SEC Forecasts an Increase in Whistleblower Cases and Awards

The following post comes to us from Michael T. Jones, partner in the Litigation Department at Goodwin Procter, and is based on a Goodwin Procter client alert by Mr. Jones and Jennifer Chunias.

On June 12, 2013, the U.S. Securities & Exchange Commission announced its second-ever whistleblower award under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Having received over 3,000 whistleblower tips in the first year of the revamped program, the SEC made its first whistleblower award in August of 2012 and is expected to issue an increasing number of awards in the coming months.

Among other things, Dodd-Frank provides a direct mechanism for whistleblower complaints to the SEC and enhanced protection for eligible whistleblowers who come forward and cooperate in SEC investigations and proceedings involving the corporation that employs them. Dodd-Frank also authorized the SEC to provide incentives in the form of financial awards to eligible whistleblowers who voluntarily provide the SEC with original information about a violation of federal securities laws that leads to successful enforcement proceedings—10 to 30 percent for penalties collected over $1 million. Particularly in light of the recent awards and the expected uptick in the coming months, companies that fail to take appropriate steps to respond to the increased risks associated with the program could pay a steep price.

The Second Wave of Rewards

Earlier this month, the SEC announced that it will present Dodd-Frank whistleblower awards to three individuals. Without naming the whistleblowers, the SEC announced that these three individuals will receive 5 percent of any sanctions the SEC will collect from its enforcement action against Locust Offshore Management LLC and its CEO Andrey C. Hicks, which is currently pending in Massachusetts federal court.

The SEC indicated that two of the whistleblowers provided the information that triggered the investigation, while the third provided confirmatory evidence. The actual amount each whistleblower will receive is unclear. While it has not yet collected any of the $7.5 million judgment in the Locust case, the SEC has indicated that the whistleblowers may apply for an allocation from the $800,000 collected by the Department of Justice in the companion criminal case.

Recent comments made by SEC staff suggest that these three awards are just the first of many to come. Stephen Cohen, Associate Director of the SEC’s Division of Enforcement, recently commented on the future of whistleblower program at a Corporate Crime Reporter conference. Mr. Cohen indicated that the program will produce “incredibly impactful cases” including some with “some extremely significant whistleblower awards.” Mr. Cohen went on to add, “[t]here will be a likely change in the discussion about the magnitude of some of these awards over the next six to twelve months.”

The Whistleblower Pipeline

The comments noted above are not surprising given the results discussed in the SEC’s Annual Report on the Dodd-Frank Whistleblower Program for fiscal year 2012, which was released in November 2012. In the report, the SEC stated that it had received 3,001 whistleblower tips for the fiscal year ending on September 30, 2012.

As was the case in 2011, the year the program was launched, the largest four categories of whistleblower tips involved allegations related to corporate disclosure and financials, offering fraud, manipulation and insider trading. The remaining tips involved a wide variety of other allegations, including FCPA violations, trading and pricing violations, unregistered offerings, and municipal securities and public pension violations.

The states with the largest number of whistleblower tips were California (14.5%), New York (8.2%), Florida (6.7%) and Texas (5.3%) with all other states accounting for 48.8% of the total. Over 10% of the whistleblower tips during the first year of the Dodd-Frank whistleblower program originated outside the United States. The largest number of international tips came from the United Kingdom, followed by Canada and India.

While the extraterritorial reach of the program’s provisions is not a settled issue, these complaints at least make clear that employees of United States companies operating in foreign jurisdictions are also aware of the SEC’s rising enforcement activity and increased protections and incentives for employees who report violations at their companies.

While it is still unclear exactly how many of these tips will ultimately result in investigations or prosecutions, the expansion of the whistleblower program is expected to lead to an increase in the SEC’s already active enforcement in a variety of areas—including accounting fraud, insider trading and the FCPA. The incentives for whistleblowers to report violations follow increased enforcement efforts by the SEC over the past several years in an expanding array of areas.

Practical Preparedness

An effective whistleblower program is essential to any corporate compliance program and promoting a culture of transparency and compliance throughout the organization. Particularly in light of these recent expansions and SEC signals that more significant whistleblower cases and awards are on the horizon, public companies should revisit their whistleblower and hotline reporting policies and make them as simple and productive as possible, including training under those policies. There are a few key benchmarks of an effective whistleblower program:

  • Choice of reporting mechanisms – Regardless of how a complaint is initiated (through an anonymous hotline, during a conversation with a supervisor, internally from an employee or from an external source), a company should follow a standard protocol for addressing such allegations. This protocol should ensure that complaints are responded to promptly and documented correctly.
  • Anonymity and confidentiality – Among other things, Section 301 of the Sarbanes-Oxley Act of 2002 requires that audit committees establish procedures for “the confidential, anonymous submission by employees of the issue of concerns regarding questionable accounting or auditing matters.” As a practical matter, if a company does not have a mechanism in place to accept complaints with a high degree of assurance that confidentiality will be preserved, this will significantly undermine the motivation to report internally.
  • Simplicity and accessibility – A whistleblower program that facilitates ease of use will be more likely to encourage employees to use internal systems rather than going directly to the government. For internal reporters, it needs to be obvious how to file a complaint and the procedure should be simple. In addition, companies may wish to explore how to encourage internal reporting, whether through training, or offers of perks or other benefits to those reporting true concerns.
  • Updates on progress of the complaint – Whistleblowers typically want to know that their claims are being taken seriously and reviewed by qualified advisors. While such reassurance is important, it is also necessary to protect both the privacy of the whistleblower and others who may be affected by the complaint, as well as the company itself. This can be a complex series of considerations, which should be addressed thoughtfully with counsel.
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