The Age of the Whistleblower

September 16, 2011

On Friday, August 12, 2011, the Securities & Exchange Commission (SEC) launched a new Whistleblower Office and website under the authority of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The new law allows the SEC to pay rewards from 10% to 30% of monies recovered by the US government to whistleblowers – persons who come forward with knowledge of bribery or fraud in publicly traded companies. The potential rewards are mind boggling. Take for example the case of Daimler, maker of Mercedes-Benz, which settled Foreign Corrupt Practices Act (FCPA) violation charges with the Department of Justice in April, 2010 for $185 million in criminal and civil penalties. Under the new SEC rule, a single whistleblower may have been entitled to up to $55 million.

Whistleblowers are in high demand in the US. Already there are 170 ‘Notices for Covered Actions’ with potential rewards available to individuals who voluntarily provide the SEC with original information after July 21, 2010, assuming such information leads to successful enforcement actions.

In the past three years alone, the US government has obtained settlements of nearly $3 billion in FCPA actions and recent reports indicate that the number of actions brought by the SEC against publicly traded companies doubled from 2009 to 2010. Trends indicate that this number will continue to rise with recent actions by the Department of Justice and the SEC targeting pharmaceutical and technology companies.

The SEC whistleblower incentive program provides further proof that the US government is serious about investigating fraud. But many have derided the SEC’s program as being a precarious hindrance by encouraging employees to bypass their own internal compliance programs and code of ethics to go directly to the SEC. After some pressure from the private sector, the SEC modified its rule to note that any whistleblower who reports wrongdoing through their internal corporate compliance process first would still be eligible for a reward and may actually be eligible for a larger percentage.

But the more business-friendly modification didn’t seem to make much of a dent. “It is very ambiguous language,” said Augusto Aragone, Latin American Regional Counsel for Ingram Micro, Inc. He said he was deeply concerned over the potential impact of the SEC’s whistleblower program. “We can’t compete with this,” he said. “Everybody is freaking out.”

“The SEC is incentivizing people to circumvent internal processes built over many years,” said Francisco Hernandez, General Counsel for Latin America at Tyco International. “We have made a strong effort using resources and time to develop a robust compliance program and now with these new Dodd-Frank regulations, it doesn’t matter.”

Dodd-Frank doesn’t just authorize monetary incentives to whistleblowers; it is also designed to protect them. After all, being a whistleblower isn’t easy. If an employee suspects wrongdoing at a company, not only do they bear the burden of having to snitch on their colleagues, they may also face retaliation. Former private banker Jennifer Sharkey, in a lawsuit filed against JP Morgan Chase, claims she was terminated in retaliation for warning the bank about a suspicious client. The Dodd-Frank Act strictly prohibits employers from engaging in retaliation against a whistleblower.

Companies have been preparing for this for awhile, said Richard Montes de Oca, former Assistant General Counsel for Royal Caribbean Cruises Ltd. “Part of our objective was to make sure employees had an obligation to disclose internally.” He said at one point they even considered incentivizing employees to report internally first. “It would have been like reverse bribery,” he said.

The SEC’s program is already resulting in one disturbing trend: the rapid expansion of an industry of lawyers who solicit employees to blow the whistle on alleged wrongdoers.

So what should companies do in the wake of all of this whistleblower demand? Moreover, how do you maintain the integrity of your internal compliance system against the potential lucrative rewards offered by the SEC’s whistleblower program?

For one, employees must feel protected. “Companies must enforce and reinforce that there will be no retaliation on employees,” said Mr. Montes de Oca, who now advises companies on corporate compliance issues.

At Diageo plc, which recently reached a settlement with the SEC over violations involving certain subsidiaries, they take the retaliation issue very seriously. “We have a zero tolerance policy for whistleblower retaliation,” said Virginia Valdez, Compliance & Ethics Manager for the company’s Latin American operations. “Employees are actively encouraged to disclose potential breaches of the Code of Business Conduct to management as soon as identified.” What if the employee reports a securities violation directly to the SEC? “We would make sure the employee is not penalized in accordance with our whistleblower policy,” she said.

Mr. Montes de Oca recommends that companies should push for greater awareness and branding of their compliance program. One good and viable option that worked at Royal Caribbean, he said, was promoting the company’s internal hotline. “Put it into the training program, increase its visibility, try to get people comfortable.”

But others were less enthusiastic about a hotline’s effectiveness. “You need to have it as an outlet to help you catch fraud but sometimes it ends up being used to report petty grievances between employees,” said Mr. Aragone of Ingram Micro.

“Information we receive internally is not necessarily FCPA-related,” said Mr. Hernandez. It is mostly related to “a lack of communication” or “a breakdown in a process.” He said that at Tyco, their approach has been a greater emphasis on “coming together, as a family.” “The most important thing is to work in a team and emphasize voluntary disclosure,” he said. They also invested more in education and training.

“All companies can do is promote and foster greater compliance and openness within their organizations,” suggested Mr. Aragone. He said a company should advance a more team-oriented approach to the decision making process. “The more people feel like they have a stake in the company, the more transparent and open and more collaborative the work environment will be.”

How the new SEC whistleblower incentive program impacts the workplace going forward remains to be seen. For now, more transparency and inclusiveness seems to be taking shape. “You need to articulate that this [company] is ours,” said Mr. Aragone. “It’s the only way to position this discussion.”