SEC Now Offering Big Payoffs To Whistle-Blowers

Thursday, Aug. 19, 2010

In what could give new meaning to the phrase — "If you see something, say something" — a clause within the financial reform legislation is offering big cash rewards to whistleblowers who report fraud and other wrongdoing at U.S.-listed companies and Wall Street banks.

Under the program, which is already live, anyone who provides a tip that leads to a successful Securities and Exchange Commission action will be able to collect between 10% and 30% of the amount recovered — as long as the total amount exceeds $1 million. This means the minimum payout is $100,000. The whistle-blower could be a company insider or a private investor, if they're able to offer information or analysis that leads to an action. And with potential payoffs netting millions — or even tens of millions — of dollars, experts are bracing for a surge in tipoffs. (See the worst business deals of 2009.)

Money can be "extraordinarily effective" in getting people to blow the whistle when they see fraud, says John Phillips, whose law firm Phillips & Cohen LLP specializes in whistleblower cases. The U.S. Government evidently agrees. "We expect the awards will prompt a significantly greater number of insiders to come forward with high-quality evidence of fraud," says SEC spokesman John Nester.

In the past, the SEC's whistleblowing program was limited to insider trading cases and offered only small discretionary, rather than mandatory, rewards ranging from 0 to 10% of the money recovered. "It was completely ineffectual, completely discretionary," says Phillips. (Read about a whistleblower case involving ignorance.)

The narrow scope and poor cash rewards generated little response: Since the program's launch in 1988, only 14 applications led to actions where a civil penalty was ordered, and only eight cash awards were handed out totaling $1.16 million, according to SEC officials. The largest award came last month when the ex-wife of a hedge fund adviser at Pequot Capital Management was awarded $1 million for her role in providing information that led to Pequot paying $27 million to settle an insider trading case involving Microsoft securities. The ex-wife had discovered a key email on her computer hard drive that led to the action against her ex-husband's former employer. (Read about the new sheriffs of Wall Street.)

But this legislation extends the program beyond insider-trading cases to all securities law violations and, most importantly, offers bigger payoffs and therefore bigger incentives to speak out. People can report almost any securities violations, ranging from money laundering, accounting fraud and ponzi schemes to bribery. Also, the SEC will be looking at not only independent knowledge, but even analysis as proof. The means an academic, private investor, or even a journalist or a securities analyst who conducts independent research and uncovers fraud based on that research could collect an award if their information is new and leads to an action.

"So you can have people who might have done analysis for academic reasons or personal trading reasons or research that they sell, that they may now, in addition, provide to the SEC with an eye toward getting a bounty," says Paul Leder, a partner at Richards, Kibbe & Orbe LLP and former SEC official for 12 years. He noted how the options backdating scandal in 2006 stemmed from academic articles that described how the option grants to executives and board members were extraordinarily well-timed. The SEC picked up on the analysis and wound up filing dozens of cases against companies and executives. (Comment on this story.)

Even a CEO could squeal on his own company as long as he wasn't personally convicted in connection with the fraud. "Yes, to the extent that they themselves are not culpable," says Phillips. "You can't initiate the fraud and then go collect on it."

The legislation bars certain people from receiving awards — officers or employees of a regulatory agency, the department of justice, a self-regulatory organization, the Public Company Accounting Oversight Board or a law enforcement organization, as well as company auditors and anyone convicted of a crime related to the securities violation.

The program also protects squealers against company retaliation. Any whistleblower who is fired, demoted, suspended, threatened, harassed or discriminated against by a company for providing info or testifying in an SEC investigation, can file an action in the U.S. District Court. If they succeed in proving their case, the legislation guarantees the person's reinstatement, two times the amount of backpay owed, and coverage of all court and attorney fees—so long as the action is filed within a certain time period.

The potential payoff is high. The recent judgment against Goldman Sachs resulted in a $550 million penalty. "If you got 10% of that, it's pretty good money," says Leder.

Even a mid-cap company could wind up with a consent order or suit in the millions of dollars, says Daniel Karson, executive managing director and counsel at Kroll, a risk consulting company. "So 10% for making a phone call is a pretty good payday," he says.

One obvious question overhanging this new lure for whistleblowers is whether the SEC will have the staff to handle it. "The government always has limited resources," says Karson. "I think the SEC is going to be overwhelmed in short order with people bringing these kinds of actions — they're going to have to sort through what has substance and what doesn't." The SEC has indicated it will be opening a whistle-blowing office and chairman Mary Schapiro told a House committee the agency would need to hire 800 new people to fully implement the financial reform bill's changes.

"There's real money to be made," says Leder. "I think it's a powerful incentive."

TIME