On June 12, 2013, the Securities and Exchange Commission ("SEC" or "the Commission") announced that three claimants would receive awards under the whistleblower bounty program created as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 922, 124 Stat. 1376, 1841 (2010) ("Dodd-Frank" or "the Act").1 The three awards come nearly a year after the SEC announced the first award under Dodd-Frank's whistleblower provisions.2 As with the first award claimant, the Dodd-Frank confidentiality provisions prevent the disclosure of the identities of the three award recipients.
- Analysis of the Award
According to the SEC's Order Determining Whistleblower Award Claim, the three claimants "voluntarily provided original information to the Commission that led to a successful enforcement action" in SEC v. Andrey C. Hicks and Locust Offshore Management, LLC, 1:11-cv-11888-RGS (D. Mass. 2011) (the "Locust Matter") and, as a reward for providing this information, each will receive five percent (5%) of the total monetary sanctions collected as part of the action.
The SEC has described Locust as a "sham hedge fund" whose chief executive, Audrey Hicks, defrauded investors of $2.7 million by misleading them about his credentials and diverting their funds into his personal bank account.3 In March 2012, the United States District Court for the District of Massachusetts entered default judgments against both Locust and Hicks and ordered them to pay roughly $7.5 million in disgorgement and penalties. Because the SEC has not collected any portion of that amount to date, the whistleblowers cannot yet collect their award from the Investor Protection Fund. The Department of Justice ("DOJ"), however, has collected approximately $800,000 in a related action, and under section 21F(b)(1) of the Securities Exchange Act and its implementing regulations, 17 C.F.R. § 240.21F-11, the three whistleblowers are entitled to apply to the SEC to receive an award based on amounts collected by DOJ.
The three awards are notable for their relatively small size, both in terms of the percentage of the total possible award (the 15% collectively awarded to the claimants is only half of the maximum award of 30%), as well as the absolute dollar amounts, though this result is simply a reflection of the modest penalties collected thus far in the action. Indeed, the total monetary sanctions associated with the action could be approximately $10.5 million.4 Though the final award amount likely will pale in comparison with amounts awarded under other government whistleblower programs-such as the $104 million awarded to a whistleblower by the Internal Revenue Service in September 2012 5-it nevertheless still would be substantially more than the amount of the first SEC whistleblower award of $50,000, which was 30% of the total recovery to date in that action.
The recent Order additionally denied an award to a fourth claimant because that claimant's tips regarding "naked short selling" did not contain information on the Locust Matter and did not mention the Locust Matter defendants, and the Commission's complaint in the action did not make allegations of "naked short selling." More specifically, the Commission agreed with the Office of the Whistleblower's Claims Review Staff's December 2012 Preliminary Determination that the fourth claimant's claim be denied because 1) the information provided prior to July 21, 2010 was not "original information" as defined by Dodd-Frank because it was not supplied after the date of the Act's enactment; and 2) the information that was provided after July 21, 2010 did not lead to the successful enforcement of the Locust Matter. As such, there was no basis for a whistleblower award for the fourth claimant.
- More Awards to Come?
The lack of announced awards during the nearly two years in which the Office of the Whistleblower has operated should not be seen as an indication that the office is not receiving tips or contemplating whistleblower awards. In an interview related to the announcement of the latest awards, the head of the Office of the Whistleblower, Sean McKessy, stated, "We are likely to see more awards at a faster pace now that the program has been up and running and the tips we have gotten are leading to successful cases."6 McKessy has previously remarked that the $453 million currently contained in the Investor Protection Fund is "burning a hole in my pocket."7 Given the amount of time necessary to bring a complex enforcement action where the monetary sanctions reach into the tens-if not hundreds-of millions of dollars, it is little surprise that there have been so few SEC whistleblower awards. As more large investigations turn to enforcement actions and the whistleblower program receives more attention, announcements of large whistleblower awards likely are to become more common. And, as they do, and as announced awards become higher dollar figures, the ever-present threat of whistleblower reporting outside a company's internal reporting processes is likely to increase.
- Reminder for Public Companies Dealing with Whistleblowers8
The SEC's second award under the whistleblower provisions of the Dodd-Frank Act provides a reminder to public companies of the critical importance of establishing and maintaining a tailored compliance and internal reporting program. Indeed, as more awards are announced, knowledge of the program will spread, prompting companies to take steps to ensure the effectiveness of their compliance and internal reporting systems. Although off-the-shelf programs may be a useful start, they are unsuitable as a final form for most public companies. Guidance from both DOJ and the SEC stress the importance of having a compliance program tailored to specific risks and nuances of a company and its industry.9
Companies should strive to encourage employees to report any suspected violations of law or the company's code of conduct to company compliance, internal audit, or legal personnel. Company culture-including "tone at the top"-is an important factor not only in encouraging employees to make use of internal reporting systems but also in demonstrating a commitment to compliance with the laws. Companies should ensure that employees are trained on the company's code of conduct and on the requirement to comply with applicable laws, including the Foreign Corrupt Practices Act ("FCPA") and the UK Bribery Act.10 During the training, appropriate emphasis should be placed on encouraging employees to utilize internal reporting channels, such as hotlines, and on the importance of reporting violations of the code of conduct or laws. Such training programs are critical to reducing violations of law, to mitigating any sanctions for the company if employees violate the law,11 and to encouraging internal reporting of suspected misconduct.
A critical component of every corporate compliance program, especially now, is a formalized process to identify and promptly respond to potential violations of federal securities laws. Companies must have anonymous reporting hotlines for employees and vendors and should develop a system in which tips and complaints can be prioritized based on risk. A pre-identified outside counsel should be engaged to investigate more serious allegations such as alleged misconduct by management, violations of the FCPA, and significant accounting violations. With the potential for employees to go straight to the SEC with allegations, companies must treat every allegation seriously and promptly investigate potential violations of federal securities laws so that the company can be in a position to remediate the wrongdoing and to self-report the possible violations to the SEC and, where appropriate, to the DOJ.
Companies face additional challenges in situations where a whistleblower complaint is brought to their attention in the first instance by the SEC. In those instances, companies should recognize that the SEC Enforcement Staff nonetheless will welcome a credible and thorough internal investigation, even after having received a whistleblower tip or complaint.12
Given the Dodd-Frank Act's anti-retaliation provisions,13 companies should consider whether and to what extent they want to take steps to identify the individual who reported to the Commission. If a company has uncovered the identity of the whistleblower, then it must determine whether and to what extent it wants to keep the whistleblower informed of the status (but not the findings) of the internal investigation.