Commission's rewards for enforcement actions makes resolving problems in-house more urgent than ever
On September 24, moviegoers attending the opening of Oliver Stone’s Wall Street: money never sleeps in Manhattan may also have seen plaintiffs’ lawyer Stuart Meissner’s trailer announcing his new website, www.secsnitch.com. The site encourages whistleblowers to serve up evidence of corporate wrongdoing in the hope of receiving the new 10 percent to 30 percent bounty on SEC enforcement fines against companies committing serious financial misdeeds.
The SEC bounties, which are mandated by Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, are stirring up profound controversy. ‘Companies are worried,’ says John Coffee, law professor at Columbia University. ‘They’re worried that a certain amount of misinformation will be reported to the SEC and that some employees may not report internally but may go straight to the commission.’
Stephen Kohn, executive director of the National Whistleblowers Center in Washington, DC, also sees the move as a game-changer, but for completely different reasons. ‘If the SEC properly administers this law, this makes the primary motivating factor on Wall Street – maximization of profits – consistent with honesty and compliance,’ he says.
Although experts disagree on the merits of the whistleblower provisions of Dodd-Frank, everyone points out that bounties could be quite hefty, given enforcement settlements of the recent past. On July 15, 2010, for instance, the SEC announced that Goldman Sachs would pay a record $550 million for having misled investors about a subprime mortgage collateralized debt obligation that the firm marketed.
Experts believe the SEC will take this program seriously, given the public black eye it’s suffered over its mishandling of several recent scams and frauds. Harry Markopoulos, an independent fraud investigator, approached the SEC many times over several years to express concern about Bernie Madoff, but nothing was done. ‘The SEC cannot afford another Madoff,’ says David Childers, chief executive officer of Portland, Oregon-based EthicsPoint.
What the rules will say
As Corporate Secretary went to press, the SEC had yet to issue guidance on its new whistleblowing regulations, but corporate secretaries won’t have long to wait. The commission has to adopt these regulations no later than April 21, 2011 (nine months from enactment).
The Dodd-Frank Act applies to all original information the SEC receives after July 22, 2010. Already, the regulator has received tips: as of October 1, 2010, Meissner says he has received 20 or 25 calls from whistleblowers and has initiated five actions, with a few more in the works.
The breadth of the regulations remains unknown. Steven Berk, founder of Washington, DC-based Berk Law and author of the Corporate Observer blog, points out that corporate interests will inevitably try to narrow the scope of the regulations. He predicts others will argue that any type of misconduct, whether it relates to breaches of the Foreign Corrupt Practices Act or to environmental negligence, could fall under the SEC’s whistleblowing purview.
Nell Minow, founder of the Corporate Library, says the introduction of the SEC’s whistleblower regulations is predictable given the financial collapse of 2008. ‘Every crisis leads to a new whistleblower provision,’ she explains. Most notably, after the Enron crisis, Section 301c of SOX required companies to create internal whistleblower hotlines, with information from these hotlines going straight to a board’s audit committee.
The new SEC regulations reach well beyond SOX inasmuch as whistleblowers are financially rewarded for fines exceeding $1 million and no longer need to be employees, observes Childers. ‘Is the whistleblower going to be a customer? Is it going to be a supplier? Or will it be a family member or spouse who might want to profit from what he or she knows?’ he asks.
Coffee maintains that the question of what constitutes ‘original’ information could also be subject to debate. ‘Information has to be original, but it doesn’t have to be critical,’ he points out. ‘So I think in many instances there are going to be multiple whistleblowers, and there’s going to be some fighting over who gets what share of the bounty.’
How one views the SEC’s whistleblower compensation program depends on how one perceives the mythic figure of the whistleblower. Because whistleblowers often act anonymously, these polarizing figures have become something of a Rorschach test.
One widespread conception is that whistleblowers are acting from dishonorable motives. ‘Many whistleblowers are emotionally unstable or have grievances,’ avers Coffee. Minow warns that whistleblower programs create a double-edged sword: ‘You want to create a safe place for people to tell you the truth about what’s going on. What you don’t want is to create perverse incentives for people to protect their employment by starting this process. Once you blow the whistle, any kind of effort to make you do your job can be seen as retribution. You can pretty much write your own ticket.’
Kohn, on the other hand, points out that whistleblowers have historically brought key information to government. He also notes that before an individual blows the whistle on corporate practices, that individual has almost always exhausted traditional avenues for lodging complaints. Kohn says every whistleblower who has approached the National Whistleblowers Center has first approached his or her supervisor.
Another Rorschach test is how one views plaintiffs’ lawyers. Under Dodd-Frank, whistleblowers may act anonymously. This means the information they provide would be relayed to the SEC through a lawyer, raising questions about the integrity of the process.
David and Goliath
Meissner, who prosecuted fraud cases as a former New York State assistant attorney general under Eliot Spitzer, perceives www.secsnitch.com as a means of ‘helping clean up Wall Street – it’s a David and Goliath thing.’ What’s more, he envisions himself as a ‘partner’ with the SEC, an agency that might soon be overwhelmed by an avalanche of tips.
Coffee, however, is convinced that ‘the idea of advertising for whistleblowers shows the entrepreneurial mindset of the plaintiffs’ bar at work. The plaintiffs’ bar can polish up testimony, take off the rough edges and make something look less like a personal grievance. Plaintiffs’ lawyers may try to market complaints to the SEC, presenting it with evidence on a platter.’
When a public company receives a report of internal misconduct, management often weighs the pros and cons of approaching the SEC voluntarily. Lucinda Low, a partner at Steptoe & Johnson in Washington, DC, says ‘companies that get a whiff of something being done wrong can’t let the grass grow under their feet. That was true before, but it’s even truer now.’ Although companies may understandably wish to conduct their own internal investigations before contacting the SEC, the new whistleblower bounties make the whole process far more urgent.
Peter Henning, a law professor at Wayne State University and a blogger for the New York Times’ DealBook, worries that the new SEC regulations will ‘give employees an incentive to bypass internal reporting.’ The problem, he suggests, is that ‘when you put a financial reward out there, you may get people with something questionable that they don’t report because they didn’t think it was that important.’
‘There will be many general counsel who won’t want to tell the SEC about something embarrassing, something potentially actionable – they’d prefer to lie low,’ says Coffee. In the coming months, he anticipates that the question of when to approach the SEC will be hotly debated. ‘Most inside counsel are not eager to blow the whistle on themselves, even though it will stop the whistleblower,’ he explains. ‘But it may be the way to put the most favorable face on a situation and to enter into a non-pecuniary settlement.’
Companies need to anticipate what toll whistleblowing will take on the cultural fabric of their organizations. ‘We’re almost 10 years post-SOX,’ says Childers. ‘Many companies have worked hard to create a culture of trust within their organizations, but now the SEC has created a competition with pay to almost usurp that culture.’
Be that as it may, Childers believes the most critical step for companies today is making themselves trustworthy – and fast. ‘If an organization is built on trust, people will report information internally,’ he says. ‘If not, they’re going to go to outside sources.’
Preparing for the starting whistle
Childers points out that while SOX 301 emphasized whistleblower hotlines, these hotlines yield only a small percentage of relevant information. In fact, a 2009 survey on internal reporting conducted by the Ethics Resource Center finds that only 3 percent to 7 percent of all reports of misconduct came through internal hotlines. The vast majority of misconduct reports are obtained through exit interviews and conversations between employees and managers, explains Childers. More worrisome still, a 2010 report by the Compliance and Ethics Leadership Council suggests that only 21 percent of misconduct reported to managers ever reaches the legal or compliance departments.
Childers advises corporate secretaries and boards to begin asking for more information on potential misconduct beyond what’s reported through whistleblowing hotlines. He notes that establishing web forms on a corporate intranet for reporting potential misconduct is one idea. Boards might also ask supervisors to write up
reports of misconduct and then submit these reports to the board on a quarterly basis.
Experts agree that culture is at the heart of making oneself bulletproof when it comes to SEC investigations. ‘The most successful whistleblowing program is one where it’s not necessary to blow the whistle because the internal controls capture the information before it gets to that point,’ says Minow. Ethics complaints need to be well integrated and ultimately handled at the board level, because only there can they be independently evaluated.
The National Whistleblowers Center has begun ‘urging mandatory notification of every employee of his or her rights under this law. It should be in the employee manual and in trainings,’ says Kohn. He applauds the idea of having companies initiate their own bounties for internal whistleblowers, though no one has yet done this.
In the end, companies need to take internal reports very seriously, establishing ways in which complaints can bubble up to the very highest reaches of the organization, or else risk the SEC investigating problems that then blindside the C-suite or boardroom. Creating a culture of trust and good compliance systems has never been more important.
