On May 1, 2013, federal prosecutors in the Southern District of New York brought the first criminal case based on a referral from the Consumer Finance Protection Bureau (CFPB) in United States v. Mission Settlement Agency. In the recently unsealed indictment, federal authorities charge Mission Settlement Agency (Mission) and four of its employees—including Mission’s principal, who is a suspended attorney—with mail and wire fraud in connection with an alleged scheme to defraud customers seeking “debt settlement” services. This case is significant because prior to this action, the CFPB efforts were confined to civil and administrative enforcement remedies.

According to the indictment, Mission held itself out as being able to lower its customer’s consumer debt by 45 percent, for a nominal fee, through negotiation with credit card companies and banks. Mission marketed its services to financially disadvantaged individuals known to be struggling with credit card debt. However, as the indictment alleges, instead of helping its customers, it “systematically exploited and defrauded” customers by failing to reduce their debts and by charging excessive fees. The indictment alleges the company took fees of $2.2 million from 1,200 customers without paying any money to their creditors.

In prepared remarks in conjunction with the announcement of this indictment, CFPB Director Richard Cordray explained that the indictment stemmed from a CFPB investigation: “During our investigation, we found evidence of criminal conduct and, accordingly, we referred this information to the United States Attorney for the Southern District of New York while we continued to pursue the civil law violations. Partnerships like the one between the Consumer Bureau and the Department of Justice are integral to our success and mission.” Cordray also made clear the CFPB would be looking to make similar referrals in the future: “We will be looking for more such occasions to coordinate and collaborate [with the Department of Justice].”

The CFPB was established in 2010 by the Dodd-Frank Wall Street Reform and Consumer Protection Act. It is authorized to regulate and supervise certain consumer financial services companies and large depository institutions. Prior to Mission Settlement Agency, the CFPB’s enforcement actions typically resulted in orders that the company in question cease and desist deceptive and misleading conduct, refund customers for their losses and pay a civil penalty. This case sends a clear message that the CFPB will have an emphasis on enforcement, and not just supervision, and referrals for criminal prosecution, when warranted, should be expected.

Useful Links

• Richard Cordray’s Prepared Remarks from May 7, 2013
• U.S. Dept. of Justice Press Release regarding the Mission Settlement Agency Indictment
• U.S. v. Mission Settlement Agency et al. Indictment
• U.S. v. Felix Lemberskiy Information
• U.S. v. Zakhir Shirinov Information
• U.S. v. Mission Settlement Agency, et al. Forfeiture Complaint

          Editor's note:  The following entry was written by Jeffrey Rogers, a partner in the firm's Chicago office.  

 Late last month, Washington State Governor Christine Gregoire signed into law the state’s first Medicaid Fraud False Claims Act.  With the signing, Washington became the twentieth state to pass such legislation

            The incentive for Washington was financial, as it was for the 27 predecessor states.  That financial incentive was established with passage of the Federal Deficit Reduction Act of 2005.  Specifically, the Act provided that states with False Claims Acts that mirror the federal False Claims Act qualify for a 10% increase in their share of any amounts recovered under those laws. 

            Like the federal False Claims Act, state False Claims Acts constitute powerful tools for fighting health care fraud.  Relying upon such acts as well as other means of recovery, state Medicaid Fraud Control Units recovered $1.75 billion from civil and criminal cases in fiscal 2011 (Report of Office of Inspector General, HHS, March 28, 2012).  During that same period, approximately $2.4 billion in total Federal False Claims Acts’ settlements were from the health care industry. 

            States that seek to take advantage of this incentive are required to submit their legislation to the U.S.  Health and Human Services Office of Inspector General, who in conjunction with the U.S. Attorney General’s Office, determines whether the state act qualifies.  The states’ False Claims Acts must:  (1) create liability to the state for the submission of false or fraudulent claims with respect to Medicaid spending; (2) provide effective rewards to facilitate the filing of qui tam actions as described in the federal False Claims Act; (3) require that such actions be filed under seal for 60 days to allow for review by the state attorney general; and (4) impose civil penalties not less than those imposed by the Federal False Claims Act, that is, treble damages and a penalty of $5,500 to $11,000 per false claim.

            Following the institution of these incentives by the Federal Deficit Reduction Act, and also subsequent to the submission and approval of various state Medicaid Fraud False Claims Acts, the federal False Claims Act was amended in significant respects by the Fraud Enforcement and Recovery Act of 2009 (FERA), the Patient Protection and Affordable Care Act (ACA), and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act).  Among the provisions that were amended are those relating to the public disclosure defense, the definition of “claim”, reverse false claims and whistleblower protections.

            State acts that were submitted for review after passage of the amendments have been and will continue to be reviewed for their conformity with the new amendments.  State acts which were approved prior to the passage of the amendments are deemed to be compliant with the federal requirements until March 31, 2013.  After that date, state acts which had been previously approved, will no longer be considered compliant unless the states re-submit new legislation for consideration prior to that date.

            As both the federal and state governments continue to dramatically increase their enforcement efforts, all providers of health care services which are reimbursed in any respect by a federal or state health care program, must remain vigilant and prepared to defend against allegations of health care fraud, whether they are brought by individuals under the qui tam provisions of the respective acts, or by state and federal agencies acting on their own.

The Commodity Futures Trading Commission announced last week that Vincente Martinez has been appointed as the first director of the Commission’s recently created Whistleblower Office.  According to CFTC Chairman Gary Gensler:

The CFTC’s Whistleblower Office, which the agency implemented under the Dodd-Frank Act, provides the public an avenue to help catch misconduct in the markets and improve the CFTC’s ability to be an effective cop on the beat.

Mr. Martinez joins the CFTC from the Securities and Exchange Commission, where he served as an Assistant Director in the Division of Enforcement.  At the SEC, Martinez helped establish the Office of Market Intelligence, which drafted the SEC’s own whistleblower rules and currently oversees the SEC’s collection and analysis of whistleblower tips.  The CFTC consulted the SEC’s Office of Market Intelligence in crafting its whistleblower program, and the CFTC’s whistleblower rules are nearly identical to the SEC’s.  Thus, Martinez will be very familiar with the CFTC’s whistleblower program, and ready to step in as “an effective cop on the [CFTC] beat.” 

The CFTC whistleblower bounty program, which went into effect in October 2011, provides an award for whistleblowers who voluntarily come forward with original information that leads to a successful enforcement action in which the CFTC recovers monetary sanctions in excess of $1 million.  Qualified CFTC whistleblowers are entitled to an award of 10-30% of the amount recovered.  Like the SEC rules, the CFTC rules do not require a whistleblower to report a potential violation internally before reporting to the government. 

The CFTC rules, however, differ from the SEC rules in two significant respects: First, unlike the SEC rules, the CFTC rules do not exclude employees of public accounting firms from eligibility for a whistleblower award, meaning outside auditors of CFTC-regulated entities may blow the whistle on their clients.  Second, the CFTC rules do not contain a “double dip” provision, meaning the CFTC does not exclude from eligibility for an award whistleblowers who previously recovered a bounty from another regulator in a criminal or enforcement matter related to the same alleged misconduct.

In November, the SEC’s Office of the Whistleblower released its Annual Report on the Dodd-Frank Whistleblower Program, detailing the quantity, quality and nature of the complaints it received during its first several weeks of operation, and describing the Commission’s responses to those tips.  The Report draws on only seven weeks of data and, therefore, provides limited insight into the goings on at the whistleblower office. 

According to the Report, the whistleblower office received 334 whistleblower tips from August 12, 2011 through September 30, 2011 (roughly seven per day).   The complaints received cover the waterfront in terms of the federal securities violations alleged.  As Emily Chasan of the Wall Street Journal’s CFO Report explains, however, “most of the complaints were related to market manipulation, offering fraud, insider trading, trading and pricing, unregistered offerings and market events.”  The following comprise the most frequently reported types of whistleblower allegations:

• 16.2% of the complaints alleged market manipulation;
• 15.6% of the complaints alleged offering fraud; and
• 15.3% of the complaints alleged problems with corporate disclosures and financial statements.

Many who read the Report were surprised to find that alleged FCPA violations made up only 3.9% of the tips received. 

At a December “SEC and DOJ Hot Topics” seminar in Washington, D.C., Sean McKessy, Chief of the SEC’s Office of the Whistleblower, emphasized that the available whistleblower data is a “small sample size,” and insisted that it is too early to identify overarching reporting trends.  Nevertheless, McKessy made several “observations” about the data:

• As compared with whistleblower complaints received in the past, the whistleblower office is experiencing a marked increase in the quality of tips received;
• Contrary to popular expectations, the whistleblower office has not been inundated with “an avalanche” of whistleblower complaints;
• The alleged violations cover “the full gamut” of securities laws violations, and the “most frequently litigated areas” are well represented;
• The whistleblower office is receiving “very detailed, very specific” tips, complaints, and referrals from whistleblowers;
• The whistleblower office is working with whistleblowers and their counsel to move complaints swiftly through “the triage process;” and
• The whistleblower office is actively reviewing tips and making referrals to the SEC Division of Enforcement. 

The whistleblower office has not yet made public – in its Report or elsewhere – the details of any bounty payment made to an SEC whistleblower, but Mr. McKessy noted that the Commission has received a number of applications for whistleblower awards.  He suggested that the whistleblower office is likely to publicize the amount of any awards paid (without identifying the whistleblowers), along with details of the related enforcement matter.  Until the Office of the Whistleblower releases another Annual Report next fall, its reports of awards may provide the best source of information regarding the nature of the complaints it receives, the tips the Enforcement staff are taking up, and the overall success of the program.

While it may be too early to spot themes in the whistleblower data, Mr. McKessy’s observations present one clear takeaway: Whistleblowers are coming forward to the Office of the Whistleblower with information about potential securities laws violations, and companies who have not yet made preparations for handling whistleblower complaints internally should act now. 

The U.S. Commodity Futures Trading Commission’s (CFTC) Whistleblower Incentives and Protection program went quietly into effect on October 24^th.  The CFTC rules (available here) have not drawn as much attention as the strikingly similar SEC whistleblower program.  The comparative scarcity of public commentary, however, does not fairly reflect the potential impact of the CFTC’s program for regulated entities.  Like the SEC program, the implications of the CFTC whistleblower rules are significant.  Below I (briefly) review the CFTC whistleblower rules, discuss the areas which have garnered some public attention, and highlight several key areas where the CFTC rules differ from the SEC whistleblower program.  Regulated entities should take note. 

The CFTC whistleblower rules, described more fully in an earlier Subject to Inquiry post, reward whistleblowers who provide to the CFTC original information that leads to a successful enforcement action resulting in monetary sanctions in excess of $1 million.  In such a case, the whistleblower is eligible for an award of 10-30% of the sanctions collected in a CFTC enforcement matter or, in certain circumstances, a related action based on the same original information.  The amount of any award is determined by the CFTC, in its discretion, based on certain criteria (e.g. the significance of the information and degree of assistance provided by the whistleblower). 

Under the CFTC rules, whistleblowers may be eligible for an award based on a tip, complaint, or referral made anytime after Dodd-Frank was signed into law in July 2010.  Moreover, whistleblowers may be eligible for an award based on the submission of information that relates to a violation that occurred prior to the enactment of Dodd-Frank. 

The CFTC whistleblower program closely mirrors the whistleblower rules adopted by the SEC earlier in this year.  And like the SEC rules, the following comprise the most talked about – and, indeed, the most significant – aspects of the final rules for regulated entities:

• The rules do not require a whistleblower to report potential securities laws violations internally through a regulated entity’s compliance, legal, or audit procedures before submitting a tip to the Commission;
• A whistleblower can receive a bounty based on an internal report, regardless of whether they report to the Commission, if the regulated entity later self-reports to the Commission; and
• The whistleblower protections set out in the program apply regardless of whether the information submitted reveals an actual violation.

The CFTC rules differ from the SEC rules in several key areas.  While this is not a comprehensive list of every distinction, the following items appear to be most critical for regulated entities to understand:

• Unlike the SEC rules, the CFTC rules contain no exclusion for employees of public accounting firms.  As a practical matter, this means outside auditors of CFTC-regulated entities may report to the CFTC suspected violations and qualify for a bounty. 
• CFTC whistleblowers can recover awards from multiple regulators.  A would-be SEC whistleblower is ineligible for an SEC bounty if he or she has already received an award from the CFTC based on the same information.  Under the CFTC rules, however, a whistleblower is eligible for an award regardless of whether he or she has previously been compensated by another regulator.  As a practical matter, this means a whistleblower may be eligible for a second bounty payment from the CFTC if he or she receives the SEC award first. 
• The SEC rules do not ordinarily impute to the whistleblower a formal request for production directed to the whistleblower’s employer (e.g. a subpoena or request for voluntary production).  Under the CFTC rules, however, a request for documents or information directed to an employer is presumptively attributed to the would-be whistleblower. 
• Under the Commodity Exchange Act, CFTC whistleblowers have two years from the date of allegedly retaliatory action to bring a retaliation claim.  This is noticeably shorter than the period afforded SEC whistleblowers, who have six years from the date of the alleged violation to file a claim, or three years from when the retaliation became known to the whistleblower. 

While the full impact of the CFTC rules is yet to be determined, it is important for regulated entities to understand the new Whistleblower Incentives and Protection program, and to take steps internally to address them.  Companies that have not already done so should develop, improve, and promote internally corporate compliance and reporting policies and procedures.  To that end, entities should consider reviewing and updating their internal whistleblower programs, putting in place a dedicated team to review internal complaints, and establishing procedures for handling tips. 

We will continue to report on the CFTC whistleblower program as enforcement and reporting trends become clear.

Last Friday, August 12^th, the U.S. Securities and Exchange Commission’s Whistleblower Incentives and Protection program became effective.  But a recent U.S. Court of Appeals decision may provide ammunition for opponents of the program. 

As discussed at length in our white paper, the recently adopted SEC whistleblower program rewards whistleblowers who voluntarily submit to the SEC original information that leads to a successful enforcement action by the SEC in which the SEC obtains monetary sanctions totaling more than $1 million.  Qualifying whistleblowers are entitled to a bounty of 10-30% of the sanctions recovered.

Whistleblowers who submitted tips or complaints prior to the program’s effective date may be eligible to recover a bounty in certain circumstances.  And the SEC has acknowledged on several occasions that it has already experienced an appreciable uptick in whistleblower complaints.  Thus, as a practical matter, last Friday’s “effective date” does not sound the starting gun for the whistleblower program.  Last Friday does, however, signal the official launch of the SEC’s new Office of the Whistleblower and its webpage, which includes a link to the SEC’s online tips, complaints and referrals portal. 

The SEC’s whistleblower program is enormously unpopular with many in corporate America, who insist the program will significantly undermine internal reporting and compliance programs.  Detractors’ chief complaint is that the rules fail to make internal reporting a prerequisite for eligibility for a whistleblower award.  Despite reams of scathing commentary, however, the final rules implementing the whistleblower program narrowly passed a Commission vote in May.

Following the vote, opponents of the program began weighing possible legal remedies, and quite a few commenters expected adverse businesses or advocacy groups to challenge the rules in federal court.  No lawsuits were filed, however, before the rules went effective last Friday. 

But the whistleblower rules may not be out of the woods yet.  As reported in the Washington Post, a recent U.S. Court of Appeals decision “could spell trouble for the Securities and Exchange Commission.”  In Business Roundtable v. SEC , the Court of Appeals for the District of Columbia vacated proxy access rules recently promulgated by the SEC.  The Court found that “the Commission acted arbitrarily and capriciously for having failed … adequately to assess the economic effects of [the] new rule.” 

This ruling may catch the eye of opponents of the new whistleblower program.  The Commission’s recently enacted proxy rules, which fell short in the Court of Appeals’ estimation, dedicated some 80 pages to an economic analysis of the rules.  Meanwhile, the notes accompanying the final rules implementing the whistleblower program devote far less attention – only 35 pages – to the costs and benefits of the rule.  This may indicate that the whistleblower rules have less of an economic impact than the proxy rules, but critics of the rules may wish to test that theory. 

Still, the Commission appears to be committed to getting the whistleblower program right.  And it will certainly try to do so without recourse to the courts system.  Consider the following remarks of Commissioner Walter – an open advocate of the whistleblower rules – in a statement she made the day the Commission adopted the rules: “I would like to emphasize, however, that I do not believe that our action here today means that our work is done in this area.  In fact, it is more of a beginning.  The Commission and its staff must remain open to improving the whistleblower program as we implement it, and I strongly encourage feedback from all involved…” 

According to Reuters, Sean McKessy, Chief of the Whistleblower Office, recently echoed Commissioner Walter’s sentiment, insisting, “If our program is not doing what it’s intended to do, then we’ll look at it and figure out ways to fix it.” 

In light of recent events, the future of the Whistleblower Office and, indeed, the whistleblower rules is uncertain.  Corporate America will undoubtedly push the Commission to continually evaluate the program and to make good on its promise to improve it as needed.  Whether anyone will launch a formal challenge remains to be seen. 

On Thursday, August 4^th, during a public meeting to consider the adoption of several final rules under the Dodd-Frank Act, the U.S. Commodity Futures Trading Commission (CFTC) voted 4-1 in favor of adopting final regulations implementing its Whistleblower Incentives and Protection program.  According to a Fact Sheet available on the CFTC website, Section 748 of the Dodd-Frank Act amended the Commodity Exchange Act, mandating the creation of rules regulating a whistleblower incentives and protection program. 

The CFTC whistleblower program rewards tipsters who provide the CFTC with original information that leads to a successful enforcement action resulting in monetary sanctions in excess of $1 million.  In such a case, the whistleblower is eligible for an award of 10-30% of the sanctions collected in a CFTC enforcement matter and/or a related action based on the same original information.  The CFTC will, in is discretion, determine the amount of any such award based on criteria set out in the final rules.  On its website, the CFTC provides a useful “Q&A” summarizing the final rules in greater detail. 

The final CFTC whistleblower rules closely mirror the whistleblower rules adopted by the SEC earlier this year.  Like the SEC, the CFTC declined to put in place a requirement that whistleblowers report potential violations internally before submitting a tip or complaint to the CFTC.  The CFTC insists, however, that its final rules “include[ ] provisions to incentivize internal reporting by whistleblowers.”  According to an article on reuters.com, a CFTC official explained that under the final rules “the commission will consider a whistle-blower’s decision to report internally as a factor that can potentially increase the amount of the award.”  

The rules make clear that whistleblowers may be eligible to receive an award based on the submission of information related to violations that occurred prior to the enactment of the Dodd-Frank Act.  Whistleblowers who submit information after the enactment of Dodd-Frank, but before the final rules become effective, will also eligible for an award.   

The final rules are not yet effective, but will be in force no later than 60 days from publication in the Federal Register.  As with the SEC’s new whistleblower program, the impact of the CFTC’s whistleblower incentives and protection program is yet to be determined.  At the very least, we should expect to see a noticeable uptick in CFTC whistleblower complaints.  Whether that will lead to more investigations and enforcement actions is an open question. 

A great deal has been written on this blog and elsewhere about the recently adopted SEC Whistleblower Incentives and Protection Program.  Much less has been said, however, about the U.S. Commodity Futures Trading Commission’s (CFTC) proposed whistleblower scheme.  In addition to requiring the SEC to devise its whistleblower rewards program, The Dodd–Frank Wall Street Reform and Consumer Protection Act requires the CFTC to propose and adopt a set of whistleblower rules.  The CFTC proposed its rules in December 2010. 

Save the few instances in which Dodd Frank required a (slightly) different approach, the CFTC’s proposed rules mirror to the letter the rules proposed by the SEC in November 2010.  The rules are so similar, in fact, that the CFTC’s proposed rules include ostensibly inadvertent references to “the SEC” where it surely meant “CFTC.”  One noteworthy difference in the CFTC’s proposed rules is a requirement that companies self-report possible violations to the CFTC within 60 days of discovering the potential infraction.  The SEC rules do not include a self-reporting requirement. 

The CFTC was scheduled to vote on a final set of whistleblower rules during a public hearing scheduled for Tuesday, July 19, 2011.  As Reuters reports, however, the CFTC “unexpectedly pulled its whistleblower provision from the list of rules it had scheduled to finalize Tuesday.”  According to the CFTC, the vote had to be postponed pending an evaluation by the U.S. Government Accountability Office on Dodd-Frank.  Their review will ultimately determine how the CFTC can dole out funds collected in connection with a whistleblower complaint.  The CFTC is expected to vote on the final rules in August. 

While the SEC rules are expected to gain more traction with would-be tipsters, the CFTC rules, too, promise handsome rewards for whistleblowers.  Because the rules provide another outlet for whistleblowers, they provide another area of exposure for entities regulated by the CFTC.  We will follow closely further developments related to the CFTC whistleblower rules and report back once a final set of rules is adopted. 

As previously reported on Subject to Inquiry, the Securities and Exchange Commission missed the April 21, 2011, deadline to adopt a final set of rules implementing its new whistleblower program.  The Commission is carefully tweaking the proposed rules it released last November, and recently announced it will unveil the final rules later this summer. 

In its continued deliberations, the Commission is likely considering vigorous public sentiment in favor of incorporating a requirement that would-be whistleblowers report suspected wrongdoing internally before providing information to regulators.  As Sarah Lynch of Reuters recently reported, however, the Commission has “no plan to make internal reporting a mandatory first step for whistleblowers.”  According to Ms. Lynch, the SEC is instead considering a “more nuanced” approach that would merely “encourage” whistleblowers to make use of internal reporting programs. 

The Commission’s delay in delivering a final set of rules coupled with the prospect of a scheme that does not include an internal reporting requirement seems to have been a veritable call to action for one Congressman.  According to Ashby Jones of the WSJ Law Blog, Representative Michael Grimm will “introduce legislation requiring people alleging corporate wrongdoing to inform their employers before running to the SEC.”  Grimm’s bill would also “give the SEC leeway to deny bounties to people who otherwise meet the program’s requirements,” “would ban awards for people who participated in [the] wrongdoing,” and would bar “lawyers representing whistleblowers … from working on a contingency-fee basis.”

In addition to Representative Grimm’s efforts, and even as the Commission works internally to devise a final set of rules, the U.S. House Committee on Financial Services will host a panel of industry officials this afternoon to thrash out several issues related to the highly-anticipated whistleblower program in a hearing entitled “Legislative Proposals to Address the Negative Consequences of the Dodd-Frank Whistleblower Provisions.” 

While the window for public comment on the proposed rules closed last December, there are clearly still plenty of twists and turns ahead in the rulemaking process.  A final vote on the rules could come as early as May 25.  We will continue to monitor and report on the rulemaking process.   

Last November, the Securities and Exchange Commission proposed a highly-publicized whistleblower program under the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The proposed rules, described in greater detail in McGuireWoods’ white paper, offer handsome rewards to individuals who provide the SEC with high-quality information that leads to a successful enforcement action. 

According the SEC’s website, the Commission was required to adopt final regulations implementing its proposed whistleblower program no later than April 21, 2011.  As Jessica Holzer of the Wall Street Journal Law Blog reports, however, the Commission missed its April deadline and now expects to publish its final whistleblower rules “during the May through July timeframe.” 

The delay may result from the SEC's efforts to assess and address an outpouring of public comment and criticism that continued after the window for public comment closed.  According to Ms. Holzer, SEC Spokesman John Nester has not specifically commented on the reason for the delay, but noted that the Commission continues to rework the proposed program “with an emphasis on getting the rules right.”  

We will provide a full report on the final whistleblower rules when the SEC releases them this summer. 

As previously reported on Subject to Inquiry, last November the SEC proposed a new whistleblower program under the Dodd-Frank Wall Street Reform and Consumer Protection Act that promises handsome awards for whistleblowers who come forward with information about possible violations of the federal securities laws.  At the time, and in preparation for drafting a final set of rules, the Commission sought public comment on the proposed whistleblower program.  According to Tom Sporkin, head of the SEC’s Office of Market Intelligence and the man behind the proposed whistleblower program, the most heated debate among commenters has been whether the final rules should require would-be tipsters to make use of internal reporting mechanisms in order to qualify for an award through the Commission’s whistleblower scheme.

And although the window for public comment closed on December 17, the debate continues.  As Jessica Holzer reported yesterday, many large U.S. companies are still “prodding” the SEC to require workers to report wrongdoing internally before going to the Commission.  These companies insist that the proposed SEC whistleblower scheme will undermine robust internal compliance and reporting programs.  For months companies have urged the SEC to see things their way, and it sounds like they will continue to press the Commission to include an internal reporting requirement.

Others – including a number of plaintiffs’ attorneys – implore the Commission to reject an internal reporting requirement.  They say alerting companies to securities laws violations internally will only afford companies time to cover up the wrongdoing.  And, of course, the internal complaints may simply fall on deaf ears. 

For its part, the Commission does not seem inclined to include an internal reporting requirement in the final rule.  They believe they struck a good balance in the proposed scheme, and are quick to point out that whistleblowers are eligible for a higher award if they make use of internal reporting systems before informing the Commission.  Representatives of the Commission have stated publicly on several occasions that the proposed whistleblower scheme does not undermine internal reporting programs, and that the Commission is sincerely interested in working with companies’ compliance divisions to root our potential fraud. 

There’s no telling what the final rule will look like, but it appears the debate over internal reporting requirements will continue.  The final rule is due by mid-April.  We’ll keep tabs on further developments here at Subject to Inquiry.  And we’ll be sure to update you as soon as the final rule is released. 

On December 3, 2010, the SEC announced that it is delaying plans to set up several offices created under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, including its much-anticipated whistleblower office.  The announcement came amid a budget standoff in Congress that has left the SEC’s funding frozen at 2010 levels, along with the rest of the federal government.  SEC officials expressed that without a budget increase, it will not be possible to implement Dodd-Frank and the roughly 100 new rules it requires the SEC to create.  The extensive new law approved funding increases that would nearly double the SEC budget from $1.3 billion in 2011 to $2.25 billion in 2015, but requires a congressional appropriation to do so.

Dodd-Frank requires that the SEC establish a separate whistleblower office within the Division of Enforcement.  The current delay in staffing it means that existing enforcement staff will be responsible for administration of whistleblower claims for the time being.

Dodd-Frank’s whistleblower provisions have garnered a great deal of attention in recent months, with corporations facing the prospect of a substantial uptick in whistleblower claims under its attractive bounty provisions.  In anticipation of extensive payouts under those provisions, the SEC announced in late October that it has already established an Investor Protection Fund of over $450 million for use in paying out whistleblower awards. 

For an idea of just how attractive whistleblower bounties have become, one can turn to the pharmaceutical industry’s recent experience with the False Claims Act and its qui tam provisions.  Over the last several years this industry has been a target of increased whistleblower activity.  A May 2010 study by the New England Journal of Medicine found whistleblower payouts in False Claims Act cases within the industry between 2001 and 2009 to have ranged from $100,000 to $42 million, with $3 million as the median recovery.  The high end of that range has since been eclipsed by a recent $96 million whistleblower recovery by a single individual.

While the delay in establishing the whistleblower office is surely temporary, it provides companies additional time to digest the SEC’s recently-proposed Rule 21F for implementing Dodd-Frank’s bounty provisions.  The proposed rule demonstrates that the SEC is aware of how attractive the bounty provisions will be for would-be whistleblowers, and how disruptive they may be for corporate operations.  A key concern for corporations has been the potential for these provisions to undermine internal ethics and compliance programs by encouraging whistleblowers to take concerns directly to the government rather than report them internally.  In response, Proposed Rule 21F-4(b)(7) offers the option of reporting issues internally without losing eligibility for whistleblower status. Whistleblowers must then report their concerns to the SEC within 90 days of the internal report.  The proposed rule will encourage internal reporting by making the use of internal compliance procedures a factor that could increase the amount of a whistleblower award. 

According to the SEC, the 90-day waiting period created by Proposed Rule 21F is intended to afford “a reasonable period of time to investigate and respond to potential securities laws violations (or at least begin an investigation) prior to reporting them to the Commission or an appropriate regulator.”

This and other aspects of the proposed rule offer some positive signs to corporations with concern over Dodd-Frank’s whistleblower provisions.  More importantly, they, and the current delay in full Dodd-Frank implementation, offer incentives to review and bolster internal compliance programs now, before the bounty program gets fully under sail.

On November 3^rd, the SEC proposed a program under the Dodd-Frank Wall Street Reform and Consumer Protection Act that rewards whistleblowers who voluntarily provide original, high-quality information that leads to a successful enforcement action in which the SEC obtains sanctions in excess of $1 million.  The Proposed Rule offers would-be whistleblowers an award of 10-30% of the amount collected in the SEC action and certain related actions that rely upon the same original information. 

As Edward Wyatt of the New York Times pointed out in his recent article, “For Whistle-Blowers, Expanded Incentive,” the existing scheme for rewarding informants has been largely ineffectual, handing out less than $160,000 to all whistleblowers in the last 20 years.  Wyatt explains that, under the proposed rule, someone who came forward with original information related to the SEC’s enforcement action against Goldman Sachs could have recovered $55 million to $165 million.  That’s a very powerful incentive for someone with information about a possible violation of federal securities laws.

The incentive is so strong, in fact, that, as David Hilzenrath of the Washington Post reports, a New York lawyer recently purchased ad spots during movie previews in Manhattan cinemas informing viewers that they could take home 10-30% of SEC collections in enforcement actions.  But not anyone with knowledge of a potential violation of securities laws can turn up at the SEC and collect a check.  As Law360 reports, when it comes to the new whistleblower provisions, “the devil is in the details.”  The rule, for example, presents fairly narrow definitions of “whistleblower” and “original information,” and carves out any information that does not derive from “independent knowledge” or “analysis.”   

The so-called “lottery” or “jackpot” awards authorized by the rule have drawn a fair amount public criticism, and many argue that the rule undermines corporate regulatory compliance efforts and disincentivizes internal reporting.  But the jury is still out on the proposed rule, and the SEC is seeking public comment.  In particular, the SEC is interested in whether there is genuine fear that the rule will undermine internal compliance schemes, and whether a rule requiring a whistleblower to use a company’s internal reporting procedures before contacting the SEC would allay those fears. 

The bottom line:  Some version of this rule is likely to go into effect, and it will change the landscape for would-be whistleblowers.  Take advantage of the opportunity to comment - the deadline for filing comments is December 17th - and stayed tuned to Subject to Inquiry for a report on the final rule. 

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which President Obama signed into law on July 21, 2010, has been heralded as offering several significant changes in Wall Street regulation.  However, one of its least publicized provisions—the so-called whistleblower “bounty”—may prove to be among its most impactful.

Companies both large and small face potential impacts from Dodd-Frank’s whistleblower provisions, which incentivize individuals to bring possible violations of securities and commodities laws to the attention of the SEC or Commodities Futures Trading Commission (CFTC).  In the event those individuals satisfy Dodd-Frank’s “original source” rule and their information assists in an enforcement action brought by the SEC or CFTC that results in at least $1 million in recovery, they will be entitled to receive between 10 and 30 percent of any recovery over and above that threshold.

Dodd-Frank joins several other federal laws protecting and in some instances incentivizing whistleblowers, including the Sarbanes-Oxley Act, see 8 U.S.C. § 1514A and 15 U.S.C. § 7241 (mandating confidential reporting procedures, prohibiting retaliation against whistleblowers and entitling those subjected to retaliation to reinstatement, back pay and legal fees), the Securities Exchange Act, see 15 U.S.C. §78u-1(e) (providing the SEC discretion to give whistleblowers financial rewards of up to 10 percent of recovery in insider trading cases), and the False Claims Act, see 31 U.S.C. § 3729 (offering 15 to 30 percent of the recovery to whistleblowers who report fraud on the government).  Like Sarbanes-Oxley, Dodd-Frank provides a private right of action for retaliation, but with the ability to recover double back-pay in addition to reinstatement and legal fees.  Its wider scope and more generous recovery provisions make its use likely to be far more prevalent than that of the underutilized Securities Exchange Act reward provision (five individuals recovering just over $159,000 over the last 20 years). 

Dodd-Frank’s whistleblower provisions are most comparable to that of the False Claims Act, with which it has a number of similarities, including similar original source rules and recovery allocation procedures.  There are also key differences.  For example, the False Claims Act does not have a recovery threshold like Dodd-Frank’s $1 million requirement and provides a private right of action (qui tam cases) that is absent from Dodd-Frank.  The Acts also differ in who performs allocations (the court or parties under the False Claims Act, versus the SEC or CFTC under Dodd-Frank).  Perhaps most importantly, Dodd-Frank potentially applies to a more expansive number of claims.  This could include high profile hot button areas such as the Foreign Corrupt Practices Act (FCPA), which has seen dramatic growth in recent years both in the number of enforcement actions pursued and the size of the settlements reached.  The prospect of sharing in FCPA-related recoveries topping the tens or hundreds of millions of dollars will likely be an attractive lure for would-be whistleblowers.

Rules implementing Dodd-Frank are expected by April 2011, and should further flesh out its implications.  In the meantime, the plaintiff’s bar is already reporting a substantial uptick in calls from individuals feeling out potential claims.  Using the recent growth of qui tam litigation as a guide, it can reasonably be anticipated that Dodd-Frank will soon create a well-traveled avenue for whistleblower allegations triggering scrutiny from federal law enforcement.