What Happens to an SEC Whistleblower Tip?

Jordan Thomas -

One of the questions we’re frequently asked by clients and prospective clients is “what happens to a whistleblower tip once it’s submitted to the SEC, and how does the SEC determine which tips to actively investigate?” These are crucial questions for any potential whistleblower, especially given that the SEC receives approximately 30,000 tips, complaints and referral each year – 3,200 of which were whistleblower tips in 2013 – but can only conduct about 700 active enforcement investigations each year.  

The SEC’s process for vetting and investigating tips starts when a whistleblower submits to the SEC a Form TCR – short for “Tips, Complaints and Referrals” – describing the securities violation(s) that he or she believes has occurred. (As we’ve noted in previous posts, it’s crucial for any SEC whistleblower to submit his or her information using the Form TCR in order to remain eligible for a potential monetary award). Once the TCR is received by the SEC’s Office of the Whistleblower or “OWB,” the OWB will assign the submission a unique TCR number and send that number back to the whistleblower or the whistleblower’s attorney for record-keeping and tracking purposes. 

At that point, the TCR is forwarded to the SEC’s Office of Market Intelligence or “OMI,” which has been described as a “point guard” for the entire agency. Comprised of more than 40 attorneys, former traders, accountants and other experts, the OMI is responsible for gathering and analyzing all tips and complaints received by the SEC. The OMI conducts an initial evaluation of each tip to determine, among other things, whether it relates to an existing investigation, whether similar information has already been submitted to the agency, and whether it relates to possible misconduct that occurred within the SEC’s five-year statute of limitations for enforcement actions. Most importantly, the OMI determines whether the tip is sufficiently specific, significant and credible to referred to the Division of Enforcement – the division responsible for conducting comprehensive investigations of possible securities violations and bringing claims against defendants where warranted.  

If a tip is referred to the Division of Enforcement, it’s then up to enforcement attorneys to determine whether, and how best, to further investigate the tip. In some instances, the enforcement attorneys may determine that the tip should not be pursued, either because it appears unlikely that an actionable securities violation occurred or for some other reason. In some cases, the Division may determine that the tip should be referred to a different government agency, such as the CFTC, IRS or Department of the Treasury. In many cases, though, the tip will be used as a valuable new lead in an existing SEC investigation or as the starting point for an entirely new SEC investigation. 

As the pathway traveled by a tip reflects, the SEC cannot launch a full-blown investigation into every new allegation, and instead must make difficult but necessary decisions about how best to allocate its resources. For that reason, it’s vital that any SEC whistleblower (whether using counsel or not) provide information to the SEC in clear, compelling, detailed and organized way, explaining exactly why he or she believes a securities violation has occurred and providing any supporting evidence. This type of tip is much more likely to catch the SEC’s interest than a vague or conclusory tip, giving both the SEC and the whistleblower a better chance at achieving a successful outcome. 

SEC Wins Fraud and Insider Trading Trial Against Texas Investors

Jordan Thomas -
The SEC secured a major trial victory this week after a federal jury in Manhattan found Texas investors Sam and Charles Wyly liable for all fraud and insider trading claims brought by the agency. The SEC successfully proved that the brothers (the latter of whom died before the case was brought to trial)  had constructed an elaborate system of “sham” offshore trusts, which were used to conceal their ownership stake in several public companies, including the well-known Michael’s chain of arts and crafts stores. The Wylys, through the offshore trusts, then unlawfully traded in those companies’ stock without disclosing their ownership interests. They also executed certain trades based on non-public information about the upcoming acquisition of one of the companies, earning a profit of more than $30 million.

While the court has not yet determined the monetary sanctions the defendants will be forced to pay as a result of these violations, this verdict is significant win for the SEC, especially since the agency has come under fire for losing several high-profile cases. As we’ve noted in other posts, we think that the criticism of the SEC’s trial record is overblown – the agency won an impressive 75% of all trials between 2011 and 2013 – but it undoubtedly helps the Commission to receive another favorable verdict. Having been consulted about this case while at the SEC, I can attest to the fact that it was a particularly difficult one, involving a complex maze of entities and transactions and well-financed defendants. As Enforcement Director Andrew Ceresney noted, the verdict sends a strong message that the SEC “will continue to hold accountable, and bring to trial when necessary, those who commit fraud no matter how complex their scheme or how hard they try to hide it."

By Jordan Thomas and Vanessa De Simone

Is it a Crime? What Happens When Whistleblowers Report Potentially Criminal Misconduct to the SEC

Jordan Thomas -
The SEC, although it wields enormous power in the securities markets, has a built-in limitation on its authority: it’s a civil law enforcement agency, meaning that it can charge and penalize wrongdoers for civil violations of the securities laws, but it can’t prosecute them for crimes or put them in jail.

However, as SEC Chair Mary Jo White highlighted in a recent speech, that doesn’t mean the SEC has no role in criminal enforcement: instead, because nearly every violation of the securities laws can be a crime if done willfully (a higher standard than what is required for civil liability), the fraud investigated by the SEC often has the potential to be both a crime and a civil violation. The same holds true for investigations prompted by whistleblowers: when a whistleblower comes forward to report insider trading, FCPA violations, accounting fraud or other potential wrongdoing, there is often a good chance that significant misconduct will give rise to both criminal and civil claims.

So, what happens in this situation? The SEC would typically alert the appropriate criminal law enforcement agency – usually the Department of Justice and/or FBI – and collaborate with it to conduct parallel investigations. In our experience, that means that the whistleblower’s information would likely be shared (on a strictly confidential basis) with the DOJ, and the DOJ might participate in any interviews or briefings the whistleblower chooses to provide.

Such coordination can be enormously beneficial to law enforcement agencies because it allows them to share and save resources, use a broader range of enforcement tools, and ensure that wrongdoers are prosecuted to the greatest extent the law allows. Parallel proceedings by the SEC and other agencies also benefit whistleblowers, since these investigations may lead to two sets of monetary sanctions being obtained from the defendant.

For example, in the notorious Raj Rajaratnam insider trading prosecution, the SEC obtained a $92.8 million penalty against Rajaratnam in its civil case, and Rajaratnam was then fined $10 million in his criminal case (he’s also serving a lengthy prison sentence). According to the rules of the SEC Whistleblower Program, whistleblowers involved in such parallel actions may be eligible to receive a monetary award based on both the SEC action and the “related action” by the DOJ or other regulator, provided that certain criteria are met, including that “the same original information that the whistleblower gave to the Commission also led to the successful enforcement of the related action….”

This rule recognizes that whistleblowers can make contributions to law enforcement actions beyond just those prosecuted by the SEC, and should benefit when they do so. Look for this rule to take on increasing importance in the years ahead, as coordination between the SEC and criminal authorities continues to grow.

By Jordan Thomas and Vanessa De Simone

The SEC Could Find New Uses for an Old Law

Jordan Thomas -
One of the key messages from the SEC enforcement staff this year is that it intends to expand its enforcement arsenal, both by using newer laws and by finding innovative ways to use older laws. In a guest post published today on Financial Times' Alphaville blog, I focus on two such provisions – Sections 20(a) and 20(b) of the Exchange Act – and how they can help the SEC successfully target senior executives who violate the securities laws. Please check out the post here.

Cybersecurity - Growing Technological Threats Raise New Issues for Investors and the SEC

Jordan Thomas -
In recent months, the Heartbleed bug and massive data breaches like those experienced by Target have drawn increased attention to cybersecurity, and the need to better protect the almost unfathomable amount of sensitive data stored electronically in the U.S.

Although the securities laws may not always immediately come to mind when considering such high-tech threats, cybersecurity has emerged as an important issue for investors and, in turn, the SEC. How does cybersecurity become an SEC issue? The convergence between cybersecurity and securities fraud can happen in a number of ways. First, as SEC Chair Mary Jo White indicated in a recent speech, public companies have an obligation to disclose material risks to their business – including risks related to data security like hacking and identity theft. This disclosure obligation is critical, not only because it helps investors make informed decisions about whether to invest in companies that face cyber threats, but also because it can compel companies to improve their cybersecurity, so that they can reassure and attract investors. Public companies that sweep technology-related risks under the rug, on the other hand, might well face SEC enforcement actions.

Second, SEC rules require certain participants in the securities markets to establish data safeguards. For example, SEC Regulation S-ID “require(s) financial institutions and creditors to develop and implement a written identity theft prevention program designed to detect, prevent, and mitigate identity theft in connection with certain existing accounts or the opening of new accounts.” This regulation recognizes that lax data controls on the part of financial institutions and other businesses are often partially responsible for identity theft and similar crimes: these entities can no longer simply blame the hackers and absolve themselves of any accountability.

These are just a few of the ways that the SEC can and will play a role in protecting investors from technology-related dangers. The lesson for SEC-regulated companies is that it’s time to get serious about protecting customer data, and being forthright about potential risks. The lesson for potential whistleblowers is that if they observe wrongdoing related to cybersecurity, such as insufficient data controls, the reckless use of customer information or unreported hacking, they should not assume that these issues fall outside the scope of the SEC’s authority. Instead, cybersecurity is likely to become an increasing focus of SEC enforcement activity as technology continues to evolve in ways both good and bad.

By Jordan Thomas and Vanessa De Simone

Financial Whistleblowing on the Rise in Europe

Jordan Thomas -
As we’ve noted in previous posts, the SEC Whistleblower Program has resulted in a sharp increase in the amount of actionable information provided to the agency, with more than 3000 whistleblower tips received in 2013 alone. Now, reports from the Europe and the United Kingdom – which have experienced their own rash of financial scandals in recent years – indicate that financial fraud whistleblowing is also gaining traction overseas. The Financial Conduct Authority ( or FCA), which regulates financial services firms in the U.K., reported last week that the number of tips received from whistleblowers had increased by approximately two-thirds in 2013. A second U.K. financial services regulator, the Serious Fraud Office, received approximately 4,400 tips to its “SFO Confidential” whistleblowing program between January 2012 and June 2013 alone. Europeans with knowledge of fraud affecting U.S. companies are also reporting those potential violations to the SEC – with the U.K. being the leading source of SEC whistleblower tips outside the U.S. in 2013.

At the same time, British and European regulators are showing increased interest in adopting many of the features of the SEC Whistleblower Program, including heightened anonymity protections and the potential for monetary awards. I witnessed this effort firsthand when I was invited by M.P. Gisela Stuart to speak at the House of Commons about how the key components of the SEC Whistleblower Program could be used to enhance financial fraud enforcement in the U.K. Now, at the direction of the Parliamentary Banking Commission, the FCA is considering adding a monetary incentive to its whistleblower program to encourage additional reports. Likewise, European lawmakers have introduced a proposal to create a whistleblower program within the European Securities and Markets Authority (“ESMA”) – the  authority responsible for safeguarding the EU’s securities markets – which would allow whistleblowers to report potential abuses to ESMA without disclosing their identities. While it’s not clear that these proposals will be accepted, it’s encouraging to see that regulators around the world are thinking seriously about whistleblowing, and willing to learn from each other in the effort to prevent fraud and protect investors.

Second Circuit Considers Bounds of Insider Trading Laws

Jordan Thomas -
In recent years, one of the top priorities for the SEC and the Department of Justice, which prosecutes criminal violations of the federal securities laws, has been cracking down on insider trading, particularly by hedge funds that use confidential information to gain an investing edge. As many recent cases – including the successful prosecution of SAC trader Matthew Maratoma – reflect, such insider trading is frequently undertaken by a so-called “tippee,” an outsider who has received material non-public information from a company insider. Now, an important case pending before the Second Circuit Court of Appeals, United States v. Newman, will help define what the SEC and the DOJ must prove to establish the liability of the “tippee” and, in so doing, affect how future insider trading cases are prosecuted by both agencies.

The case involves two hedge fund managers, Todd Newman and Anthony Chiasson, who were convicted of trading on information about the financial performance of several public technology companies before that information was made public. These tips came to Newman and Chiasson on a third-hand basis: a jury found that employees of the technology companies passed the inside information onto outside acquaintances, who in turn passed it onto analysts working for Newman and Chiasson’s respective hedge funds, who in turn passed it on to Newman and Chiasson. The jury found that Newman and Chiasson traded on this material non-public information while knowing that it had been disclosed by the company insiders in violation of those insiders’ duty to keep it confidential (in other words, Newman and Chiasson knew the information had been wrongfully disclosed). The question before the Second Circuit is whether the DOJ was also required to prove beyond a reasonable doubt that the defendants knew that the company insiders had received a personal benefit for sharing the non-public information.

In briefs submitted to the court, the DOJ has made a persuasive legal argument that Newman and Chiasson’s convictions should be upheld because prior decisions by both the Second Circuit and the Supreme Court have not required prosecutors to prove that “tippees” had knowledge of such an improper benefit. But, perhaps the most compelling argument put forth by the DOJ is a common-sense one: “Trading securities based on information a defendants knows to be not only material and nonpublic, but also to have been disclosed by a company insider in violation a duty to keep the information confidential is plainly wrongful conduct.” In other words, defendants in this scenario have every reason to understand that they were breaking the law.

The DOJ’s position seems to be supported both by fairness and logic. After all, a primary purpose of the securities laws, like nearly all other laws, is to deter future wrongdoing by defining the bounds of acceptable conduct: surely we want to deter trading on non-public material information where a party knows that the confidential information was wrongfully obtained and that he or she is not supposed to have it, even if the party is not aware of the specific personal benefit that the insider gained from disclosing the information. We’re hopeful that the Second Circuit will see it the same way, empowering the SEC and DOJ to continue their important crackdown on insider trading.

By Jordan Thomas and Vanessa De Simone

Employers May Come to Regret Seeking Narrow Definition of “Whistleblower”

Jordan Thomas -
One of the most important unsettled legal questions for SEC whistleblowers and their counsel is whether the SEC Whistleblower Program’s anti-retaliation provisions apply to individuals who have reported misconduct internally, but have not yet blown the whistle to the SEC. We recently published an article in the National Law Journal on this issue, arguing that employers and their counsel may come to regret seeking a narrow interpretation of “whistleblower” that discourages internal reporting. This is a critical issue, which every potential whistleblower should understand before moving forward.  For the full article, please click here.

- By Jordan Thomas and Vanessa De Simone

New SEC Task Force Fights Financial Fraud And Encourages Collaboration with Whistleblowers

Jordan Thomas -
Last month, I attended SEC Speaks, an annual conference in which the SEC’s leadership provides insight into the agency’s priorities, projects and plans for the future. One of the key initiatives highlighted this year was the SEC’s new Financial Reporting and Audit Task Force. Comprised of SEC lawyers and accountants from around the country, the task force seeks to combat accounting and auditing fraud, like the well-known frauds perpetrated by Enron, WorldCom and Adelphia. As the SEC’s Director of Enforcement Andrew Ceresney outlined in a speech last September, the task force will place renewed emphasis on generating cases related to a wide range of possible financial reporting violations, including reserve manipulation and improper revenue recognition practices, as well as independence violations by auditors (for more information on different types of financial fraud, please see our Securities Law Primer.)

While accounting cases have not been making as many headlines in recent days as they did in the Enron-era, accounting fraud is still pervasive – and incredibly harmful to investors and the integrity of the financial markets – making this task force an important and welcome development. What’s particularly exciting to me about the task force is the fact that it has identified encouraging and collaborating with whistleblowers as one of its principal goals. Moreover, as the task force’s website reflects, it also recognizes that these potential whistleblower partners can and should include not only corporate insiders, but also “gatekeepers” such as auditors and attorneys, who often have first-hand knowledge of securities violations. Likewise, the task force identifies the important role that academics and other experts can play in promoting market integrity issues and pioneering new methods of fraud detection (as explained more fully in our SEC Whistleblower Program Handbook, outsiders such as academics may also be eligible to act as whistleblowers under the SEC Whistleblower Program rules if they voluntarily provide original information, such as an original analysis of a company’s public filings that reveals fraud, that leads to a successful SEC enforcement action.) Accounting-related misconduct is unlikely to be eradicated anytime soon, but by marshaling the combined efforts of the SEC Staff, whistleblowers, responsible gatekeepers and the academic community, I believe the task force can and will make a significant difference in the fight against financial fraud.

Senator Grassley Announces the Creation of a Congressional Whistleblower Caucus

Jordan Thomas -
Last week, we provided an update on Senator Chuck Grassley’s (R-IA) efforts to strengthen the IRS Whistleblower Program and expedite the processing of IRS Whistleblower claims. Now, Senator Grassley – a longtime advocate for whistleblower rights – has announced a new plan to create a “Senate Whistleblower Protection Caucus,” to “help bring attention to the need for ongoing whistleblower protections.” The Caucus, which Senator Grassley aims to launch in the next Congressional session, will focus on advocating for whistleblower rights and ensuring that existing legal protections for whistleblower are properly enforced.

Senator Grassley’s plan is crucial because, despite positive new initiatives like the SEC Whistleblower Program, whistleblowers remain an under-utilized law enforcement asset, which have huge potential to help numerous government agencies – from the SEC to the IRS to the FDA – uncover misconduct more quickly and efficiently. It may be a cliché but it’s true: knowledge is power. But, whistleblowing can only work as a law enforcement tool if individuals with information about wrongdoing are encouraged to come forward, and protected from retribution when they do blow the whistle. As Senator Grassley recognized, “the best protection for a whistleblower is a culture of understanding and respecting the right to blow the whistle.”

The SEC Whistleblower Program rules have already sought to develop this type of whistleblower-friendly culture by, among other things, allowing anonymous reporting and providing SEC whistleblowers with anti-retaliation employment protections. We hope that Senator Grassley’s new caucus will expand on these efforts and help other areas of the government leverage the power of whistleblowers to stop fraud, waste and other abuses.

- By Jordan Thomas and Vanessa De Simone