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A Slow Start for the SEC's Whistleblower Office?

Bruce Carton | May 14, 2013

This coming August the Securities and Exchange Commission's Office of the Whistleblower will turn two years old, but with only one award paid out so far, some are wondering if it is having the intended effect.

This office, established by the Dodd-Frank Act, opened its doors to great fanfare in August 2011 and now takes in and processes thousands of whistleblower tips per year, according to an SEC report on the program published last November.

After twenty-one months in operation, a ramp-up in the office's staff members, and the roll-out of a $21 million “Tips, Complaints, and Referrals” database, however, the Office of the Whistleblower has only paid one small award to a whistleblower. With no other clear success stories to point to thus far, and high expectations for the Office of the Whistleblower to provide meaningful information in enforcement of fraud, questions about the program's success are starting to arise.

The SEC announced the only payment in August of 2012, when it awarded $50,000 to a tax consultant named Dee Dee Stone. Sean McKessy, the chief of the Office of the Whistleblower, stated at the time that “the fact that we made the first payment after just one year of operation shows that we are open for business and ready to pay people who bring us good, timely information.”

The details that have since emerged about this case show that the SEC's new processes for taking in tips worked quite well in this instance. Stone had been doing work for a firm affiliated with China Voice Holding Corp. After detecting suspicious money transfers, she decided to contact the SEC and her telephone call was routed to the new TCR database. Within 24 hours, Stone reportedly received a call from an SEC attorney seeking more information on the issues at China Voice, and the ensuing investigation ultimately led to a successful enforcement action. SEC lawyers said that without Stone's tip, the agency might never have discovered the fraud.

Unfortunately, nine months later, the China Voice case remains the only matter in which the SEC has been able to provide an award to a whistleblower. The conspicuous, ongoing silence from the SEC in this area has opened the door for an increasing number of questions lately as to whether the agency is aggressively pursuing the leads it receives and whether it can turn these leads into successful enforcement actions.

For its part, the SEC maintains that the program is fulfilling its mission of providing solid tips to the agency's investigators, particularly in the areas of asset management, financial reporting, and “sophisticated trading” techniques. The agency adds that despite the relative absence of awards to whistleblowers so far, observers should not conclude that the SEC is not being aggressive or that the program is not paying off.

The conspicuous, ongoing silence from the SEC in this area has opened the door for an increasing number of questions lately as to whether the agency is aggressively pursuing the leads it receives and whether it can turn these leads into successful enforcement actions.

Speaking at a conference in late April, Stephen Cohen, an associate director in the SEC's Division of Enforcement, insisted that “people should take absolutely nothing, absolutely nothing, from the fact that there has been (only) one award.” Cohen said that “it's really the wrong question to ask, quite frankly, for a few years at least. The rewards will follow, I'm quite sure of that.”

While even McKessy admits that he is eager to begin paying significant awards to whistleblowers—the award money is “burning a hole in my pocket,” he says— he is quick to point out that the SEC's whistleblower program continues to successfully lay the groundwork for more awards to be paid. First, whistleblowers are becoming more aware of the program, and tips are starting to pour in. As stated in the SEC's initial Annual Report on the Dodd-Frank Whistleblower Program, the SEC received 3,001 whistleblower tips in fiscal year 2012. These tips came in from individuals in all 50 states and the District of Columbia, as well as 49 countries outside the United States.

Erika Kelton, a Washington, D.C. lawyer who brings whistleblower cases, told Corporate Crime Reporter in February that she finds the SEC's whistleblower offices to be very open to the tips being submitted. She said that although creating a “whistleblower friendly” culture is typically a challenge for a government agency, the SEC embraced such a culture immediately. Kelton has already had cases where her whistleblower client collaborated with SEC attorneys to help them understand certain documents, for example. By contrast, she said, the IRS whistleblower office has been in place for six years and she has never had a whistleblower client work collaboratively with the IRS.

Second, despite some critics who assert that the agency can take “weeks or months” before it responds to a tip, McKessy says that his team tends to be very prompt in its response time. “You'd be hard pressed to find another whistleblower program that's quicker,” he says.  To help handle the thousands of incoming tips, the Office of the Whistleblower has increased its staff to include 11 lawyers (up from eight in fiscal year 2012) and 3 paralegals.

Still, the Whistleblower Office must contend with certain obstacles—including corporate resistance. In its whistleblower rulemaking, the SEC attempted to incentivize employees to first report issues internally before taking them to the government. The program's rules provide that the amount of the award may be increased if the whistleblower has “participated in internal compliance systems.” In addition, the SEC created a “lookback period” of 120 days under which a whistleblower who reports internally maintains priority status for the purpose of receiving an award.

McKessy said in January that he was discouraged to see that despite the SEC's efforts to incentivize internal reporting, some companies have elected to not tell their employees about the whistleblower program. It was therefore part of his job, McKessy said, to get the word out that the program is in place.

Retaliation Crackdown

The whistleblower rules also prohibit retaliation by companies against whistleblowers, and the SEC is authorized to enforce these anti-retaliation protections. There have been some reports of companies allegedly retaliating in this manner. In September 2012, for example, James Nordgaard sued his former employer, Paradigm Capital Management, claiming that after he notified Paradigm that he had reported what he believed to be illegal activities to the SEC, Paradigm asked him to resign. When he refused, he says, Paradigm “embarked on a campaign of retaliation,” including removing him his job on the trading desk and assigning him to low-level compliance work “alone in a room with little ventilation.”

McKessy views retaliation as not only illegal but also as a threat to the whistleblower program, and his office is said to be “looking hard” for potential retaliation cases the SEC can bring under the Dodd-Frank Act to send a message that such conduct will not be tolerated. He has stated that one of the issues the agency must think through is the role that the Office of the Whistleblower should play (as distinguished from the Enforcement Division more broadly) when there is evidence of retaliatory conduct against an informant.

Other corporations, while not engaged in retaliation, have reportedly implemented policies that can have a chilling effect on the whistleblower program. Some companies, for example, have reportedly inserted language in employees' severance agreements asking the employees to certify that they have advised the company of any confidential information they have given to outside parties. Such a provision can deter employees from taking tips to the SEC. The SEC's Cohen emphasized in late April that the SEC will take a “dim view” of companies whose policies discourage whistleblowing.

Whistleblower lawyers in the private sector continue to predict that the flow of tips to the SEC will soon produce many more awards. Such a development would no doubt be extremely welcome at the SEC's Office of the Whistleblower as it completes its second year in operation.