Whistleblowers Set To Receive First SEC Payouts
Since its inception in 1934, the federal Securities and Exchange Commission has always had a mechanism for individuals to report securities fraud. However, until recently, there has not been a strong incentive for people to report companies to the SEC. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act mandated a formal whistleblower process that includes giving bounties to those who report corporate wrongdoing. The bounty represents a percentage (between 10% and 30%) of the fines levied against the company. The program also provides protection to internal whistleblowers against retribution by the company.

Payments Soon
Due to the length of the reporting and appeal process, no payments have yet been made to whistleblowers under the program. Complainants' lawyers expect those first payments to be made soon. Once payouts begin, the SEC is bracing for complaints to increase, as people start seeing the program working as it was designed. The SEC's first annual report after implementation captured the first seven weeks of the program. During that time, the Commission received 334 calls about securities fraud in 37 states and even internationally. By the end of the fiscal 2011 year, the fund established to fund the program held just about a half billion dollars in funding, but it had not yet resulted in the collection of fines and sanctions or any payouts to whistleblowers.

There are several types of securities fraud, and the U.S. Securities and Exchange Commission reports that the tips coming in cover most of them. One of the most common transgressions reported is financial statement fraud and lack of disclosure. This is generally a difficult area for the SEC to investigate on its own. With detailed insider information, the SEC can determine whether a company is following reporting regulations. Another common category of fraud reported is market manipulation, which could include anything from insider trading to improper release of corporate information.

IRS Success
While it is too early to determine the success of the SEC whistleblower program, one can look at a similar plan launched in 2006 by the Internal Revenue Service. The IRS plan awards whistleblowers a percentage of the taxes recovered (15-30%). In 2008 and 2009 alone, the agency logged more than 1,000 complaints with many of them alleging tax underpayments of $10 million to $100 million. In April 2011, the first of these cases was wrapped up and an internal accountant received a payment of $4.5 million after reporting his company's underpayment of more than $20 million in corporate taxes. In the IRS program, payout is only mandatory on tax recoveries of $2 million or more.

An interesting provision in the SEC whistleblower program is that employees or other insiders are allowed to report directly to the company through the audit committee and to the SEC simultaneously. This gives a company the ability to investigate and disclose its findings to the SEC without significant cost to the agency. With the projected increase in complaints under the new program, this should help the SEC manage its staffing and costs so that the system doesn't get backlogged.

The Bottom Line
Once payments to whistleblowers begin to go out, the SEC is bracing for a deluge of new allegations of securities fraud to investigate. It is too early to tell how much fraud will ultimately be uncovered. If the program works as it should, it may be the best securities law enforcement tool in the SEC's toolbox. The original intent of the Dodd-Frank Act was to clean up Wall Street and to restore faith in the American financial system. The whistleblower provision will go a long way towards meeting this goal.

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