January 17, 2012

Cover Story

Gary L. Crocker

Gary L. Crocker doesn’t gripe about his days as a broke, Harvard Business Sch...Read More

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Blowing the Whistle

How to Make Money from Securities Fraud Without Committing It

Mark W. Pugsley

January 17, 2012

On July 15, the U.S. Senate passed the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” otherwise known as the Wall Street Reform bill. President Obama signed the bill on July 21, 2010, putting into place the most significant and sweeping changes to our country’s financial regulatory system since the Great Depression. The Act includes a new whistleblower program that could pay potentially large cash rewards to individuals who report securities violations to the Securities and Exchange Commission (SEC). For the first time in history, the SEC has been authorized to pay whistleblowers at least 10 percent—and up to 30 percent—of monetary sanctions obtained in a successful enforcement action by the SEC, as long as the sanction obtained is more than $1 million. It also contains new protections from retaliation by companies against whistleblowers. What Information Qualifies? The Act requires that the information provided by the whistleblower must be “original information.” This means that it must be “derived from the independent knowledge or analysis of the whistleblower” and “not known to the commission from any other source.” The information provided cannot have been derived from statements or allegations that have been made in “a judicial or administrative hearing, in a governmental report, hearing, audit or investigation, or from the news media.” Another key exception is that payments cannot be made to a whistleblower who is convicted of a crime related to the action. In other words, if you were directly involved in the conduct that ultimately leads to the sanction—and are criminally convicted for that involvement—then you cannot benefit from reporting your own conduct to the SEC. The Act provides for a payment of between 10 percent and 30 percent of fines recovered if the fine exceeds $1 million, but the SEC’s staff has considerable discretion in determining the amount within that range. Factors they will consider include the significance of the information provided, how helpful and cooperative the whistleblower is, “the programmatic interest of the commission in deterring violations” and any other factors the SEC develops. The Act also prohibits the SEC from paying rewards to whistleblowers who gain the information by auditing financial statements as required under the securities laws. The SEC has 270 days to implement regulations on these new whistleblower provisions, but information provided by a whistleblower in writing to the SEC prior to that time can qualify. Moreover, whistleblowers may be eligible for an award even if the conduct they report occurred before the Act was signed by President Obama. The financial incentives can also be paid to whistleblowers if the information provided to the SEC leads to a successful action brought by another federal agency. It is also possible to provide information to the SEC anonymously through an attorney and still qualify for the program. Protection of Whistleblowers The Act contains new protections against retaliation by employers for whistleblowers. No employer may “discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against” any employee who provides information to the SEC or otherwise assists in an SEC investigation. Employees who are retaliated against can sue in federal court to obtain reinstatement, double back pay and attorneys’ fees. Whistleblowers who cooperate with the SEC may also be able to take advantage of new SEC policies (not part of the Act) that permit “cooperation agreements” with company insiders who agree to provide information leading to enforcement actions in exchange for governmental protection. The SEC recently instituted a formal framework of incentives to secure the cooperation of persons who saw, heard and witnessed securities fraud first-hand, and to protect them from prosecution in some cases. It is unclear at this point whether this program will be available to whistleblowers. Potential whistleblowers should know that although the benefits may be significant, there are many pitfalls in this process—particularly if they have had some involvement in the conduct they are reporting to the SEC. Individuals who are interested in blowing the whistle with the SEC should retain competent legal counsel to navigate these new rules and protect themselves. What Should Businesses Do? Overall, these new provisions could be very important to Utah businesses. These new cash incentives will surely lead to a significant increase in the number of reports against Utah companies—both justified and not—by current and former employees who want to cash in on their way out or benefit from knowledge they obtain while still employed. But there are several things a company can do to protect itself. First, businesses should be proactive: • Develop robust internal controls and procedures to ensure that all employees conduct themselves in a lawful manner. • Undertake periodic internal compliance audits to identify issues that need to be dealt with and additional internal controls and/or training that need to be implemented. Second, companies who become aware that the SEC has initiated an investigation should immediately retain independent outside counsel to conduct an internal investigation into the allegations. The benefits of internal investigations and self-reporting (if appropriate) are compelling. Aggressive efforts to investigate and resolve problems internally can demonstrate to the SEC that the conduct has been stopped and does not merit a full investigation. On balance, the cost of dealing with these issues internally is typically far less than the cost and risk of protracted litigation. Mark W. Pugsley is the chair of the Securities Litigation Group at Ray Quinney & Nebeker. He also maintains a blog on these issues at Utahsecuritiesfraud.com.
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