The Securities and Exchange Commission announced it paid a $1 million bounty to a compliance officer who blew the whistle on his employer, the second such case where the agency has paid a company official charged with rooting out misconduct for bringing evidence of it to the SEC instead.
In its news release, the SEC is careful to note it adhered to rules it developed after the Dodd-Frank Act of 2010 authorized bounties for employees who bring information about securities law violations to the SEC. To avoid obvious conflicts of interest -- not to mention a potential breach of the attorney-client privilege -- whistleblowers who work within a company's compliance division must first report the suspected wrongdoing to a superior, then wait 120 days before determining nothing will be done about it and going to the SEC.
But is that enough? Some lawyers, as well as the influential New York County Lawyers' Association, think not. By paying the very people whose job it is to make sure a company is complying with the law for information suggesting it's breaking it, the government is giving them a strong incentive to sit back, wait 120 days, and try to cash in.
When the SEC was developing the rules for whistleblowers, "a lot of comment revolved around `we can't have a system that allows in-house counsel and compliance officials, who are tasked to be at the epicenter of problems and solve those problems, to be incentivized to end-run their employer and go to the SEC,'" said Gregory Keating, a shareholder with Littler Mendelson and management representative on the Congressional Whistleblower Protection Advisory Committee.
The special rules for compliance officials, most of whom are lawyers, are designed to prevent unethical behavior like allowing a problem to fester so the potential bounty is larger. Compliance officials can only turn over confidential information to the SEC if they suspect the company or investors are in danger of imminent financial harm, for example.
"I would submit that's a malleable standard," said Keating, as is the requirement that compliance officers first notify their superiors of the situation. "What is giving them information?" he said. "A lot of times the recipient of the information will say `you're simply doing your job,'" which is to investigate wrongdoing, report it to superiors, and then come up with a solution.
The New York County Lawyers Association took a look at the issue and, in a 2013 opinion, held that there would be a conflict of interest in “the overwhelming majority of cases,” if a lawyer effectively went to work for the government under Dodd-Frank by turning over confidential information in search of a bounty. There are well-established exceptions to the attorney-client privilege when a lawyer learns his client is engaged in fraud, say, or supplied false information that corrupted a filing with the court. The lawyer doesn't collect a payment for alerting the government or a judge to those situations, however.
"Even when disclosure is permitted under the New York Rules, for example, when clear corporate wrongdoing rising to the level of crime or fraud has been perpetrated through the use of the lawyer's services, preventing wrongdoing is not the same as collecting a bounty," the New York County association said.
Paying lawyers to turn over information could give them an incentive to slow-roll the investigation they are in charge of overseeing, for example, to get past the 120-day deadline. The prospect of a bounty might also change the advice a lawyer gives his employer in a complex situation where the legal implications are ambiguous.
Especially under these delicate circumstances, a financial incentive might tend to cloud lawyer’s professional judgment. Yet Dodd-Frank permits the SEC to pay lawyers potential bounties of 10%-30% of collected fines in excess of $1 million. The potential bounties range from $100,000 to literally millions of dollars in larger cases. The prospect of financial benefit could place the attorney’s personal interests in potential conflict with those of the client.
At least one court has looked at a similar situation involving a would-be whistleblower involved in a false-claims suit and said no way. In U.S. vs. Quest Diagnostics, a federal judge in New York dismissed a qui tam suit by three former executives of a company that had been purchased by Quest because one of them, former general counsel Mark Bibi, violated his ethical duties by using information he obtained from his client to pursue a whistleblower suit against it. The court threw out the case, which was brought by a partnership the three executives formed, and disqualified their lawyers at Troutman Sanders and the Michael Law Group for pursuing a case tainted by misconduct.
Keating said the 120-day waiting period is a particular problem since it is too short for a compliance official to investigate allegations such as violations of the Foreign Corrupt Practices Act or a complex accounting scheme. Such investigations often involve hundreds of employees in multiple countries and a compliance officer motivated to receive a million-dollar reward might not pursue them with the zeal of a fully independent employee.
"I’m asking Jim Smith my compliance officer to protect me and handle complaints," Keating said. "instead, what's going on here is a person can become aware of a problem and wait a requisite period of time and then cash in."
The SEC can reduce a whistleblower's payout if it determines he also engaged in misconduct. But Keating said that's small comfort to employers who worry the in-house lawyers they are paying to keep them out of trouble can make even more money by bringing evidence of misconduct to the government.
That may be one reason the U.K. took a close look at our system of whistleblower bounties and decided not to follow suit.
