[IMGCAP(1)][IMGCAP(2)]Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in response to the 2008 financial collapse and the recession that followed.
Passed in 2010, the goals of the Dodd-Frank Act include promoting the financial stability of markets within the United States, ending the systemic risk generated by financial institutions that are “too big to fail,” protecting taxpayers by ending bailouts, and protecting the public from abusive financial services practices.
Congress viewed whistleblowers as an integral tool for accomplishing these goals. The Dodd-Frank Act established a securities whistleblower incentives and protection program that is administered by the Securities and Exchange Commission through its Office of the Whistleblower.
The Whistleblower Program is designed to encourage individuals to submit relevant information to aid the SEC in preventing, detecting and prosecuting violations of the federal securities laws. The program rests on three essential components: monetary awards, retaliation protection, and confidentiality protection for the informant. This article concentrates principally on the monetary awards.
The Importance of Monetary Awards
Under the Whistleblower Program, the SEC must make monetary awards to eligible individuals who voluntarily provide the Commission with original information about a violation of the federal securities laws that has occurred, is ongoing, or is about to happen. The information supplied must lead to a successful SEC enforcement action (and/or related action) resulting in a final judgment exceeding $1 million.
The amount of the award is determined at the SEC’s discretion but it must be at least 10 percent and no more than 30 percent of the monetary sanctions that the Commission and the other authorities in related actions, if applicable, are able to collect.
If the SEC awards a bounty to two or more individuals in connection with the same action, the Commission will decide the respective percentage award for each whistleblower based on their relative contribution to the success of the enforcement action, but in no event will the total award to all whistleblowers be less than 10 percent or greater than 30 percent of the monetary sanctions the SEC or other authorities collect.
In determining the appropriate total award percentage, the SEC may consider factors that tend to increase the amount of the award. In this regard, if the nature of the information provided by the whistleblower significantly contributed to the success of the Commission action, and its reliability and completeness resulted in the conservation of SEC resources, the informant can expect a greater award.
Also, a person who provides extensive and timely cooperation by, for example, explaining complex transactions, encouraging others to assist the SEC, or helping the authorities recover money derived from the illegal acts, may receive a larger award.
The SEC does not view all violations of federal securities laws in the same way. If the nature of the violation is a Commission priority, the whistleblower exposed an industry-wide practice, the amount of harm or potential harm to investors presented by the underlying violations is significant, and/or there are a large number of individuals or entities harmed, the SEC may increase the award.
A whistleblower who reported the possible securities violation through the company’s internal compliance procedures before, or simultaneously with reporting it to the Commission may receive a bigger award.
Just as there are factors that the SEC considers in increasing the award, there are also factors that may reduce the amount of an award. The Commission will assess the culpability of the whistleblower regarding the reported securities law violation. The award may be decreased if the whistleblower’s role in the securities violation was prominent, if he acted with scienter, financially benefited from the violation, and/or the violation he committed was egregious.
A whistleblower who unreasonably delays reporting the securities violation to the SEC may also receive a smaller award. Likewise, the Commission may reduce an award, if the informant interfered with his company’s internal compliance system to prevent or delay detection of the reported securities violation.
The award determined by the SEC is paid from a separate fund established by Congress, called the Investor Protection Fund, to ensure that payments to whistleblowers do not reduce the recoveries for victims of securities laws violations. The fund’s balance as of Sept. 30, 2015, the fiscal year end, was approximately $400.7 million. Since the inception of the fund in August 2010 and through the end of fiscal year 2015, the SEC has paid $54.8 million in awards.
Who is Eligible to Receive an Award?
A whistleblower eligible to receive an award is an individual who, alone or jointly with others, voluntarily provides the SEC with original information, pursuant to the procedures established by the Commission, about a possible violation of federal securities laws that has occurred, is ongoing, or is about to occur.
A company may not be a whistleblower, and the whistleblower is not required to be an employee of a company to submit information about that company. The information supplied must lead to a successful SEC enforcement action (and/or related action) resulting in a final judgment or order of monetary sanctions exceeding $1 million.
It is important for a potential whistleblower to understand what violations of law are covered under the program. The violations that can trigger an award are not limited to what might be viewed as classic breaches of federal securities laws, such as fraudulent financial reporting, offering fraud and insider trading. The SEC is also responsible for enforcement of the Foreign Corrupt Practices Act. This statute generally makes it unlawful for U.S. companies to offer anything of value to a foreign government official in order to obtain or retain business. This law also applies to foreign companies that have securities registered in the United States or that are required to file reports with the SEC. The FCPA also includes accounting provisions that require companies with securities listed on the U.S. stock exchanges and their subsidiaries to create and maintain accurate books and records, and to devise an adequate system of internal accounting controls. The Dodd-Frank Whistleblower Program covers the reporting of violations under the FCPA.
In order to qualify for an award, the whistleblower must provide the information voluntarily. The submission of information is voluntary as long as the individual provides the information before it has been requested by: (a) the Commission, (b) the Public Company Accounting Oversight Board, (c) Congress, (d) any other authority of the federal government, or (e) a state Attorney General.
Original information is information derived from the whistleblower’s independent knowledge or analysis that is not already known by the SEC from another source, unless the informant is the original source of the information.
The information to be considered original must also not be exclusively derived from an allegation made in a judicial hearing, in a governmental report, or from the news media, unless the whistleblower is the source of the information.
The SEC will not consider that the whistleblower provided original information if the whistleblower obtained the information through a communication that was subject to the attorney-client privilege, or in connection with the legal representation of a client on whose behalf the whistleblower is providing legal services, unless the disclosure of that information would otherwise be permitted by an attorney.
Further, the whistleblower will not be eligible for an award if he obtained the information in a manner that is determined by a United States court to violate federal or state criminal law.
There are restrictions upon giving awards to certain classes of people. However, several exceptions greatly reduce the applicability of these restrictions. Generally, whistleblowers will not be eligible for an award if they learned of the information because they were:
• Officers, directors, trustees or partners of an entity and another person informed them of allegations of misconduct, or they learned the information from the entity’s internal compliance system;
• Employees whose main responsibilities involve compliance or internal audit functions, or employees of a firm retained to perform compliance or internal audit functions for an entity;
• Employed by a firm retained to investigate possible violations of law; or
• Employees of a public accounting firm and obtained the information through the performance of an engagement required of an independent public accountant under federal securities laws (other than the type of audit discussed below), and that information related to an engagement client’s violation.
However, whistleblowers that fit any of the above categories may be eligible for an award if:
1. They have a reasonable basis to believe that disclosure of the information to the SEC is necessary to prevent the respective entity from engaging in behavior that is probable to cause substantial injury to the financial interest or property of the entity or investors;
2. They have a reasonable basis to believe that the respective entity is engaging in conduct that will prevent an investigation of the misconduct; or
3. At least 120 days have passed since the whistleblower reported the violation through the entity’s internal compliance system, before reporting it to the SEC.
In this connection, in 2014 the SEC awarded over $300,000 to an individual with internal audit responsibilities that provided critical information to the Commission at least 120 days after the whistleblower reported the violations internally.
Also, on April 22, 2015 the SEC awarded $1.6 million to a compliance officer who reported the securities violation to the Commission, because the officer had a reasonable basis to believe that disclosure to the SEC was necessary to prevent imminent misconduct from causing substantial financial harm to the company or investors.
In addition, the following categories of whistleblowers are not eligible to receive an award:
a) Officers and employees of the Commission, other government agencies, or any law enforcement organization;
b) Foreign government officials;
c) Persons who are convicted of a criminal violation that is related to the SEC action or related action;
d) Persons who obtained the original information through an audit of an entity’s financial statements, and making a whistleblower submission would be contrary to the audit requirements of Section 10A of the Securities Exchange Act of 1934. Auditors already have the legal obligation to report consequential illegal acts by directors, management and other employees to the appropriate level of management and audit committee of the issuer. They also must report material illegal acts to the SEC that have not been remediated, after the auditor informed the board of directors about them and the board of directors failed to report them to the Commission. However, auditors who submit tips about possible violations concerning their own firm’s performance of audit services are eligible;
e) Persons who acquired the original information with the intent to evade any provision of the SEC’s rules;
f) Persons who knowingly make false representations to the Commission.
Except for those whistleblowers who under the SEC’s Final Rules are not allowed to receive an award, a whistleblower employee may be eligible for an award, if he reported the securities violation to the company’s internal compliance department, and within 120 days of reporting it internally he also reports the information directly to the Commission. However, internal reporting is not necessary.
Common Characteristics of Whistleblower Award Recipients
The SEC has stated that whistleblower award recipients had certain commonalities. First, they provided specific, credible and timely tips. These tips included the identity of the individuals involved in the fraud, specific documents that substantiated the allegations or described the fraudulent transactions, and the tips related to misconduct that was current or ongoing.
Second, almost 50 percent of the award recipients were current or former employees of the company committing the securities violation, while the remaining award recipients were either investors who had been victims of the fraud, contractors to the company, or had a personal relationship with one of the defendants.
Procedures for Reporting a Tip
To be eligible for an award, the whistleblower must provide the SEC with original information about a possible federal security laws violation either through the Commission’s online Tips, Complaints and Referrals questionnaire or by completing Form TCR and faxing or mailing it to the Office of the Whistleblower. Furthermore, the informant must declare under penalty of perjury that the information submitted is true to the best of the whistleblower’s knowledge and belief.
The whistleblower may submit the information to the SEC anonymously. To do so, the whistleblower must be represented by an attorney. Before the Commission will pay any award, however, the whistleblower must disclose his identity to the Commission on Form WB-APP discussed below. The disclosure of the whistleblower’s identity to the SEC is required because the Office of the Whistleblower needs to determine whether the whistleblower pertains to a category of individuals who are not eligible to receive an award. The SEC will not publicly disclose the identity of a whistleblower, except that in a court proceeding the Commission may be required to produce documents which would reveal the whistleblower’s identity.
Since the inception of the SEC whistleblower program in August 2011 through Sept. 30, 2015, the Commission has received 14,116 tips, of which 3,923 were received during fiscal year 2015, an 8.4 percent more than in 2014.
For fiscal year 2015, except for the “Other” category, the most common types of complaints reported were:
a) Corporate Disclosure and Financials (17.5 percent). This category includes corporate governance violations, executive compensation violations, failure to notify shareholders of corporate events, false financial statements, false offering documents, failure to file reports, etc.;
b) Offering fraud (15.6 percent), including Ponzi schemes;
c) Manipulation of securities/prices (12.3 percent); and
d) Insider trading (7 percent).
Additional subjects of complaints included Foreign Corrupt Practices Act violations and trading and pricing violations (e.g., inaccurate quotes).
In fiscal year 2015, the SEC received complaints from 4,135 individuals, of which 69.9 percent were from the United States, 10.2 percent were from a foreign country, and 19.9 percent did not specify a country. The states within the U.S. with the highest number of individual reporting tips were California (22.3 percent) and New York (9.0 percent).
The program is not restricted to United States citizens or residents. Foreign individuals living abroad may submit tips and be eligible to receive an award. In this regard, on Sept. 22, 2014 the SEC awarded more than $30 million to a non-U.S. resident who provided original information related to an ongoing fraud. The award is the largest ever made by the Commission to date.
In fiscal year 2015, the SEC received Form TCRs from individuals in 61 foreign countries. Of the 421 foreign individuals reporting complaints, the highest number came from the United Kingdom (17.1 percent), Canada (11.6 percent), China (10.2 percent), India (7.8 percent), and Australia (6.9 percent).
Considering Latin America only, Brazil and Mexico accounted for the largest percentage of individuals reporting tips since the Program started (each with 21.8 percent) followed by Argentina (18.6 percent).
The SEC’s Office of Market Intelligence assesses every TCR submitted, identifying those with high-quality information and assigning them to the appropriate enforcement office within the Commission.
Procedures for Applying for an Award
For each SEC action where a final judgment alone, or collectively with other judgments previously entered in the Commission action, results in monetary sanctions exceeding $1,000,000, OWB posts on its website a Notice of Covered Action, or NoCA.
An individual has 90 calendar days from the date of the NoCA to file a claim for an award on Form WB-APP, Application for Award for Original Information Provided Pursuant to Section 21F of the Securities Exchange Act of 1934, or the claim will be barred. The whistleblower must sign Form WB-APP as the claimant and mail or fax it to the Office of the Whistleblower, or OWB.
For example, on Feb. 27, 2015, OWB posted Notice 2015-17, notifying that the U.S. District Court for the Southern District of New York entered default judgments against eight Argentine citizens. Because they violated the securities registration laws, the court disgorged $33.3 million from defendants, and ordered the payment of penalties of $160,000 per defendant, totaling $34.6 million in monetary sanctions. Individuals who had previously submitted the tip to the SEC had until May 28, 2015 to file Form WB-APP to claim an award.
OWB evaluates each award application and prepares a written recommendation. The Claims Review Staff considers OWB’s recommendation, and then issues a preliminary determination allowing or denying the whistleblower claim and, if allowed, determining the proposed award percentage. Preliminary determinations are communicated to whistleblowers to give them a chance to submit a written response to OWB.
All Final Orders denying a whistleblower claim or approving an award are posted to OWB’s website but are redacted to protect the identities of the whistleblowers.
If the SEC denies an application for an award, the whistleblower may appeal the Commission’s decision in the appropriate United States Court within 30 days of the Final Order.
Payment of a whistleblower award will be made on the later of the date on which the monetary sanction is collected or upon the completion of the appeals process for all whistleblower award claims.
Relevance of the Dodd-Frank Whistleblower Program
Violators of federal securities laws seldom act in isolation and go unobserved. Actions taken in connection with false accounting entries, deceitful offering materials and false statements to facilitate a Ponzi scheme are likely to be observed by people who are not involved in the actual scheme.
The Dodd-Frank whistleblower program was designed to encourage individuals to submit relevant information to help the SEC prevent, detect and prosecute violations of federal securities laws and the Foreign Corrupt Practices Act. The program motivates individuals to come forward by providing them with the possibility of claiming significant monetary awards, shielding them against employer retaliation, and protecting their identities.
The recent experience of the program in terms of the increased number of whistleblower tips submitted and successful enforcement actions suggests that it is an important tool for combating securities fraud in the United States.
Eduardo Singerman, CFE, CPA, is a litigation director in the Global Forensics practice at BDO USA in the firm’s New York office. Paul S. Hugel, Esq., is an attorney who specializes in federal securities laws and partner at Clayman & Rosenberg, a New York law firm.