Legal Developments in Securities Law

How Can I Claim an SEC Whistleblower Award: Dodd-Frank’s Whistleblower Incentives
Under the Sarbanes-Oxley Act of 2002 (SOX), the whistleblower provision prohibited publicly traded corporations from taking any adverse employment action against an employee that internally reported or externally disclosed conduct reasonably believed to be a violation of any rule or regulation of the Securities and Exchange Commission (SEC) or a violation of any provision of federal law concerning fraud against shareholders. While SOX was initially thought to provide important whistleblower protection, it soon became apparent that the laws under SOX did not do enough to encourage potential whistleblowers to come forward.

With the passage of the Dodd-Frank Act came great whistleblower incentives, including anti-retaliation provisions and the payment of bounty for a whistleblower’s tip, complaint or referral. Since July 21, 2010, whistleblowers have been able to submit information to the SEC or CFTC pursuant to the new provisions in the Dodd-Frank Act, but the new Whistleblower Program took full effect today.

Individuals who feel they may have important information concerning a potential securities law violation should be aware of the following conditions:

Who Can Be a Whistleblower:
A whistleblower is not limited to an employee of a company, but can be any individual with original information about a potential securities law violation. Notably, companies and organizations cannot qualify as whistleblowers. In addition, a whistleblower will be denied a bounty if:

  • the whistleblower fails to submit information in accordance with the form required by the SEC
  • the whistleblower is or was at the time of submission a member of a regulatory agency, the Department of Justice, a self-regulatory organization, the Public Company Accounting Oversight Board, or any law enforcement organization
  • the whistleblower is convicted of a criminal violation related to the judicial or administrative action involved; or
  • The whistleblower learned the information through performing an audit.

What Entitles a Whistleblower to a Bounty:
The Exchange Act has been modified to provide the whistleblower a monetary incentive if the individual provides information relating to a violation of ANY of the securities laws. A whistleblower is entitled to an award if:

  • A proceeding by the SEC results in monetary sanctions which exceed $1 million
  • The information provided by the whistleblower came from the whistleblower’s independent knowledge or analysis
  • The information provided by the whistleblower is either the only source for the SEC of that information or if it was the original source for the SEC; and
  • The information provided is not exclusively obtained from a judicial proceeding or other public source, unless the whistleblower was the original source of that information.

What Kind of Bounty Could a Whistleblower Receive:
If all of these conditions are met, then the SEC is required to pay the whistleblower 10% -30% of the monetary sanctions imposed in the action. Although the SEC is required to pay the whistleblower an amount from 10-30%, the actual amount is within the discretion of the SEC, dependent on factors such as the significance of the information provided, the degree of assistance from the whistleblower, the SEC’s interest in creating an incentive for reporting potential securities law violations and other factors as established by the rule or regulation.

The whistleblower “bounty” program creates an incentive that previously did not exist – a whistleblower could stand to benefit immensely from alerting the SEC or CFTC about a potential securities law violation. For example, if the SEC collects $2,000,000 in penalties, disgorgement and interest from its successful prosecution of securities law violations that were related to the original information provided by the whistleblower, the whistleblower could earn between $200,o00 and $600,000 for his or her tip, complaint or referral.

What Other Incentives Are Offered to Whistleblowers:
Anti-Retaliation: The Dodd-Frank Act now protects whistleblowers from being demoted, suspended, threatened, harassed (directly or indirectly) or in any way discriminated against because the whistleblower provided information to the SEC, assisted in any proceeding brought by the SEC based on such information or made any disclosures required or protected under SOX. The new legislation now provides a private cause of action for reinstatement of the same seniority status the whistleblower would have had but for the discrimination, two times the amount of back-pay otherwise owed, with interest, and compensation for litigation costs, expert witness fees, and reasonable attorneys’ fees.

Anonymity: If the whistleblower wishes to remain anonymous, he or she must retain an attorney to submit the information about a potential securities law violation to the SEC or CFTC.

What the Dodd-Frank Whistleblower Incentives Mean:
With the new incentives in this legislation, individuals can gain a monetary reward in addition to greater legal protections from retaliation. Individuals who have experienced retaliation as a result of providing information to the SEC or those who feel they have important information to submit to the SEC should consider retaining an attorney with securities law experience to assist them with their retaliation claim or with submitting their information through the SEC’s online questionnaire or a Form-TCR. Of course, those individuals who wish to remain anonymous are required to retain an attorney to participate in the Whistleblower Program.

View the SEC’s Statement on the New Whistleblower Program

Legal Developments in Securities Law

Too Good to be True?: Investment Schemes to Watch Out For
Recently, the North American Securities Administrators Association (“NASAA”) released a list of the “Top 10 Financial Products and Practices” that investors should watch out for. See the NASAA’s article here.

The article lists the following products and practices:

  • PRODUCTS: distressed real estate schemes, energy investments, gold and precious metal investments, promissory notes, and securitized life settlement contracts.
  • PRACTICES: affinity fraud, bogus or exaggerated credentials, mirror trading, private placements, and securities and investment advice offered by unlicensed agents.

Although the lists above provide the most likely culprits, investors should be diligent and watch out for warning signs with any investment they seek to make. Some of these warning signs may include:

  • If the promised return of an investment seems too good to be true, it probably is. Above normal rates of return could signal a Ponzi scheme, now often associated with Bernie Madoff and Bernard L. Madoff Investment Securities. Investors may be promised large rates of return, then those returns are paid with the funds investors’ contributed, and more investors may continue to contribute as word spreads that the investment is paying off. Ultimately, however, the funds will diminish and investors will no longer receive their payments or a return of their initial investments.
  • Watch out for investments offered by individuals whose credentials cannot be verified. In a world where a multitude of information is accessible through the Internet, it is easy to research someone’s background online. Investors should particularly look out for previous securities violations, which can be investigated through the Securities and Exchange Commission’s website or the Financial Industry Regulatory Authority’s website. Some individuals may try to emphasize prior successful enterprises or ties with influential individuals – investors can investigate these issues, as well. Note the NASAA’s example of how individuals can try to use credentials to mislead investors:
    • Securities regulators in Utah came across a broker who listed “C.H.S.G.” after his name on his business card. When asked, the broker told regulators the initials stood for “Certified High School Graduate.”
  • If you are not a sophisticated investor, investments that are not offered to you by a securities professional you trust should be treated with extreme caution. Even a prospectus or financial statements that are provided to you should be carefully investigated if you are interested in the potential investment, as those documents can be fabricated. Of course, as the NASAA points out, investors are often unaware that their securities brokers or investment advisers are unregistered or unlicensed. Even when enlisting the advice of a securities professional, be sure to check the SEC’s Investment Adviser Search or FINRA’s BrokerCheck to ensure the professional is licensed to give you advice.

What to Do if You Believe Your Investment was Part of a Scheme

If you believe you may have fallen victim to a potential investment scheme because it falls into one of the NASAA’s categories or because it fits some or all of the criteria mentioned above, you should immediately preserve all documents pertaining to the investment and contact an attorney with experience in the field. You may also wish to report the conduct to the SEC (see the blog post below on the SEC’s Whistleblower Incentives). Be aware that a statute of limitations may apply.

Legal Developments in Securities Law

The SEC & “Small and Emerging Companies”: Could the Rules Governing Private Capital Change?
This week, the SEC announced the formation of an Advisory Committee on Small and Emerging Companies (“Committee”) “to focus on interests and priorities of small businesses and smaller public companies.” You can find the SEC’s announcement here.

Of great importance to all small or private companies, the SEC intends to explore capital raising through private placements and public securities offerings for privately held small businesses and publicly traded companies with less than $250 million in public market capitalization. The SEC noted that it must strike a balance between facilitating capital formation and protecting investors.

For such companies, this is good news. Currently, once a private company gains 500 shareholders and has $10 million in assets, it is required to make the same disclosures as a public company. For small companies, the regulatory expense of preparing disclosures can be prohibitive. The disclosures required of the company include:

  • its company’s operations;
  • its officers, directors, and certain shareholders, including salary, various fringe benefits, and transactions between the company and management;
  • the financial condition of the business, including financial statements audited by an independent certified public accountant; and
  • its competitive position and material terms of contracts or lease agreements. Small Business FAQ from the SEC.

The SEC’s new Committee could weigh in on increasing the number of shareholders allowed before triggering reporting requirements or making it easier for companies to publicize their shares.

Coincidentally, this week Rep. Patrick McHenry (R. N.C.) introduced legislation that would make it easier for private companies to use “crowd funding.” According to the Wall Street Journal, “The measure would allow an unlimited number of people to contribute a total of $5 million to a crowd-funded start-up, with individual contributions capped at $10,000, or 10% of their annual incomes.” Read the WSJ Article here. Additionally, House Majority Whip Kevin McCarthy (R., Calif.) has brought up the need to ease restrictions on direct mail or advertisements to solicit investors for private placements. Currently, several exemptions to registration do not permit public solicitation or general advertising in connection with a private securities offering.

Although the SEC has formed the Committee, it will be up to the SEC to decide whether to implement any policies or regulations recommended by the Committee.

Changes in private capital could be coming in the future, but for now, private companies must continue to adhere to the SEC’s limitations on private funding. To be sure that your company is in compliance with securities laws, it is important to consult an attorney with experience in securities law for legal advice.

Legal Developments in Securities Law

The Foreign Corrupt Trade Practices Act: Why It Matters to Your Company
Recently, Deloitte LLP conducted a survey which demonstrated that United States companies are having a difficult time detecting or preventing corruption prohibited by the Foreign Corrupt Trade Practices Act (“FCPA”). You can read more about Deloitte’s survey here.

Of course, Deloitte’s survey is particularly of interest as government agencies are increasing the number of FCPA enforcement actions each year. In 2009, the Department of Justice (“DOJ”) and the Securities and Exchange Commission (“SEC”) collectively brought 40 enforcement actions concerning the FCPA; in 2010, that number jumped to 74 enforcement actions – 85% greater than the previous year. Indeed, 2009 itself was another record year for its number of FCPA related enforcement actions.

Clearly, the number of enforcement actions have been increasing as it has become obvious that the stakes are high. In 2008, the United States’ settlement with Siemens AG, a Germany based company, netted the government $800 million in fines and disgorgement of ill-gotten gains. In 2009, Halliburton Co. paid $579 million in criminal fines and disgorgement, the largest combined settlement ever paid by a United States company since the FCPA’s inception. In 2010, with settlements of over $350 million by Snamprogetti Netherlands B.V. and BAE Systems plc, among other massive settlements, the SEC and the DOJ showed the true strength and impact of the FCPA.

What is the FCPA?
The FCPA was passed in 1977, as a response to numerous SEC investigations in the mid-1970s that revealed over $300 million in bribes to foreign officials. The FCPA’s purpose was to restore public confidence in the integrity of American businesses. The FCPA provides for internal accounting requirements and provisions which prohibit bribery of foreign officials. The FCPA potentially applies to payments by any individual, firm, officer, director, employee, or agent of a firm and any stockholder acting on behalf of a firm.

Internal Accounting Requirements
Under the FCPA, public companies are required to keep records of their transactions and disposition of assets of the company and must maintain a system of internal accounting controls.The controls must be able to detect any differences between the accountability for assets and the existing assets.

Anti-bribery Provisions
U.S. public companies, U.S. nationals, and foreign firms or persons who take any act to further a forbidden transaction in the United States are all prohibited from making an offer, payment or promise of payment to any foreign official or foreign political party in order to obtain or retain business with any person. Under this provision, foreign official means any officer or employee or individual acting in an official capacity for a foreign government or any department, agency, or instrumentality, or of a public international organization.

What is at stake?
The SEC and DOJ have been aggressive with their enforcement of the FCPA and with demanding large penalties. Under the FCPA, there are numerous criminal and civil remedies available to the SEC and the Department of Justice for violations. Criminal sanctions state that corporations and other business entities are subject to a fine of up to $2,000,000, while officers, directors, stockholders, employees, and agents are subject to a fine of up to $100,000 and imprisonment for up to five years. Moreover, under the Alternative Fines Act, these fines may be much higher – the actual fine may be up to twice the benefit that the defendant sought to obtain by making the corrupt payment. Given these sanctions, a small bribe could result in significant fines. It is also important to note that fines imposed on individuals may not be paid by their employer or principal.

What can my company do to protect itself?
The DOJ and the SEC have stated that the existence of a corporate compliance program is a factor to be considered when deciding whether to bring charges. Additionally, Federal Sentencing Guidelines allow lower fines if an effective compliance program exists within a company. The compliance program must have been effective or designed to detect potential corrupt practices.

A good FCPA compliance program will include a written corporate policy that makes clear which standards should be followed by those involved in any foreign transactions in order to avoid violations of the FCPA and other anti-corruption laws. The procedures should include a system to which potential violations should be reported, preferably with an anonymous tipline. The written policies should include appropriate disciplinary actions for violations of the FCPA, foreign anti-bribery laws or the company’s own policies. Companies should obviously maintain an adequately staffed compliance office, which will also maintain a list of people who are most likely to do business with foreign entities. The compliance office should also maintain very good records, including permanent records of all approvals for foreign transactions. Other factors to consider include:

  1. Education of the company’s officers, directors, employees and agents
  2. Due diligence of the companies with which your company does business
  3. Identifying high risk countries

Companies that take precautions to detect FCPA violations by implementing a compliance program are in a better position to avoid costly investigations and damage to their reputation. Given the potential costs at stake, companies are advised to retain an attorney with FCPA experience, who can aid the company in developing an effective compliance program that will suit its needs.

Legal Developments in Securities Law

FINRA Settles with the SEC: Accused of Doctoring Documents
Today, FINRA settled civil charges by the SEC which stemmed from accusations that FINRA had doctored certain documents requested by the SEC. The Wall Street Journal reported:

According to the SEC, the director of Finra’s regional office in Kansas City altered in August 2008 the minutes of three internal staff meetings, editing or deleting certain information hours before providing the “inaccurate and incomplete” documents to the SEC’s inspection team.

The Finra director wasn’t identified in documents released by the SEC on Thursday. The SEC said the person resigned in 2010 after the alleged offenses were exposed.

The 2008 incident was the third time in eight years that an employee of Finra or predecessor the National Association of Securities Dealers provided altered or misleading documents to the SEC, it said. See article here.

The settlement provides, in part, for remedial measures, such as educating its staff members on “document integrity.”

Interestingly, in August of this year, an SEC employee accused the SEC of destroying thousands of documents concerning investigations into Wall Street banks and hedge funds. The SEC countered that it follows a system of periodically destroying documents, which does not violate any securities laws or policies. See the Wall Street Journal article from August here.

Regardless of the merit of the accusations against these agencies, individuals subject to SEC or FINRA inquiries can take a lesson from these headlines. Individuals who are the subject of an inquiry by the SEC or FINRA should ensure that they maintain copies of any information provided to the agencies and never alter any documents in an investigation. Providing complete and accurate information to a watchdog can be a difficult task, but an experienced attorney can guide you through the process and help you ensure that you are in compliance with securities laws.

Legal Developments in Securities Law

Dodd-Frank Update: New Private Fund Rules Released
Recently, the Securities and Exchange Commission (“SEC”) adopted final rules concerning the registration of advisers to private funds. Some of these rules varied greatly from the initial proposed rules. In the Release by the SEC and the Commodity Futures Trading Commission (“CFTC”), it was clear that many changes addressed commenters’ concerns with the proposed rules and their viability or effectiveness at achieving the rule’s purpose. Many commenters expressed concerns with certain fund advisers’ ability to provide reliably accurate data within a short deadline.

A number of these provisions are important to private fund advisers. To begin with, private fund advisers are divided into two general groups – a large private fund adviser or a smaller private fund adviser. Large private fund advisers are divided as follows:

  • Large Hedge Fund Advisers – $1.5 billion in hedge fund assets under management,
  • Large Liquidity Fund Advisers – $1 billion in combined liquidity fund and registered money market fund assets under management, and
  • Large Private Equity Fund Advisers – $2 billion in private equity fund assets under management.

Smaller private fund advisers are all other advisers, but note that not all smaller private fund advisers may be required to file the Form PF, if they have less than $150 million in private fund assets under management. Depending on the fund adviser’s classification, the deadlines to file the Form PF and the portions of the Form that must be completed will vary. The Form PF is a new reporting form developed to provide regulators with private fund information; notably, this Form will receive confidential treatment by the SEC and CFTC, although its contents may be disclosed to other Federal departments, agencies or self-regulatory organizations, in addition to the CFTC and FSOC. The Form PF is divided as follows:

  • Section 1: Information regarding the adviser’s identity and assets under management; limited information regarding the size, leverage and performance of all private funds subject to the reporting requirements, and; requires additional basic information regarding hedge funds.
  • Section 2: Aggregate information about the hedge funds the adviser manages; additional information about any hedge fund it advises that has a net asset value of at least $500 million as of the end of any month in the prior fiscal quarter.
  • Section 3: Information regarding the fund’s portfolio valuation and its valuation methodology, as well as the liquidity of the fund’s holdings; information regarding whether the fund, as a matter of policy, is managed in compliance with certain provisions of rule 2a-7 under the Investment Company Act.
  • Section 4: Information regarding the activities of private equity funds, certain of their portfolio companies and the creditors involved in financing private equity transactions.

Of course, the requirements and questions within each section are more detailed than the overview provided above, but private fund advisers should prepare themselves for the type of information that will be requested of them.

The deadlines to submit Form PFs to the SEC are categorized as follows:

  • Smaller Private Fund Advisers: Within 120 days after the end of the fiscal year. Reporting occurs on an annual basis. The previous proposed deadline provided 90 days.
  • Large Private Equity Advisers: Within 120 days after the end of the fiscal year. Reporting occurs on an annual basis. The previous proposed deadline provided only 15 days.
  • Large Hedge Fund Advisers: Within 60 days from the end of each fiscal quarter. Reporting occurs on a quarterly basis. The previous proposed deadline provided only 15 days.
  • Large Liquidity Fund Advisers: Within 15 days from the end of each fiscal quarter. Reporting occurs on a quarterly basis.

In addition to the new deadlines, the rules also made clear which portions of the Form PF each type of private fund adviser must complete, as follows:

  • Smaller Private Fund Advisers: Must provide only basic information regarding their operations and the private funds they advise, including their performance, leverage and investor data (all or portions of Section 1 of Form PF).
  • Private Equity Advisers: Must submit information on Form PF regarding the financing and activities of these funds in section 1 of the Form, and large private equity advisers are required to provide additional information in section 4 of the Form.
  • Hedge Fund Advisers: Must submit information on Form PF regarding the financing and activities of these funds in section 1 of the Form, and large hedge fund advisers are required to provide additional information in section 2 of the Form.
    • Under the rules, to be classified as a hedge fund, the private fund must have one of the following three characteristics:
      • (a) a performance fee that takes into account market value (instead of only realized gains)
      • (b) high leverage; or
      • (c) short selling.
  • Liquidity Fund Advisers: Must submit information on Form PF regarding the financing and activities of these funds in section 1 of the Form, and large liquidity fund advisers are required to provide additional information in section 3 of the Form.

Obviously, the above summary is provided as an indication of the requirements private fund advisers will face in the near future (as early as June 15, 2012 for some advisers). Private fund advisers should prepare for compiling, reviewing and filing the Form PF, and contact an experienced attorney if you have any questions.

Legal Developments in Securities Law

Federal Judge Critiques SEC’s Proposed Settlement with Citigroup
Could Force SEC to be More Aggressive in the Future
This blog post references Peter Latman’s NY Times article, “Judge in Citigroup Mortgage Settlement Criticizes S.E.C.’s Enforcement,” found here.

Yesterday, the Securities and Exchange Commission (“SEC”) was asked by Judge Rakoff to defend its proposed settlement with Citigroup Global Markets, Inc. (“Citigroup”) based on its structuring and marketing of a largely synthetic collateralized debt obligation. Specifically, the SEC alleged that Citigroup negligently misrepresented key deal terms, such as its own financial interest in the transaction and that Citigroup had exercised significant influence over the selection of assets.

Judge Rakoff questioned the SEC’s decision to accept a settlement of $285 million, while indicating that the SEC estimated that investors lost close to a total of $700 million in the investments. Judge Rakoff was equally inquisitive about the SEC’s injunction, to bar Citigroup from violating securities laws in the future. Notably, the Judge asked, “Why do you ask for an injunction when you never use it?” The SEC can file civil contempt proceedings if an organization or individual under an injunction not to violate securities laws in fact violates securities laws again in the future. Notably, no such charges have been brought in the last ten years. Such injunctive relief has been the subject of ridicule in the past – it is axiomatic that an organization or an individual is prohibited by law from violating securities laws. As is standard with settlements with the SEC, the entity or individual involved does not admit or deny any wrongdoing with regard to the allegations. Judge Rakoff likewise questioned Citigroup’s unwillingness to admit liability in this matter.

Some may remember that Judge Rakoff likewise questioned the SEC’s proposed settlement with Bank of America concerning whether Bank of America misled investors about its acquisition of Merrill Lynch. There, Judge Rakoff initially rejected a $33 million settlement proposal, and later reluctantly accepted a revised settlement for $150 million.

Judge Rakoff’s refusal to “rubber stamp” the SEC’s proposed settlements with large financial institutions could have potential ramifications on the settlements the SEC negotiates in the future. Judge Rakoff’s comment, “I won’t be cute and ask what percentage of Citigroup’s net worth is $95 million because I do not have a microscope with me,” indicates that this type of scrutiny is perhaps reserved for larger financial institutions, rather than their smaller counterparts or even individuals. Seemingly, given the alleged violations involved and the impact on the shareholders involved, the settlement amount was not proportionate to the harm based on Judge Rakoff’s observation. Although the SEC may adjust its disgorgement figures or civil penalties based upon a respondent’s showing of its/his/her financial inability to pay, an entity like Citigroup clearly does not face such a burden. As a result of Judge Rakoff’s refusal to acquiesce to whatever settlement proposal the SEC sets forth, the SEC may play hardball with large financial institutions to avoid future judicial scrutiny. Further, it is conceivable that the SEC may file a civil contempt proceeding the next time that an institution that has been barred from violating securities laws, violates securities laws. Although the SEC has not done so in at least ten years, pressure from the public may mount if an entity like Citigroup or Bank of America is accused of violating securities laws again. It seems unlikely, however, that respondents would be forced to admit liability as a condition of settlements – the practice of neither admitting nor denying liability is not only standard among settlements with the SEC, but in the general practice of law.

So-called smaller actors, such as smaller entities or individuals, may nonetheless find the SEC requesting large settlement amounts, especially given the impact, severity or frequency of their alleged securities law violations. The SEC takes into account a number of factors when determining an appropriate civil penalty, such as the egregiousness of the defendant’s actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant’s assurances against future violations, the defendant’s recognition of the wrongful nature of his conduct, and the likelihood that his occupation will present opportunities for future violations. Think of an individual like Raj Rajaratnam, who was recently ordered to pay a total of $156.6 million in fines and disgorgement, an amount that Judge Rakoff again questioned given Rajaratnam’s net worth and the fact that the civil penalty was designed, in Judge Rakoff’s words, “to make such unlawful trading a money-losing proposition not just for this defendant, but for all who would consider it.”

Further, although the SEC may request injunctive relief that an individual be barred from violating securities laws in the future, that individual may also be barred from serving as a director of a public company, from working in the securities industry, or from participating in the issuance of certain kinds of securities offerings, to name but a few examples. Judge Rakoff’s remarks should serve as a wake-up call for large financial institutions, but others are by no means less vulnerable to the range of consequences the SEC could request.

Legal Developments in Securities Law

SEC Dodd-Frank Whistleblower Claim Update
The SEC recently released its Fiscal Year 2011 Annual Report on the Dodd-Frank Whistleblower Program, found here. The report noted that 334 whistleblower tips were received in only the first seven weeks of the program. The most common tips were concerning market manipulation, corporate disclosures and financial statements, and offering fraud.

Tips were received from 37 states, China, the United Kingdom, and a number of other foreign nations. In the United States, whistleblowers from California and New York submitted the most tips.

It is not surprising that no awards have been allocated to whistleblowers yet, but whistleblowers who submitted claims should pay attention to the SEC’s procedure for claiming an award to which they may be entitled. If an action results in an entry of final judgment that exceeds $1 million, the whistleblower may be entitled to an award (see our previous blog post). After the final judgment on an action is entered, the Office of the Whistleblower will publish a Notice of Action on the SEC’s website. At this time, the whistleblower will have 90 days to apply for his or her award by completing the Form WB-APP. The SEC noted in its report that they may eventually provide individual notices to whistleblowers who may have contributed to the successful final judgment, but for the time being, whistleblowers should pay careful attention to the Notices of Action posted on the SEC’s website.

Legal Developments in Securities Law

Madoff Employee Admits Guilt : Three Simple Ways to Avoid Facilitating Securities Fraud at Your Job
Recently, a former trader at Bernard Madoff’s investment firm admitted to creating fictitious, backdated trades in Madoff’s notorious Ponzi scheme. Although certain types of securities fraud violations may be clear to an employee, such as being asked to falsify documents that are sent to investors, other requests by an employer may fall into a grey-area. How can an employee tell whether he or she is aiding the company in some way that enables it to carry out a massive fraud on its investors? Each individual case will vary, but here are some guidelines you can use to help you address this inquiry:

1. React immediately to wrongdoing.
As mentioned above, if you’re being asked to falsify documents or if you’re getting payments for turning a blind eye, it’s very clear that there is wrongdoing, and you are involved in it. Even if you are not the mastermind behind the fraud, benefiting from it or aiding it will nonetheless implicate you. If you discover anything that clearly evidences that there is wrongdoing, your first step should be to take action to prevent the fraud from continuing. See #3 below for more information on what you can do.

2. Trust your intuition.
If you feel that something isn’t quite right, there may be something more there. For example, if the company struggles to operate profitably despite advertising consistent profits, it’s possible the company may be intentionally misleading investors. Or, you may notice an accounting error. If you notice an error, you may want to bring it to the attention of the individual who can correct the error, but it may also help to speak with your company’s compliance department or even leave an anonymous tip on the company’s hotline.

3. Know your options.
Your company may have a compliance department that can address any concerns you may have. If you work at a smaller company, they may have guidelines on how to report any concerns you may have. If you work at a company with no compliance department, anonymous tip hotline or other guidelines to follow, you can consider filing a Tip, Complaint or Referral with the SEC through its new Dodd-Frank Whistleblower Program. Indeed, the SEC’s Whistleblower Program may even be your first option, depending on certain prerequisites for certain types of employees. If your attempts at resolving the issue within the company are unsuccessful, the Whistleblower Program is a great follow-up option, as well. Remember, under the SEC’s new program, whistleblowers can actually receive a reward for their cooperation, as detailed in our previous blog posts, here and here. Of course, each individual case may be different, and the advice of an experienced attorney can be valuable if you are unsure of what you can do. Under the federal securities laws and numerous state laws, whistleblowers who are fired in retaliation for reporting wrongdoing are legally protected and may be entitled to damages or even reinstatement to their prior positions.

Legal Developments in Securities Law

SEC Seeks to Raise Potential Civil Penalties
Earlier this week, the SEC’s chairperson, Mary Schapiro, sent a letter to Senators Jack Reed and Mike Crapo urging that Congress change the current rules on how the SEC can fine individuals and companies and to plead for greater maximum civil penalties.

Currently, the SEC can impose up to $150,000 per violation as a civil penalty against an individual, but the SEC has requested that the potential fine be increased to up to $1 million. For an entity, the civil penalty can be up to $750,000 under current rules, but Chairman Schapiro would like that potential penalty to go up to $10 million.

Other changes proposed included the ability to calculate the fine as three times the disgorgement figure, which represents the profits that were made by the accused. Currently, another method by which the SEC calculates a civil penalty is a fine that is equal to the disgorgement figure. Further, the Chairman proposed basing the fine on the amount of investor losses, rather than being based on the disgorgement figure, which could be significantly lower. Finally, the Chairman also asked that penalties be increased for repeat offenders. The SEC’s ability to recover from defendants may provide a deterrent to future securities violations, but by the same token, defendants would still be able to demonstrate their financial inability to pay a civil penalty.

It seems apparent that the Chairman’s suggested increases would increase the penalties for entities, more so than for individuals. While the proposed maximum civil penalty for individuals is five times the current maximum, the proposed maximum fine for entities is ten times greater than the current maximum. Given the recent issues with the Citigroup settlement that were raised by Judge Rakoff and the anti-Wall Street sentiment that has developed across the country, it is not surprising that the SEC would react in this way. To truly deter financial entities from committing securities violations in the future, arguably, any potential punishment would have to outweigh the potential gain to the entity, if the entity operates purely on a profit-seeking basis. That sentiment certainly seemed to be echoed by Judge Rakoff last month.

Chairman Schapiro’s staff is in the process of preparing draft legislation for legislators to consider. In the meantime, this letter from Chairman Schapiro is likely just another step to demonstrate the SEC’s willingness to aggressively pursue potential securities law violations, and more changes from the agency are likely in the future.