Panelists Debate SEC Whistle-Blower Awards For Compliance Personnel, Corporate Insiders

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By Yin Wilczek

March 17 — The Securities and Exchange Commission shouldn't award bounties to compliance personnel, directors and officers, and other corporate insiders except in cases where the company clearly isn't doing the right thing, an attorney said March 17.

Because of how the commission's whistle-blower program has changed the dynamics around corporate compliance, the exceptions under which these professionals may collect rewards should be construed “narrowly and carefully,” said Christian Bartholomew, a partner with Jenner & Block LLP, Washington.

Sean McKessy, chief of the SEC's Whistleblower Office, responded that the presumption is that such individuals can't collect unless they fall into one of three exceptions. However, if an exception applies, the individual is otherwise eligible under the SEC's rules, and if he or she exposes wrongdoing that the company is trying very hard to conceal, then it is “appropriate” that the informant be rewarded, he said.

Bartholomew and McKessy spoke at a D.C. Bar panel. McKessy said his views were his own and did not reflect those of the commission or other staff members.

First Award to Former Officer 

In a novel action, the SEC March 2 gave a bounty of between $475,000 and $575,000 to a former corporate official who blew the whistle on a securities fraud.

In August 2014, the agency awarded its first-ever bounty to a whistle-blower with an audit or compliance function.

Generally, compliance and audit personnel, outside accountants, lawyers, and corporate officers and directors can't be rewarded for tipping off the SEC except in three circumstances:

• when they have a reasonable basis to believe that reporting to the SEC is necessary to prevent the company from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or investors;

• when they have a reasonable basis to believe that the company is engaging in conduct that will impede an investigation; and

• when the perceived wrongdoing has not been internally addressed within 120 days.

 

The SEC rewards to the corporate and compliance officers both fell under the third exception.

Bartholomew noted that audit and compliance personnel and corporate insiders are “uniquely situated” to know whether frauds are being perpetuated within a company. Although they shouldn't be entirely excluded from SEC rewards, the “real difficulty is figuring out under what circumstances” they should be allowed to collect the bounties, he said.

Compounding the problem is the heavy redaction in the SEC's whistle-blower orders to protect the informants' identities, Bartholomew said. Companies parsing these orders often find it challenging to understand what happened, why the informants came forward and how the SEC viewed their actions, he said.

‘Black Box.'

This is “kind of a black box,” Bartholomew said. It places companies in a difficult situation so that while they are trying to investigate wrongdoing, they also have to constantly worry about whether they will be second-guessed on otherwise reasonable judgments by an insider who may then run to the commission.

Bartholomew pointed as an example to the comment by SEC Enforcement Director Andrew Ceresney in the release announcing the reward to the former officer. Ceresney said that the individual should be “commended for stepping up to report a securities law violation when it became apparent that the company’s internal compliance system was not functioning well enough to address it.”

What does “well enough” mean? Bartholomew asked. “That's a red flag.”

“I hope the SEC” will act with circumscription on these tips and in giving rewards, Bartholomew said. The SEC shouldn't grant rewards to insiders in cases involving close facts, he said.

‘Natural Headwinds.'

McKessy declined—absent specific facts—to give a “predictive answer” as to when the SEC will reward corporate insiders. He noted that in both the compliance and corporate officer cases, the companies involved had no intention of taking action, and the 120-day deadline was comfortably surpassed.

McKessy also observed that there are “natural headwinds against” compliance and audit personnel, and officers and directors becoming whistle-blowers. Such individuals tend to possess professional and personal traits that will prevent them from leaping on the SEC reward bandwagon, he suggested. “They generally really don't want to” approach a regulator.

McKessy noted that the SEC may issue a reward only if the sanctions in a successful enforcement action exceed $1 million. Accordingly, companies shouldn't be concerned if there is nothing to the whistle-blower's complaint, he said.

‘50 Shades of Gray.'

For his part, panel participant Daniel Hurson, a Washington attorney who represents whistle-blowers, noted that very few situations are “clear cut.” The world “in which I live” is “more like 50 shades of gray,” he said.

It is not a “light decision” for a compliance officer to approach the SEC, Hurson continued. “These people are scared” and in some cases come forward at the risk of their lives, not to mention their careers.

Hurson added that the Financial Industry Regulatory Authority and other regulators are starting to “bear down” on compliance officers for violations, in some cases hinging liability on their supervisory authority. “So compliance officers have to worry about that, too,” he said. “That's a big growing pressure on them.”

Moreover, Hurson suggested that the third exception is one that has put the “fear of God” into the corporate community, who now knows it has a 120-day deadline to investigate potential wrongdoing. Companies know that there always will be someone somewhere watching the clock, and “that has made a tremendous difference to corporate America in dealing with” securities-related problems, he said.

‘Stryker' Case 

In other comments, McKessy spoke about a recent decision—Stryker v. SEC—in which the U.S. Court of Appeals for the Second Circuit agreed that the SEC correctly denied a whistle-blower reward to a tipster who provided information before enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

The decision is the first appellate ruling that bears directly on the whistle-blower program, and the court gave “Chevron-like deference” to the commission's interpretation that the whistle-blower statute is not retroactive, McKessy said.

To contact the reporter on this story: Yin Wilczek in Washington at ywilczek@bna.com

To contact the editor responsible for this story: Ryan Tuck at rtuck@bna.com