In its 2016 annual report to Congress, the Securities and Exchange Commission acknowledged that fiscal year 2016 was historic for the Dodd-Frank Whistleblower Program.
Since the beginning of the program in August 2011 through Sept. 30, 2016, the Commission has awarded over $111 million, of which $57 million consisted of awards issued in fiscal year 2016 alone. That is, the total amount of awards issued in fiscal year 2016 was greater than the sum of the awards issued in all prior fiscal years. In fact, during fiscal year ended Sept. 30, 2016, the SEC authorized the second-highest award ever made of over $22 million.
If this by itself was not significant enough, the SEC announced on Nov. 14, 2016 an award of at least $20 million, the third-highest award ever made, to a whistleblower who provided original and timely information to the SEC that led to a near total recovery of investors’ funds. Further, on Dec. 5, 2016 and Dec. 9, 2016, the Commission announced awards of $3.5 million and almost $1 million, respectively. Thus, the program has now awarded over $136 million to 37 whistleblowers.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 established a securities whistleblower incentives and protection program, which was implemented in August 2011 after the SEC issued the final rules. The program is administered by the SEC’s Office of the Whistleblower and is based on three fundamental pillars: monetary awards, prohibition against retaliation by employers, and confidentiality protection of the identity of the whistleblower.
The program requires the SEC to pay monetary awards to eligible individuals who voluntarily provide the Commission, following the procedures established in the final rules, with original information about a violation of the federal securities laws that has occurred, is ongoing, or is about to happen. The information supplied must lead to a successful Commission enforcement action (and/or related action) resulting in a final judgment or order of monetary sanctions exceeding $1 million. No awards are paid until the sanctions are collected.
A whistleblower must be an individual. A company or any other entity may not be a whistleblower, and it is not necessary for a whistleblower to be employed by a company to submit information about that company.
The amount of the award to a whistleblower is between 10 and 30 percent of the monetary sanctions that the SEC and the other authorities in related actions (such as the U.S. attorney general), if applicable, are able to collect. The SEC has discretion to determine the award percentage within this range. Awards are not based on an exact mathematical formula, but rather on the facts and circumstances of each case.
Factors that may increase the award percentage within the legal range include the significance of the information supplied by the whistleblower, the degree of help provided by the whistleblower, the SEC’s law enforcement priorities, and whether the whistleblower reported the possible federal securities law violation through the company’s internal compliance procedures.
Factors that may reduce the award percentage within the legal range include the culpability of the whistleblower regarding the reported securities law violation, the whistleblower’s unreasonable delay in reporting the violation to the Commission, and the informant’s interference with his company’s internal compliance system to prevent or delay detection of the reported securities violation.
Congress established a separate fund termed the Investor Protection Fund to pay the awards determined by the SEC so that payments to whistleblowers do not diminish the recoveries for victims of securities laws violations. The fund’s balance as of Sept. 30, 2016, the fiscal year end, was approximately $368.1 million. In determining the award percentage, the SEC does not consider the balance of the fund.
Types of Violations of Laws Covered under the SEC Whistleblower Program
Since the inception of the program in August 2011 through Sept. 30, 2016, the Commission has received 18,334 tips, of which 4,218 were received during fiscal year 2016 alone, a 7.5 percent increase with respect to 2015. The total number of tips received in fiscal year 2016 represents the highest amount ever.
The violations of laws that can trigger an award are not restricted to classic breaches of federal securities laws, such as fraudulent financial statements of public companies whose securities are traded in U.S capital markets, deceitful offering materials, Ponzi schemes, the sale of unregistered stock to the public, securities manipulation, insider trading, trading and pricing violations, and anti-money laundering policy violations.
In fact, the Dodd-Frank Whistleblower Program extends to the reporting of violations of the Foreign Corrupt Practices Act. Common violations of the FCPA include bribes paid to foreign government officials by U.S. companies and foreign companies that have securities registered in the United States, including their subsidiaries. Violations of the FCPA also encompass inaccurate books and records and a deficient system of internal accounting controls in companies with securities listed in the U.S. stock exchanges and their subsidiaries that may facilitate the payment and concealment of bribes.
For fiscal year 2016, except for the “Other” category, the most common types of violations reported were:
a) Corporate Disclosure and Financials (22.2 percent): This category includes corporate governance violations, executive compensation violations, failure to notify shareholders of corporate events, false financial statements, false offering documents, failure to file reports with the SEC, etc.;
b) Offering fraud, including Ponzi schemes, (15.3 percent);
c) Manipulation of securities/prices (11.2 percent);
d) Insider trading (6.2 percent);
e) Trading and pricing violations, including late trading and inaccurate quotes, (6.1 percent); and
f) FCPA violations (5.6 percent).
Profiles of Award Recipients
The SEC stated that whistleblowers who have received awards since the beginning of the program through Sept. 30, 2016, had certain common characteristics. First, they supplied the SEC with specific, credible and timely information. Their tips included the names of persons involved in the fraud, provided documents that substantiated the allegations or indicated where these documents could be found, or described the specific fraudulent transactions. Additionally, the tips related to illegal acts that were recent or still ongoing at the time they were reported to the SEC.
Second, almost 60 percent of the award recipients supplied original information that caused the SEC to open an investigation, while the remaining 40 percent provided original information that significantly contributed to an investigation that was already open.
Third, almost 65 percent of the award recipients were insiders of the company committing the illegal act. Company insiders include not only ordinary current and former employees, but also compliance officers and internal auditors. The remaining 35 percent of award recipients were either investors who were damaged by the fraud, professionals working in the same or related business, or people who had a personal relationship with one of the defendants
Fourth, about 80 percent of the company insiders reported the violation to their supervisors or compliance personnel, or believed that their supervisors or compliance personnel already knew of the violation, before reporting the tip to the SEC.
Fifth, approximately 50 percent of the award recipients were represented by an attorney when they initially filed their tips with the SEC and half of them chose to file their tips anonymously.
Sixth, various award recipients submitted tips related to violations of federal securities laws by financial services firms, including broker dealers and investment advisers.
Seventh, the types of violations reported by the award recipients to the SEC included Ponzi schemes, false statements in a firm’s offering memoranda, false pricing information, false financial statements, and internal control violations, among other types of wrongdoing.
Finally, approximately 24 percent of award recipients were foreign nationals.
Geographic Location of Whistleblower Tips
In fiscal year 2016, the SEC received tips from 4,453 individuals, of which 69.3 percent were from the United States, 10.4 percent came from a foreign country, and 20.3 percent did not specify a country.
Under the Dodd-Frank Whistleblower Program, two or more individuals can jointly submit a tip. This explains why the number of individuals submitting a tip in fiscal year 2016 (4,453) exceeded the number of tips received (4,218).
The states within the US with the highest number of individuals reporting tips were California (17.7 percent), New York (9.6 percent), Florida (7.7 percent), Ohio (7.5 percent) and Texas (7.0 percent).
The program is not limited to United States citizens or residents. Foreign persons living abroad may submit tips and be eligible to receive an award. In this regard, on Sept. 22, 2014 the Commission awarded more than $30 million to a foreign national living outside of the United States who provided original information related to an ongoing fraud. The award is the largest ever made by the SEC to date.
Since the beginning of the program in August 2011 through Sept. 30, 2016, the Commission has received tips from 2,093 individuals in 103 foreign countries. In fiscal year 2016 alone, the Commission received tips from 464 individuals in 67 foreign countries, with the highest number coming from Canada (14.7 percent), followed by the United Kingdom (13.6 percent), Australia (11.4 percent), China (7.5 percent), Mexico (6.3 percent), and India (4.3 percent).
Considering Latin America only, Mexico accounted for the largest percentage of individuals reporting tips since the program started (33.3 percent), followed by Brazil (20.2 percent) and Argentina (14.3 percent).
The SEC’s Review of Restrictive Agreements
During fiscal year ended 2016, the SEC brought significant enforcement actions against companies that were using confidentiality, severance and other type of agreements that interfered with the employee’s ability to report possible federal securities law violations to the Commission.
Under Rule 21F-17(a) of the SEC’s final rules, no person may take any action to prevent an individual from communicating directly with the SEC about a possible securities law violation, including enforcing, or threating to enforce, a confidentiality agreement with respect to such communication.
In August 2016, the SEC instituted a stand-alone action against a health insurance provider based in California for violating Rule 21F-17(a). The company used severance agreements requiring terminated employees to waive their right to obtain monetary awards from the Dodd-Frank Whistleblower Program as a condition of collecting severance payments. In June 2013, the firm deleted the SEC-specific language from its severance agreements, but kept a restricted clause requiring an employee to waive any right to monetary awards that stemmed from any communication by the employee with any federal or state agency. In 2015, the Company amended the severance agreements to remove all such restrictive language. In the settling the charges with the SEC, the company agreed to the payment of a $340,000 penalty and to notify former employees who had executed the severance agreements that they were not barred from seeking a whistleblower award from the SEC.
The SEC undertook similar enforcement actions against other companies throughout 2016 that made it clear firms may not use severance agreements requiring terminated employees to relinquish possible whistleblower awards in exchange for receiving their severance payments.
The SEC’s Anti-Retaliation Enforcement Actions
The Dodd-Frank Whistleblower Program prohibits companies from retaliating against their employees who report wrongdoing to the SEC based on the employees’ reasonable belief the information provided relates to a possible violation of federal securities laws that has occurred, in ongoing, or is about to occur. In this regard, employers may not discharge, demote, suspend, threaten, harass or discriminate against their whistleblower employees.
Individuals who are victims of such retaliation may pursue a private action in the appropriate United States district court. Further, the SEC may enforce the anti-retaliation provisions of the Dodd-Frank Whistleblower Program even when an employee does not pursue a private action.
The anti-retaliation protection also applies in such cases where a whistleblower employee does not satisfy the requirements, procedures and conditions to qualify for an award.
In September 2016, the SEC brought its first stand-alone whistleblower anti-retaliation enforcement action against a casino-gaming company. The firm fired an employee with years of positive performance evaluations because the employee had reported to senior management and the Commission that the company’s financial statements might be inaccurate. The SEC found the firm violated the Dodd-Frank Whistleblower Program anti-retaliation protection and the company agreed to pay $500,000 in civil penalties.
Employer retaliation actions against whistleblower employees are considered to be a violation of federal securities laws. Accordingly, employees who suffered such retaliation may report it to the Commission and claim an award if the SEC’s monetary sanctions against the employer exceed $1 million. In this respect, in April 2015, the Commission announced an award of 30 percent of the monetary sanctions applied to an investment advisory firm, after the company retaliated against its head trader because he had previously reported prohibited principal transactions to the SEC. The employee in this anti-retaliation case received an award of over $600,000 for providing relevant original information that led to the success of the SEC enforcement action.
There is a division between federal courts of appeals on whether the Dodd-Frank Whistleblower Program anti-retaliation protection extends to employees who report possible violations of federal securities law through the company’s internal compliance system without reporting directly to the SEC. The U.S. Court of Appeals for the Fifth Circuit considers the program’s anti-retaliation protection to be limited only to those employees who report federal securities law violations directly to the Commission. Conversely, the U.S Court of Appeals for the Second Circuit agrees with the SEC interpretative guidance, which states that employees are protected from employer retaliation if they report the federal securities violation internally through their companies’ compliance systems regardless of whether they have separately submitted a tip to the SEC.
The Extent and Impact of the Program
The information and assistance provided by 34 whistleblowers who received $111 million in awards since the program began in August 2011 through Sept. 30, 2016, led to successful Commission enforcement actions that resulted in monetary sanctions of over $584 million. And after taking into account the latest announcement made on Dec. 9, 2016, the Commission has now awarded more than $136 million to 37 whistleblowers.
The Dodd-Frank Whistleblower Program, which extends not only to U.S. citizens and residents but also to foreign nationals worldwide, induces individuals to report to the SEC violations of federal securities laws and the Foreign Corrupt Practices Act. The program’s inducement results from offering the possibility of claiming significant monetary awards, shielding whistleblowers against employer retaliation, and protecting their identities.
The Office of the Whistleblower currently is tracking more than 800 matters stemming from whistleblowers’ tips. Even though not all of the matters will result in enforcement actions, many of them will, which will allow the SEC to better fulfill its mission of protecting investors and capital markets in the United States.