Key Takeaways From The SEC's Whistleblower Report

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1 Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY Phone: Fax: Key Takeaways From The SEC's Whistleblower Report Law360, New York (December 05, 2014, 9:57 AM ET) -- On Nov. 17, 2014, the Office of the Whistleblower of the U.S. Securities and Exchange Commission, which is headed by Sean X. McKessy, released its annual report to Congress on the Dodd-Frank Whistleblower Program. The report indicates that the program is growing both in terms of the size and number of awards made and the number of whistleblower tips received. Additionally it says that the OWB is tracking some 600 matters in which whistleblowers are involved. Most significantly, however, and in a marked departure from prior reports, the report is quite transparent in profiling the 14 individuals who have received awards to date. Sixty percent of these awardees were current or former employees or otherwise affiliated with the company as consultants or contractors, and 80 percent of the current or former employee awardees first reported internally. Several of the underlying cases involved financial institutions and others involved a company s offering memorandum or marketing materials or false pricing information. Christian R. Bartholomew The report also discusses the major awards made during FY14, including the record and widely reported $30 million dollar award and awards made to an employee who first reported internally and another who was a compliance officer. It touts the SEC s first anti-retaliation case and makes clear that the SEC is looking hard at retaliation issues in general and at severance agreements that might muzzle whistleblowers in particular. Finally, in an important development, the report indicates that the OWB is working closely with the SEC s new Financial Fraud Task Force and is actively looking for tips from corporate insiders and gatekeepers. FY14 Whistleblower Program Metrics According to the report, the SEC received 3,620 whistleblower tips, an increase of about 9 percent from the 3,238 tips received in 2013 and a 20 percent increase from As in previous years, at least one whistleblower in every state provided a tip in 2014, with whistleblowers in California providing by far the greatest number of tips at 556, followed by Florida with 264, Texas with 208, and New York with only 204 (nine less than last year). The SEC also received tips from individuals in 60 foreign countries, with the greatest number of tips coming from individuals in the U.K., Canada, India and China.

2 During FY14, an additional 139 Notices of Covered Action (NOCA) were posted. These are notices identifying SEC enforcement actions that resulted in monetary sanctions over $1 million for which a whistleblower who provided original information that led to the success of that enforcement action may seek an award. Since the program s inception in August 2011, the SEC has posted 570 NOCAs to its website. The SEC s Investor Protection Fund, established under the Dodd-Frank Act to provide funding for the whistleblower award program, had $437,795, available for awards at the end of However, because the $30 million award and others made during FY14 had not yet been paid out, the fund s current balance is probably closer to $410 million. Whistleblower Complaints As in prior years, the top three categories of tips were again corporate disclosures and financials (16.9 percent), offering fraud (16 percent), and manipulation (15.5 percent). Notably, a quarter of all of the whistleblowers who reported to the SEC were unable to choose one of the nine proffered categories and categorized their tips as other. Moreover, despite recent suggestions by senior SEC officials that they are seeing a substantial increase in tips relating to potential violations of the Foreign Corrupt Practices Act, these tips represented a very small percentage of the total in 2014, just as in 2013 and There were only 159 FCPA tips in 2014 (4.4 percent), slightly less than in OWB Efforts to Promote the Program The OWB describes increas[ing] public awareness of the program as one of [its] primary goals, emphasizing that its staff engages in many speaking opportunities and other efforts to market the program, and also uses its website to promote the program. Importantly, the OWB website links to the SEC Enforcement Division s Financial Reporting and Audit Task Force, whose objective... is to identify and prosecute securities law violations related to financial reporting and audit failures. The report states that the SEC hopes that [i]nformation from a corporate insider or gatekeeper can often act as the springboard for the SEC to launch an investigation or provide the final piece of the puzzle in an existing investigation. OWB effectively acts as an advocate for whistleblowers. According to the report, OWB works with Enforcement Division staff to identify and track all enforcement cases potentially involving a whistleblower to assist in the documentation of the whistleblower s information and cooperation in anticipation of a potential claim for award. Once a claim for an award is submitted, OWB attorneys confer with Enforcement Division staff to assess the applicant s assistance or contribution on the matter. The report states that OWB staff will even go so far as to contact whistleblowers who have been actively working with Enforcement staff to confirm they are aware of the posted NOCA and the applicable deadline for submitting a claim for award. The report states that the OWB currently is tracking over 600 matters in which a whistleblower s tip has caused a Matter Under Inquiry ( MUI ) or investigation to be opened or which have been forwarded to Enforcement staff for review and consideration in connection with an ongoing investigation. In addition to the formal tips that the OWB receives through its Tips, Complaints, and Referrals (TCR)

3 system, the OWB returned over 2,731 calls from members of the public. Profiles of Award Recipients Since the creation of the OWB, the SEC has authorized awards to 14 whistleblowers, with nine of those awards made in FY14. Given Dodd-Frank s command that the SEC ensure the anonymity of all whistleblowers even those who agree to be identified prior annual reports have been quite circumspect in making even generalized disclosures regarding the program, how awards are made, and information regarding award recipients. This year s report departs from that practice and provides substantial new information about the award recipients and the kinds of cases involved. In describing the awards, the report said that in each case the whistleblower provided high-quality original information that allowed the [SEC] to more quickly uncover and investigate the securities law violation, thereby better protecting investors from further financial inquiry and helping to conserve limited agency resources. The report explained that the award recipients had provided specific information that: identified particular individuals involved in the fraud ; pointed to specific documents that substantiated their allegations or explained where such documents could be located ; and/or identified specific financial transactions that evidenced the fraud. Moreover, in each instance, [t]he alleged misconduct was relatively current or ongoing. The report also provides descriptive information regarding the awardees themselves, including that: over 40% of the individuals who received awards were current or former company employees ; an additional 20% of the award recipients were contractors, consultants, or were solicited to act as consultants for the company committing the securities violation ; the remaining, approximately 40 percent, of the awardees were either defrauded investors, professionals in the industry, or had a personal connection to one of the defendants; and certain of the award recipients are foreign nationals who reside outside the country. The report provides the following information regarding the kinds of cases involved: [s]everal of the cases... concerned firms involved in the financial services industry, with some involving broker-dealers ; [a] number involved ongoing Ponzi schemes; and [o]ther award recipients provided tips relating to false or misleading statements in a company s offering memorandum or marketing materials or false pricing information.

4 Finally and perhaps most importantly, the report indicates that, of the current or former employee awardees (who comprised 40 percent of the 14 awardees), more than 80 percent of them first reported internally before reporting to the SEC. The report explained that these individuals reported information concerning possible securities violations to the [SEC] only after reporting the information internally and understood that the entity was not taking steps to address or remedy the violative conduct. Discussions and Descriptions of Major Awards The $30 Million Award At the end of the fiscal year, the SEC announced its largest award to date an award of more than $30 million to a whistleblower living in a foreign country. According to the report, [t]he information provided by this whistleblower allowed the SEC to discover a substantial and ongoing fraud that otherwise would have been very difficult to detect. Interestingly, the report explains that the SEC found that the claimant had unreasonably delayed reporting the securities violations, which led to additional harm by investors. Although the SEC could have denied the whistleblower s claim entirely, it decided merely to reduce the award by some unspecified percentage because some of the period of delay occurred before the whistleblower award program was established... In his introduction to the report, McKessy emphasized that this was the fourth award to a whistleblower residing outside of the United States, demonstrating the program s international reach. McKessy went on to say that [w]e hope that awards like this one will incentivize company and industry insiders, or others who may have knowledge of possible federal securities law violations, both in the U.S. and abroad, to come forward and report their information promptly to the [SEC]. Award to a Compliance Professional and an Employee Who First Reported Internally The report also noted the SEC made an award of over $300,000 to a whistleblower with compliance or internal audit responsibilities. Compliance personnel are eligible for a whistleblower award under limited circumstances. The report explained that, in this case, the compliance person was granted an award because the individual reported the violation internally and then waited at least 120 days before reporting to the SEC. Another interesting award made in 2014 was to a whistleblower who, in the words of the report, aggressively worked internally to bring the securities law violation to the attention of appropriate personnel in an effort to obtain corrective action. The SEC noted that the whistleblower would not normally have qualified for an award because the whistleblower s submission concerned the same issue previously investigated by an SRO. However, the SEC waived the application of that exclusion given the unique facts of this case. These two awards demonstrate the SEC s flexibility in applying the rules to make awards to whistleblowers who provide valuable tips. Retaliation Case For the last several years, the OWB has emphasized the SEC s authority to enforce the anti-retaliation provisions of the Dodd-Frank whistleblower statute. As many observers expected, the SEC brought its first anti-retaliation case this past summer against a New York investment adviser and hedge fund.

5 In In re Paradigm Capital Management Inc., the SEC alleged substantial retaliation against its head trader who was involved in and reported to the SEC and allegedly illegal trading. After reporting to the SEC, the employee informed the firm he had done so. Immediately after he told the firm, the employee was relieved of his supervisory duties, taken off the trading desk, put on leave, and then assigned what is best understood as make work (e.g., manually reviewing trading data). The report described these as a series of retaliatory measures. The hedge fund and individual owner settled the case and paid disgorgement and penalties of $2.2 million. Notably, the report emphasized that unlawful retaliation does not require that an employee be terminated. Rather, any retaliatory action, including demoting, suspending, threatening or harassing an employee for engaging in protected whistleblowing activity, may be actionable. Accordingly, firms who learn of a culpable whistleblower must proceed carefully: They must act to stop any ongoing securities violations but may risk an SEC investigation of retaliation if the disciplinary action is not narrowly tailored to the culpable conduct. Firms should be careful about taking any adverse employment actions with whistleblowers given the SEC s strong interest in bringing further anti-retaliation cases. The report notes that federal courts have disagreed about the scope of Dodd-Frank s anti-retaliation provisions. Most courts have deferred to the SEC s interpretation that individuals are protected from retaliation even if they do not report any claim to the SEC, but rather report internally. Not all courts have accepted this position, but the OWB claims that [t]he only court to rule on the issue briefed by the [SEC] agreed with the agency that internal reports can be protected. The Fifth Circuit has taken a contrary position, but no other circuit has yet ruled after panels on both the Second and Eighth Circuits declined to address the issue. Like last year, the report again indicates that OWB is reviewing employee confidentiality, severance and other agreements that may interfere with an employee s ability to report potential wrongdoing to the SEC. The report stated that the OWB will continue to focus on agreements that attempt to silence employees from reporting securities violations to the [SEC] by threatening liability or other kinds of punishment. This issue has also recently received a lot of attention, and last year, senior SEC enforcement officials emphasized that they will look hard at such cases. By Christian R. Bartholomew and J. Douglas Wilson, Jenner & Block LLP Christian Bartholomew is a member in Jenner & Block's Washington, D.C., office and a former trial lawyer for the U.S. Securities and Exchange Commission. Douglas Wilson is an associate in the firm's Washington office. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. All Content , Portfolio Media, Inc.