March 7, 2021

DealBook: Facing Complaints, S.E.C. Opens Whistle-Blower Office

The S.E.C. was hammered by critics for ignoring tips about Bernard L. Madoff's huge Ponzi scheme.Mary Altaffer/Associated PressThe S.E.C. was hammered by critics for ignoring tips about Bernard L. Madoff’s huge Ponzi scheme.

Get your whistles out, corporate employees.

The Securities and Exchange Commission’s whistle-blower office opened its doors on Friday, much to the delight of plaintiffs’ lawyers and the consternation of corporate America.

The new program will issue cash rewards to employees who report fraud to the government, an effort by the S.E.C. to expose corporate crime in the aftermath of the financial crisis. The S.E.C., hammered by critics for ignoring tips about Bernard L. Madoff’s huge Ponzi scheme and other corporate malfeasance before the crisis, is gearing up to spend top dollar for first-class tips.

Under the program, corporate tipsters could reap as much as 30 percent of the money the S.E.C. collects from a company or its executives. To qualify for the reward, an employee must turn over new information that leads to successful enforcement actions yielding more than $1 million in fines. The agency will tap the $450 million Investor Protection Fund to dole out awards.

Still, the S.E.C. says the whistle-blower program will actually save money in the long run, as tipsters offer guidance to the agency’s strapped staff of lawyers and investigators.

The program “will strengthen our ability to carry our mission and it will save us much time and resources in the process,” Sean McKessy, chief of the S.E.C.’s whistle-blower office, said in a speech on Thursday at Georgetown University’s McDonough School of Business.

The agency, Mr. McKessy said, has already received an uptick in quality tips, including lengthy letters laying our elaborate schemes. On Day 1, the office has seven employees to review the claims and a revamped Web site to collect them.

The program is the product of the Dodd-Frank financial regulatory law, which mandated an overhaul of the S.E.C.’s whistle-blower provisions. Until now, the agency limited its whistle-blower program to insider trading cases, and capped awards at 10 percent of the penalties.

Once the S.E.C. adopted the changes in May, Mr. McKessy began a charm campaign to tame some fierce opposition from corporations and their lawyers. He joined some 10 panel discussions and Webinars about the topic and huddled with various lawyers, ultimately reaching more than 1,000 people, he said.

And yet, Mr. McKessy said, “there exists still some misunderstanding about the hotly contested issues.”

Corporate lawyers and lobbyists have compared Mr. McKessy’s office to a bounty program, saying it will generate bogus tips while producing a windfall for plaintiff’s lawyers who represent scorned employees.

When the S.E.C. first announced plans for the office in November, it incited a contentious six-month lobbying campaign by corporate interests. The agency received a flood of more than 200 comments and 1,300 forms letters about the program from a cross section of Wall Street firms and corporate America – including JPMorgan Chase, Citigroup, General Electric and Google. Some of the loudest complaints came from the United States Chamber of Commerce, which alone sent four comment letters and held at least three discussions with S.E.C. officials.

When a divided S.E.C. approved the whistle-blower program in a 3-2 vote in May, the chamber lashed out at the agency.

“In approving this new whistle-blower rule, the S.E.C. has chosen to put trial lawyer profits ahead of effective compliance and corporate governance,” David Hirschmann, president and chief executive of the Chamber’s Center for Capital Markets Competitiveness, said at the time. “This rule will make it harder and slower to detect and stop corporate fraud.”

The chamber’s concerns centered on the most controversial aspect of the program, which allows whistle-blowers to expose fraud without first sounding the alarms at their company. The program, the chamber argues, will undermine internal compliance departments that corporations were forced to bolster under the Sarbanes-Oxley Act.

Mr. McKessy, who previously served as corporate secretary for both AOL and the Altria Group, which owns tobacco giant Phillip Morris, disputed the industry’s alarmist claims. By not mandating internal reporting, he said, the program will enable employees to report fraud, even when their bosses are involved in the scheme.

He also noted that the agency tweaked it original whistle-blower proposal to address some industry concerns. Under the final rules governing the program, the S.E.C is allowed to dish out heftier awards to employees who first report securities violations to corporate compliance departments.

In a December letter to the S.E.C., the Financial Services Roundtable asked the agency to do just that, urging that reporting internally “must be a specific factor in determining the amount of any award.” The language appeared nearly word for word in the S.E.C.’s description of the final regulation, which said working with internal compliance departments was “a factor that can increase the amount of an award.”

The program also allows tipsters to collect their bounty even when they first reported wrongdoing to the company’s compliance department, so long as the employee shares the same information with authorities within 120 days.

“The whistle-blower program will bolster, not hamper, internal compliance departments,” Mr. McKessy said.

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