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SEC Whistle-Blowing Report: We’ve Only Just Begun

By Allen Smith  11/30/2012
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Employers have been lulled into a false sense of complacency over whistle-blower complaints, according to Steven Pearlman, an attorney with Proskauer Rose in Chicago.

That’s because since the Dodd-Frank Act was enacted in 2010, the Securities and Exchange Commission (SEC) has made just one payout from the agency’s award program for whistle-blowers.

Pearlman said it’s possible there will be “a significant number of whistle-blower awards over the next fiscal year,” noting that there are 143 notices of actions for whistle-blower complaints in the pipeline, according to the SEC’s first report on whistle-blower tips to the agency, issued Nov. 15, 2012. Describing the first award as “the tip of the iceberg,” Pearlman recommended in a Nov. 26, 2012, interview that employers “take concerted measures right now to heighten the likelihood employees will report internally.”

The report says the program the SEC has developed already has resulted in more than 3,000 tips. Pearlman said this shows employees are aware of the program. Companies’ “own employees essentially have been deputized by the government to look over the shoulder of managers and compliance and alert the government of anything illegal,” he remarked.

Employers should “take no comfort” in the fact that thus far, there has been only one award from the program, he said, predicting “more and more awards.”

Relevance to All Companies

Although Dodd-Frank mainly targets publicly traded companies, Pearlman recommends nonpublic companies consider implementing a whistle-blower rapid response system, also. It “behooves companies of all sizes” to contain possible damages to their brand by addressing whistle-blower complaints head on.

Nonpublic companies may face whistle-blower complaints to agencies other than the SEC, such as the Environmental Protection Agency, or to licensing boards, he cautioned. Whistle-blowing complaints might address public health threats, claims of someone “cooking the books” or a wide range of other compliance failures.

As for public companies, they should be encouraging employees to bring complaints to their attention through their internal compliance programs, even though employees don’t have to do that. Instead, they may go first to the SEC to try and collect an award for the tip.

In some instances, where public companies find merit in internal whistle-blower complaints, the companies may choose to report the complaints to the SEC themselves, he added.

Pearlman said it was “most troubling” that so far, the SEC has had a “lack of transparency” in the factors used to determine the size of its whistle-blowing awards—apart from the Dodd-Frank Act’s requirements. Under the law, SEC awards are available for individuals who offer high-quality original information that leads to an SEC enforcement action in which more than $1 million in sanctions is ordered. Awards may range from 10 to 30 percent of the money collected.

Types of Whistle-Blower Complaints

While the SEC report sheds little light on how awards are calculated, the report notes that in fiscal year 2012, it received the following types of whistle-blower tips:

Corporate disclosure and financials: 547.

Offering fraud: 465.

Manipulation: 457.

Insider trading: 190.

Trading and pricing: 144.

Foreign Corrupt Practices Act (FCPA): 115.

Unregistered offerings: 100.

Market event: 85.

Municipal securities and public pensions: 64.

Other: 70.

Blank (No allegation type checked by whistle-blowers on SEC’s tip, complaint or referral (TCR) form): 131.

These categories are similar to the ones on the TCR form, but Pearlman said the categories are “very broad,” making it “difficult to say with precision what types of fraud they encompass.” Some categories overlap, he noted, before summarizing what the categories probably mean.

Corporate disclosure and financials. Public companies must disclose information that is material to shareholders. If there has been a violation of the FCPA, bribes, rigged bids or a major settlement, that information could affect investor’s valuation of a stock, resulting in fraud if that information is not disclosed.

Offering fraud. When stock is offered for people to buy, it is “critically important they be given precise information,” Pearlman noted. This type of complaint involves when inaccurate information is provided or returns are overstated.

Manipulation. Manipulation may include false appearances in the value of a product, or spreading false rumors of a takeover or acquisition, which could affect a stock price. A false rumor might, for example, include misinformation about a product soon receiving approval from the Food and Drug Administration.

Insider trading. The SEC defines illegal insider trading as “buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.”

Trading and pricing. Insider trading is not the only kind of trading with rules to follow, so other whistle-blower claims may involve other types of trading and pricing violations.

FCPA. Bribery is among the type of corrupt practices prohibited by the FCPA, such as Wal-Mart’s highly publicized bribery scandal in Mexico.

Unregistered offerings. Pearlman said that stocks must be registered with the SEC and offered with a license to sell, but sometimes entities attempt to sell unregistered stock or sell without a license, which he called an “egregious” violation.

Market event. Pearlman said it wasn’t clear what the SEC meant by this category, but it likely overlapped with other categories, such as manipulation.

Municipal securities and public pension.
This category of claims involves fraud in transactions involving municipal securities or public pensions.

The SEC is being “deliberate and careful” in rolling out its award program for whistle-blowers, Pearlman said, and is becoming less secretive. He called the report “a step in the right direction.”

At the same time, he said, many employers remain out of step with whistle-blower protections. “Employers are aware of the risk, but have very tight budgets,” he said, adding that this may not be a priority for many employers.

He finds this “troubling,” and urges employers to “get out in front of this issue proactively,” and prepare for more whistle-blower laws coming down the pike, as demonstrated most recently when President Barack Obama signed into law the Whistleblower Protection Enhancement Act of 2012 on Nov. 27, 2012.

Allen Smith, J.D., is manager, workplace law content, for SHRM.

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