United States: When The Whistle Blows

Last Updated: January 14 2013
Article by Steven A. Wolf and Orie Attas

The enhanced regulatory environment under Sarbanes-Oxley, Dodd-Frank and the Foreign Corrupt Practices Act coupled with financial incentives to whistleblowers will drive a renewed need for legal counsel and forensic accountants to investigate, report, and remedy alleged U.S. Securities and Exchange Commission ("SEC or Commission") violations. Richard Fogarty, Managing Director of Capstone Advisory Group's FCPA and Global Fraud Investigations practice says, "Given the increased protection and avenues of reporting for whistleblowers, combined with the aforementioned financial incentives and overall efforts of regulators in pursuing the investigation of potential violations of Dodd-Frank, FCPA, or a myriad of other regulations, companies should be ready to investigate."  He added, "Companies should be prepared to operate in a much more active whistleblower environment."

Dodd-Frank Whistleblower Program First Anniversary

The SEC whistleblower program implemented under Section 922 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, effective August 12, 2011, recently celebrated its first anniversary. This whistleblower program is primarily intended to reward individuals who act early to expose violations and who provide significant evidence that helps the Commission bring successful cases against those who violate federal securities laws. To be considered for an award, the rules require that a whistleblower must provide the SEC with original information that leads to the successful enforcement action whereby the SEC obtains monetary sanctions totaling more than $1 million. Awards can range from 10 percent to 30 percent of the money collected.

While Dodd-Frank's monetary award provision and retaliation protection has seen little fanfare thus far, with only one reported SEC sanction and award to date as of October 2012, it may be the catalyst of many more whistleblower actions to come. As a result, organizations should re-examine their internal compliance programs to ensure they are prepared to address possible whistleblower activity that gives rise to SEC enforcement actions, including having a team of outside professionals to perform an independent internal investigation. The Dodd-Frank Act includes enhanced anti-retaliation employment protections for whistleblowers and provisions to protect their identities. The law specifies that the SEC cannot disclose any information, including information the whistleblower provided to the SEC, which could reasonably be expected to directly or indirectly reveal a whistleblower's identity. This protection should also provide potential whistleblowers incentives to report potential securities violations.

Origin of Whistleblower

Whistleblower monetary incentive awards and protection are not new concepts. Even though the Commission enacted the whistleblower award provision only fourteen months ago under Dodd-Frank, its origin dates back 150 years when Congress passed the False Claims Act in 1863, signed by President Lincoln. The False Claims Act was established as a result of fraud and abuse against the federal government by government contractors during the Civil War. Noted examples of the basis for this Act include many Union War Department contracts marked by fraud and abuse such as the government's purchase of faulty rifles and ammunition, purchase of rancid rations for soldiers and the Army's purchase of sick horses from dubious sellers. In fact, the concept of a whistleblower action originates centuries earlier during the 13th century in England. Known as a writ of qui tam, it allowed for a private individual with knowledge of past or present fraud, who assists the prosecution, to receive all or part of any penalty imposed. Today, the qui tam provision of the False Claims Act includes financial incentives to individual "relators", commonly referred to as whistleblowers, to share a percentage of the recovery.

Whistleblower Incentives and Results

According to the Department of Justice ("DOJ"), the U.S. government recovered $30.3 billion pursuant to the False Claims Act between 1987 and 2011. During the fiscal year ending September 30, 2011, approximately 84% or 638 of the 762 new cases that were initiated by the DOJ were whistleblower qui tam actions. This year the DOJ expects False Claims Act recoveries to reach $9 billion. These expected whistleblower recoveries are in large part due to several investigations initiated through qui tam actions involving pharmaceutical manufacturers. Similarly, it is expected that the Dodd-Frank whistleblower provisions will have comparable results for the SEC in the coming years.

The Commission has reported that since the enactment of the Dodd-Frank whistleblower program the number of alleged violation tips per day has steadily increased. In the SEC whistleblower program's first year, 2,870 tips, or about eight per day, were reported as of August 12, 2012. The first award recently announced that has had substantial publicity may lead to additional tips being filed with the SEC. The director of the SEC's whistleblower office, Sean McKessy, stated "We are getting very, very high-quality information from whistleblowers and the fact that we made the first payment after just one year of operation shows that we are open for business and ready to pay people who bring us good, timely information." SEC Chairman Mary L. Schapiro, who advocated for the program, stated that "the whistleblower program is already becoming a success," and "we're seeing high-quality tips that are saving our investigators substantial time and resources." However, Forbes has raised questions about the viability of the program, including whether the quantity of tips will be too high, or the quality too low, to result in many effective enforcement actions, and whether the anonymity provisions will work as intended.

Recent Dodd-Frank First Whistleblower Award

To date, the Commission has reported only one whistleblower case that resulted in an award for helping stop a multi-million dollar fraud. The whistleblower's assistance led to a court ordering more than $1 million in sanctions, of which approximately $150,000 has been collected thus far. In this case, the whistleblower is expected to receive nearly $50,000. The award represents 30 percent of the amount collected in the SEC enforcement action against the perpetrators of the scheme, the maximum percentage payout allowed by the whistleblower law. Although this first award is modest in dollar amount it reflects the maximum whistleblower percentage reward allowable under the Act. Future dollar rewards will likely increase commensurate with greater SEC dollar recoveries.

The award recipient, who did not wish to be identified, provided documents and other significant information that allowed the SEC's investigation to move at an accelerated pace and prevent the fraud from ensnaring additional victims. Of note, the SEC did not approve a claim from a second individual seeking an award in this matter because the information provided did not lead to or significantly contribute to the SEC's enforcement action, as required for an award. The court is considering whether to issue a final judgment against other defendants in the matter. Any increase in the sanctions ordered and collected will increase payments to the whistleblower. "This whistleblower provided the exact kind of information and cooperation we were hoping the whistleblower program would attract," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Had this whistleblower not helped to uncover the full dimensions of the scheme, it is very likely that many more investors would have been victimized."

The SEC whistleblower program allows a whistleblower to report violations or potential violations to the SEC while remaining anonymous if the whistleblower submits their information through an attorney. An anonymous tip provides further protection against retaliatory action and added comfort for a whistleblower. Mr. McKessy states that "assistance and information from a whistleblower who knows of possible securities law violations can be among the most powerful weapons in the law enforcement arsenal of the Securities and Exchange Commission. Through their knowledge of the circumstances and individuals involved, whistleblowers can help the Commission identify possible fraud and other violations much earlier than might otherwise have been possible."

In the federal court decision Kramer v. Translux, an employer's motion to dismiss a claim of whistleblower retaliation under the Dodd-Frank Act was denied. In this case, the employee worked as a Vice-President of Human Resources responsible for ensuring that the company's benefit plans were in compliance with applicable law. He had expressed concern to his company's audit committee as well as the SEC of his company's failure to adhere to statutory disclosure requirements. The employee claimed he was reprimanded and was the subject of an investigation. Thereafter, he claimed he was stripped of his responsibilities and later terminated.

The court allowed the employee's claim to proceed, noting that under the facts alleged, the employee had a viable claim. Issues in this case addressed whether the employee was a "whistleblower" protected under the Dodd-Frank Act, 15 U.S.C. Sec. 78u -6(h)(10(A). The employer argued that the employee letter to the SEC was not a protected activity because the employee did not comply with the requirements established by the SEC. The court rejected this argument and found that the employee need only allege that he had "a reasonable belief that the information ...relates to a possible securities law violation". The court found that the protection language of the act is not "unambiguous" and found that e-mails and letters by the employee demonstrated that he "reasonably believed" the company was committing violations of SEC rules or regulations. As Dodd-Frank whistleblower retaliation provisions have begun to be tested and applied, this federal court decision should provide whistleblowers added comfort and assurance to provide tips without fear of retaliation.

Conclusion

During the past year, it appears that the monetary incentive awards and retaliatory protection afforded by the Dodd-Frank whistleblower program are taking hold, resulting in increased tips to the SEC for suspected corporate securities violations. As a result, audit committees, directors and officers, risk compliance managers, and general counsel should anticipate a rising tide of whistleblower activity. Undoubtedly, the Dodd-Frank whistleblower program will stir a renewed effort for corporations to enhance their internal control environment to address how employees report suspected SEC violations and revisit their anti-fraud detection programs. This new wave of investigation will drive a need for outside counsel to engage forensic accountants, fraud investigators and computer forensic professionals to conduct internal investigations.

For more information about the whistleblower program and how to report a tip, visit www.sec.gov/whistleblower.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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