This week, I will take a break from my Solutions column series on the Department of Defense (DoD) to report on some breakthroughs on the new Securities and Exchange Commission (SEC) attempt to strengthen the laws for SEC whistleblowers. There are plenty more columns to write about the DoD and more of them will be published in the weeks to come.
Last December, I published a Solutions column called “The SEC Whistleblower Program: How to Avoid Killing a Good Idea,” written by expert whistleblower attorney Eric R. Havian. Havian has been one of the most successful federal qui tam False Claims Act attorneys in history; he wrote about the potential successes and failures of the new SEC whistleblower law. This law was enacted by Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, with the idea of trying to get people in Wall Street to come forward on fraud before it wreaks more havoc on the US economy.
This new SEC reform would give awards for tips related to any securities law violation that leads to a penalty or disgorgement of $1 million or more, as well as guaranteeing that qualified whistleblowers will receive at least 10 percent of the amount recovered. The bill would also increase protection for whistleblowers from retaliation and include other provisions that would encourage whistleblowers to risk their careers and come forward.
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However, as I have mentioned before in this column, passing reform legislation is only the first step of a solution for a governmental problem. There can be much mischief and deform of the intent of the original legislation that is passed during the implementation of the actual law by the bureaucracy. Even though tough legislation can be passed, once the entrenched powers lose in the legislative arena, they use their influence with the executive branch to distort and weaken the impact of the law. When this new SEC whistleblower law passed, those on Wall Street who might lose in successful whistleblower fraud cases, came out in droves during the comment period on this law. Mr. Havian, in his column, warned about the various ways this new SEC whistleblower law could be deformed, based on his experience of the success of the qui tam False Claims Act law and the not-so-successful IRS whistleblower law. The SEC had a public comment time for suggestions on the adoption of the final rules, and there were frantic efforts on the part of companies to find ways to weaken the law and make it almost impossible for whistleblowers to be successful in reporting fraud to the SEC.
I am happy to report that, on May 25, 2011, the SEC voted 3-2 (with the two Republican members voting against) to adopt a set of rules that, for the most part, overrules the suggestions of industry and is friendly to potential SEC whistleblowers.
Here are the areas where the final rules (in italics) will help whistleblowers expose wrongdoing, with my comments below, according to the Project on Government Oversight (POGO), a good-government, nonprofit organization that played a major role in fighting deadly rules pushed by industry (for full disclosure, I founded POGO and still serve as a member of the board of directors):
Reject industry's calls for an internal reporting requirement.
Industry, led by the US Chamber of Commerce, tried to force a rule that a whistleblower had to go through the company's internal reporting channels before going to the SEC. This rule would allow cheating companies to destroy files, cover their tracks and demonize a whistleblower before the SEC could even investigate. There was a fierce fight between industry and good-government groups over this provision. The SEC final rules did not require a whistleblower to go through the company's internal reporting channels, but did put in an incentive of getting more of a reward if a whistleblower did report the fraud to the company and the company reported it to the SEC, or if a whistleblower first informed the company and then informed the SEC within 120 days. Ironically, for all the chest beating by industry that whistleblowers would blindside a company by reporting fraud without the company having a chance to fix it, experience shows that most whistleblowers do inform someone in the company about the fraud and usually don't go outside the company except when the company fails to act. I have found that is true with most of my whistleblowers over my 30 years of helping them.
Clarify that a tipster like Harry Markopolos could qualify for an award for providing the SEC with “independent analysis,” even if that analysis is largely based on information obtained from publicly available sources.
Markopolos is an American hero with his ten-year attempt to get the SEC to listen to him about the Bernie Madoff $65 billion Ponzi scheme. He first stumbled on to the scheme when his employers saw Madoff's impressive returns for his investors and asked Markopolos to reverse engineer the numbers to see how Madoff was doing it. He found that it was too good to be true and built a case based on publicly available sources, but used his brilliant mathematical mind to put it all together. The federal qui tam False Claims Act law and other whistleblower laws don't allow people to read about a fraud from public sources and file a case, but this law will have an exception for that because SEC matters are extremely complicated and whistleblowers with unique analytical abilities are sometimes the only people who can put fraud cases together. To understand just how hard it is to figure out many of the Wall Street schemes, I would urge you to read Markopolos' amazing book, “No One Would Listen.” Markopolos is just exactly the type of whistleblower for which this law was written.
Lower the threshold to allow employees with legal, compliance, audit, supervisory or governance responsibilities to report to the SEC if a company fails to conduct an adequate internal investigation.
Usually, if a whistleblower has the job of reporting fraud, they are not eligible for a reward for just doing their stated job. However, there are times when that the company fails to act on that reporting and this law will give exceptions, so if companies are told by their oversight employees that there is fraud and they ignore it, those employees can go to the SEC.
Recognize that there may be situations in which a whistleblower obtains information through a violation of a foreign criminal law without violating U.S. federal or state securities laws, in which case the whistleblower should not automatically be disqualified from reporting to the SEC.
Clarify that protective orders in private litigation can never be used to conceal violations of securities laws from the SEC.
This is such an important provision. I have been involved with private litigation cases that settle and, therefore, the public never knows about a company's fraud. I wrote about this problem in another Solutions column and strongly believe that the public's safety should always override any protective order.
Clarify that employees would be protected by Dodd-Frank's anti-retaliation measures even if they don't technically qualify for an award.
This protection is similar to the whistleblower protection in the federal qui tam False Claims Act law where, even if the whistleblower's information does not lead to a successful case, a company or others can still be fined by the courts for retaliating against a whistleblower who merely brought the information forward to the government. It is a good protection for people who are trying to do the right thing, but sometimes a case cannot go forward.
Stipulate that nobody can try to impede a whistleblower from communicating directly with the SEC about a securities law violation by, for instance, forcing the whistleblower to sign a confidentiality agreement.
One of the most famous cases concerning the public good and protective orders, was the confidentiality agreement that almost held back tobacco whistleblower Jeffery Wigand, as depicted in the movie “The Insider.” Companies should not be allowed to hide fraud under the ruse of a employer confidentiality agreement.
I know, for many of the readers, this column will seem to be getting into the weeds of SEC whistleblower laws, but it is just this type of scrutiny that is needed so that the industry does not ruin a good oversight law. There are many seemingly noble oversight laws on the books that have fatal flaws that render them ineffective – placed there by the industries that would be affected. These laws are worse than having no laws because it gives the public a false idea that someone is watching out for their tax dollars. It is very hard work by good-government groups and the media to keep on top of all the efforts to deform reform legislation, and the public should appreciate and support groups that go up against these powerful companies against the odds.
Unfortunately, the public, whistleblowers and the good-government groups cannot completely celebrate this victory for the little guy because the Empire is already striking back. Even though the industry was not successful during the rule-making process of this law, they have backed a draft bill by Rep. Michael Grimm (R-New York). This bill, if enacted into law, would overturn much of the hard-fought reform rules listed above, deny whistleblowers from having attorneys working on a contingency basis (which would eliminate most legal help for whistleblowers to bring their cases) and allow the companies to do self-investigation and self-reporting to the SEC to limit their liability – a total loophole that is similar to what was tried in the 1980s in a DoD program called “voluntary disclosure,” where the company would investigate itself and report only a small amount of its wrongdoing to inoculate itself from larger investigations.
A collection of good-government groups have already written their opposition to this draft bill that would overturn all the work to get this SEC legislation enacted. If this bill is successful and guts this new law, it will take many more years of work to try to get the desperately needed oversight on Wall Street companies.
There is also a big self-dealing, revolving-door problem with the SEC that was discovered by POGO in their new database that will also hurt oversight as individuals at the SEC don't do their tough oversight responsibilities so they can get lucrative jobs on Wall Street.
SEC whistleblowers, armed with these new and effective rules, need to come out of the closet and start getting cases started with the SEC. The more cases that are successful, the harder it will be to deform this law. When I helped enact the federal qui tam False Claims Act law in 1986, industry and the Republican Department of Justice tried to do everything to kill it or make it ineffective. Now that the qui tam law has returned over $18 billion back to the US Treasury, the industry tries to get bad judgments in the courts that restrict the law, but they know that they cannot completely eliminate the law through legislation. We need to get some early large fines and judgments with this new SEC law in order to protect the hard-fought rules that will make it effective. Our government, our Treasury, our personal finances and our economy can't afford to wait much longer as these companies continue to defraud us all.