By Peter Tyson and Simon Riveles
On June 12 2013, the Securities and Exchange Commission (SEC) issued its second-ever whistleblowing award to three anonymous tipsters who helped the SEC enforce an action for fraud against Locust Offshore Management, LLC and its CEO, Andrey Hicks. Two of the tipsters provided information to the SEC regarding the fraudulent offer and sale of shares in the Locust Offshore Fund, Ltd., an investment fund allegedly incorporated in the British Virgin Islands. This information prompted the SEC to investigate and prevent the fraud before more investors were harmed. The third tipster confirmed information provided by the others, as well as identified key witnesses. The three whistleblowers are each poised to receive 5 percent of the monetary sanctions ultimately collected against Locust Management and Hicks, who allegedly defrauded investors of $2.7 million, and who have been ordered to pay $7.5 million in disgorgement and penalties. Although this is only the second-ever whistleblowing award since the SEC’s whistleblower program went into effect in August 2011, Stephen Cohen, the Associate Director of the SEC’s Division of Enforcement, stated at the most recent Corporate Crime Reporter conference that in the upcoming months, the SEC will produce, “incredibly impactful cases” with some “extremely significant whistleblower awards.” Mr. Cohen’s comments, in addition to the magnitude of the award in the Hicks case, demonstrate the SEC’s commitment to the whistleblower program, and emphasize the need for fund managers to consider the impact of the whistleblower program on fund operations and management.
An Overview of the Dodd-Frank Whistleblower Program
The SEC whistleblower program was launched in August 2011 pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act. The whistleblower program is designed to encourage individuals to provide “original” information that leads to successful SEC enforcement actions against individuals who violate federal securities laws, and which result in monetary sanctions of over $1 million. “Original” information is information that is derived from the whistleblower’s independent knowledge (not publicly known) or from the whistleblower’s independent analysis (an evaluation of information which may be publicly available, but which is not generally known). Subject to some restrictions, individuals who voluntarily report original information that significantly contributes to a successful SEC enforcement action may receive between 10 and 30 percent of the total amount collected in the SEC action, or in a related action brought by the Department of Justice or other certain regulatory and law enforcement organizations. Individuals may submit original information to the SEC anonymously if an attorney represents them.
While internal reporting is not required under the whistleblowing program, the SEC encourages individuals to internally submit information regarding federal securities violations through company reporting and compliance procedures. A whistleblower award may be increased if an individual reports possible securities violations through internal whistleblower, legal or compliance procedures, even if such internal reporting occurs after submission to the SEC. Likewise, a whistleblower award may be decreased if it is found that an individual interfered with its company’s internal compliance and reporting systems.
The SEC’s whistleblower program also protects whistleblowers from employers who retaliate against them for reporting to the SEC. If an employer discharges, demotes, suspends, harasses, or in any way discriminates against a whistleblower for lawfully providing information to the SEC under the whistleblower program, the whistleblower may bring a private action in federal court against its employer. A prevailing whistleblower may be entitled to reinstatement, double back pay, litigation costs, expert witness fees, and attorney’s fees.
According to the SEC’s 2012 report on the whistleblower program, 3,001 whistleblower complaints were received from individuals in all 50 states, the District of Columbia, Puerto Rico and 49 other countries outside the United States. The most common complaint categories reported by whistleblowers were Corporate Disclosures and Financials (18.2%), Offering Fraud (15.5%), and Manipulation (15.2%). Despite the number of complaints received, the SEC only awarded one individual with a whistleblower award in 2012 – the first ever to receive a whistleblower award – which amounted to around $50,000 (30% of the amount collected by the SEC). However, as of September 2012, the fund established to finance the SEC’s whistleblower program had a balance of approximately $450 million. The balance of the whistleblower program’s fund, combined with the SEC’s recent whistleblower award in the Hicks case, lend credence to Mr. Cohen’s comments regarding future cases that will be “incredibly impactful” and which will yield “some extremely significant whistleblower awards.”
What Fund Managers Should Consider Now
The award in the Hicks case, as well as related comments by the SEC emphasize the need for fund managers to prepare for increased whistleblower activity. Fund managers should ensure that their companies maintain strong compliance and training programs with proper procedures for reporting and addressing complaints of misconduct internally and with the SEC. Fund managers should also carefully consider how they act towards whistleblowers, given the anti-retaliation provisions of the whistleblower program.
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