Speech by SEC Staff:
Remarks at Georgetown University
Sean X. McKessy
Chief, Office of the Whistleblower
U.S. Securities and Exchange Commission
August 11, 2011
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, or of the author's colleagues upon the staff of the Commission.
Thank you for that kind introduction and for inviting me here today.
As many of you know, the Securities and Exchange Commission serves to protect investors from fraud and ensure our markets operate fairly.
We are a relatively small agency responsible for regulating more than 35,000 entities – from investment advisers to corporate filers to national exchanges. In fact, our entire operating budget is smaller than the amount that some individual financial firms spend on their IT systems alone.
Because we simply cannot be everywhere, our Chairman -- Mary Schapiro -- constantly urges us to find new ways to leverage the resources of others to fulfill our mission.
That is why the new whistleblower program authorized by last year’s financial reform legislation is so crucial to our work. It will help us to more quickly identify and pursue frauds that we might not have otherwise found on our own. It will strengthen our ability to carry our mission. And, it will save us much time and resources in the process.
To summarize, the WB program provides a monetary incentive of between 10 and 30 percent of sanctions we collect for WB who voluntarily provide us with original information that lead to a successful SEC action with sanctions exceeding $1 million.
This speech on the whistleblower program is particularly timely now because tomorrow marks the first day that our final rules implementing this program go into effect. So I am excited to be here and to announce the launch tomorrow of our new Office of the Whistleblower website tomorrow morning, which I hope you will check out.
And, as the first Chief of the SEC’s Office of the Whistleblower, I am excited about the promise that this program holds.
Since the Final Rules were adopted by the Commission in May, I have focused my efforts on reaching out to various sectors and constituencies to let people know about the benefits of the whistleblower program and the way the rules work.
It has been the part of this job that I have enjoyed the most, as it helps me put a face to the names of people who will be directly affected by this new program –whistleblowers, in-house compliance officers and lawyers.
I have been impressed at how thoughtful many have been in parsing through the rules to try to understand what they require and how they may play out. But, my outreach efforts -- and review of the widely distributed commentary on the rules -- have led me to conclude that there still exists some misunderstanding about certain hotly debated issues related to the whistleblower program. So I’d like to try to address three of them here today. As I do so, please keep in mind that my remarks represent my own views and not necessarily those of the Commission, the staff or any of the Commissioners.
Issue Number 1:The Whistleblower program will bolster, not hamper, the internal compliance systems at companies across the country.
This seems rather apparent to me, yet no topic has been, and continues to be, more heavily debated than this one. The fact is that the SEC whistleblower program is the first and only such program in the country that makes available a monetary award from the government to an individual that reports possible wrongdoing internally. Put another way, the SEC’s WB program is the only one in the country that extends significant benefits to individuals that report internally that enhance the opportunity for a whistleblower award, and possibly an award at a higher end of the allowable range.
Here’s how: the rules specify that employees who report wrongdoing internally first and, within 120 days, then report the wrongdoing to the SEC, benefit in two significant ways.
First, those employees will be deemed to have reported the information to the SEC on the date they reported internally. This preserves their place in line in terms of when information was provided to the SEC.
Second, the employees who report internally first receive the benefit of all the information uncovered by the company in connection with its own internal investigation of the alleged wrongdoing.
These are not hypothetical or inconsequential benefits. Under this scenario, an employee who reports information internally that itself might not have warranted an SEC investigation, could nonetheless become eligible for an award if the internal investigation uncovers such information that does lead to an SEC investigation. For example, imagine an employee who, based on his experience, knows but does not have sufficient proof to substantiate that something is amiss with the company’s accounting for a certain matter. That “gut feeling” in and of itself, may not be sufficiently timely, specific and credible to cause the SEC to open an investigation if it were reported to us. If, however, the employee were to report that gut feeling internally, and the company’s subsequent investigation were to uncover specific, timely and credible information that is reported to us, the reporting employee – who might not have otherwise even qualified for an award – would then be eligible.
Additionally, the employee gets the benefit of all the facts and details uncovered and reported to us by the company in connection with its internal investigation of the issue. So, the percentage of the award to the employee could be increased based on the enhanced quality and value of the information uncovered by the company’s internal investigation. So the same employee that reported the “tip of the iceberg” – something is wrong – gets the benefit of the full iceberg – everything that the internal investigation uncovered. That employee’s award will be based on the whole iceberg – likely a higher award than if just the tip were uncovered. The rules also require that cooperation with internal compliance programs be considered as a positive factor that could increase a whistleblower award, and interference with such programs as a negative factor that could decrease an award.
These significant benefits to those who report internally first offer a great opportunity for companies and their compliance officers and personnel. Rather than undermining or weakening internal compliance programs, I believe the whistleblower program actually should empower internal compliance personnel to advocate for stronger and more transparent internal compliance programs. Why? Because the rules leave it to the employee to decide whether to report internally first – or to contact the SEC -- and those companies that best ensure that their employees view internal reporting as a viable and credible option to address possible securities law violations are more likely to have the wrongdoing reported internally first.
In my view, the net effect of the incentives for reporting internally is a rising tide that should lift all boats when it comes to the strength and effectiveness of internal compliance programs.
Issue Number 2: The final rules recognize that in most instances, attorneys, compliance personnel and external auditors should not be allowed to become whistleblowers.
Some have argued that by failing to adopt an absolute exclusion on attorneys, auditors and compliance officials, the final rules provide negative “incentives” – that is to say, it encourages these individuals to abandon their professional responsibilities in favor of a potential bounty award. But I don’t believe the rules have created any negative incentives.
The best way to address this issue is to take a step back and consider the purpose of the whistleblower award program. While I certainly hope and expect that the SEC will end up paying awards to individuals who have provided information, such payment is the end result, but not the purpose, of the whistleblower program. Instead, the program was created to add a tool to the SEC’s arsenal to identify wrongdoing, prevent or stop it and, if appropriate, punish those responsible. By providing for the possibility of a whistleblower award to attorneys, compliance officials and auditors, the final rules recognize that we may in some narrow circumstances, need these individuals to come forward, in order to accomplish that goal. And I believe that, in the narrow circumstances described below, these individuals can and should be eligible for an award.
But, make no mistake, those circumstances are limited. In essence, a monetary incentive is provided to these types of professionals to report to the Commission only when
- it is necessary to prevent imminent or ongoing misconduct; or,
- the misconduct has been identified and reported, but not remediated in a timely fashion.
Let’s consider each group and the rationale to understand why these exceptions that allow for the possibility of an award are appropriate.
Attorneys . With respect to attorneys, the final rules are very clear that attorneys may not break their attorney-client privilege for the purposes of reporting wrongdoing and receiving an award. Indeed, the rules specifically exclude from the definitions of “independent knowledge” or “independent analysis” (required to be eligible for an award) any information obtained through a communication subject to the attorney-client privilege.
However, the final rules make reference to policy determinations -- made long before the whistleblower program was created -- that permit attorneys to come forward with potentially privileged information under very limited parameters.
First, the rules provide for the possibility of an award to an attorney if disclosing the information is permitted under the Commission’s attorney conduct rules adopted in connection with the Sarbanes-Oxley Act of 2002. Those rules – adopted in 2003 -- are limited to the issuer context and permit attorneys to disclose information only if they reasonably believe that disclosure is necessary:
- to prevent the issuer from committing a material violation that is likely to cause substantial injury to the financial interest or property of the issuer or investors;
- to prevent the issuer from interfering with an ongoing Commission or investigation or
- to rectify the consequences of a material violation by the issuer that caused, or may cause, substantial injury.
Similarly, the final rules do not preclude an award to an attorney who provides information when disclosure is permitted by state attorney conduct rules. These rules -- which pre-date the creation of the whistleblower program by decades -- vary by state but generally permit attorneys to disclose information:
- to prevent reasonably certain death or substantial bodily harm;
- to prevent a client from committing a crime or fraud; or,
- to prevent, mitigate or rectify substantial injury to the financial interests that is reasonably certain to result or has resulted from the client’s commission or a crime or fraud.
By allowing for the possibility of an award to an attorney who reports under these circumstances, the final rules have created no negative incentives for attorneys. Think about the circumstances I just described. If the ultimate goal is to ferret out wrongdoing, how is it negative to provide for the possibility of an award to attorneys when severe harm is imminent?
Compliance and Internal Audit Personnel. As for compliance and internal auditors, some claim the final rules allow for the possibility of an award to these professionals merely for doing what the company is paying them to do.
But, as with attorneys, an employee with compliance or internal auditor responsibilities may only be eligible for a whistleblower award under the same limited circumstances as attorneys; that is if they have a reasonable belief that reporting is necessary to prevent actions that will result in imminent harm or impede an investigation.
For the same reasons as with attorneys, allowing for the possibility of a whistleblower award under these circumstances does not encourage a breach of their responsibilities – it rewards them for taking those obligations seriously.
The third circumstance under which there is a possibility of an award to compliance or internal audit personnel occurs only when more than 120 days have passed since the information was reported to certain officials – including the entity’s audit committee, chief legal officer, chief compliance officer or supervisor.
In this case, an award is possible only after these professionals have done what they are paid to do: They reported wrongdoing internally with a view of having it addressed -- – but, for whatever reason, the entity failed to take timely remedial action.
Keeping in mind the ultimate goal to prevent or stop possible violations of the securities laws, I see nothing wrong with incentivizing compliance and internal audit employees to come forward when the internal compliance process has failed.
External Auditors. And, with respect to external auditors, their eligibility is also limited to narrow circumstance. In their case, it’s where the auditors have a reasonable basis to believe that their employer (the audit firm) failed to make the required disclosures of the audit client’s wrongdoing under Section 10A of the Exchange Act. In these rare instances, the eligibility for an award is limited to the reporting of misconduct that has been detected but not reported to us.
Issue Number 3: The whistleblower program ensures that efforts to address misconduct are sped up, not delayed.
Of course, I’ve heard the claim that employees will delay reporting ongoing misconduct to increase the size of the potential award. The theory is that since the whistleblower award percentage is calculated against the monetary sanctions obtained, whistleblowers will be incentivized to allow misconduct to grow so the sanctions will be greater. However, this theory ignores some significant aspects of the final rules.
First, to be eligible for an award, a whistleblower must provide the SEC with “original” information – that is, information not already known. This requirement is a natural and powerful disincentive for an individual to “sit on” information about ongoing misconduct – because doing so means someone else may come forward first.
Second, information reported to us must be specific, credible and timely if it is to lead us to open an investigation. So an individual who delays reporting risks that the information will not lead to an investigation -- a no investigation, no case, and no case, no award.
Third, the final rules include an ‘unreasonable delay’ as one of the factors that might decrease the size of an award. So, the whistleblower who waits may end up with a lesser percentage than he or she might have gotten if he or she had report promptly.
Additionally, I’ve also heard some claim that wrongdoing reported by a whistleblower will be allowed to continue because the SEC will needlessly keep management in the dark about the report, depriving the company of the opportunity to take swift responsive action. This theory rests on the assumption that because a whistleblower is involved, the SEC cannot or will not involve the company in the investigation.
In fact, the SEC has been working with insiders and whistleblowers long before the whistleblower award program was established, and, when appropriate, we have included the company in efforts to investigate and punish wrongdoing most effectively and efficiently.
Companies should expect that the SEC’s practice of involving them where appropriate will continue. The possibility that there could be a monetary award paid to the whistleblower at the conclusion of a successful action should in no way alter this historic practice.
* * * * *
While the final rules go into effect tomorrow, we have already seen an increase in the quality of the tips we have received since the passage of Dodd-Frank in July 2010. Long letters that include detailed information about potential violations. It’s information like this that can save our attorneys months of investigation and allow us to stop a fraud earlier in the process.
Violations of the securities laws have far-reaching consequences even beyond those directly affected by the wrong. Surely, the enormous losses suffered by investors are tragic enough, but perhaps a greater harm is the loss of confidence by the public in the fairness of the investment process.
While the vast majority of companies and securities professionals are honest and law-abiding, the actions of a few rotten apples can unfairly taint the entire industry in the minds of much of the public.
It is in the interest of all of us -- investors, companies, securities professionals, regulators and whistleblowers -- to stop those who seek to violate the securities laws, manipulate the markets and cheat investors. At the same time, we also understand the need to ensure that the heavy hand of government does not place an undue burden on the proper functioning of our markets and the capital formation process.
The Whistleblower Program is a balanced approach designed to aid the SEC' by encouraging those aware of misconduct to come forward while at the same time incentivizing those individuals to report their suspicions of misconduct to their companies first – so the companies take appropriate action to remedy it.
The Whistleblower Program recognizes that we all have a stake in eliminating wrongdoing and that only when we act together can we effectively stop those who seek to take unfair advantage of the vast majority of investors and companies that play by the rules.
Thank you for your time and attention and I will be pleased to take any questions.