Understanding the New SEC Whistleblower Program: Breaking down the Largest Whistleblowing Rewards in U.S. history

Investing

By Susan Lyon

Think you get far too excited when receiving that oh-so coveted tax refund check from the IRS each April? That average $3,000 refund is milk money compared to the $104 million dollars the IRS just paid to former UBS banker Bradley Birkenfeld for his role as a whistleblowing informant, who provided the IRS valuable insider information resulting in a giant settlement with UBS.  But the IRS whistleblower program is just one piece of the puzzle – and it’s slow, old and rusty, not to mention controversial.

To improve our fraud reporting system at the national level, the 2010 Dodd-Frank Act, one of the largest financial reform bills in U.S. history, established the country’s new Office of the Whistleblower within the Securities and Exchange Commission (SEC) to try to do more.  This program attempts to go above and beyond existing whistleblower programs by allowing whistleblowers to report securities fraud with both a financial incentive and protection from retaliation, should their tip come to fruition.

Dodd-Frank has ushered in a new era of whistleblowing by focusing specifically on securities fraud.  Under IRS law, Birkenfeld might have received a record-setting reward, but he also had to suffer a forty-month jail sentence and a five-year wait from the date the case began.  Might things have turned out differently had he reported fraud under the SEC’s new program instead?

Who can the blow the whistle?

A whistleblower is any individual who reports misconduct or fraud at an institution (private or public).  The federal government has sought to secure the rights and protections of whistleblowers since the 1800s. During the Civil War era, many government contractors committed acts of “false claim” from providing non-functional equipment to over charging for previously agreed upon contracts. These acts of fraud led to the passage of the False Claims Act of 1863 also known as the “Lincoln Law,” setting precedent that the whistleblower is entitled to part of any monetary fine that are a result of the whistleblower’s actions.

The Dodd–Frank Wall Street Reform and Consumer Protection Act:

There have been several attempts to create special whistleblower incentives in the financial sphere specifically with protection from retaliation, which Dodd-Frank now does best:

  • Section 922 of the Act laid out critical incentives to bring forth whistleblowers, including (1) financial compensation as well as (2) protection under the law from criminal penalties.
  • Individuals who report valuable information to the SEC or DOJ on securities fraud like as insider trading, fraud, money laundering, and so forth are entitled to up to 30% of any settlements that result in payments collected over $1 million payments.
  • The first recipient of the SEC whistleblower program received a payout of $50,000 on August 21, 2012; an official press release noted represents 30% of the penalty amount collected.

IRS versus SEC:

Meanwhile, on the IRS side of things, Birkenfeld’s own arrest and subsequent payout were only one case in a recent slew of federal investigations into corporate misconduct.  Birkenfeld’s reward by the numbers:

  • Birkenfeld spent 15 years working at a variety of Swiss banks. It was during his time working for UBS when he came to realize that the bank was explicitly violating terms of an agreement made with the IRS.
  • In 2005, Birkenfeld reported his concerns about the banking giant’s practices to internal authorities at UBS.  Birkenfeld resigned from his position later that year.
  • After several unsuccessful attempts to follow up with the inquiry internally at UBS, Birkenfeld met with Department of Justice (DOJ) officials in 2007.
  • The information provided by Birkenfeld drove a DOJ investigation that led to a fine of $780 million levied against UBS. The penalty was result of an ongoing case implicating the bank in encouraging unlawful tax-evading practices.
  • UBS paid the fine and revealed the identities of about 4,500 account holders suspected of withholding taxes from the IRS.
  • Birkenfeld pled guilty to one count of conspiracy to defraud the government and was sentenced to 40 months in jail in 2009.
  • Current status of Birkenfeld: out of jail, under house confinement, and $104 million richer.

Expert Opinions: What’s Next For Whistleblowing?

The Dodd-Frank Act’s whistleblower program, established under the SEC, is the most recent attempt at strengthening and speeding up federal whistleblower programs.  While the DOJ, SEC, and IRS continue to push forth their own whistleblowing programs, the debate concerning proper retribution and consequences for such informants rages on.

We ask the experts: is the SEC’s new program working, and is it better than the old IRS program?

  • Eva Marie Carney, Partner at RK&O LLP and former Assistant General Counsel at the SEC, highlights the advantages of being able to anonymously report fraud to the SEC:

“The Dodd-Frank Whistleblower program as implemented by the SEC offers the express advantage of anonymous reporting to the SEC through a lawyer.  This is not an express component of the IRS whistleblower program and I believe will make the program very attractive.  It’s the unusual person who will make a report if doing so means his or her job will be at risk or that workplace harassment, or other more subtle retaliation will result – so the ability to report suspicion of wrongdoing anonymously is significant.

Also, in response to many voices raising the concern that the SEC not write rules implementing the program that effectively undermine internal compliance programs and make irrelevant systems that companies have installed designed to deter, identify, and correct violations, the SEC’s whistleblower rules encourage (but don’t require) internal reporting.  Other whistleblower regimes – e.g., the False Claims Act and the IRS whistleblower law – do not expressly provide incentives for reporting internally.

The goal of the Dodd-Frank Whistleblower program is to detect and deter fraud.  The program has been a driver for companies and advisory firms (my client base) to do more than ever before to encourage employees to come forward internally and as early as possible with reports of compliance concerns.  So in that respect I think it is working.  Organizations have been revamping their internal whistleblower programs, including their investigation of concerns – they have been working more intently on running issues to ground.  Also they are doing significantly more messaging around encouraging employees to raise compliance concerns internally and on an early basis.  They are focusing on communicating the fairness and thoroughness of their handling of employee compliance concerns, spelling out the specifics of the process so there is no mystery about it, and making it clear that retaliation against those who report wrongdoing internally won’t be tolerated.”

  • Tom Devine, Legal Director of the Governmental Accountability Project, explains how the SEC has implemented the gold standard of whistleblower programs by protecting the whistleblower from industry retaliation:

“While it’s still too soon to tell exactly how much taxpayers will save as a result of the program, the SEC did a very good job setting up balanced regulations to protect whistleblowers despite intense industry pressure to the contrary.  Rates of disclosure under this program have skyrocketed.

The SEC’s whistleblower program is very different from the one previously established by the IRS because it offers protection against retaliation, which the IRS program does not.  The Dodd-Frank program has best practice whistleblower protection, whereas if you look at Birkenfeld’s recent payout by the IRS, the justice department also sued him for his involvement.  Dodd-Frank has three whistleblower anti-retaliation sections, and its best practice rights cover all of this.”

  • Professor Larry Hamermesh, Professor at Widener Law and Director of the Institute of Delaware Corporate & Business Law, argues that the SEC program was set up as a reasonable balance between competing interests but it’s too soon to know if it’ll work better than the older programs in place:

“Clearly the one thing that Congress saw and wanted to fix was an insufficient incentive system for whistleblowers who had witnessed corporate misconduct.  So they decided to effectively hold out a ‘carrot’ – a portion of the money recovered as a result of any information the whistleblower provided.

The big question is how this will interact with internal corporate grievance and reporting programs already in place.  Firms were afraid the SEC program would take the wind out of their sails, but instead the program may actually bolster internal practices because the same person can now both report internally and to the SEC.  The commission did an admirable job setting up a reasonable balance between them to harmonize the two mechanisms.  We’ve now seen two claims addressed but the SEC can’t say much more about how well the program is working without threatening whistleblower anonymity.”

  • Professor Richard Moberly, Associate Dean at the University of Nebraska School of Law, notes the unique aspects of the SEC program set up by Dodd-Frank in providing both strong retaliation protection as well as financial incentives:

“Dodd-Frank seeks to address a different type of fraud than the IRS and False Claims Act did; while those focused on tax evasion and governmental fraud respectively, the new SEC program set up by Dodd-Frank addresses securities fraud in particular.  Modeled in part on the historical success of the FCA (meanwhile the IRS was under fire for having not done enough), Dodd-Frank provides both a financial incentive for reporting fraud while also increasing the retaliation protections for those who report it.

Dodd-Frank goes further, though, by setting up the Office of the Whistleblower specifically for investigating tips; there’s a specific infrastructure and budget to prevent tips from getting lost in the bureaucracy.  In my view, it’s important that tips reach the SEC directly to increase their chances of being heard.  Further, I think there’s mounting evidence that the anti-retaliation protections were necessary but not sufficient in bringing forward quality information, and the hope is that this new program will combine both.”

  • Professor Geoffrey Rapp, the Harold A. Anderson Professor of Law and Values at the University of Toledo College of Law, draws attention to the key differences between SEC, IRS and FCA whistleblower programs:

“Two differences stand out between the SEC (Dodd-Frank) and IRS programs. First, the Dodd-Frank whistleblower rewards are triggered based on the level of sanction levied against a securities fraud wrongdoer.  Both the False Claims Act (FCA) and IRS programs are linked to the level of fraud committed.  In the case of the FCA, there is no minimum level of fraud necessary for a whistleblower to earn a reward (although unless the fraud is sufficient to warrant a lawyer’s time, it’s unlikely there will be a suit).  In the case of the IRS program, there are required minimum levels of fraud needed.  But the Dodd-Frank program is linked to the level of sanction obtained by the SEC.

There are two implications – first, we have to wait for a final resolution to know what that sanction will be; second, the Dodd-Frank program, compared to the other two, does not as closely align whistleblower incentives to the seriousness of the fraud. It’s common for SEC cases to settle for less than $1 million in sanctions, and the SEC often uses other, non-monetary approaches, to sanction offenders.

Based on what I’ve seen reported in the media, the SEC is receiving a far greater number of quality tips now than it did prior to Dodd-Frank.  In that sense, the existence of the statute appears to have changed the enthusiasm of whistleblowers for bringing information to the government’s attention.  I think that we will see relatively few get paid, but that doesn’t mean the statute isn’t working.

Congress should consider expanding the Dodd-Frank program and giving whistleblowers the kind of qui tam right they have in the False Claims Act context to pursue litigation even if the SEC declines to get involved.  I’m worried that the SEC could remain a roadblock to whistleblowers – although my preliminary sense so far is that the SEC is taking the mandate Dodd-Frank has given it quite seriously.  I would also like to see the SEC be given discretion to pay bounty rewards even where less than $1 million in sanctions are obtained.”