SEC's $14 Million Award Highlights the Importance of Effectively Responding to Internal Whistleblower Reports

10/09/2013

After two years of operations, the SEC’s whistleblower program announced its first multimillion dollar award - a record $14 million payment to an anonymous tipster. The award is the largest of three announced since the program’s inception and emphatically signals the SEC’s continuing emphasis on its whistleblower program. Since whistleblower activity is likely to increase, public companies should take steps to leverage the incentives provided in the Dodd-Frank Act and implement procedures that encourage internal reporting. By designing a system of internal controls and processes to handle internal complaints, companies can quickly discover and halt ongoing violations, avoid external reporting of frivolous complaints through an effective investigation and feedback system, and benefit from SEC rules that give credit to companies with effective compliance procedures.

SEC Awards $14 million to Whistleblower

On October 1, 2013 the U.S. Securities and Exchange Commission announced an award of more than $14 million to an unidentified whistleblower whose information led to an SEC enforcement action that recovered substantial investor funds. The whistleblower provided original information and assistance that enabled the SEC to bring an enforcement action more quickly than it could have otherwise - less than six months after receiving the whistleblower’s tip. This is the largest award made by the SEC’s whistleblower program to date. The $14 million award is expected to draw increased attention to the whistleblower program and will likely increase the number of whistleblower tips. SEC Chair Mary Jo White has stated that the SEC “hope[s] an award like this encourages more individuals with information to come forward.”1

How the SEC Whistleblower Program Works

The SEC’s Office of the Whistleblower (the “OWB”) was established in 2011 as authorized by the Dodd-Frank Act. The whistleblower program rewards whistleblowers who share high-quality original information that results in an SEC enforcement action with sanctions exceeding $1 million. The whistleblower awards can range from 10 to 30 percent of the money collected in a case.2 According to the OWB’s 2012 Annual Report on the Dodd-Frank Whistleblower Program, last year the Office received more than 3,000 tips from individuals in all 50 states and from 49 countries outside of the United States.3 The four most common categories of whistleblower tips were Corporate Disclosures and Financials, Offering Fraud, Manipulation, and Insider Trading.

Despite the high number of complaints received since the inception of the program, the SEC only publicly announced two previous whistleblower awards. The first award, issued in August 2012, was less than $50,000 paid to a whistleblower who helped stop an unidentified multi-million dollar fraud.4 The second award, announced in August 2013, was a total of $125,000 paid to three whistleblowers who assisted in the SEC’s enforcement action against sham hedge fund Locust Offshore Management LLC and its CEO Andrey C. Hicks.5

This $14 million award reflects the strong financial incentive a whistleblower has to report high-quality original information to the OWB. The attention drawn to this award will likely cause a further uptick in whistleblower tips and enforcement activity. As a result, public companies should evaluate their own compliance programs to ensure that they have effective processes and procedures in place.

Evaluating Compliance Programs in Light of the SEC Whistleblower Program

A company should maintain an atmosphere of ethical and law-abiding conduct that emphasizes the importance of compliance with regulatory requirements and adherence to ethical corporate practices. A strong compliance program will have several components:

  • Regular training of employees on pertinent regulatory requirements.
  • Adoption of appropriate corporate codes of conduct and whistleblower policies that encourage internal reporting of issues or concerns.
  • Procedures that facilitate conducting appropriate investigation of complaints.
  • Clearly communicating that intentional misconduct is not tolerated through appropriate discipline upon discovery of violations.

Effectively Investigating and Addressing Whistleblower Complaints

While the Dodd-Frank Act does not require internal reporting, it encourages potential whistleblowers to first report internally. The rules make clear that the SEC will consider, in determining the amount of an award, whether the whistleblower first assisted with any company investigation.6 Whistleblowers who report internally can maintain their priority status over other whistleblowers for 120 days to permit a company to conduct an internal investigation.7 Finally, a whistleblower who reports internally can receive credit for all information that is subsequently self-reported by the company.8

Given these incentives for internal reporting and the rewards to employees for external reporting, companies should be prepared to quickly and effectively respond to any internal reports of a potential securities violation. A successful response plan should include:

  • Protocols for delegating responsibility to quickly assess the seriousness of alleged violations;
  • Identified outside experts in appropriate fields, including outside counsel, forensic accountants, or electronic evidence experts as needed;
  • Investigation protocols that enable:
    • A highly-focused initial inquiry with procedures to assist in making a determination whether investigation is required.
    • Preservation of all appropriate electronic evidence.
  • A procedure for selecting an investigation timeframe that permits the company an opportunity to consider self-reporting within the 120-day whistleblower look-back period.
  • A plan for making a determination whether to self-report a violation to the SEC.

The company should also consider establishing procedures for communicating with whistleblowers during an investigation. In addition to policing compliance with anti-retaliation rules, communication with a whistleblower can provide a company with an opportunity to mitigate the risk that the whistleblower will prematurely report to the SEC before learning about the seriousness of the company’s response, any conclusion the company reaches about wrongdoing or materiality, and any remedial or disciplinary action taken by the company.

Following a common set of procedures after an internal report of a potential securities violation will benefit a company whether or not the report turns out to be frivolous. Where there has been a frivolous complaint, comprehensive procedures will lead to a fulsome investigation and report of the relevant conduct that will assist the company in later addressing any SEC inquiry or legal action. If the complaint proves legitimate, the company can stop the offending conduct expeditiously, take appropriate discipline, modify internal systems to prevent future violations, and potentially benefit from self-reporting to the SEC under the new cooperation rules.9

Conclusion

In the event that SEC Chair White’s prediction is correct, and the recent $14 million award “encourages more individuals with information to come forward,” public companies would be well-advised to encourage internal reporting of potential violations, and to have a plan in place to address those reports in a manner that helps the company to quickly and effectively address them.

For more information, please visit the SEC Enforcement and Internal Corporate Investigations pages of the Haynes and Boone, LLP website, or contact one of the attorneys below.

Kit Addleman
214.651.5783
kit.addleman@haynesboone.com

 

Ronald W. Breaux
214.651.5688
ron.breaux@haynesboone.com

Kathleen M. Beasley
214.651.5697
kathleen.beasley@haynesboone.com

David Siegal
212.659.4995
david.siegal@haynesboone.com

Melissa M. Goodman
214.651.5628
melissa.goodman@haynesboone.com

Dean J. Schaner
713.547.2044
dean.schaner@haynesboone.com

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1 Order Determining Whistleblower Award Claim, Securities Exchange Act of 1934 Release No. 70554 (Sep. 30, 2013).
2 Implementation of the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934, Release No. 34-64545, 17 CFR Parts 240 and 249 (May 25, 2011).
3 Annual Report on the Dodd-Frank Whistleblower Program for Fiscal Year 2012 (Nov. 15, 2012), available at https://www.sec.gov/about/offices/owb/annual-report-2012.pdf.
4 See Order Determining Whistleblower Award Claim, Securities Exchange Act of 1934 Release No. 67698 (Aug. 21, 2012); Order Determining Whistleblower Award Claim, Securities Exchange Act of 1934 Release No. 67699 (Aug. 21, 2012).
5 Order Determining Related Action Whistleblower Award Claims, Securities Exchange Act of 1934 Release No. 70293 (Aug. 30, 2013).
6 Rule 21F-6(a)(4) of the Securities Exchange Act of 1934.
7 Rule 21F-4(b)(7).
8 Rule 21F-4(c)(3).
9 SEC Announces Initiative to Encourage Individuals and Companies to Cooperate and Assist in Investigations (Jan. 13, 2013).

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