Speech by SEC Staff:
Remarks at Georgetown University
by
Sean X. McKessy
Chief, Office of the
Whistleblower
U.S. Securities and Exchange Commission
Washington, D.C.
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.
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