Riveles Law Group Alert: SEC Signals Increased Utilization of Whistleblower Program

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The SEC's recent whistleblower awards in the Hicks case and comments by SEC officials signal increased reliance on whistleblowers to rout out securities industry crimes highlighting, again, the need for fund managers and others to implement robust compliance and training programs.

Simon Riveles

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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.

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 (SEC v. Andrey C. Hicks and Locust Management, LLC, No. 1:11-cv-11888-RGS (D. Mass 2011) (the "Hicks Case"). 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, but which was ultimately found to be fictitious. 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. According to the SEC's June 12, 2013 whistleblower award proceeding for the tipsters involved in the Hicks case, each of the three whistleblowers is 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 approximately $7.5 million in disgorgement and penalties according to the SEC's March 22, 2012 litigation release regarding the Hicks case. 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 and years, the SEC will produce, “incredibly impactful cases” with some “extremely significant whistleblower awards.”According to hedge fund attorney Simon Riveles, 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 voluntarily 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. According to final rules implementing the whistleblower program under Section 21F of the Securities Exchange Act of 1934 ("Exchange Act") “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, Rule 21F-6 of the Exchange Act, 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. Under Rule 21F-2 of the Exchange Act, 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

Riveles Law Group believes 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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