeed, according to a recent survey of senior in-house counsel, one-third of the respondents said they expected an increase in whistleblower activity within their industry. 51 Given the new financial incentives for whistleblowers created by the SEC program, they are surely right. 50. Los Angeles Times, SEC whistle-blower program starts paying off for agency, tipsters (Aug. 22, 2012), available at business/la-fi-sec-whistleblower (visited Feb. 27, 2013). 51. Law360, GCs Brace For More Whistleblower Suits (Feb. 26, 2013), available at (visited Feb. 27, 2013)