OIG Report Praises SEC Whistleblower Program

Jordan Thomas -

The internal watchdog for federal government agencies, including the SEC, is the Office of the Inspector General (“OIG”), which conducts audits and investigations of the SEC to “promote integrity, economy, efficiency, and effectiveness in the Commission's programs and operations.” In keeping with this mission, the OIG has issued its first audit report on the SEC Whistleblower Program. Fortunately, this report was overwhelmingly positive, confirming that the whistleblower program is off to a strong start. The OIG’s key findings included:

  • The SEC Whistleblower Program rules are clearly defined and user-friendly;
  • The SEC promptly reviews whistleblower submissions to determine whether further enforcement action is warranted;
  • The funding mechanism for the Investor Protection Fund – the fund from which whistleblower awards are paid –  is sufficient, and an appropriate balance of more than $450 million has been maintained in the fund; and
  • The Freedom of Information Act (“FOIA”) exemption that helps the SEC protect the anonymity of whistleblowers is a vital feature of the program and should remain in effect.

These findings are especially significant because an OIG report is far from a “rubber stamp” of approval when it comes to whistleblower programs – to the contrary, past OIG reports sharply critiqued the OSHA whistleblower program and the SEC insider trading “bounty” program in place before the inception of the current whistleblower program. The fact that the SEC Whistleblower Program was able to earn such a positive report on its first try is an indicator both of the SEC’s commitment to the program, and the program’s effective leadership. That’s good news – not just for potential SEC whistleblowers, but for all of the investors who benefit when whistleblowers come forward to exposure fraud and wrongdoing.

- By Jordan Thomas and Vanessa De Simone

SEC Orders Show Importance of Complying with Whistleblower Program Rules

Jordan Thomas -
As reported in the Wall Street Journal, the SEC recently denied two individuals’ applications for whistleblower awards because they had not met the requirements of the SEC Whistleblower Program rules. In the first case, an anonymous woman claimed that she had provided information that helped the SEC build its sub-prime mortgage fraud case against several former executives at Countrywide Financial and New Century Financial Corp., including former Countrywide CEO Angelo Mozilo, who reached a $67.5 million settlement with the SEC in 2010. The woman claimed that she had provided tips about the fraud to the U.S. Department of Housing and Human Development (or HUD) between 2008 and 2011, and that HUD had shared this information with the SEC. The SEC determined that, to the extent the woman was seeking an award for information provided to HUD prior to the official launch of the SEC Whistleblower Program in July 21, 2010, that information could not be the basis for an award. Additionally, the SEC determined that even if HUD had provided information to the SEC based on the woman’s tips after July 21, 2010, that information would not have been provided to the SEC in writing by the Claimant, as the rules of the SEC Whistleblower Program require.

In the second case, an unnamed person sought an award in connection with the SEC’s case against several defendants who had perpetrated a fraudulent penny stock offering scheme involving the stock of Anscott Industries, Inc. That case led to more than $21 million in sanctions being imposed against the defendants. The SEC denied that claimant’s application for an award because it found that he or she had not made the award application within 90 days of the time that the SEC posted its “Notice of Covered Action” – the official notice that alerts whistleblowers and others that a case involving more than $1 million in sanctions has been resolved and that any potentially eligible whistleblowers may seek an award. The SEC also found that the tips at issue did not constitute “original information,” as the rules require, because they were not provided to the SEC for the first time after July 21, 2010.

These cases show that, while whistleblowers with actionable information about wrongdoing have the opportunity to reap significant monetary awards, they must remain mindful of the rules of the SEC Whistleblower Program, both when initially submitting information to the SEC and when seeking an award (for more information about these rules, please see our SEC Whistleblower Program Handbook). That’s even more true for attorneys, accountants and auditors who may be considering blowing the whistle, since, although they can participate in the SEC program, they are subject to special rules and eligibility criteria. The rules of the SEC Whistleblower Program are not overly burdensome, but they are extremely important, especially given the high personal and financial stakes at issue in whistleblower cases. The moral of this story is that the more a potential whistleblower learns about the program before stepping in, the better experience and outcome he or she is likely to have.

- By Jordan Thomas and Vanessa De Simone

Senator Grassley Urges IRS to Strengthen Whistleblower Program

Jordan Thomas -
Both in our practice and on our blog, we typically focus on the SEC Whistleblower Program, which seeks actionable intelligence about possible violations of the federal securities laws. But, the SEC Whistleblower Program is only one of several federal programs that seek to leverage whistleblower information to detect and deter wrongdoing. One of the other prominent whistleblower programs is the IRS Whistleblower Program, which was revamped in 2006 to better incentivize individuals with information about possible tax evasion to report that misconduct. Under the program, whistleblowers may be eligible to collect a monetary award if they provide information that “substantially contributes” to the collection of taxes, penalties or other amounts in excess of $2 million.

While the IRS Whistleblower Program has had some notable successes, taxpayer advocates – including, most significantly, Senator Chuck Grassley (R-IA) – are calling for the IRS to do even more to encourage whistleblowers to come forward and help stop tax fraud. Senator Grassley urged the IRS to move more quickly to investigate and resolve cases based on whistleblower tips, stating “The agency should do everything it can to make these cases a priority.” Senator Grassley’s remarks were echoed in an article by Forbes contributor Erika Kelton, who called for a shift in culture at the IRS.

These remarks come on the heels of the IRS’s latest report to Congress on the status of the whistleblower program, which revealed that the IRS did not make its first award under the updated 2006 program rules until 2011 – a five year gap. The SEC Whistleblower Program, by contrast, made its first award just a year after the rules of the program became final. Moreover, the IRS acknowledged that there are limitations to its current program, including the fact that IRS whistleblowers (unlike SEC whistleblowers) are not accorded specific protection from retaliation under the statute that amended the IRS Whistleblower Program rules.

We agree with Senator Grassley that “supporters of whistleblowers need to stand firm. We can’t let up.” Given the enormous potential of whistleblowers to assist the IRS (and other government agencies), we hope the IRS will heed Senator Grassley’s call and devote additional resources to ensuring that whistleblower complaints are handled quickly, effectively and successfully.

- By Jordan Thomas and Vanessa De Simone

SEC Announces Additional Payout to Whistleblower

Jordan Thomas -
The SEC announced on Friday that it made an additional payout of $150,000 to the recipient of the first monetary award under the SEC Whistleblower Program, after successfully collecting more sanctions from one of the defendants in the action. With that additional payout, the whistleblower – who is entitled to receive up to 30% of any sanctions collected by the SEC under the original award order – has received a total of nearly $200,000. The SEC is now continuing its efforts to collect additional funds from the defendants, meaning the final award to the whistleblower is likely to be even bigger. This whistleblower reported the “multi-million fraud” at issue anonymously, and has not been identified by the SEC. Indeed, as in other cases, the SEC has revealed almost no information about the underlying case, such as the name of the defendants, in an effort to protect the whistleblower’s confidentiality – an encouraging sign for other individuals considering coming forward on an anonymous basis.

While this new payout may not grab as many headlines as larger awards like the $14 million award paid in October, it’s a positive reminder that monetary awards available under the SEC Whistleblower Program have the potential to grow over time if the original information provided by the whistleblower leads to additional recoveries. (As explained in our SEC Whistleblower Program Handbook, the total sanctions ordered in enforcement actions resulting from the whistleblower’s tip must exceed $1 million for a whistleblower to be eligible for a monetary award). That potential can be especially significant in cases involving multiple defendants: for example, if an eligible whistleblower reported accounting fraud at his or her company, resulting in the SEC ordering aggregate sanctions of more than $1 million against both the company and its auditor, the whistleblower could receive 10-30% of the total sanctions collected from both defendants, even if the case against the auditor was resolved months or years after the case against the company (or vice versa).

Ultimately, the objective of the SEC Whistleblower Program is to detect and deter harm to investors by aligning the interests of whistleblowers, investors and the Commission – all of who win if the SEC is able to recover funds from those who violate the securities laws, especially since awards to whistleblowers do not come from, or reduce, funds used to pay back damaged investors. Payouts like this one bring the program one step closer to that goal.

- By Jordan Thomas and Vanessa De Simone

SEC Officials Provide Promising Reports on the SEC Whistleblower Program

Jordan Thomas -
One of the questions I’m most frequently asked by clients, other lawyers and friends is “what’s happening inside the SEC with respect to the whistleblower program?” Recently, several top SEC officials have provided insight onto this question – and their comments indicate that the SEC continues to see the SEC Whistleblower Program as a powerful tool for combating securities fraud.

For example, at the recent “SEC Speaks” conference in Washington, D.C. the Chief of the SEC’s Foreign Corrupt Practices Act (“FCPA”) unit, Kara Brockmeyer, indicated that whistleblowing tips are now one of the leading ways in which the SEC learns of potential FCPA violations. Likewise, Jina Choi, the Regional Director of the SEC’s San Francisco office, described the SEC Whistleblower Program as “huge” and praised its contribution to the Commission’s ability to detect securities fraud. These remarks echo similar comments by other SEC leaders, including Stephen Cohen, the SEC’s Associate Director of the Division of Enforcement, with whom I spoke on a panel last June. Cohen reported that he is personally “participating in numerous cases where we are working very closely with whistleblowers” and that the whistleblower program has “clearly turbocharged” the Division’s enforcement efforts. Indeed, according to the SEC’s most recent annual report on the Whistleblower Program, the agency received more than 3,000 tips from around the world in 2013, which Cohen predicts will lead to “incredibly impactful cases.”

Brockmeyer, Choi and Cohen’s remarks certainly ring true in light of my own experience representing SEC whistleblowers: not only is our firm seeing cases involving major frauds, but also cases involving senior-level employees with timely, original and actionable intelligence about possible violations. Given that enforcement officials at the SEC continue to enthusiastically welcome whistleblower tips – and that the SEC has already paid one extremely significant award of $14 million as well as several other smaller awards – I predict that more major awards will be coming in the months ahead, as the SEC begins to resolve open investigations driven by whistleblowing. These investigations may take time, but ultimately I believe that’s a good thing for both investors and whistleblowers, since it will allow the SEC to properly investigate every tip and build strong cases against those who violate the securities laws and threaten the integrity of our markets.

High-Frequency Trading: Further Thoughts on the “Flash Boys” Debate

Jordan Thomas -
The firestorm sparked by Michael Lewis’ new book on high-frequency trading, Flash Boys, raged on this week, with both opponents and supporters of high-frequency trading entering the fray. In a heated debate on CNBC’s Power Lunch, Lewis and the founder of IEX – a new exchange designed to limit high-frequency trading – repeated the charge that the U.S. stock market is “rigged.” Defending ultra-fast traders and the stock exchanges on which they operate was William O’Brien, president of the BATS exchange, who accused IEX of distorting the facts to promote its own business model. Charles Schwab also weighed in, with a scathing statement that described high-frequency trading as “cancer” and “a technological arms race designed to pick the pockets of legitimate market participants.”

Whichever side is right, it’s clear that high-frequency traders have gone to huge lengths to gain mere milliseconds in trading time and other informational advantages. As reported by the Wall Street Journal, some high-frequency trading firms have spent hundreds of millions of dollars to lay specialized fiber optic cables between the New York and Chicago exchanges, while others have developed sophisticated lasers to beam information between exchanges.

What is also clear is that these high-frequency trading practices raise fundamental questions whether regulatory reforms can keep up with an ever-changing and hyper-competitive market. The SEC and other regulators must be nimble enough to recognize new trends in the market, and be able to articulate whether and when these practices cross the line. Since the SEC is up against the nearly unlimited capital and creativity of Wall Street, that also means that the SEC must be given adequate resources to do the job. If the high-frequency trading industry can invest billions to boost their trading speed by a few milliseconds,we should invest at least an equivalent amount to protect investors.

- By Jordan Thomas and Vanessa De Simone

High-Frequency Trading: Whistleblower Aids SEC and FBI Investigations

Jordan Thomas -
The buzz on Wall Street this week has been all about high-frequency trading and Michael Lewis’ new book on the topic, Flash Boys. As Lewis explains, high-frequency trading typically works by exploiting a powerful combination of speed and information: high-frequency traders use sophisticated computer programs to see and analyze trade orders that are placed by other stock market participants, then quickly make their own trades based on that data before the original orders can be filled. Known as “front-running,” these advance trades often mean that traditional, slower traders – including some pension funds and other institutional investors – receive less favorable terms for their own stock sales and purchases. Such front-running can represent a securities violation in some, but not all, circumstances – for example, a violation would likely occur if a stock exchange gave high-frequency traders access to order information that it had promised to keep confidential. SEC rules also prohibit national exchanges from distributing market data in an “unreasonably discriminatory” manner, as reflected in a recent enforcement action against the exchange Euronext.

While Lewis’ book is likely to open many investors’ eyes to the realities of modern stock trading, he is not the first to identify the dangers (and potential illegality) of high-frequency trading. In fact, as reported in the Wall Street Journal, a Goldman Sachs trader-turned-whistleblower, Haim Bodek, disclosed many of these abusive practices to the SEC in 2012. Bodek apparently told the SEC that certain exchanges offered high-speed traders the right to “jump ahead” of other investors’ trades – for an extra fee. According to the Journal, both the SEC and the FBI are actively investigating such practices, likely based at least in part on Bodek’s whistleblowing. Bodek’s case is yet another example of the ways in which whistleblowers can help the SEC and other law enforcement agencies to understand and successfully police even the most complex and rapidly-changing corners of the financial markets.

- By Jordan Thomas and Vanessa De Simone

‘Big Short’ Case Tests the Reach of the SEC’s Administrative Forum

Jordan Thomas -
On March 21, Wing Chau – a subprime CDO manager who featured prominently in Michael Lewis’s best-selling book “The Big Short” – sued the SEC, claiming that the SEC violated his constitutional rights by choosing to bring its fraud claims against him in its own administrative forum, rather than in federal court. The SEC administrative proceeding in question focuses on allegations that Chau and his company allowed a hedge fund called Magnetar to help choose collateral for a 2006 CDO, even though Chau knew that Magnetar’s investment strategy would allow it to profit if the CDO failed, creating a conflict of interest that was not properly disclosed to CDO investors. Chau now claims that he will be denied due process and equal protection under the law if the SEC pursues its case through an administrative proceeding, instead of a traditional trial (similar claims were brought in 2011 by Galleon defendant and former Goldman director Raj Gupta, who was eventually convicted of insider trading in federal court and whose appeal was recently denied).

While the choice of a forum for an SEC case may not seem as gripping as the events underlying “The Big Short” and the substantive claims against Chau, this case raises crucial issues for everyone involved in  SEC enforcement actions, including current and potential whistleblowers. These issues are now coming to the fore because the Dodd-Frank Act significantly expanded the jurisdictional scope of the SEC’s administrative forum, giving the SEC the right to seek through administrative proceedings civil money penalties from any person, instead of merely the “regulated persons” (including registered broker-dealers and investment advisers) who were previously subject to its administrative jurisdiction. In other words, the SEC now has much freer rein to bring cases in the administrative forum.

The SEC’s enhanced ability to bring cases in the administrative forum is noteworthy because there are crucial differences between an SEC administrative proceeding and a federal trial. Perhaps most significantly, an administrative proceeding is conducted and decided by an Administrative Law Judge (“ALJ”), without the option of a jury. While these ALJ decisions are eventually reviewable by a federal appellate court, litigants must first appeal any adverse decision to the Commission itself, which reviews the case de novo. Also important is the fact that, pursuant to the SEC Rules of Practice, SEC administrative proceedings must, in nearly every case, proceed on an expedited schedule, with far more limited pre-trial discovery than is allowed in federal court. For example, except in rare cases, the parties may not conduct pre-trial depositions (although the SEC Staff may, of course, take testimony during SEC investigations).

While conducting a complex litigation in the SEC administrative forum is not without risk to the SEC trial staff – which must also abide by the expedited schedule – administrative proceedings are widely seen as a way for the SEC to more efficiently and effectively bring enforcement actions. Indeed, enhancing the SEC’s enforcement capabilities seems to have been the driving force behind Congress’s decision to expand the scope of administrative proceedings. Top SEC officials have repeatedly indicated that they plan to take advantage of  this new power and, in the words of Assistant Chief Counsel Charlotte Buford, will no longer “be bound by false ties to outdated presumptions” about which types of cases must be brought in federal court versus an administrative proceeding.

These developments are obviously nerve-wracking for defendants like Wing Chau – who believe they would have better luck in a federal court – but what do they mean for current and potential SEC whistleblowers? My view is that the SEC’s willingness to bring more cases in the administrative forum provides the agency with increased flexibility and will lead to more timely resolutions of enforcement matters, which bodes well for whistleblowers and investors (although most cases, including those based on whistleblower tips, remain likely to settle prior to the institution of either an administrative proceeding or a federal suit). Defendants who decide to contest SEC charges will inevitably continue to protest the expanded use of the administrative forum, but the Commission has an important mission and should use all of the lawful tools provided by Congress to protect investors and ensure a fair marketplace.

Why Do People Commit Securities Fraud? SEC Speech Probes for Answers

Jordan Thomas -
One of the most vexing questions in securities enforcement – and in life more generally – is “why do otherwise good people end up doing bad things?”.  Why do once promising professionals risk their careers, integrity and freedom for a few more dollars, or to shore up their company’s stock price?

These questions were recently the subject of an excellent and thought-provoking speech by Andrew Barton, Director of the SEC’s Office of Compliance Inspections and Examinations – the division charged with administering the SEC’s national examination program.  The speech, aptly entitled “People Handling Other People’s Money,” sought to distill the “root causes of harm to investors and our markets,” based on Barton’s decades of experience and his review of past SEC examinations and enforcement actions in the investment advisor space.

In Barton’s view, the majority of securities violations uncovered by the SEC are caused by three types of problems.  First, and most obviously, some people simply “lie, cheat and steal.” These are the bad apples who purposely, and sometimes even gleefully, victimize others for their own gain.

The other two categories of problems, however, are both less obvious and more interesting, as well as almost certainly more common in the financial services industry.  The second problem identified by Barton is “people who behave recklessly.”  These people may not start out with a specific intention to harm investors, but they disregard red flags, take unacceptable risks, and fail to establish adequate internal controls to protect investors.  As Barton noted,  such reckless behavior is especially likely to occur when an individual or a business feels pressure to keep up with industry changes, new technologies or new client demands, and reacts without fully and carefully considering the possible consequences of their conduct.  Such pressure, while sometimes understandable, does not excuse an individual or an entity from civil liability for securities violations undertaken recklessly, as explained in our Securities Law Primer.

Finally, Barton identifies the third problem as “conflicts of interest,” which often blind well-meaning people to the fact they are causing, or threatening to cause, harm to their clients.  In Barton’s words, “[c]onflicts are also interesting and insidious, because we see them at an individual, firm and industry level.  One person, a close group of people, or seemingly everyone in the entire system, can incrementally, over time, through the accretion of justifications, customs and excuses convince themselves that they are entitled to money and opportunities that fairly belong to their clients.”  This observation certainly holds true in my experience as a whistleblower lawyer, where I see again and again that a conflict of interest creates a chain reaction of bad decisions, which ultimately results in one or more securities violations.

The good news is that these three root causes of securities fraud can be, and are being, addressed.  While Barton’s focus is on strengthening the SEC’s examination program and on helping compliance professionals prevent fraud, I believe that the SEC Whistleblower Program will also be an important tool in combatting each of these three problems.  First, any individual who might think about lying, cheating, stealing or even acting recklessly will know that other employees can and might blow the whistle to the SEC, significantly increasing the probability of detection and creating a crucial deterrent effect.  Likewise, employees who find that their company, or even their entire industry, has fallen prey to conflicts of interest now have extra incentives to report, and hopefully eliminate, those conflicts due to the enhanced employment protections, anonymous reporting option, and potential monetary awards provided under the SEC Whistleblower Programs. As Barton recognizes, it is possible for both individuals and companies to maintain ethics and integrity even in a highly competitive and ever-changing financial services industry, and the SEC Whistleblower Program is another valuable step in that direction.

Madoff Verdicts Show the Risks of Staying Silent

Jordan Thomas -
After the revelation in 2008 that Bernard Madoff’s “wealth management” business was actually a colossal Ponzi scheme, Madoff’s victims and the public immediately asked: “Who else in the Madoff organization knew and, if they knew, why didn’t they come forward?” On Monday, that question was answered, at least in part, by a jury considering criminal charges against five former Madoff employees, including his longtime secretary, two computer programmers and his director of operations for investments. The jury found all five defendants guilty on 33 total charges, establishing that these employees were aware of, and complicit in, Madoff’s long-running fraud. In the case of the computer programmers, for example, the U.S. Attorney Office presented evidence that they created software to automatically generate fabricated account statements, while other defendants helped create a fake set of books and records that was provided to the SEC.

The Madoff verdict is yet another lesson to employees that complicity in fraud comes with enormous personal and professional risks, even for non-management employees like Madoff’s former secretary. Had any of these former employees chosen to step forward and blow the whistle on Madoff, the outcome for both themselves and Madoff’s investors would have been far different: the employees would almost certainly not be facing lengthy prison terms (as they are now) and investors would have been spared at least some of their devastating losses.

With the advent of the SEC Whistleblower Program, the choices for employees like those in the Madoff case are even more blunt, since blowing the whistle can now not only help individuals avoid personal liability for securities violations, but may also allow them to obtain substantial monetary awards if they voluntarily provide original information that leads to a successful SEC enforcement action (for more information on eligibility please see our SEC Whistleblower Program Handbook). Critically, the rules of the SEC Whistleblower Program do not automatically exclude employees from eligibility merely because law enforcement agencies have already begun to investigate their company: while any disclosure of information must be voluntary to give rise to a monetary award, that disclosure can be made after the SEC or another regulator is “on the scene.” And, even individuals with potential civil liability may be eligible for monetary awards under the program, as long as they are not criminally convicted for related misconduct. In other words, it may not be too late for an employee to become a whistleblower – and perhaps avoid being viewed as a co-conspirator – even if the company is already under the scrutiny of the SEC or other regulators. Becoming a whistleblower is not easy, and should not be undertaken lightly, but the Madoff case shows that staying silent also carries huge potential costs.  No doubt the Madoff defendants are second-guessing their decisions today.