The SEC's whistleblower program and its effect on internal compliance programs.

• Author: Miralem, Iskra

INTRODUCTION

On January 19, 2010, the FBI and United Kingdom law enforcement orchestrated what is now known as the "Catch 22" sting operation. (1) Undercover FBI agents, posing as members of the Nigerian Defense Ministry, used a confidential informant to conduct a false transaction with an individual suspected of bribing the Nigerian Ministry in a $15 million arms sale. (2) The sting operation yielded solid evidence against the suspects, and the FBI subsequently arrested twenty-two corporate executives and employees in the military and law enforcement-product industry. (3)

The Catch 22 sting operation may be the most creative example of the recent surge in Securities Exchange Commission ("SEC") and Department of Justice ("DOJ") charges against companies and individuals violating the Foreign Corrupt Practices Act of 1977 (4) ("FCPA") and securities laws. (5) At the end of 2010, thirty-four individuals and companies were awaiting trial on FCPA charges. (6)

In July 2009, the SEC charged two corporate executives for violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B)and 30A of the Securities Exchange Act of 1934, and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. (7) The SEC did not allege that the executives had personal knowledge of, or involvement in, the illegal conduct, yet the executives consented to have final judgments entered against them. (8) Each executive paid $25,000. (9) Thus, the SEC is aggressively pursuing individuals responsible for corporate corruption, whether or not those individuals had actual knowledge or direct involvement in the violation. On March 18, 2010, the SEC Enforcement Director Robert Khuzami stated that "law enforcement authorities within the U.S. and across the globe are working together to aggressively monitor violators of anti-corruption laws." (10) The Department of Justice recently made FCPA enforcement one of its highest priorities, leading to a significant increase in prosecutions. (11) Assistant Attorney General Lanny Breuer, speaking at the 24th National Conference on the FCPA on November 16, 2010, openly warned of this crackdown on corruption: "I am aware that, for some of you, as we have become more aggressive, you have become more worried.... I want to tell you this afternoon that you are right to be more concerned." (12)

In general, corporations caught engaging in criminal conduct have used internal compliance programs that should have prevented their criminal activities. (13) The sting operation, discribed above, and the hundreds of other prosecutions reveal that under the current system, internal compliance programs alone cannot be trusted to effectively discover and eliminate fraudulent corporate conduct. Rather, internal compliance programs seem to require external incentives to ensure their effectivness.

On May 25, 2011, the Securities and Exchange Commission (the "SEC") adopted final rules to implement the requirements of Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), (14) which created a whistleblower reward program. Is These rules reward individuals who provide the SEC with high-quality tips that lead to successful enforcement actions against companies that violate the federal securities laws. (16) Whistleblowers are eligible for a reward of ten to thirty percent of any monetary sanctions resulting from the SEC enforcement action or any related action. (17) The bounty program coupled with the unprecedented undercover sting operation (18) exemplify the SEC's and DOJ's aggressive stance on prosecuting and collecting fines from violators of securities laws. Additionally, the successful extradition of foreign nationals to the United States to face FCPA charges (19) suggest that the whistleblower program will play a key role in further identifying and prosecuting violators of the FCPA and securities law.

But many critics argue that it will do so at a price: the whistleblower program may incentivize whistleblowers to report out rather than in, thwarting internal compliance programs that have spent years building and maintaining. (20) Encouraging employees to report violations directly to the SEC rather than internally diminishes the "culture of compliance and integrity" that is essential to the maintenance of effective internal compliance programs. (21) This argument begs the question: are companies' current internal compliance programs really worth fighting for?

This Comment argues that the current trend in aggressive FCPA and securities law prosecutions coupled with the new whistleblower program will likely interfere with already established internal compliance programs in the short term, but will encourage more robust and effective internal compliance programs in the long run. The 2007-10 surge in FCPA charges is a clear example that the SEC and DOJ are right not to leave it up to companies' compliance programs to find and report violations of U.S. laws. Rather, company employees are in the best position to uncover and prevent these violations. And as companies face the possibility of harsh penalties and more frequent whistleblowing, they may be encouraged to create stronger mechanisms for compliance.

This Comment first examines the whistleblower provisions that preceded the SEC's final rules. It then describes the provisions of the SEC regulations on whistleblower bounty and the incentives that the rules provide for employees to report out rather than in. Next, this Comment addresses the potential negative and positive consequences of these incentives to internal compliance programs. It concludes by arguing that an aggressive stance on FCPA and securities violations will help businesses formulate legal and profitable ways to do business and will bolster current internal compliance programs that have been ineffective to date.

1. A BRIEF HISTORY OF WHISTLEBLOWER STATUTES

   The United States has enacted a variety of statutes designed to encourage employees to blow the whistle on fraudulent conduct. (22) Many of the whistleblower statutes are enacted in response to financial scandals. For instance, Congress enacted the Insider Trading and Securities Fraud Enforcement Act in reaction to insider trading scandals like the Drexel Burnman Lambert, Inc. scandal. Likewise, after the Enron and Worldcom debacles, Congress enacted the Sarbanes-Oxley Act. (23) The effectiveness of these statutes however has varied tremendously. This section discusses the most notable of these statutes and compares them to the SEC's Dodd-Frank whistleblower provisions. (24)

   "[T]he first statutory cause of action protecting whistleblowers from employer retaliation" was the Civil Service Reform Act of 1978. (25) The Civil Service Reform Act only protected federal employees, however, (26) and, overall, it "had little impact." (27) Congress later expanded the whistleblower protections by enacting the Whistleblower Protections Act of 1989. (28) This Act modified prior whistleblower protections by establishing a separate agency to litigate claims, (29) permitting whistleblowers to file claims without government support under certain circumstances (30) and allowing courts to shift attorneys' fees from whistleblower plaintiffs to defendants. (31)

   Alternatively, the Securities and Exchange Act of 1934 (32) provided a financial reward to whistleblowers. Under the 1934 Act, the SEC rewards a whistleblower with up to ten percent of a monetary sanction collected from a company for violating insider-trading laws. (33) However, the whistleblower's reward is not guaranteed: the SEC reserves absolute discretion in determining whether to grant an award and, if so, its amount. (34) Because whistleblowers are unable to rely on this statute, and because the award is unsubstantial, the statute is an ineffective incentive for potential whistleblowers. (35) Thus far, only five people have received awards in the twenty years the statute has been in effect, totaling a mere $159,537. (36)

   The False Claims Act, (37) however, has been more effective than the 1934 Exchange Act. Congress enacted the False Claims Act in 1863, and has amended it several times (38) to produce the government's "primary vehicle ... for recouping losses suffered through fraud." (39) The Act provides two ways a whistleblower can receive an award for reporting fraud: (1) the Attorney General can bring a civil action against a violator, in which case the whistleblower would receive 15 to 25 percent of any penalty the government collects from the investigation, (40) or (2) any individual "may pursue the claim, qui tam, if the government chooses not to pursue the claim within sixty days of filing the claim." (41) Either way, the False Claims Act guarantees both the whistleblower's award (42) and retaliation protection. (43) The False Claims Act has been successful--"[i]n the 2010 fiscal year," for example, "the Department of Justice recovered $3 billion in False Claims Act cases, with whistleblower awards totaling $385 million." (44)

   More recently, the Sarbanes-Oxley Act (45) provides antiretaliation protection for whistleblowers who report securities-related violations. (46) The provisions prohibit employers from taking retaliatory action against a whistleblower and entitle victims of retaliation to reinstatement, back pay, and legal fees. (47) Sarbanes-Oxley requires that corporations create internal compliance programs that "'provide employees with a standardized channel to report organizational misconduct internally within the corporation.'" (48)

   The Dodd-Frank Act, enacted in 2010, amended significant portions of the Sarbanes-Oxley Act. For instance, it (1) broadened the scope of protected disclosures, (49) (2) removed the requirement that claimants first exhaust all administrative remedies with the Department of Labor before bringing an action in federal district court, (50) and (3) provided more expansive remedies such as granting a whistleblower who succeeds in a...