The Securities Exchange Commission (“SEC”) is continuing to promote its whistleblower reward program and recently announced awards to two individuals who provided key information leading to successful SEC enforcement actions. One whistleblower, a compliance officer, will receive an award of approximately $1.5 million. The other whistleblower, a former head trader, will receive a maximum payout of 30 percent of the amounts collected (which totals over $600,000). The string of recent whistleblower awards and the SEC’s emphasis on the whistleblower complaint process highlight what has become the new “normal” for public companies – spelling out policies for and maintaining an environment to encourage internal reporting of potential misconduct. Only by developing a mechanism that allows employees to internally report suspected misconduct without fear of retribution, and by responding promptly and appropriately to reports of potential violations, can a company stay abreast, or even ahead, of potential SEC investigations.
Under Dodd-Frank, the SEC is authorized to provide monetary awards to individuals who provide original information that leads to a successful enforcement action resulting in over $1 million in monetary sanctions, which includes penalties, disgorgement, and interest. A whistleblower’s award is discretionary, and may range from 10 to 30 percent of the monetary sanction. Since its inception in 2011, the program has received an increasing number of whistleblower tips each year. In FY2014, the SEC reported receiving 3,620 tips and subsequently issued more whistleblower awards than in all previous years combined. The two whistleblower awards discussed below both stem from successful enforcement actions by the SEC.
The $1.5 million award made recently to a company’s compliance officer is only the second time the SEC has offered an award to such an employee. Under the SEC’s rules, employees with compliance or internal audit responsibilities are generally ineligible for whistleblower awards unless they fall within the following limited exceptions: (a) the employee reasonably believes disclosure is necessary to prevent substantial injury to the company or investors, (b) the employee reasonably believes the company is engaged in conduct that will impede investigation into the misconduct, or (c) at least 120 days have elapsed since the employee internally reported the misconduct or received the information under circumstances indicating that the company was aware of the misconduct. According to the SEC’s announcement in this case, the compliance officer reported the alleged misconduct to the SEC “after responsible management . . . became aware of the potentially impending harm to investors and failed to take steps to prevent it.”
Also since the passage of Dodd-Frank, the SEC is authorized to bring enforcement actions based on retaliation against whistleblowers who report violations to the SEC. The other recently announced whistleblower award, in the amount of $600,000, arises from the SEC’s first enforcement action under that rule, In the Matter of Paradigm Capital Management, Inc. and Candace King Weir, File No. 3-15930 (June 16, 2014). According to the SEC in that matter, after the whistleblower reported to the SEC, the company “immediately engaged in a series of retaliatory actions . . . including removing the whistleblower from the whistleblower’s then-current position, tasking the whistleblower with investigating the very conduct the whistleblower reported to the SEC, changing the whistleblower’s job function, stripping the whistleblower of supervisory responsibilities, and otherwise marginalizing the whistleblower.” These retaliatory actions ultimately led to the head trader’s resignation. In light of the “unique hardships” suffered by the whistleblower, the SEC awarded the whistleblower the maximum payment of 30 percent of the funds paid by Paradigm.
Generally speaking, companies prefer for employees to report potential misconduct internally, rather than to the SEC, so that the company has the opportunity to conduct an internal investigation and then self-report violations, as necessary. However, employees are sometimes loath to report internally, for a variety of reasons, including fear of retaliation. (Employees’ motivations to report externally are amplified in the Fifth Circuit by Asadi v. G.E. Energy (USA), 720 F.3d 620 (5th Cir. 2013), in which the Fifth Circuit held—contrary to numerous lower courts and the position taken by the SEC itself—that whistleblower protections – including bounties – apply only to individuals who provide information to the SEC.)
The existence and encouragement of whistleblowers is the new normal for the SEC. It is therefore important for companies to have policies and procedures in place to properly and effectively handle allegations of misconduct. Upon receiving an internal report of potential misconduct, companies should immediately assess the nature and credibility of the allegation to determine whether to open a formal investigation. In making this determination, companies need to have a clear understanding of their obligations under SEC rules and all other applicable laws. To encourage internal reporting, companies also should consider the following:
- Promote a culture of compliance that fosters open communication between management and employees and removes any fear of adverse action against employees who report misconduct
- Train managers and supervisors on how to react to employees who report wrongdoing
- Establish a program that incentivizes employees to internally report wrongdoing
- Provide periodic updates to employees who make internal reports so they are confident their concerns are being addressed
- Create multiple avenues for employees to report misconduct
- Publicize enhancements to a company’s internal reporting program