SEC Whistleblower’s Program Working…Slowly

Sep 5 2014 | 4:30am ET

By Mary Campbell
Senior Reporter, FINalternatives

Prior to the creation of the SEC Whistleblower Program, law enforcement authorities were like “beat cops without a 911 system,” said one of the architects of that program.

“We were policing the streets looking for disturbances and problems but didn't have a mechanism that effectively allowed people to notify us of wrongdoing,” Jordan Thomas told FINalternatives' Mary Campbell in a recent interview.

Now a lawyer in Labaton Sucharow's whistleblower practice, Thomas was one of a handful of people tasked with designing a whistleblower program for the SEC—an idea first articulated by former chair Mary Schapiro during her confirmation hearings.

“One of the great mysteries for law enforcement and regulatory organizations has been why more witnesses have not come forward and reported some of the wrongdoing that has led to high-profile corporate scandals and the financial crisis,” said Thomas. “And one of the key conclusions was that we needed to better incentivize and protect...individuals who wish to report possible securities violations.”

To do so, the Office of the Whistleblower (OWB) was created with the mandate of overseeing the SEC's Whistleblower Program. Following the passage of the Dodd-Frank Act in 2010, the Whistleblower Program was formally launched in August 2011.

Since that time, the program has received over 6,500 tips (3,238 in 2013 alone) and made 11 awards to five individuals (occasionally a tip will result in multiple awards to the same whistleblower). The largest award to date was $14 million to an anonymous tipster (whose cover was later blown, but more on that later).

Incentives

To “incentivize” whistleblowers, the OWB followed the example of other government bodies—including the Department of Justice and the Internal Revenue Service—and offered monetary rewards. 

More precisely, individuals who “voluntarily provide the Commission with original information that leads to a successful enforcement action resulting in monetary sanctions of over $1 million may be eligible for an award equal to 10-30% of the monies collected by the Commission or in a related action.”

But just how big a motivating factor is the reward? According to Thomas, the image of the whisteblower as mercenary or “in it for the money” is overblown:

“That has not been what I saw at the Commission and it's not what I'm seeing in private practice. And this view is consistent with  numerous surveys by the Ethics Resource Center and other organizations which have found that the vast majority [of whistleblowers] report internally first. And whistleblowers would not report internally first if they were only about the money because reporting internally represents risk.”

And while the promise of a reward does bring some people forward who might never have come otherwise, Thomas said there are many other reasons why people decide to blow the whistle:

“Sometimes they're boy scouts and they just believe that people should report wrongdoing when they see it. Some are troubled by the fact that their organization may be tarnished by wrongdoing and they want to put a stop to it and they either feel that they won't be effective reporting internally or they tried to deal with it internally and have been unsuccessful. There are times that people are more concerned about their own situation. So, they're in a group, the group's doing things that are illegal or unethical and they don't want to be implicated in it and they see that the only way to get out of it is to leave or report it so that they're not implicated.

“There's times where people report wrongdoing because they think it's unfair that some people have been promoted or financially rewarded for engaging in wrongdoing when they didn't or wouldn't. Periodically you'll have the ex-spouse who will report for  personal reasons that you can guess.”

But the number one reason why people come forward, in Thomas' experience? Retaliation.

“Companies regularly tell their employees that if you know about wrongdoing, report it. And the vast majority of people do and if they perceive that they've been retaliated against, that breaks their tie to the organization and they no longer care. At that point they want to prove that they're right and they want the company to be held accountable—not only for the wrongdoing now but for retaliating against them.

“If I were giving one piece of advice to responsible organizations, I would say: Be aggressive in your efforts to protect people who report wrongdoing, whether they're right or wrong, because a whistleblower who believes they've been retaliated against is much more likely to report externally.”

Protection

In June, the SEC brought its first ever retaliation charge against a company—hedge fund Paradigm Capital Management. Paradigm and its chief executive were accused of “engaging in prohibited principal transactions and then retaliating against the employee who reported the trading activity to the SEC.” The firm and its owner agreed to pay nearly $2.2 million to settle the SEC’s claims.

In a June 2014 article on the subject, attorneys with Foley & Lardner warned that this is unlikely to be the last such case:

“The SEC may soon bring additional enforcement actions under far different facts. For example, the SEC may bring a stand-alone enforcement action for violation of the anti-retaliation provision, including in cases in which the whistleblower incorrectly (but "reasonably") thought there was a potential securities law violation. In addition, the SEC asserts that a whistleblower need not report to the SEC in order to be protected by the anti-retaliation provisions. Thus, the SEC's enforcement of the anti-retaliation provisions could have far broader application in the future.”

But Thomas—who admits he's biased because the whistleblower in the Paradigm case was one of his clients—thinks this is a good thing:

“Essentially, whistleblowers now have a big brother with a big stick to protect them that they didn't have before. That's good for the SEC whistleblower program and it's good for whistleblowers because now they're more likely to come forward because they know that they're going to be backed up by the SEC.”

Of course, companies are also mobilizing to deal with potential whistleblowers and one way they are doing so is through increasingly broad confidentiality agreements. These, in Thomas' opinion, are “unenforceable,” but as the SEC has yet to address the issue, Labaton Sucharow, in conjunction with the Government Accountability Project and other concerned parties, has asked the Commission to hold hearings on the issue.

“Corporate America is likely to argue that these confidentiality agreements serve an important corporate interest of protecting their corporate intelligence or operations whereas law enforcement organizations and whistleblower advocates will be arguing that anything that impedes people from coming forward is against public policy.”

By deciding the issue, he said, the SEC “will essentially...establish the new best practice.”

Anonymity

That said, the best protection for whistleblowers may be reporting anonymously.

“For many of the senior people I represent, their greatest fear, the great deterrent for coming forward, is the fear of blacklisting and retaliation...[R]eporting anonymously provides a powerful and effective means to avoid that.”

Thomas said that between the SEC's efforts to protect the identity of whistleblowers and the techniques used by “sophisticated counsel,” people have been able to remain anonymous.

“For instance, the $14 million [award] was the largest award by far and every major media organization in the country wanted to know who that person was, but they weren't discovered until there was a dispute between the whistleblower and someone else who claimed the whistleblower promised them part of the award and when they fell out, the disappointed individual filed a public suit against the whistleblower, outing him...I guess the lesson from that is, if you want to be anonymous, don't promise people any of your winnings…and fail to pay them.”

But while the program is able to protect whistleblowers' identities, it is not always so great at keeping them informed of the status of their cases. This troubles Thomas:

“Because the SEC is unwilling or unable to communicate with whistleblowers, some of those whistleblowers, over time, are going to become frustrated and they are more likely to report issues and concerns to the media, to Congress and that's unfortunate...if the Commission has done or is doing a thoughtful investigation.”

“The other thing is, the SEC receives 30,000 tips in the course of a year and they can only actively investigate about 2,000 tips and those cases take two to four years to do and that means that there's only about 700-800 opportunities for new cases, so there's a lot of folks who are going to be disappointed that the SEC is not investigating their case. I worry about the backlash of disappointed whistleblowers.”

But, he adds quickly, it's a problem the SEC is even now attempting to solve:

“They're aware of the problem and I think that they're working through it.”


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