Whistleblower Update

       A.    Who is a Protected Whistleblower?

The following is from an excellent SIFMA presentation provided by Wayne Carlin and Cheryl Haas.

On February 21, 2018, the U.S. Supreme Court issued its decision in Digital Realty Trust v. Somers, 138 S. Ct. 767 (2018), holding unanimously that Dodd-Frank prohibits retaliation against whistleblowers only if they report suspected wrongdoing to the SEC directly. Accordingly, whistleblowers who report their suspicions to their employer or another entity without also going to the SEC will receive no protection from retaliation under Dodd-Frank. The unanimous opinion invalidated an SEC interpretive rule which construed the anti-retaliation protections of Dodd-Frank as applying to employees who reported potential violations to their employers, even if no report was made to the commission.

The Supreme Court focused on the clear statutory language, ruling that Section 78u-6 “describes who is eligible for protection- namely a ‘whistleblower’ who provides pertinent information ‘to the commission.’” The Court stressed that the “core objective” of the Dodd-Frank Whistleblower Program was to “motivate people who know of securities law violations to tell the SEC.” Id. (quoting S. Rep. No. 111-176 at 38). The Ninth Circuit in Digital Realty had previously held that an employee was entitled to anti-retaliation protections notwithstanding his failure to report the wrongdoing to the SEC. 850 F.3d 1045 (9^th Cir. 2017). That court reasoned that the meaning of “whistleblower” under the statute was ambiguous and thus deferred to the Commission’s interpretation that the term as broad enough to cover those who report wrongdoing internally instead of to the Commission. The Supreme Court decision resolved a Circuit split: the Ninth Circuit’s decision was consistent with the holding of the Second Circuit in Berman v. Neo@Ogilvy LLC, 801 F.3d 145 (2nd Cir. 2015) but in opposition to the Fifth Circuit, which came to a contrary result in Asadi v. G.E.Energy (USA), LLC, 720 F. 3d 620 (5^th Cir. 2013).

Whistleblowers who report internally but do not to the SEC may still have some recourse against retaliation under state law or Sarbanes-Oxley. However, the process is more cumbersome and lengthier. Thus, whether the ruling has a significant impact on how and where whistleblowers make their initial reports remains to be seen. On June 28, 208, the SEC announced that it had voted to propose new whistleblower rule amendments. See SEC Press Release, SEC Proposes Whistleblower Rule Amendments (June 28, 2018). Among other things, the SEC proposed rule amendments in response to the Supreme Court’s holding in Digital Realty which essentially invalidated the Commission’s rule interpreting Section 21F’s anti-retaliation protections to apply to internal reports. The proposed rules would modify Rule 21F-2 by, among other things, establishing a uniform definition of “whistleblower” that would apply to all aspects of Exchange Act Section 21F- i.e., the award program, the heightened confidentiality requirements, and the employment anti-retaliation protections. For purposes of retaliation protection, an individual would be required to report information about possible securities laws violations to the Commission “in writing.” The SEC anticipates new rules being adopted in FY 2020.

On July 9, 2019, the House of Representatives passed the Whistleblower Protection Reform Act of 2019 (H.R.2015). The Act would clarify that whistleblowers who report potential violations of securities laws to their employers are protected by the anti-retaliation provisions of Dodd-Frank, effectively overturning the holding in Digital Realty. The bill is now awaiting action in the Senate.

Under the SEC whistleblower-reward program, the SEC issues rewards to eligible whistleblowers who provide original information that leads to successful SEC enforcement actions with total monetary sanctions exceeding $1 million. The SEC has awarded approximately $387 million to 67 whistleblowers since issuing its first award in 2012. In FY 2019, the SEC awarded approximately $60 million to eight, significantly less than the $168 million awarded last year. The SEC’s proposed rule amendments would give the agency additional discretion to increase or decrease the size of the award under certain circumstances and allow the payment of awards to whistleblowers even when the matter is resolved outside of the context of a judicial or administrative proceeding.

      B.     Impeding Whistleblowing Activity

In April 2015, the SEC brought its first enforcement action against a company for using improperly restrictive language in confidentiality agreements with the potential to stifle the whistleblowing process. See SEC Press Release, Agency Announces First Whistleblower Protection Case Involving Restrictive Language (April 1, 2015). In that case, the SEC charged Houston-based technology and engineering firm, KBR, with violating whistleblower protection Rule 21F-17 enacted under Dodd-Frank. KBR required witnesses in certain internal investigation interviews to sign confidentially statements with language warning that they could in fact discipline and even be fired if they discussed the matters with outside parties without the approval of the law department. The SEC found that these terms violated Rule 21F-17 which prohibits companies from taking any action to impede whistleblowers from reporting possible securities violations to the SEC. The SEC said that its rules prohibit employers from taking measures through confidentiality, employment, severance, or other type of agreements that may silence potential whistleblowers before they can reach out to the SEC.

       C.    More Recent Actions

The SEC has been very focused on whistleblower-related issues. In FY 2017, the SEC instituted administrative proceedings against four companies for violating Rule 21F-17. In the space of one week in August 2016, the SEC brought two enforcement actions reiterating its focus on protecting the rights of whistleblowers. In each case, companies attempted to remove the financial incentives for departing employees to submit whistleblower reports to the SEC. The result instead was a pair of administrative orders (on a neither admit nor deny basis) finding that each company violated SEC Rule 21F-17, which prohibits any person from taking any action to impede a whistleblower from communicating with the SEC about possible securities law violations. In the Matter of BlueLinx Holdings Inc., Rel No. 78528 (August 10, 2016); In the Matter of Health Net, Inc., Rel. No. 78590 (August 16, 2016).

Both of these cases involved severance agreements entered into with individuals in connection with the termination of their employment relationship, as a condition to the receipt of severance payments and benefits. As is common, such agreements included language that memorialized the departing employee’s obligation to maintain the confidentiality of company information. Notwithstanding the confidentiality provisions, BlueLinx included language in its agreements that acknowledged, among other things, the employee’s right to “file a charge” with the SEC. The BlueLinx agreements went on, however, to provide that “Employee understands and agrees that Employee is waiving the right to any monetary recovery in connection with any such complaint or charge…” Similarly, Health Net’s severance agreements included a provision in which the departing employee expressly waived the right to file an application for a whistleblower award pursuant to Section 21F of the Securities Exchange of 1934. Health Net removed the specific reference to the Exchange Act from later agreements, but still retained language providing that the employee waived any right to monetary recovery in any proceeding based on any communication by the employee to any government agency.

While the principal focus of these cases is the relatively unusual interference with financial incentives discussed above, the BlueLinx agreements also included a more common-place provision requiring employees to notify the company’s legal department in the event that they believed they were required by law or legal process to disclose any confidential information. BlueLinx thus raises the question whether the SEC would assert that a notice requirement without an express carve-out for whistleblowing violates Rule 21F-17, even if it is entered into at a time when no investigation is in progress or contemplated and even if there are no provisions in the agreement directly aimed at deterring whistleblower activity.

On September 29, 2016, the SEC filed its first stand-alone retaliation action against International Game Technology, a casino-gaming company. In the Matter of Game Technology, Rel. No. 78991 (Sept. 29, 2016). IGT agreed to pay a half-million-dollar penalty for discharging an employee because he reported to senior management and the SEC that the company’s financial statements might be distorted. The SEC found that the employee was removed from significant work assignments within weeks of raising concerns and fired approximately three months later.

A number of recent actions continue to focus on agreements that improperly hurt or discourage employees or former employees from reporting suspicions of wrongdoing to the SEC. On December 17, 2016, the SEC announced a settlement with Neustar, Inc., pursuant to which the company agreed to pay a penalty of $180,000 to settle charges involving its severance agreements. See SECPress Release, Company Violated Rule Aimed at Protecting Potential Whistleblowers (Dec. 19, 2016). Those agreements contained a broad non-disparagement clause forbidding former employees from engaging with the SEC in “any communication that disparages, denigrates or maligns or impugns” the company. The next day, the SEC revealed an agreement to settle charges with SandiRidge Energy Inc. See SEC Press Release, Company Settles Charges in Whistleblower Retaliation Case (Dec. 20, 2016). The company used retaliation language in its separation agreements prohibiting outgoing employees from participating in any government investigation or disclosing information potentially harmful or embarrassing to the company. On January 19, 2017, financial services company HomeStreet Inc. agreed to pay a $500,000 penalty to resolve charges that it conducted improper hedge accounting and then took steps to impede potential whistleblowers. See SEC Press Release, FinancialCompany Charged with Improper Accounting and Impeding Whistleblowers (Jan. 19, 2017). Those steps included suggesting to one individual that the company might deny indemnification for legal costs during the SEC investigation and requiring several employees to sign severance agreements waiving potential whistleblower awards or risk losing their severance payments and other post-employment benefits.

Most recently, the SEC filed an amended complaint against Collectors Café alleging that it had violated Rule 21F-17 by interfering with an investor’s ability to communicate with eh SEC about possible misconduct in the company. See Amended Complaint, SEC v. Collectors Café Inc. et al, 19-cv-04355-LGS-GWG (S.D.N.Y. 11/4/19). The Complaint alleges that the company included a representation in a stock purchase agreement with investors who had raised concerns with the company about their investments that they had not and would not contact any third party for the purpose of commencing or promoting an investigating, including governmental or administrative agencies. This is the first time that the SEC has applied the rule outside the context of the traditional employer/employee relationship.

These enforcement actions confirm that the SEC continues to focus on protecting whistleblower rights. Companies should review all forms of agreements with employees, including standard form separation agreements and releases, to ensure that the terms do not prohibit an employee from exercising any legally protected whistleblower rights, and should not consider including an express exclusion with that effect. In light of the SEC’s position in Collectors Café, companies should also pay particular attention to these issues when preparing agreements with outside investors.

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Are SEC Whistleblowers Really Safe Anymore?

Some federal courts have ruled that Whistleblowers are not protected from retaliation if they only make an internal report to their employer, rather than one to the SEC.  And a state district court recently ruled that a post-employment whistleblower’s submission to the SEC is subject to civil discovery even though there was no whistleblower retaliation claim pending. 

Contrary to the CFR and case law, the state court explicitly stated the whistleblower’s submission as a former employee is “too late” for whistleblower protections.  This, of course, actually encourages every employer to sue their former employees to gain knowledge and access to confidential submissions, even when the former employee isn’t claiming a retaliation discharge (because the employer didn’t even know about the submission prior to termination.)[1] The problem with this logic is that any such retaliation claim must be brought in federal court.  Moreover, federal regulations prohibit any type of harassment of or interference with even a former employee whistleblower.  If having to share every confidential tip and follow-up communication with the SEC with the subject of the tip isn’t interference, what is?  Food for thought.

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[1] Let the fishing expeditions begin!  

SEC PAYS WHISTLEBLOWER AWARD OF $50 MILLION -- ITS LARGEST EVER

The U.S. Securities and Exchange Commission awarded nearly $50 million to a whistleblower – its largest-ever sum to a single person in a case where someone who gave firsthand information about a company’s misconduct resulted in a large amount of money returned to harmed investors. The SEC said in an order that the unnamed whistleblower’s “information was highly significant,” as it “provided firsthand observations of misconduct by the company that was previously unknown to the staff.” The information “laid out in detail substantial aspects of the scheme and provided a road map for the investigation” that led to the commission’s bringing an enforcement action, the order says. The SEC’s order notes, “Claimant 1’s information allowed the Commission to bring an enforcement action that . . . returned a significant amount of money to those harmed by the company’s misconduct.” 

            The $50 million award eclipses $39 million awarded to an individual in 2018. Two individuals shared an award of nearly $50 million that same year, according to the SEC. “This award is the largest individual whistleblower award announced by the SEC since the inception of the program, and brings the total awarded to whistleblowers by the SEC to over $500 million, including over $100 million in this fiscal year alone,” Jane Norberg, chief of the SEC’s Office of the Whistleblower, said in a statement. “Whistleblowers have proven to be a critical tool in the enforcement arsenal to combat fraud and protect investors.” 

Whistleblowers awards range from 10% to 30% of the many collected when the monetary sanctions exceed $1 million, meaning this case involved at least $500 million in sanctions. Steven Peikin, co-director of the SEC’s Division of Enforcement, said in a recent speech that from mid-March to mid-May, the Commission received 4,000 whistleblower tips, 35% more than the same period the year before. There were 5,200 in all of 2019. 

Cosgrove Law Group, LLC has experience representing confidential SEC whistleblowers, both during and after the end of their tenure of employment. Food for thought.

OBTAINING WHISTLEBLOWER STATUS THROUGH YOUR BROKER-DEALER’S COMPLIANCE DEPARTMENT

A financial adviser that provided a tip through his broker-dealer’s compliance department recently received a whistleblower award of $4.5 million.  In late May, the SEC accepted the Claims Review Staff’s Preliminary Determination recommending that hefty award.  

The SEC’s analysis hinged on the application of Exchange Act Rule 21F-4: whether “original information submitted by a whistleblower led to the successful enforcement of a judicial or administrative action.”  Rule 21F-4(c)(3) even allows for whistleblower status if you “reported [the] original information through [your broker-dealer’s] internal whistle blower, legal or compliance procedures for reporting allegations of possible violations of house before or at the same time of law before or at the same time to reported them to the Commission . . . You must also submit the information the Commission . . . within 120 days of providing it to the entity.  (Emphasis Added). 

This last clause is your key takeaway from this blog.  If you provide original information to your compliance department but fail to follow through with the Commission, you might lose out on millions of dollars!  It is also important to understand that 1) you are taking a risk, 2) the compliance or legal department might not investigate and report to the SEC without a push, and 3) Rule 240 is an extensive fine-print maze of definitions and procedures.  In sum, you should obtain legal counsel to help you evaluate your “original information” and guide you through a complicated process that can take years to run its course. 

There are many attorneys out there claiming on their websites that they represent whistleblowers. But if you are a financial advisor or investment adviser what you need is an attorney that has experience representing whistleblowers in the financial industry. Food for thought.

SEC Victory in Protection of Whistleblowers

SEC Victory in Protection of Whistleblowers

A federal court of appeals ruled in early September that the 2010 Dodd-Frank financial reform law protected corporate whistleblowers who voice concerns to their company about possible wrongdoing prior to alerting securities regulators. The decision comes as a defeat for those who argue protection should not be granted if the individual does not first approach the government with their concerns.[i]

The Dodd-Frank Wall Street Reform and Consumer Protection Act, better known as Dodd-Frank, is an outgrowth of the 2008 Great Recession. It is a law intended to protect consumers and prevent a reoccurrence of abusive lending practices that brought about the collapse of major financial institutions.[ii]

Recognizing the feasibility of retaliation faced by those who bring attention to possible wrong-doing, Dodd-Frank created, “significant new whistleblower incentives and protections, including the creation of SEC and CFTF (Commodities Futures Trading Commission) whistleblower programs, expansion of current whistleblower protections under the Sarbanes-Oxley Act of 2002, and a new whistleblower cause of action for employees performing tasks related to consumer financial products or services.”[iii]

Judge Jon Newman, author of the federal appeals court opinion, suggested that, “expanding the protections would chiefly benefit auditors and attorneys who are barred from reporting alleged wrongdoing to the SEC until they have brought it to their employer’s attention.”[iv] Food for thought.

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[i] Whistleblowers, SEC Are Winning in Ruling (2015, September 11) The Wall Street Journal, p. B4.

[ii] Dodd-Frank Act: CNBC Explains (2012, May 11) [electronic format] Retrieved from http://www.cnbc.com/id/47075854

[iii] Whistleblower Claims Under the Dodd-Frank Wall Street Reform and Consumer Protection Act: The New Landscape (n.d) New York State Bar Association [electronic format] Retrieved from https://www.nysba.org/Sections/Labor_and_Employment/Labor_PDFs/LaborMeetingsAssets/Whistleblower_Claims_Under_Dodd_Frank.html

[iv] Whistleblowers, SEC Are Winning in Ruling (2015, September 11) The Wall Street Journal, p. B4.

Bailouts, Whistleblowers, and Fraud: The Whistleblowers (Part 3 of 3)

This is that final part in a three part series that will analyze the legislation that sets the foundation for the bailout and provides the means for private litigants to come forward and provide an in-depth assessment setting forth the statutory provisions, processes and procedures that whistleblowers must comply with when disclosing information regarding the misuse of TARP and other stimulus funds. We have already discussed the Federal False Claims Act, creating qui tam actions, and the Bailout Bill creating the TARP programs and subsequent fraud. This final part addresses the whistleblower protections and procedures for invoking protection, as well as the procedural requirements for filing a qui tam lawsuit.

The American Recovery and Reinvestment Act of 2009: Creating Whistleblower Protection

In early 2009, Congress enacted the American Recovery and Reinvestment Act of 2009 (“ARRA”), also known as the “Stimulus Act,” amending certain provisions in ESSA. Section 1553 of ARRA contains a broad whistleblower protection provision protecting whistleblowers who report misuse by “non-Federal employers” that received funds under ESSA or ARRA. See Pub. L. No. 111-5, 123 Stat. 115 § 1553 (2009). The purpose of including Section 1553 in ARRA was to ensure that Government funds were not mismanaged or misspent. Specifically, law prohibits non-federal employers from retaliating against an employee for reporting misuse of funds received by their non-federal employer as part of the stimulus or bailout.

The ARRA broadly defines a “non-Federal employer” as an employer that is a contractor, subcontractor, grantee, or recipient of covered funds, any professional organization, agent or licensee of the Federal government or any “person acting directly or indirectly in the interest of an employer receiving covered funds,” any State or local governments receiving “covered funds”, or any contract or subcontractor of such State or local governments. Pub L. 111-5, 123 Stat. 115 § 1553(g)(4).

“Covered funds” are also broadly defined to include "any contract, grant, or other payment received by an non-federal employer if--(A) the Federal Government provides any portion of the money or property that is provided, requested, or demanded; and (B) at lease some of the funds are appropriated or other made available by this Act." Under this definition of "covered funds," TARP funds are included, so the whistleblower protection extends to claimants making disclosure under EESA.

The definition of an “employee” is exceedingly broad to include any “individual performing services on behalf of an employer.” Pub L. 111-5, 123 Stat. 115 § 1553(g)(3). This definition therefore includes not only employees, but also independent contractors of recipient non-federal employers, thus allowing nearly anyone in an organization to become a whistleblower.

The employee disclosure must be regarding information which the employee “reasonably believes” is evidence of:

• Gross mismanagement of an agency contract or grant relating to covered funds;

• A gross waste of covered funds;

• A substantial and specific danger to public health or safety related to the implementation or use of covered funds;

• An abuse of authority related to the implementation or use of covered funds; or

• a violation of law, rule, or regulation related to an agency contract or grant, awarded or issued relating to covered funds.

Protection is even extended to disclosures made in the ordinary course of the employee’s duties. Similar to other whistleblower statutes, the complainant-employee need not be correct about his belief, just that that belief be reasonable.

Obtaining Whistleblower Protection

However, in order to invoke protection under Section 1553, an employee must make the disclosure to the Recovery Accountability and Transparency Board, “an inspector general, the Comptroller General, a member of Congress, a State or Federal regulatory or law enforcement agency, a person with supervisory authority over the employee, a court or grand jury, the head of a Federal agency, or their representatives,” and then there must be some form of retaliatory action from the employer as a result of disclosure to one of these entities. Because disclosure of wrongdoing can be made to a court, a complainant would be able to seek whistleblower protection after filing an qui tam action—if the employer engaged in a retaliatory action or reprisal.

After a retaliatory action, the whistleblowing employee must submit a written complaint to the inspector general of the federal agency administering the covered funds, file a complaint online through an online complaint form or call into the Fraud, Waste, and Abuse hotline. The inspector general has 180 days to review the complaint and complete an investigation, if it decides to pursue the matter. If the inspector general cannot complete the investigation within that time period, the investigation period can be extended up to an additional 180 days, with or without the complainant’s consent. After completion of the investigation, the inspector general issues a report to his agency head. The agency then has 30 days to issue an order awarding or denying any relief, such as reinstatement, back pay, compensatory damages, benefits, attorneys fees, and costs. Ordered relief must then be taken to the District Court to be enforced. At that time, the District Court has discretion to grant additional relief including injunctive relief, compensatory and exemplary damages, attorneys fees and costs. Review of all agency orders is also available directly through appeal to the U.S. Court of Appeals.

If the agency issues an order denying relief, in whole or in part; has not issued an order within 210 days after the submission of the complaint; decides not to investigate; and there is no evidence of bad faith on the part of the complainant-employee, the complainant may bring a private action de novo against the employer for compensatory damages and any additional relief provided for in ESSA and the ARRA. Moreover, if the employee brings a private right of action, Section 1553 expressly provides a jury right in the de novo action.

In order to be successful on a claim, the whistleblower must prove that the protected disclosure was a “contributing factor” in the employer’s retaliation. Pub. L. No. 111-5. 123 Stat. 115 § 1553(c)(1)(A)(i). The ARRA specifies that in order to make this showing, the complainant must show that “the [employer] undertaking the reprisal knew of the disclosure” or that “the reprisal occurred within a time period of time after the disclosure such that a reasonable person could conclude that the disclosure was a contributing factor in the reprisal.” Id. § 1553(c)(1)(A)(ii).

There are several extraordinary measures in Section 1553, which set it apart from predecessor whistleblower statutes. First, rights under it are non-waiveable and cannot be subject to pre-dispute arbitration agreements, unlike the whistleblower provisions in the Sarbanes-Oxley Act of 2002. Further, there is no express statute of limitations for a cause of action. Arguably, however, the default 4-year limitations period will be applicable. See 28 U.S.C. § 1658(a) (providing a four-year statue of limitations for analogous causes of action). Additionally, this Section expressly states that it does not displace State laws providing additional whistleblower protection and relief, further allowing the qui tam relator to recover under both federal and state laws.

Bringing a Qui Tam Action

Remember, a qui tam relator is filing a suit on behalf of the United States. As such, a qui tam relator must follow certain procedural requirements, in addition to the ones imposed under Section 1553 of ARRA for whistleblower protection. A qui tam suit is initiated upon the filing of the complaint under seal for 60 days without service to the defendant, which means the complaint is unknown to the defendant. The purpose of this “blackout period” is to allow the Government time to (1) conduct its own investigation without the defendant’s knowledge and (2) to determine whether to intervene in the action. 31 U.S.C. § 3730(b).

Also, a copy of the complaint and a written disclosure statement is served on the U.S. Attorney and the Department of Justice. This written disclosure statement must contain “substantially all material evidence and information the person possesses.” 31 U.S.C. § 3730(b)(2). The purpose of this disclosure statement is to provide the Department of Justice with the information necessary to conduct a proper investigation that will allow it determine whether to intervene. It also provides the U.S. Attorney with the information required to determine whether it should pursue a criminal action against the defendant. The disclosure statement need not be filed simultaneously with the complaint, however it must be filed within a reasonably short period of time after. If the Department of Justice decides to intervene, it takes over the discovery and litigation process. If not, the qui tam action moves forth under the relator’s original action.

Conclusion

Undoubtedly, the massive amounts of Federal monies distributed under ESSA ($700 billion) and ARRA ($800 billion) coupled with the FCA and Section 1553 of ARRA will (and already have) lead to an influx of whistleblower tips and complaints. This means more federal enforcement activity, potentially subjecting bailout and stimulus recipients to civil and/or criminal liability for fraud, waste, error, and abuse.

The Emergency Economic Stabilization Act of 2008 sets forth a detailed and complex program for receiving federal monies under TARP. The False Claims Act and subsequent amending acts of Congress, such as the Fraud Enforcement and Recovery Act of 2009 and the American Recovery and Reinvestment Act of 2009, provide sources of whistleblower protection for TARP fraud qui tam relators. The interplay between these various Acts further complicates the issues surrounding TARP. Because of the complexity of these issues, it is important to select a law firm that understands the nuances of these issues and can navigate these difficult legislative provisions.

Bailouts, Whistleblowers, and Fraud: The Bailout And The Fraud (Part 2 of 3)

This is a three part series that will analyze the legislation that sets the foundation for the bailout and provides the means for private litigants to come forward and provide an in-depth assessment setting forth the statutory provisions, processes and procedures that whistleblowers must comply with when disclosing information regarding the misuse of TARP and other stimulus funds. The second part analyzes the legislation setting up the TARP programs, the authority given to the Treasury, some of the specific requirements of imposed on TARP recipients, and finally addresses some of the most common types of TARP fraud.

Since the crash of 2008, words like “bailout” and “stimulus” have swirled around the financial and housing markets across the country. You may even be more familiar with specific programs like TARP or CAP. The bailout and stimulus programs were extraordinary acts of Congress enacted swiftly to react to the dire circumstances facing the nation at the end of 2008. But the bottom line is that the federal government pumped huge sums of money into the markets very rapidly in an effort to stabilize the marketplace. Of course in doing so, the Government opened itself up to potential fraudsters. As such, qui tam whistleblowers, acting under the Federal False Claims Act, are playing a critical role exposing fraud in the government programs created under these Bills.

The Emergency Economic Stabilization Act of 2008: Creating The Troubled Asset Relief Program

After the collapse of Bear Stearns and subsequent bank failures, Congress quickly enacted the Emergency Economic Stabilization Act of 2008 (“EESA”), more commonly known as the “Bailout Bill.” The purpose of EESA was “to immediately provide authority and facilities that the Secretary of Treasury can use to restore liquidity and stability to the financial system of the United States.” See Pub. L. No. 110-343, 122 Stat. § 3765 (2008), codified at 12 U.S.C. § 5201, et seq.

Under this authority, the Government established the $700 billion Troubled Asset Relief Program (“TARP”). Congress delegated authority under TARP to the Secretary of Treasury and the newly created Financial Stability Oversight Board. Pursuant to this authority, the Secretary of Treasury was authorized “to purchase, and make and fund commitments to purchase, troubled assets from any financial institution.” 12 U.S.C. § 5211(a)(1). It should also be noted that EESA created the $200 billion credit pool for the financial industry through the Term Asset-Backed Securities Loan Facility (“TALF”).

According to the new authority delegated to it, the Secretary of Treasury, together with several other executive agencies and departments, setup the Capital Purchase Program (“CPP”) and its successor, the Capital Assistance Program (“CAP”). Both programs operated under TARP to provide a mechanism for additional taxpayer support to stabilize the financial and banking systems whereby the Department of Treasury invested in preferred equity securities or warrants of qualified financial institutions. See GAO Report, GAO-09-161, published December 2, 2008. However, in providing relief under TARP authority, the Secretary of Treasury was required to “take such steps as may be necessary to prevent unjust enrichment of financial institutions participating in a program established under this section.” 12 U.S.C. § 5211(e).

Executive Compensation & Corporate Governance Requirements

After receipt of federal funds, TARP recipients became subject to certain standards for executive compensation and corporate governance. These standards became hotly contested prompting the Treasury to promulgate “TARP Standards for Compensation and Corporate Governance.” 31 C.F.R Part 30 (2009). These new standards require recipients to:

• include a provision allowing the Government to recover “any bonus, retention award, or incentive compensation paid to a senior executive officer...based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.” 12 U.S.C. § 5221(b)(3)(B);

• place “limits on compensation that excludes incentives for senior executive officers of the TARP recipient to take unnecessary and excessive risks that threaten the value of such recipients during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding.” 12 U.S.C. § 5221(b)(3)(A); and

• “have in place a company-wide policy regarding excessive or luxury expenditures...which may include excessive expenditures on—(1) entertainment or events; (2) office and facility renovations; (3) aviation or other transportation services; or (4) other activities or events that are not reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course of the business operations of the TARP recipient.” 12 U.S.C. § 5221(d).

In order in ensure compliance, certain senior executive officers, usually the CEO and CFO, are required to certify annually that the recipient corporation adhered to 12 U.S.C. § 5221, including submittal of an attesting statement verifying that a compensation committee or board of directors performed a semi-annual review of the TARP recipient’s luxury expenditure policy and executive compensation plan. Moreover, a recipient must also report loan volumes to the Department of Treasury on a monthly basis and prepare a quarterly report for the Office of the Comptroller of Currency describing any changes in management, use of TARP funds, and forward planning.

Most Common Types of Fraud Under TARP

The corporate governance and executive compensation standards laid out in TARP are, not surprisingly, a source of TARP fraud. Some of the most common types of fraud under TARP include the false certification of eligibility for funding; conflicts of interest for private parties managing recipient funds; collusion among participants to use Federal funds for personal financial gain; and failure to comply with these standards. Another prevalent type of fraud is known as Mortgage Modification Program Fraud, which is the falsification of residence, income and mortgage values in order to receive FHA and TARP monies. Additionally, the massive distributions of cash into the markets gave rise to money laundering illicit funds through disbursements.

EESA sets forth a detailed and complex program for received Federal funds. TARP alone encapsulates twelve different federally-funded programs to create liquidity and stability in the banking and financial markets. Navigating these complex programs is difficult and requires the skill of an experienced attorney.

Bailouts, Whistleblowers, and Fraud: The Legislation Behind Qui Tam Actions (Part 1 of 3)

Since the crash of 2008, words like “bailout” and “stimulus” have swirled around the financial and housing markets across the country. You may even be more familiar with specific programs like TARP or CAP. The bailout and stimulus programs were extraordinary acts of Congress enacted swiftly to react to the dire circumstances facing the nation at the end of 2008. But the bottom line is that the federal government pumped huge sums of money into the markets very rapidly in an effort to stabilize the marketplace. Of course in doing so, the Government opened itself up to potential fraudsters.

Special Inspector General Neil Barfosky testified to this effect before the House Ways and Means Committee on Oversight:

“We stand at the precipice of the largest infusion of Government funds over the shortest period of time in our Nation’s history. If by percentage, some of the estimates of fraud in recent government programs apply to the TARP programs, we are looking at the potential exposure of hundreds of billions of dollars in taxpayer money lost to fraud.”

As such, qui tam whistleblowers, acting under the Federal False Claims Act, are playing a critical role exposing fraud in the government programs created under these Bills.

This is a three part series that will analyze the legislation that sets the foundation for the bailout and provides the means for private litigants to come forward and provide an in-depth assessment setting forth the statutory provisions, processes and procedures that whistleblowers must comply with when disclosing information regarding the misuse of TARP and other stimulus funds. This first article looks at the legislation which created a qui tam lawsuit, the Federal False Claims Act.

The Federal False Claims Act

The False Claims Act (“FCA”), 31 U.S.C. §§ 3729-3733, was originally enacted in 1863 in response to contractors defrauding the United States Government by selling unfit supplies to both the Confederate and Union armies. It has since been revered as the single-most effective tool for detecting fraud against the U.S. Government by allowing private citizens to bring suit on behalf of the Government and share in the recovery. (Since 1986, claims brought under the FCA have recovered $28 billion).

The FCA provides that any person who knowingly submits or causes to be submitted a false or fraudulent claim to the Government for payment or approval is liable for a civil penalty of not less than $5,500 and not more than $11,000 for each such claim submitted or paid, plus three times the amount of the damages sustained by the Government. 31 U.S.C. § 3729(a); 12 C.F.R. § 85.3(a)(9).

More specifically, liability under the FCA attaches when a person:

• “Knowingly presents, or causes to be presented, to an officer or employee of the United States Government or a member of the Armed Forces of the United States a false or fraudulent claim for payment or approval...” 31 U.S.C. §3729(a)(1);

• “Knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim...” 31 U.S.C. §3729(a)(2), as amended by, The Fraud Enforcement and Recovery Act of 2009 (Pub. L. No. 111-21, §§ 4(a)(a) and 4(f)); or

• “Knowingly makes, uses, or causes to be made or used, a false record or statement to conceal, avoid, or decrease an obligation to pay or transmit money or property to Government.” 31 U.S.C. § 3729(a)(7).

The terms “knowing” and “knowingly” are defined under the FCA as “a person, with respect to information—(1) has actual knowledge of the information; (2) acts in deliberate ignorance of the truth or falsity of the information; or (3) acts in reckless disregard of the truth or falsity of the information.” Moreover, the FCA does not require “proof of specific intent to defraud.” 31 U.S.C. § 3729(b).

Therefore, the FCA allows a private individual having information regarding a false or fraudulent claim against the Government to bring an action for himself, as “relator,” on behalf of the Government and to share in the Government’s recovery. The legislative intent behind sharing in the Government’s recovery was to entice private individuals to come forward with information.

However, as will be discussed in Part 3 of this series, there are certain procedural requirements with which a qui tam relator must comply. Filing a qui tam action is a complex and detailed process. It is important to choose an attorney who understands these requirements.

SEC Whistleblower Program: Compliance Nightmare or Missed Opportunity?

As part of Dodd-Frank Wall Street Reform and Consumer Protection Act passed last summer, the Securities and Exchange Commission was given the authority to establish a whistleblower program with monetary incentives as a way to entice individuals to come forward about corporate financial wrongdoings. Section 21F provides that whistleblowers who provide new information to the SEC about financial misconduct are able to collect monetary awards totaling between ten and thirty percent of the sanctions recovered through civil or criminal proceedings that total more than $1 million. The SEC characterizes “new information” as information that is original and “based on independent knowledge not already known to the Commission nor taken exclusively from public sources.”

According to the SEC, the new whistleblower authority will help the agency maximize its resources and effectiveness by increasing the number of high-quality tips that it might not otherwise receive without the incentives in place. SEC spokesman, John Nester, has already reported that that SEC has seen a “significant increase in high-quality tips.”

However, the whistleblower program is highly controversial. Many argue that such an incentive program pits employees against employers and creates a disincentive for employees to utilize internal compliance structures mandated by the 2002 Sarbanes-Oxley Act. According to Susan Hackett, senior vice president and general counsel for the Association of Corporate Counsel, the new program encourages “a lot of people who are being opportunistic or who are looking to actually help create problems they can then profit from.” She argues that compliance culture morphs from a “let’s fix it” attitude into a self-enterprising one, which creates clear compliance challenges. Tom Quaadman, vice president of the Capital Markets Competitiveness at the U.S. Chamber of Commerce takes a similar stance. Both advocate that whistleblowers should first be required to make use of internal reporting and investigative systems before submitting their complaints to the SEC. Further, these organizations call for a ban on monetary recovery for individuals who were engaged in the underlying misconduct before reporting. Quaadman asserts that whatever rules are finally implemented need to operate in such a way so as to promote good corporate behavior, not employee contrivance.

Another concern about the proposed Whistleblower Program is that there will be an increase in the number of frivolous allegations. This concern arises from acknowledgement that whistleblower complaints can act as a double-edged sword: they can be instrumental in identifying and correcting corporate misconduct but often, such complaints are made by underperforming employees in an attempt to advance personal grievances against their employer.

To counter these arguments, proponents of the whistleblower program cite to other successful programs with robust monetary rewards like that under the False Claims Act, which helped facilitate large settlements with pharmaceutical giants Pfizer and Eli Lilly for corporate misconduct. They take the stance that individuals who become aware of misdeeds are not eager to blow the whistle, but merely do so to keep their jobs or do what is right. Even among supporters, there is dissonance regarding the scope of the SEC’s proposed program. Some advocate for a broader definition of “whistleblower” and others are skeptical about the program’s potential for success because of limited resources and the program’s failure to address coordination of investigations between overlapping federal agencies.

In November 2010, the SEC released its proposed set of rules that will be used to implement the whistleblower program. The comment period for these rules expired on December 17, 2010, but the SEC has not issued final rules yet. Under the deadline set by Dodd-Frank, the SEC was supposed to have its final rules for the Whistleblower Incentives and Protection Program in place by April 21, 2011. In an April 26 interview, Mary Shapiro, chairman of the SEC, disclosed that the SEC is “now finalizing its whistleblower rules.” However, according to the SEC’s implementation calendar, the planned finalization of the rules is slated to be released between now and July. So far, the only completed installation of the program is the establishment of the new Whistleblower Office and appointment of Sean McKessy as the new director of that office.

Despite the delay in final rules and implementation, whistleblowers are currently protected from retaliation and entitled to applicable monetary rewards because Dodd-Frank provided temporary rules applicable for anyone who came forward after July 22, 2010. These temporary rules remain in effect until the SEC passes its final rules.

District Court Retroactively Applies Dodd-Frank Ban on Pre-dispute Arbitration in SOX Whistleblower Claims

The U.S. District Court for the District of Massachusetts applied the Dodd-Frank Act (“the Act” or “Dodd-Frank”) prohibition on pre-dispute arbitration agreements under the Sarbanes-Oxley (“SOX”) whistleblower protection retroactively. In a March 1 ruling, in Pezza v. Investors Capital, et al, Judge Douglas P. Woodlock, reasoned that retroactive application was appropriate due to the lack of clear Congressional intent to restrict the temporal scope and procedural nature of Section 922.

Section 922 of the Act, among other things, confers jurisdiction on the courts, rather than to a Financial Industry Regulatory Authority (FINRA) arbitration panel, by voiding arbitration provisions in employment agreements that purport to force an employee to arbitrate, rather than litigate disputes arising under Section 806 of SOX.

The suit arose from a claim of wrongful retaliation (in violation of SOX) against the plaintiff after he raised concerns about the defendant’s misconduct in connection with securities transactions. (The plaintiff had previously filed the requisite complaints with the Department of Labor.) The defendants, Investors Capital Corp., Investors Capital Holdings, Inc., and Timothy Murphy, argued that the plaintiff was required to submit his dispute to arbitration, not the courts, pursuant to a pre-dispute arbitration provision in his employment agreement. However, while the defendant’s motion to compel arbitration was under advisement, Congress enacted Dodd-Frank, which included the prohibition on pre-dispute arbitration agreements for whistleblower claims brought under SOX.

In determining whether to apply Section 922 retroactively, the court used the framework setup by the Supreme Court in Fernandez-Vargas v. Gonzales, which essentially instructs a court to first look to whether there is any Congressional intent allowing for retroactive application. If there is no clear indication by Congress, the court then must look to whether retroactive application would result in a disfavored consequence affecting a substantive right. If the court answers in the negative, retroactive application is appropriate.

Here, Section 922 did not include any express provisions or clear statements of Congressional intent regarding retroactivity. Further, after applying the standard rules of statutory construction, the court found nothing that indicated Congress intended for the provision to apply to existing arbitration agreements. The court also found it insufficient that Congress vested the authority to limit future pre-dispute arbitration provisions with the new Bureau of Consumer Financial Protection and the CFTC. Thus the court determined that the result regarding retroactivity under Fernandez-Vargas was inconclusive.

However, under Landgraf v. USI Film Prods, the Supreme Court recognized that jurisdictional statutes may be applied retroactively absent specific legislative authorization without raising retroactivity issues. As a result, the District Court construed Section 922 to be a jurisdictional statute and relied on the holding from Landgraf instead of the retroactivity test under Fernandez-Vargas. Accordingly, the court denied the defendants’ motion to compel arbitration and concluded that Section 922 should be applied retroactively to combat bad conduct arising prior to the enactment of Dodd-Frank.

SEC Proposes Rules for Tipster Program

On November 3, 2010, the Securities and Exchange Commission voted unanimously to propose a whistleblower program pursuant to Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Dodd-Frank substantially expands the SEC’s authority to compensate individuals who provide information that results in a successful action for violations of securities laws.

Cosgrove Law, LLC has previously written about the specific provisions in Section 922, which an in-depth discussion of this Section can be found here. The SEC’s rule proposals maintain the original language and definitions provided by Dodd-Frank; however, the proposed rules go a bit further to address concerns about the beefed-up tip program. According to an SEC press release, the primary concern was that companies feared the program would undermine existing anonymous hotlines and other internal whistleblower programs put into place after Sarbanes-Oxley in 2002.

To address those fears, the SEC proposal includes a protection that will not disqualify tipsters if they first report internally provided they report to the SEC within 90 days and to give them extra bounty for first reporting wrongdoing through the proper company channels.

Additionally, the SEC’s proposed rules set out a list of ineligible informants. Generally, compliance staff, outside accountants, attorneys who attempt to use information gathered from internal investigations, people within a company who are in positions of responsibility, and people who have a pre-existing duty to report their information are all barred from the award system.

Despite these exclusions, the bounty program is very broad. It allows tips on any securities law violation by an individual or company, public or private. The program also awards people that have no insider knowledge, but provide an analysis to help uncover or detect fraud. Further, even tipsters who were complicit in the fraud can get an award if they are not convicted of any wrongdoing.

The promise of potentially multi-million dollar payouts for tipsters could provide the agency with more information from insiders with knowledge of big frauds than in the past.

The rule comment period will be open until December 17, 2010.