Business Insurance reported late last week that the Securities and Exchange Commission will award $5-6 million to a whistleblower who provided information on securities violations that would have been “nearly impossible” for the SEC to detect on its own.  Such an award would be the third larges award ever granted to a whistleblower by the SEC.  This also comes on the heels of a $3.5 million whistleblower award from the week before.  whistleblower

The takeaway is that the SEC continues to heavily incentivize company insiders to report possible securities violations.  It is critical to have internal controls and monitoring to catch these problems before a whistleblower runs into the SEC.  Self-reporting can drastically reduce exposure to damages and fines, but if you do not have proper compliance checks in place, you may never even catch the problem yourself.  Routine internal investigations and a rigorous compliance and monitoring system will go a long way to preventing and spotting securities issues early, and thereafter managing and mitigating the fallout.

The SEC’s Office of the Whistleblower’s top priority going into 2016 will be to assess company confidentiality agreements for compliance with Rule 21-F-17(a).  Rule 21F-17(a) provides that no person may take any action to impede an individual from reporting information about wrongdoing to the SEC.  The OWB’s primary focus in enforcing Rule 21-F-17(a) has been to discourage companies from enforcing or threatening to enforce confidentiality agreements that prohibit employees from discussing the substance of interviews they gave in internal investigations without the approval of the company’s legal department.

whistleblowerWe previously reported on the Securities and Exchange Commission’s efforts to crack down on anti-whistleblower agreements earlier this year.  At that time, the SEC brought charges and accepted payment of a penalty related to a company’s anti-whistleblower confidentiality agreements.  It is clear from the OWB’s 2015 Annual Report that the SEC will be prioritizing this issue again next year.

Thus, corporate counsel must walk a fine line to avoid including language that could be interpreted as impeding potential whistleblowers.  We previously recommended adding disclaimer language to any confidentiality agreements that makes it clear that employees are free to report possible violations to the SEC and other federal agencies without company approval or fear of retaliation.  While such a disclaimer would not necessarily be a safe harbor for companies, it would help in any action brought by the SEC.  Counsel should also consider adding cautionary language or revisions to their employment agreements to avoid broad restrictions that could discourage potential whistleblowers from reporting violations to the SEC.

The Securities and Exchange Commission released its 2015 Annual Report on its Whistleblower Program this week and announced another rise in the number of whistleblower tips that it received.  The SEC reported receiving 3,923 tips during its 2015 Fiscal Year, which is up from 3,620 in 2014 (as we previously reported), and up over 30% from 2012, which was the first full year that these numbers were reported.  Additionally, in its FY 2015, the SEC paid out $37 million to whistleblowers, which included a whopping reward of over $30 million to just one whistleblower.  The SEC’s Office of the Whistleblower (OWB) rewards whistleblowers for “their provision of original information that led to a successful Commission enforcement action with monetary sanctions totaling over $1 million” and can net tipsters between 10% and 30%, which is the statutory maximum allowed under the Dodd-Frank Act.

whistleblowerThe OWB determines the reward percentage for whistleblowers based on the particular facts and circumstances of each case, rather than any hard-set mathematical formula.  Some of the positive factors that may increase an award percentage include “the significance of the information provided by the whistleblower, the level of assistance provided by the whistleblower, the law enforcement interests at stake, and whether the whistleblower reported the violation internally through his or her firm’s internal reporting channels or mechanisms.”  Negative factors that may decrease an award percentage include “whether the whistleblower was culpable or involved in the underlying misconduct, interfered with internal compliance systems, or unreasonably delayed in reporting the violation to the Commission.”

A positive takeaway for companies from the OWB’s report is that 80% of the 2015 whistleblower award recipients initially raised their concerns internally to their supervisors or compliance personnel before reporting their information to the SEC.  The Dodd-Frank Act allows whistleblowers to do so, as it is designed to protect individuals who report internally to their companies, as well as those who report directly to the SEC.  Thus, for the most part, companies are still able to get an early notice of any wrongdoing prior to the SEC’s involvement, so that it can promptly respond, such as engaging counsel as early as possible to investigate and advise on the proper path forward.

Around this time last year, the Securities and Exchange Commission’s Office of the Whistleblower warned lawyers that they may be disciplined for drafting contracts to incentivize whistleblowers to not bring alleged company wrongdoing to the SEC’s attention.  It appears the SEC is beginning to make good on its threat.  Last week, the SEC resolved its first enforcement action against a company for allegedly using improperly restrictive language in confidentiality agreements with the potential to stifle whistleblowers.  That company agreed to pay a $130,000 penalty to reach a “no admissions” resolution with the SEC.

According to the SEC, the company required witnesses in certain internal investigations interviews to sign confidentiality statements with language warning that they could face discipline and even be fired if they discussed the matters with outside parties without the prior approval of the company’s legal department.  Since these investigations included allegations of possible securities law violations, the SEC asserted that these terms violated Rule 21F-17 (enacted under the Dodd-Frank Act), which prohibits companies from taking any action to impede whistleblowers from reporting possible securities violations to the SEC.

The SEC said there were no apparent instances in which the company actually prevented employees from communicating with the agency, but that such a “blanket prohibition” on discussing internal investigations with outsiders has a “a potential chilling effect on whistleblowers’ willingness to report illegal conduct to the SEC.”

In addition to paying the fine to the SEC, the company also amended its confidentiality agreements by adding language making clear that employees are free to report possible violations to the SEC and other federal agencies without company approval or fear of retaliation.

As we previously cautioned, general counsel and securities compliance attorneys should be careful when drafting employment contracts to avoid including language that could be interpreted to incentivize employees to keep potential securities fraud whistleblower complaints in-house or confidential, or in this case disincentivize whistleblowers from bringing those complaints to the SEC.  While the disclaimer described above should certainly be included in any employee confidentiality restrictions, the SEC has not stated that such a disclaimer would be a safe harbor for companies.  Thus, counsel may want to consider additional cautionary language or revisions to their employment agreements to avoid broad restrictions that could discourage potential whistleblowers from reporting violations to the SEC.

FINRA recently warned that firms could face disciplinary action if they enter into settlement agreements that bar customers or former employees from reporting wrongdoing at the firm.  Although FINRA recognized that confidentiality provisions were acceptable, it noted that they have to be written in such a way to authorize the individual to contact FINRA or another regulator to report improper activity. 

Similarly, FINRA announced that any confidentiality stipulation that at arbitration panel enters in a case would not apply to sending information to regulators about the firm.  The timing of this announcement coincided with the SEC approving a FINRA rule change that allows arbitrators to make a referral to enforcement before the end of a case.  This was certainly not coincidence. 

So what is the take away from these policies?  For one, it could embolden whistleblowers to reach a resolution with a member firm, only to then report the firm to FINRA or another regulatory body.   

In the end, this may result in more litigation and enforcement proceedings.  It may also result in more FINRA arbitrations being tried to award.  In other words, the firm may as well try to get exonerated by a panel if the claimant could just report the firm to FINRA regardless of a settlement. 

The other side of this coin is FINRA’s push for transparency.  By restricting these agreements and allowing arbitrators to report firms to enforcement during arbitration, FINRA is stepping up its oversight of member firms. confusion.jpg

The cynic in me says that the lawyers will be the one that will ultimately benefit from these policies because firms may be forced to litigate claims to a conclusion and fight more enforcement matters.   

One unfortunate outcropping of these policies may also be frivolous reports to FINRA to use as settlement leverage.   Compounding that issue, making a whistleblower report is at least entitled to a qualified privilege such that firms may have little recourse for a whistleblower that makes a bogus report. 

So what should firms do?  The key is leadership from the top that promotes a culture of compliance.  This may be cliché, but solid firm leadership that has a no-nonsense approach to compliance and supervision will stand in a better position than firms that deal with compliance and supervision on an ad hoc basis. 

Life for member firms and registered representatives is becoming more challenging, and FINRA is not making it any easier.  Nonetheless, you should take a hard look at yourself.  Are you doing enough to create a culture of compliance to avoid the sting of whistleblowers?

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Now that 2014 is here, it is a good idea to understand what the Enforcement Division might focus on this year.  In a recent article that appeared in the BNA, David Marder, a partner with Robins, Kaplan, Miller & Ciresi identified fifteen things to expect in the coming year. 

The fifteen things he noted to expect include: 

  1.             Increased use of whistle-blowers;
  2.             Increase requiring defendants admit guilt in settlements;
  3.             Increasing the use of available technology;
  4.             Increase the number of easier to prove cases;
  5.             Push self-reporting of securities violations;
  6.             Increased focus on microcaps;
  7.             Continued focus on gatekeepers;
  8.             An emphasis on financial reporting;
  9.             Protection of market structure and integrity;
  10.             Increase the activity of specialized SEC units;
  11.             Continue attacking insider trading;
  12.             Investigate misconduct at hedge funds, private equity funds and mutual funds;
  13.             Increase the size of the trial unit to avoid losing at trial;
  14.             To further leverage the exam program; and
  15.             Increase administrative proceedings.

 Although this certainly seems like a robust agenda, expect the SEC under the leadership of Chair Mary Jo White to pursue it with particular vigor.   

It seems like the SEC has a lot to prove; in part, to justify it budget.  The question is whether the industry is adequately prepared to deal with a bulked up and more aggressive SEC.  Time will tell . . . .

The SEC’s Division of Enforcement is performing well according to its departing director.

The soon to be ex-Enforcement Director credits this strength to his re-organization of the Division based on expertise and the tips received from whistleblowers, among other things.  The Dodd-Frank Act was the impetus for the SEC’s whistleblower program, and the SEC received over 3,000 tips in a year.  Many of these tips relate to disclosure and financial fraud; market manipulation; as well as offering fraud, among other things.  The SEC has also found that these whistleblower complaints come from all over the country and world.

In short, the SEC seems to be waiting for you to blow the “whistle.”

The SEC’s Whistleblower Office received 3,001 tips last year, involving a number of different areas and from all over the United States and the world. 

The SEC views the program as a valuable tool, and believes the “bounty program”– the payment for these tips– has enhanced the disclosure and its usefulness.  This year even saw the first award to a tipster. 

We can hear the music from here. . .

The SEC is strongly reviewing if corporations are ensuring that informants are protected.

The SEC will not permit a retaliation.  The SEC is seeking to determine if corporations are retailing against individual persons who submit internal complaints.  As one indication, the SEC is reviewing personnel files to ensure that there is no negative reference to these individuals who have informed on corporate misconduct. 

In sum, corporations need to protect themselves from this type of review.  Reporting corporate misconduct is serious enough without then being accused of retaliation.  Avoid it like the plague!!