SEC Bounty Program May Complicate Whistleblowing

As compliance officers spend the summer poring over the 2,000-plus pages of Congress’ regulatory reform bill, they might want to pay particular attention to one provision about whistleblowing that could become a big deal for all public companies.

Tucked away in Section 922 is wording to create a bounty program within the Securities and Exchange Commission to let whistleblowers who report securities violations recover as much as 30 percent of any settlement that exceeds $1 million. That could give employees aware of misconduct a much stronger incentive to ignore the corporate hotline and dial the SEC directly.

Rosenbaum

“From a securities law point of view, this is the sleeper provision in the reform bill,” says Martin Rosenbaum, a partner in the law firm Maslon Edelman Borman & Brand. “Most people haven’t focused on it, but companies should be thinking about it. It creates an incentive for people to go outside of a company’s internal systems and call the SEC instead.”

The provision gives the SEC discretion to determine the amount of any award, based on the significance of the information provided, the degree of assistance provided by the whistleblower, and the “programmatic interest of the Commission in deterring violations,” as well as any other factors the SEC establishes. Recipients can get anywhere from 10 to 30 percent of the SEC’s total take.

Clearly companies would rather hear about and address potential conduct themselves instead of fielding inquiries from the SEC. But David Nolte, a principal with consulting firm Fulcrum Inquiry, admits that “once employees realize that there is potentially money to be made from filing a complaint with the SEC, it will be difficult to encourage employees to handle the complaint internally.”

Kaizer

Andrew Kaizer, a partner in the law firm Arent Fox, says the potential for a reward “is very material, since some of the settlements in the Foreign Corrupt Practices Act world are very big.” Indeed, the SEC settled an FCPA case against French engineering firm Technip SA just last week where Technip disgorged $98 million in profits. It also paid another $240 million to the Justice Department.

Of course, bounty programs aren’t a new idea. The IRS has had one for years to reward people who provide information leading to the collection of federal taxes. The SEC itself already has a bounty program to encourage reports of insider trading, although it is little-publicized and seldom used: From its inception in 1989 through January 2010, the SEC had only paid a total of $159,537 to five claimants under that program, according to a report from the SEC’s inspector general.

“Once employees realize that there is potentially money to be made from filing a complaint with the SEC, it will be difficult to encourage employees to handle the complaint internally.”

—David Nolte,

Principal,

Fulcrum Inquiry

The new bounty program is an offshoot from that report by SEC Inspector General David Kotz. Kotz first suggested creating a new program in June 2009, in response to a request by U.S. Rep. Paul Kanjorski (D-Pa.), chairman of the House Sub-committee on Capital Markets, Insurance, and Government-Sponsored Enterprises. Kanjorski was seeking recommendations on modifying federal securities laws ahead of congressional action on regulatory reform legislation.

The SEC was widely faulted last year for failing to provide ways for the public to alert the agency to Ponzi schemes and other scams, most notably the gigantic fraud run by former Wall Street financier Bernard Madoff. Harry Markopolos, the whistleblower who had tipped the agency about the Madoff fraud for years before the scheme was finally exposed, stumped for expansion of the SEC bounty program in his February 2009 testimony before the House Financial Services Committee.

The SEC, meanwhile, has undertaken an overhaul of its entire system for handling tips and complaints, following Kotz’s scathing review of its failings in the Madoff case. The agency created an Office of Market Intelligence last year to serve as the Enforcement Division’s liaison to the tip, complaint, and referral process and system.

What CCOs Can Do

At the very least, experts say companies should revisit their existing whistleblower hotlines and procedures to ensure that they’re up-to-date and followed properly. “The best defense against employees making external complaints will continue to be a robust internal mechanism for reporting and following up on concerns employees may have,” says Christopher Cook, a partner at the law firm Jones Day.

WHISTLEBLOWER CRITERIA

The following excerpt the regulatory reform bill provides information on whistleblower awards:

WHISTLEBLOWER.

The term ‘whistleblower’ means any individual who provides, or 2 or more individuals acting jointly who provide, information relating to a violation of the securities laws to the Commission, in a manner established, by rule or regulation, by the Commission.

AWARDS - 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), 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 1 0 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.

AWARDS - 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), 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 1 0 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.

PAYMENT OF AWARDS.

Any amount paid under paragraph (1) shall be paid from the Fund.

(A) DISCRETION.

The determination of the amount of an award made under subsection

(b) shall be in the discretion of the Commission.

(B) CRITERIA.

In determining the amount of an award made under subsection (b), the Commission (i) shall take into consideration (I) the significance of the information provided by the whistleblower to the success of the covered judicial or administrative action; (II) the degree of assistance provided by the whistleblower and any legal representative of the whistleblower in a covered judicial or administrative action; (III) the programmatic interest

of the Commission in deterring violations of the securities laws by making

awards to whistleblowers who provide information that lead to the successful enforcement of such laws; and (IV) such additional relevant

factors as the Commission may establish by rule or regulation; and (ii) shall not take into consideration the balance of the Fund.

DENIAL OF AWARD.

No award under subsection (b) shall be made (A) to any whistleblower who is, or was at the time the whistleblower acquired the original information submitted to the Commission, a member, officer, or employee of (i) an appropriate regulatory agency; (ii) the Department of Justice; (iii) a self-regulatory organization; (iv) the Public Company Accounting Oversight Board; or (v) a law enforcement organization; (B) to any whistleblower who is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower otherwise could receive an award under this section; ( C) to any whistleblower who gains the information through the performance of an audit of financial statements required under the securities laws and for whom such submission would be contrary to the requirements of section lOA of the Securities Exchange Act of 1934 (15 U.S.C. 78j-1); or (D) to any whistleblower who fails to submit information to the Commission in such form as the Commission may, by rule, require.

Source

Full Text of Financial Regulation Bill (June 29, 2010).

Cook

Cook says companies “would be wise to respond quickly and proactively to any allegations of fraud or corrupt payments as they arise.”

Rosenbaum says retraining employees on those procedures and stepping up communications about reporting mechanisms are also good ideas.

“Make sure people know how they can report a suspected violation and that they won’t be retaliated against for doing so,” he says. “Complaints are more likely to go outside if people feel they’re not being listened to. Companies should see if they can communicate more often and more effectively to get the message across.”

One caveat: Efforts to encourage more internal reporting often “increase the noise level” of inconsequential or illegitimate complaints, Rosenbaum warns. That means compliance officers will also need to be vigilant in efforts to determine which reports are serious.

The creation of the bounty program could also change the calculus for a company in deciding whether or not to self-report an issue. In the past, Kaizer says, a company might have investigated a minor issue, corrected it, and determined it didn’t need to self-report. But a bounty program “raises the stakes” of doing that—because if a company does not self-report and a whistleblower comes forward, “the company loses any upside it would’ve gotten from going to the government.”

Rosenbaum agrees. “In a borderline case, it could make a difference.”

Nolte

Nolte says the new environment could to lead to “more and quicker voluntary disclosures,” since issuers may be more inclined to self-report if that helps them avoid the more severe consequences likely to come when a whistleblower goes to the SEC first.

And if it’s any solace, companies won’t be the only ones facing more work as a result of the bounty program. The SEC will probably have its hands full investigating tips as well.

“Paying bounties likely will result in an immediate increase in the SEC’s securities fraud and FCPA caseload,” Cook says. The long-term outlook is “less certain.”

“Giving witnesses a financial stake in enforcement actions may undermine the legitimacy and reliability of complaints,” he says.

The bottom line, says Rosenbaum, is that “there’s a decent chance of unintended consequences, so people need to prepare.”