The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

Whistleblower information may be one of the SEC’s “most effective weapons in its new enforcement arsenal,” but the agency’s whistleblower program “faces challenges on many fronts,” according to an April 23, 2013 New York Times Dealbook article entitled “Hazy Future for Thriving S.E.C. Whistle-Blower Effort” (here). As evidence of the whistleblower program’s promise that article cites several “previously undisclosed” enforcement actions that whistleblower information have triggered or aided. Yet due to several potential obstacles and impediments, the future of the program may, according to one source cited in the article “hang in the balance right now.”

For its part, the agency says that it has “ramped up” its staffing and the program has “gained momentum.” As evidence of the value the program has already delivered, the article cites the agency’s investigation of Knight Capital. The SEC was already investigating problems the trading company was having following the company’s bungled installation of new trading software. The investigation had been narrow until a whistleblower came forward and “the agency was able to shift gears and expand the investigation.”

According to the article, with the help of a whistleblower, the agency’s investigation of the Oppenheimer’s investment firm’s alleged overstatement of the performance of a private equity fund resulted in a fine of nearly $3 million.

The article also details an enforcement action that resulted in the first whistleblower bounty payment under the Dodd Frank Act’s whistleblower provisions. According to the article, Dee Stone, an outside consultant to China Voice Holding Corp, received a whistleblower bounty of $46,000 (so far) for providing documents showing that the company was operating a Ponzi scheme. (Refer here for more about this award, which was the first and is so far the only award under the Dodd-Frank whistleblower bounty program). The identity of the whistleblower and the subject of her whistleblower report had not previously been disclosed.

But though the program has had its successes, the SEC has also encountered obstacles from companies. Some companies have “drafted policies compelling their staffs to report fraud internally,” while other companies require employees to “attest annually that they never witnessed any fraud, a certification that could be used to discredit employees who later blew the whistle.”

The article also notes that companies have been accused of retaliating against whistleblowers. The article cites the September 2012 complaint that James Nordgaard filed in the Southern District of New York against his employer, Paradigm Capital Management and related entities, as well as against its founder and President, in which Nordgaard alleged that his employer retaliated against him after he notified the employer that he had reported what he believed to be illegal activities to the SEC.

In his complaint, a copy of which can be found here, Nordgaard sought to recover damages for retaliation under the Dodd-Frank Act. Nordgaard alleged that after he made his report, he was stripped of trading duties and “constructively terminated.” Initially, the company sought to have the dispute submitted to arbitration. In December 2012, Nordgaard voluntarily withdrew his complaint.

Discussion

Even though the article highlights the successes that the whistleblower program has already produced, the article nevertheless also suggests that company efforts may undermine the program or limits its usefulness. It may be true that some companies may succeed in diverting would be whistleblowers to internal programs, but even that could still be useful as long as the whistleblower’s reports are not swept under the rug but are dealt with.

And while company retaliation could well deter whistleblowing, the specific example of company retaliation that the article notes suggests that retaliation could be as big of a problem for the retaliating company than for the employee, given the retaliation protection available to whistleblowers under the Dodd-Frank Act.

The fact is that during the first full fiscal year of the whistleblower’s operation, the SEC received 3,001 whistleblower reports (as discussed in the agency’s 2012 annual whistleblower report, a copy of which can be found here). And while that number may be, as an unnamed source in the article suggests, “somewhat exaggerated,” it is clear that the SEC is receiving a very substantial number of whistleblower reports – and that is despite the deterrent efforts of some companies noted in the article.

The agency has at this point made only a single whistleblower bounty award. As the agency makes further awards and as those awards attract publicity, would-be whistleblowers will likely be even further motivated to come forward. As a plaintiffs’ law firm noted in a press release earlier this week, whistleblower awards provide “a reason for taking a risk.” (And it should not be overlooked that the plaintiffs’ bar clearly sees the development of a whistleblower practice as a growth opportunity. The efforts of the plaintiffs’ bar may not by itself be sufficient to cancel out the efforts of companies to try to deter whistleblowers but it does at a minimum represent a countervailing force.)

My take is that though companies may be taking steps to avert whistleblower problems, the whistleblower program ultimately will prove, as the article suggests, to be “one of the most effective weapons in the new enforcement arsenal.”

As I have said previously on this blog, if 2012 was the year in which the Dodd-Frank whistleblower program finally got off the ground, 2013 will likely be the year when the program picks up serious momentum. It seems likely  that – notwithstanding the impediments noted in the Times article -- we will not only see increased enforcement activity as a result of whistleblowers’ tips, but that we will see increased numbers of whistleblowers’ bounty awards, as well as the possibility of increased private civil litigation following in the wake of the enforcement actions.

• Print
• Comments
• Trackbacks
• Share Link

With the implementation of potentially rich whistleblower bounties under the Dodd-Frank Act, there have been concerns that the incentives will  not only lead to increased numbers of reports and increased enforcement activity, but that the regulatory action will in turn generate follow-on civil litigation. A securities class action lawsuit filed this past week against Bank of New York Mellon give a glimpse of how heightened whistleblower activity could lead to increased follow- on civil litigation.

As reflected in their press release (here), on December 14, 2011, plaintiffs’ lawyers initiated a lawsuit in the Southern District of New York against the Bank of New York Mellon, twenty of its directors and officers, and its offering underwriters. According to the press release, the plaintiff’s complaint, which can be found here, alleges that the defendants “misled investors regarding the Company's financial condition by reporting inflated revenue and concealing risks attributable to BNY Mellon's participation in a scheme to fraudulently overcharge its custodial clients for foreign currency ("FX") trades.”

According to the complaint, the details about the bank’s alleged practices first surfaced in January 2011 when two whistleblower lawsuits (in the form of qui tam actions) against BNY Mellon in Virginia and Florida were unsealed. Among other things, the whistleblower suits alleged that BNY Mellon manipulated FX rates, which were selected to maximize the company’s fees. As a result of publicity surrounding these allegations, the Virginia attorney general filed a complaint in intervention relating to the company’s foreign currency. In October 2011, the New York Attorney General and the U.S Department of Justice each filed civil actions against BNY Mellon. The securities lawsuit complaint alleges that the company is also the subject of an SEC investigation.

The regulatory actions against BNY Mellon all followed in the wake of the initial whistleblower allegations, which in turn led to the various civil actions against the company, now including the securities class action lawsuit.

The qui tam actions that the initial whistleblower filed against the BNY Mellon are not directly related to the whistleblower provisions of the Dodd-Frank Act. (However, as noted in a November 16, 2011 Wall Street Journal article, here, BNY’s foreign currency practices are also the subject of whistleblower reports to the SEC.) The train of events that the BNY Mellon whistleblower allegations set in motion shows how the revelation of whistleblower allegations can lead not only to significant regulatory action but also to significant follow on civil litigation.

The whistleblower provisions of the Dodd-Frank Act have only recently been implemented and the SEC’s program is only in its earliest stages. It remains to be seen exactly where the program will lead. But given the substantial bounties provided for in the Act it seems likely there will be increased numbers of reports to the SEC, which in turn could mean increased levels of enforcement activity. Along with all other concerns these possibilities present, there is also the concern that the increased number of reports and increased enforcement activity could, following the same sequence illustrated in connection with the BNY Mellon, lead to a surge in follow-on civil litigation. As we head into 2012, we will have to watch whether increased whistleblowing lead to increased follow-on civil litigation, similar to the suit with which BNY Mellon was just hit.

A View from a Window: In those days, the car ferry traversed the Cook Strait twice daily, in the morning heading south from Wellington, on the Southern end of the North Island of New Zealand, and in the evening heading north from Picton, on the Northern end of the South Island. (There are more ferries now, and the crossings more frequent.)

After the ferry leaves Picton, the first hour of the northward journey runs through the Queen Charlotte Sound, winding through sea-drowned valleys and steeply sloped channels. Where the Sound finally opens up into the Strait, a single white house sits on a huge bluff, standing alone against a stark landscape.

Sometimes when I am having trouble falling asleep, I picture myself standing in the window of the house, in the evening, just as the ferry passes below. A few sounds from the ship drift up to house – a bit of conversation, the clink of a glass, a few notes of music. But the ship moves quickly and it soon disappears into the gathering night. The white foam from the ship’s wake quickly dissipates as well, and all is quiet, in a place remote from the troubles and worries of the world.

I watch for a time as the unfamiliar stars of the Southern sky emerge. I turn from the window and slide into bed. And then gentle Sleep envelops me in her warm, soothing embrace, and I drift away, dreaming dreams of serenity and contentment.  

The essay question on one of my son’s college applications supplied only the brief prompt: “You are looking out of a window.” For some reason, I felt compelled to respond to this odd prompt. Strangely, my son was uninterested in my brief essay, and uninterested in showing me what he came up with as his response, as well.

• Print
• Comments
• Trackbacks
• Share Link

Even thought the SEC’s final regulations for the Dodd-Frank whistleblower program just became effective on August 12, 2011, the agency has already filed its first report on the whistleblower program. Under Section 924(d) of the Dodd Frank Act, the SEC must report annually to Congress on its activities, whistleblower complaints and the agency’s response to the complaints. Because the agency’s November 2011 report is written as of the September 30, 2011 end of the fiscal year, it covers only seven weeks of whistleblower data for fiscal year 2011. The Report can be found here.

The report shows that during the first seven weeks of the program, the agency received 334 whistleblower tips. The SEC itself cautions that “due to the relatively recent launch of the program and the small sample size, it is too early to identify any specific trends or conclusions from the data collected to date.” Nevertheless, even though it is early yet, there are some interesting tidbits in the report’s data.

First, a surprising number of the reports originated outside the United States. That is, not only did the agency receive individual whistleblower submissions from individuals in 37 different states, but it also received reports from individuals in eleven different foreign countries. These non-U.S. whistleblowers 32 submissions represented roughly ten percent of all of the whistleblower submissions during the reporting period. The country with the highest number of submissions was China (10), followed by the U.K. (9).

Second, though many commentators had expected that the Dodd Frank whistleblower provisions would trigger a flood of FCPA-related reports, and though there were so many reports from outside the U.S., whistleblower submissions reporting FCPA violations represented only four percent of the submissions during the reporting period, a level of submissions that has puzzled some commentators (refer for example here).

When the Dodd-Frank Act was first enacted, there was a great deal of concern that the bounty rewards in the whistleblower provisions would trigger a flood of whistleblower reports. (The bounty provisions require an award of between 10% and 30% of the amount of SEC recoveries based on the whistleblower submissions, when the SEC’s recovery exceeds $1 million). Some might find the 334 of whistleblower submissions during the reporting period surprisingly low.

But in addition to the reporting period only representing seven weeks, it is also worth noting that there still have been as yet no bounty awards under the Dodd-Frank whistleblower program. The SEC’s recent report shows that the agency maintains a fund of over $452 million in order to fund future whistleblower awards.

A former SEC official who helped draft the whistleblower provisions has said that he expects that in coming years “the SEC will exceed its previous records in both number of actions brought and the amount of sanctions collected as a result of whistleblower assistance.”

The $452 million fund available for bounty awards suggests that we will indeed see significant numbers of whistleblower submissions in the future. Based on the history of other government whistleblower programs that offer steep financial motivations, the expectation that there will be significant numbers of whistleblower report in the future seems well founded. For example, an entire industry has grown up in support of qui tam actions under the False Claims Act, with serial claimants and specialized law firms organized to pursue these claims systematically. David Barrio has a very interesting November 17, 2011 in the AmLaw Litigation Daily article (here) discussing the serial qui tam claimant and his “industrious” law firm that has over a 16-year period recovered over $2.5 billion from pharmaceutical companies accused of ripping off Medicare and Medicaid. 

And while the SEC’s first report since the whistleblower program covers only a short time period and reflects only a small number of whistleblower submissions, among those submissions are some significant items. As discussed in Jean Eaglesham’s November 16, 2011 Wall Street Journal article (here), among the reports the SEC received during the initial reporting period were tips that the Bank of New York Mellon and State Street Corp. were improperly charging large institutional clients for currency trades.

These examples show the potential significance of the whistleblower program. As these types of whistleblower reports translate into bounty awards, more submissions will follow. The SEC’s initial report for the short reporting period provides a cryptic but tantalizing glimpse of the likely future of this program.

EEOC Releases 2011 Report: And speaking of annual government reports, the Equal Employment Opportunity Commission has also released its fiscal 2011 Performance and Accountability Report. The EEOC’s report, which can be found here, contains a detailed overview of the agency itself. The report also contains some data relating to the agency’s enforcement activities.

Among other things, the agency’s report shows that in fiscal 2011, the agency received a record number of charges during fiscal 2011. The 99,947 charges the agency received during 2011 slightly exceeded the 99,922 charges the agency received in 2010. This relatively slight annual gain in the number of charges between 2010 and 2011 contrasts with the steep increase in the number of charges between FY 2004 and FY 2009, when the annual increases in the number of charges ranged from 12 to 38 percent. This rapid ramp up of the number of charges has produced increased what the report describes as the agency’s “inventory.” The report details the steps the agency is taking to try to reduce its accumulated inventory.

Cases Against U.S-Listed Chinese Companies Continues to Accumulate: As I have previously noted elsewhere, one of the significant factory in securities class action litigation filing activity during the past 18 months has been the flood of new cases involving U.S.-listed Chinese companies. One of the frequent comments about this surge of filings has been that sooner or later this phenomenon has to play itself out, since sooner or later the plaintiffs’ lawyers will just run out of companies to sue.

But while this filing phenomenon has to come to an end sooner or later, the lawsuits involving U.S. listed Chinese companies are still continuing to come in. In their November 16, 2011 press release (here), plaintiffs’ attorneys’ announced that they had filed an action in the Central District of California against Keyuan Petrochemicals and certain of its directors and officers. In their complaint, which can be found here, the plaintiffs allege that the company failed to disclose certain related party transactions and that the company’s financial statement did not reflect the company’s true financial condition.

With the filing of this complaint, there have now been a total of 36 securities class action lawsuits in 2011 involving U.S. listed Chinese companies, and a total of 47 since January 1, 2010.

Viral Video Explained: Earlier this week I included an embedded link to a bizarre video showing a group of elderly Chinese singing and dancing to the Lady Gaga song “Bad Romance.” A November 17, 2011 post on The New Yorker’s website (here) has an interesting explanation of the video, which apparently has gone viral, much to the puzzlement of the Chinese. The New Yorker post includes the video, for those who have not yet seen it.

• Print
• Comments
• Trackbacks
• Share Link

On May 25, 2011, the SEC adopted the final rules implementing the whistleblower provisions of the Dodd-Frank Act. The SEC declined to propose a rule that would have required whistleblowers to report first through internal corporate compliance programs. However, the SEC adopted changes that are intended to “incentivize whistleblowers to utilize their companies’ internal compliance and reporting systems when appropriate.”

The SEC’s May 25, 2011 press release about the final whistleblower rules can be found here. The SEC’s 305-page document describing the final rules can be found here. The SEC’s rules will be effective 60 days after they are submitted to Congress or published in the Federal Register.

Section 922 of the Dodd-Frank Act created certain new whistleblower incentives and protections. The section directs the SEC to pay awards to whistleblowers that provide the Commission with original information about a securities law violation that lead to the successful SEC enforcement action resulting in monetary sanctions over $1 million. The section also prohibits retaliation against whistleblowers.

The SEC released proposed rules to implement the whistleblower provisions in November 2010. The SEC received hundreds of comments on the proposed rules. The final rules document released yesterday describes many of the comments as well as the way that the SEC took the comments in to account in promulgating the final rules.

One of the most significant issues raise in the comments related to the impact of the whistleblower program on internal corporate compliance processes (refer here for a discussion of this issue). The gist of the concern is that the SEC whistleblower provisions would encourage the whistleblowers to bypass internal reporting mechanism (many of which have only recently been implemented pursuant to the requirements of Sarbanes Oxley). Though some commentators urged the Commission to require whistleblowers to report violations first internally, the SEC decided not to include this requirement. Rather, the SEC included in the final rules elements it hopes will encourage potential whistleblowers to use internal compliance processes.

Specifically, the rules make the whistleblower eligible for an award if the whistleblower reports the violation internally and the company informs the SEC about the violation. The SEC will also treat the informant as a whistleblower as of the date of an internal report of the employees provides the same information to the SEC within 120 days (this allows whistleblowers to save their “place in line” for a possible award). Finally, the informant’s voluntary participation in the company’s internal reporting program will be a factor the SEC will use to increase the amount of an award.

The SEC’s final rules also identify a number of categories of persons who will not be eligible for an award, including those with a preexisting legal or contractual duty to report their information; those who obtain their information either by privileged or illegal means; officers and directors who are informed by another person of the violations; compliance and audit personnel. (There are defined circumstances when compliance and audit personnel can be eligible.

The rules also clarify the whistleblowing procedures, and provide clarification of what constitutes a voluntary report; what constitutes original information; what constitutes a successful enforcement action and so on.

These rules will be effective shortly, most likely later in the summer. The ultimate practical effect of these new rules depends on how forthcoming prospective informants are; the quality of the information; and what the SEC does with the information.

The sheer scale of the prospective awards (from 10 to 30 percent of awards in excess of $1 million) is clearly designed to encourage whistleblowing, as indeed is the SEC’s final rule. For its part, the SEC has a huge incentive in the post-Madoff era to heed whistleblower’s warnings and to pursue the reported information. Just looking at the way the incentives and motivations line up, the most probable outcome here seems to be that there will be significant numbers of whistleblower reports and that these reports will trigger significant numbers of investigations and enforcement actions. These enforcement actions could well be followed by follow-on civil litigation, which could increase the potential exposure that companies and their senior officials could face as a result of the implementation of these rules.

It certainly appears that a portion of the plaintiffs’ bar things there is an opportunity here supporting prospective whistleblowers and perhaps using their reported information as the basis for separate civil suits – refer for example to this advertisement for the “SEC Whistleblower Claims Center.” The quick emergence of an opportunistic plaintiffs’ bar eager to try to turn these new rules to their advantage is hardly surprising. Enterprising plaintiffs’ lawyers have been profiting from the whistleblower incentives in the False Claims Act for years (refer, for example, here)

However these incentives may appear now, they will all be augmented exponentially once a whistleblower or two has garnered a significant award. Given the magnitude of some of the recent SEC enforcement actions (as for example in connection with SEC enforcement action under the FCPA, refer here) the likelihood that we might see some large awards seems high. Refer here for further discussion of the particular concerns surrounding the prospects for whistleblowing activity in the FCPA context.

The bottom line is that for those of us who worry about the potential exposures of directors and officers of public companies, there is a whole new category of concerns.

Special thanks to a loyal reader for the link to the whistleblower advertisement.

• Print
• Comments (1)
• Trackbacks
• Share Link

A number of different organizations  generate annual publicity for themselves by designating a word (or words) of the year. We are not yet half way through 2011 but I am already prepared to propose my own candidate for this year’s word of the year – the word is “whistleblower.” From the provisions of the Dodd-Frank Act and the predecessor provisions of the Sarbanes Oxley Act to the litigation activities of activist investors, whistleblowers’ actions and protections are a growing source of attention and concern – and litigation.

Since the Dodd Frank Act’s  passage last summer, the whistleblower provisions of the Dodd-Frank Act have received a great deal of scrutiny. The SEC proposed rules to implement the provisions last November (refer here).  The proposed rules have not yet been enacted by the SEC. However, according to a May 5, 2011 Reuters article (here), the vote on the final rules implementing the whistleblower provisions could come as early as May 25, 2011.

Among the issues surrounding the final rules is the question of whether or not they mandate  that would-be whistleblowers must first report wrongdoing internally before reporting violations to the SEC, in order to be eligible for the so-called whistleblower bounty.  According to the Reuters article, the SEC has “no plan to make internal reporting a mandatory first step for whistleblowers.” However other alternatives are under consideration, including the possibility of allowing company employees to reap full benefits of the bounty provisions if a combination of the employee’s tip and information from a company’s internal probe lead to the imposition of fines or penalties for securities law violations.

While the final rules on the whistleblower bounty provisions are pending, there have also been developments related to the other significant components of the Dodd-Frank whistleblower provisions -- the provisions’ anti-retaliation protections. A May 4, 2011 order in a case pending in the Southern District of New York took a detailed look at who may invoke the anti-retaliation provisions and what is required to invoke the protection. The order can be found here. UPDATE: Please note that  in a subsequent September 1, 2011order, here, Judge Sands dismissed the plaitiffs' claims with prejudice, having concluded that the plaintiff has insufficiently pled his claims of retaliation and of securities fraud.

This case was brought by an employee of Trading Screen. The employee believed the company’s CEO was diverting opportunities and assets from Trading Screen to a company solely controlled by the CEO. The employee reported the CEO’s actions to the company’s President, who in turn reported the information to the company’s Board. The Board hired outside counsel (the Latham & Watkins firm) which investigated and concluded that the activity was taking place as the employee reported. However, when the Board sought the CEO’s voluntary resignation from the company, the CEO  was able to wrest control of the Board. The CEO later fired the employee who had reported the violation.

The employee filed suit against TradingScreen, the CEO and a variety of related entities asserting a number of claims, including a separate cause of action for retaliatory discharge under the Dodd Frank whistleblower provisions (about which generally refer here). Among other things the relief available under the provisions includes reinstatement, double back pay, and costs and fees.

In moving to dismiss with respect to these allegations the defendants contended that the plaintiff is not covered by the Dodd Frank anti-retaliation provisions because he did not personally report the alleged violation to the SEC and because he does not otherwise come within the four other categories of activity that would bring his conduct within the provision.

The four other categories of disclosures protected under the Dodd Frank anti-retaliation provisions are disclosures: under the Sarbanes Oxley Act; under the Securities Act of 1934; under federal statutory provisions relating to investigative officers; or disclosures under any other law, rule or regulation of the Commission. In his May 4, 2011 order, Southern District of New York Judge Leonard Sand found that because TradingScreen is a private company, the employee’s disclosures did not come within the Sarbanes Oxley Act or the Securities Act, and that plaintiffs’ allegations were otherwise insufficient to bring his actions within the other two categories of disclosures.

The employee himself had not disclosed the alleged violation to the SEC. But the employee contended that he nevertheless came within the statute because he had made the disclosure to the SEC “jointly” with the outside law firm that investigated his allegations of misconduct. Judge Sand allowed that if the disclosures had been made to the SEC by the law firm, they were made “jointly” by the employee with the law firm, because law firm’s investigation of his report had led to the disclosure. However, Judge Sand also found that the plaintiff had not sufficiently alleged that the law firm had in fact disclosed the information to the SEC, but he granted the plaintiff leave to amend his complaint in order to try to establish that the law firm had in fact disclosed the information to the SEC. However, it should also be noted that in his September 1, 2011 order, Judge Sands dismissed the plaintiffs' claims with prejudice, concluding in particular that "Plainitff's Second Amended Complaint fails to allege a claim under the Securities Whistleblower Incentives and Protection provisions of teh Dodd-Frank Act." 

Much of the focus of discussion about the Dodd Frank whistleblower provisions has been on the whistleblower bounty. However, given the breadth of the anti-retaliation provisions, those provisions could also prove to be critically important. 

On May 3, 2011, the Ninth Circuit issued an opinion (here) in a separate alleged whistleblower retaliation case, this one under the whistleblower protections in the Sarbanes Oxley Act.  The case involved two individuals who had been part of the IT Sarbanes Oxley audit group at Boeing. The two had become concerned that Boeing was putting pressure on the audit team to rate Boeing’s internal controls “effective.” After raising concerns internally, the two had communicated with a reporter at the Seattle Post-Intelligencer, who wrote articles about the company’s audit process. After an investigation, the company concluded that the two had violated the company’s policy against releasing internal information to the press without authorization, and the company terminated the employment of the two individuals.

The two individuals filed an action against the company alleging retaliation for actions protected by Sarbanes Oxley. The district court had granted the company’s motion for summary judgment and the two individuals appealed.

In its May 3 order, the Ninth Circuit concluded that the individuals were not protected under Sarbanes Oxley because it provides protections only for disclosures to a federal regulatory agency; a member or committee of Congress; or a supervisor or other individual authorized to investigation such misconduct. “Members of the media,” the court found, “are not included,” noting that Congress had limited the activity protected under the provisions to “employees who raise certain concerns of fraud or securities violations with those authorized or  required to act on the information.”

The court concluded that the provision “does not protect employees of public companies who disclose information regarding fraud or certain securities violations to members of the media.” The court concluded that Boeing was within its rights to terminate the employees for violating company policy. The Ninth Circuit affirmed the district court.

The Ninth Circuit’s opinion and to a lesser extent Judge Sand’s opinion in the case discussed above serve as a reminder that those who comply with the statutory requirements will be able to bring themselves within the statutory protection.  The statutory provisions do not protect whistleblowing in and of itself, but only certain kinds of whistleblowing under certain kinds of circumstances and conditions. Along with cases exploring the protections available under these statutory provisions, we can expect further cases examining the question of when supposed whistleblowers are entitled to the protection of the statutory provisions.

One final note during on the general whistleblowing theme is the lawsuit that was unsealed this past week in which taxpayers allege that certain loans extended by the Federal Reserve Bank of New York in the fall of 2008 as part of the bailout of AIG had defrauded taxpayers. The lawsuit, which first filed in the Southern District of California in 2010, and which was ordered unsealed last month, asserts claims under the False Claims Act. The taxpayers’ amended complaint can be found here.

The taxpayers’ complaint relates to two emergency loans the government extended to AIG that totaled over $40 billion and that were used to settle trades involving blocks of mortgage-backed securities that AIG had guaranteed. The lawsuit, which names as defendants not only AIG but also the transaction counterparties (which included Goldman Sachs, Deutsche Bank, Bank of America and Societe Generale), alleges that the Fed’s loans were improper because they were made without first obtaining a pledge of appropriate collateral as required by applicable law. The plaintiffs seek to recover for the U.S. government the losses sustained by the government as a result of the fraud and false claims alleged in the complaint.

Though the taxpayers’ action may be different in kind and character than the other cases discussed above, the cases collectively serve to underscore the prevalence of whistleblowing activity. Courts undoubtedly will continue to sort out the prerequisites necessary to invoke the statutory whistleblower protections. But even while there may be many issues yet to be sorted out, whistleblowing itself already is a significant phenomenon, as witness by a host of current devopments, including the Wikileaks disclosures. With the protections and bounties under Dodd-Frank, its importance seem likely to increase. The likelihood for increased litigation involving whistleblower-related activity seems high.

Speakers' Corner: On May 11, 2011, I will be moderating a session in Menlo Park, California entitled "Dodd-Frank and the Rise of Shareholder Empowerment." The session is sponsored by the Orrick law firm, The Directors Network and Deloitte, and will take at place at the Orrick law firm's Menlo Park offices. The program, which is free and which will run from 8:45 am to 11:45 am, will provide insights and practical advice regarding fundamental changes in the corporate governance environment and the emerging role of shareholders in the U.S. corporation.

The session includes an all-star cast of panelists, including; Consuelo Hitchcock, Principal, Regulatory and Public Policy at Deloitte; Marc Gross, of the Pomerantz, Haudek, Grossman & Gross law firm; Anne Sheehan, Director of Corporate Governance at CalSTRS; George Paulin, the President of George Cook & Co.; and Jonathan Ocker and Bob Varian of the Orrick law firm.

Further information about the program, including registration information, can be found here.

• Print
• Comments
• Trackbacks
• Share Link

Among the many innovations introduced in the massive Dodd-Frank Wall Street Reform and Consumer Protection Act enacted this past July are the new whistleblower provisions, designed to encourage employees and others to report securities law violations to the SEC. The bounty award provided for in the whistleblower provisions seem likely to encourage fraud reporting, but many observers are voicing concerns about these provisions. And as noted below, there may be other concerns above and beyond those generally noted, particularly with respect to potential D&O insurance coverage issues.

Section 922 of the Dodd Frank Act specifies that a person who provides "original information" to the SEC of fraud within the company that leads to an enforcement penalty of $1 million or more may be entitled to collect between 10 and 30 percent of the penalties of $1 million or more. The provision also provides substantial retaliation protections for whistleblowers.

An article in the November 1, 2010 Wall Street Journal article (here) notes a number of concerns about the new whistleblower provisions, the first and foremost of which is that the bounty provisions provide incentives for prospective whistleblowers to race to the SEC in order to be the first to report violations, which in turn encourages prospective whistleblowers to bypass internal fraud detection mechanisms mandated by the Sarbanes Oxley act. Bruce Carton previously discussed many of these same concerns on his Securities Docket blog, here.

There is little doubt that the bounty provisions are likely to encourage fraud reporting. As I have noted elsewhere, penalty awards, for example, have skyrocketed in recent years, with many recent awards in the hundreds of million dollars. Whistleblowers potential rewards are enormous.

To put this into perspective, and as noted in the Journal article, the whistleblower whose tip resulted in the recently announced $750 million settlement between GlaxoSmithKline and the Justice Department stands to get an award of $96 million, under similar whistleblower provisions in the False Claims Act.

In recognition of the likelihood of substantial whistleblower awards, the SEC has already established a fund of approximately $452 million to fund the payments to whistleblowers, according to the SEC’s Annual Report to Congress on the Whistleblower Program, which was released last week. (The congressional report was mandated by the Dodd Frank Act.)

Under these circumstances, it seems highly likely that whistleblower actions will proliferate, and so the concerns noted in the Journal article and elsewhere seem warranted. In addition to the items noted elsewhere, there are a couple of other issues arising from the new whistleblower provisions that are worth considering as well.

The first is that the threat of legal proceedings from the whistleblower action is not limited just to the possible SEC enforcement action. A related and accompanying threat is the possibility of a follow-on civil litigation, brought on behalf of the target company’s investors, in which the plaintiffs will claim that the company’s senior managers failed to take appropriate steps to ensure that proper controls were in place, or that investors were misled by the company’s statement about the company’s controls.

These kinds of follow-on civil actions have been a frequent accompaniment of FCPA enforcement actions, as I have often noted on this blog. It seems probable that as whistleblower actions mount in response to the Dodd-Frank Act provisions, that there will be a parallel increase in civil actions following on after the whistleblower enforcement action.

The fines and penalties associated with a whistleblower enforcement action would likely not be covered under a D&O insurance policy, although the fees incurred in defending against the action potentially could be covered, at least as to individual defendants.

The follow-on civil actions would likely be covered under the typical D&O insurance policy, subject to all of the applicable policy terms and conditions. However, one potential D&O insurance coverage issue that might arise concerning the follow-on civil actions has to do with the possibility that the individual whistleblower could be an insured person under the D&O policy. This might arise, for example, if the whistleblower is also an officer of the company. The risk is that either the enforcement action or the follow on civil proceeding might run afoul of the insured v. insured exclusion typically found in most D&O insurance policies.

Following the enactment of the Sarbanes Oxley whistleblower provisions a few years ago, many D&O insurance policies were amended to ensure that a claim related to a Sarbanes-Oxley whistleblower action would not run afoul of the insured v. insured exclusion. Many of these amendments were written sufficiently broadly that the coverage carve back for whistleblower claims would preserve coverage not only for Sarbanes-Oxley whistleblower claims, but would also preserve coverage under other types of whistleblower claims. Many of these amendments were written sufficiently broadly that they would likely preserve coverage for Dodd-Frank whistleblower claims as well.

However, not all of the whistleblower carve back amendments are equally broad, which may raise the question about the potential applicability of the insured v. insured exclusion to Dodd Frank whistleblower claims, whether with respect to the initial enforcement action or even the possible follow-on civil action. Given the high likelihood of future Dodd Frank whistleblower claims, the review of the applicable D&O insurance policy language, seems like a critical next step.

In any event, the range of possibilities seems to include the likelihood of an increase both in enforcement actions and follow-on civil lawsuits, which has important implications far beyond the narrow provisions of the policy’s exclusionary provisions.

More Securities Suits Against For-Profit Educational Companies: One of the most distinctive securities class action lawsuit filing trends in the second half of 2010 has been the sudden arrival of a multitude of securities suits against for-profit education companies. As I noted in an earlier post, these suits follow a congressional investigation in to the companies’ practices involving student loans.

In recent days, plaintiffs have added two more companies to the growing list of for-profit education companies that have been hit with securities lawsuits. First, on October 28, 2010, plaintiffs’ lawyers initiated a securities suit against The Washington Post Company and certain of its directors and offices, in connection with the companies Kaplan, Inc. education subsidiary. Second, on November 1, 2010, plaintiffs’ lawyers initiated a securities suit against DeVry, Inc. another for-profit education company.

These two latest suits brings the number of securities suits filed against for-profit education companies so far this year to nine, which represents about 6% of the approximately 145 securities lawsuit filed this year.

Though the Washington Post Company is obviously a media company, it actually carries the 8200 SIC Code (Educational Services), reflecting the relative importance of the Kaplan Inc. subsidiary’s revenues to the company’s overall financial picture.

• Print
• Comments (1)
• Trackbacks
• Share Link