Whistleblowers E-Book

Frederick D. Lipman

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Corporate F&A
• Sprache: Englisch

Seitenzahl: 378

Veröffentlichungsjahr: 2011

Beschreibung

Solid guidance for managing whistleblower policies in light of the new Dodd-Frank Act provisions In July 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act that greatly expanded whistleblower bounties in connection with violations of federal securities laws, including the Foreign Corrupt Practices Act. Discussing business protection strategies and best practices in dealing with whistleblowers, Whistleblowers will appeal to board members, executives, corporate compliance personnel, attorneys for whistleblowers and defense attorneys, as well as potential employee whistleblowers. * Case studies of GlaxoSmithKline, Pfizer and other high profile whistleblower incidences * Examines new Dodd-Frank incentives to whistleblowers * Recommends best practices for corporations in light of new whistleblowing incentives * Explores other federal and state statutory incentives to whistleblowing Timely and comprehensive, Whistleblowers emphasizes the disincentives to whistleblowing, reviewing the academic studies of whistleblowers with the idea of developing best practices in working with whistleblowers.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Dedication

Other Works by Frederick D. Lipman

Foreword

Acknowledgments

Introduction

CLASSIFICATION OF WHISTLEBLOWERS

ORGANIZATION OF BOOK

NOTES

Part One: The Whistleblowers and the Dodd-Frank Incentives

Chapter One: The Dramatic Expansion of Whistleblower Awards under Dodd-Frank

WHISTLEBLOWER PROVISIONS OF DODD-FRANK

WHAT IS “ORIGINAL INFORMATION”?

WHAT ARE VIOLATIONS OF THE FEDERAL SECURITIES LAWS?

RULE 10B-5: MARKET MANIPULATION

VIOLATING THE ACCOUNTING STANDARDS

FALSE FINANCIAL STATEMENTS BY PUBLIC COMPANIES

OTHER SECURITIES LAWS

PROTECTIONS FOR WHISTLEBLOWERS

COMMODITY EXCHANGE ACT

NOTES

Chapter Two: The Remarkable Story of Cheryl Eckard and the $96 Million Bounty under the False Claims Act

WHO IS CHERYL ECKARD?

ECKARD'S POST-TERMINATION ACTIVITIES

ECKARD'S SUPERIORS

BACKGROUND ALLEGATIONS

ALLEGED VIOLATIONS

TIMELINE OF ECKARD'S ALLEGED ACTIVITIES

THE LESSONS OF GLAXO

NOTES

Chapter Three: The Pfizer Whistleblowers Who Collected Over $100 Million under the False Claims Act

JOHN KOPCHINSKI

BEXTRA

THE COMPLAINT

PFIZER LESSONS

NOTES

Part Two: Disincentives and Factors Motivating Public Disclosure

Chapter Four: Disincentives to Internal Whistleblowers

FINANCIAL DISINCENTIVES

NONFINANCIAL DISINCENTIVES

CONTRACTUAL COMMITMENTS AND FIDUCIARY DUTIES

ETHICS RESOURCE CENTER SURVEY

REINSTATEMENT AS A REMEDY

EMPIRICAL STUDY

NOTES

Chapter Five: Women as Whistleblowers

SHERRON WATKINS

CYNTHIA COOPER

COLEEN ROWLEY

EXTERNAL REPORTING BY INTERNAL WHISTLEBLOWERS

WHISTLEBLOWER ANONYMITY

NOTES

Part Three: Organizational Best Practices

Chapter Six: Why Should Organizations Adopt a Robust Whistleblower System?

DIMINISHMENT OF SHAREHOLDER WEALTH

BOARDS OF DIRECTORS

WE WERE DUPED!

EXECUTIVE WHISTLEBLOWERS

WHY INDEPENDENT DIRECTORS CANNOT RELY SOLELY ON INDEPENDENT OR INTERNAL AUDITORS

LEGAL STANDARD

CAREMARK

RECOMMENDED STRATEGY

CRIMINAL LIABILITY OF AN ORGANIZATION

RESPONSIBLE CORPORATE OFFICER DOCTRINE

THE ACME MARKETS CASE

THE U.S. DEPARTMENT OF JUSTICE CRIMINAL GUIDELINES

THE DISADVANTAGES OF A ROBUST WHISTLEBLOWER SYSTEM

NOTES

Chapter Seven: Establishing a Robust Whistleblower System

PROBLEMS WITH THE CURRENT WHISTLEBLOWER SYSTEM

INITIAL STEPS

ELEMENTS OF A ROBUST WHISTLEBLOWER POLICY

INDEPENDENT DIRECTORS MUST BE IN CHARGE

THE WHISTLEBLOWER PROGRAM MUST BE INDEPENDENTLY ADMINISTERED

WHISTLEBLOWER COMPLAINTS SHOULD BE INVESTIGATED BY INDEPENDENT COUNSEL REPORTING DIRECTLY TO THE INDEPENDENT DIRECTORS

THERE SHOULD BE NO PRESUMPTION THAT ANONYMOUS COMPLAINTS ARE LESS DESERVING OF INVESTIGATION

MOTIVATIONS AND PERSONALITY OF THE WHISTLEBLOWER ARE NOT RELEVANT TO THE TRUTH OF THE ALLEGATIONS

ABSOLUTE PROTECTION OF WHISTLEBLOWERS' IDENTITY IS ESSENTIAL

ASSESS THE EFFECTIVENESS OF HOTLINES AND PROVIDE EMPLOYEE COMPLIANCE TRAINING

INDEPENDENT COUNSEL SHOULD REPORT THE STATUS AND RESULTS OF THE INVESTIGATION

INTERNAL WHISTLEBLOWERS SHOULD RECEIVE MEANINGFUL MONETARY REWARDS

THE WHISTLEBLOWER POLICY MUST BE COMMUNICATED EFFECTIVELY

THERE SHOULD BE MILDER SANCTIONS FOR WHISTLEBLOWERS INVOLVED IN ILLEGAL GROUP ACTIVITY

RETALIATION CLAIMS SHOULD BE INDEPENDENTLY INVESTIGATED

THE DIRECTOR OF CORPORATE COMPLIANCE SHOULD BECOME THE EYES AND EARS OF THE INDEPENDENT DIRECTORS

MAJOR DOs AND DON'Ts FOR CEOs

NOTES

Part Four: Statutory Incentives and SEC Award Regulations

Chapter Eight: The False Claims Act: Qui Tam Cases

WHAT IS A FALSE CLAIM?

FALSE CLAIMS ACT BOUNTIES

U.S. DEPARTMENT OF JUSTICE MEMORANDUM

STATUTE OF LIMITATIONS

NOTES

Chapter Nine: IRS Whistleblowers

SECTION 7623(b): MANDATORY WHISTLEBLOWER AWARDS

REDUCTION OF AWARD PERCENTAGE

SECTION 7623(a): DISCRETIONARY AWARDS

FORM 211

IRS WHISTLEBLOWERS AWARDS

IRS AWARD DETERMINATIONS

AWARD ADMINISTRATIVE PROCEEDINGS

APPEAL TO TAX COURT

DURATION OF PROCESS AND AWARD PAYMENT

CONFIDENTIALITY OF WHISTLEBLOWER

RIGHT TO COUNSEL

IRS CONTRACTS

DISQUALIFICATION OF U.S. TREASURY DEPARTMENT FEDERAL EMPLOYEES

NOTES

Chapter Ten: Other Statutory Incentives and Protections for Whistleblowers

ACT TO PREVENT POLLUTION FROM SHIPS

FALSE PATENT MARKING STATUTE

U.S. TARIFF ACT OF 1930

STATE FALSE CLAIMS STATUTES

WHISTLEBLOWER PROTECTIONS

BARKER V. UBS

OTHER STATUTORY WHISTLEBLOWER PROTECTIONS

NOTES

Chapter Eleven: A Step-by-Step Guide to SEC Whistleblower Awards under Dodd-Frank

SUMMARY

SEC INVESTOR PROTECTION FUND

DOES THE WHISTLEBLOWER NEED AN ATTORNEY?

STEP-BY-STEP GUIDE

DETERMINING WHETHER THE OVER $1 MILLION THRESHOLD IS SATISFIED

DETERMINING THE AMOUNT OF AN AWARD

MUST AN EMPLOYEE COMPLY WITH THE COMPANY'S INTERNAL COMPLIANCE PROGRAM?

CONFIDENTIALITY

NONWAIVER OF WHISTLEBLOWER RIGHTS

APPEALS

ANTI-RETALIATION PROVISION

NOTES

Appendix One: IRS Form 211

Appendix Two: SEC Form TCR—Tip, Complaint or Referral

Appendix Three: SEC Form WB-APP —Application for Award for Original Information Submitted Pursuant to Section 21F of the Securities Exchange Act of 1934

Appendix Four: SEC Whistleblower Rules

§ 240.21F-1 GENERAL

§ 240.21F-2 WHISTLEBLOWER STATUSAND RETALIATION PROTECTION

§ 240.21F-3 PAYMENT OF AWARDS

§ 240.21F-4 OTHER DEFINITIONS

§ 240.21F-5 AMOUNT OF AWARD

§ 240.21F-6 CRITERIA FOR DETERMINING AMOUNT OF AWARD

§ 240.21F-7 CONFIDENTIALITY OF SUBMISSIONS

§ 240.21F-8 ELIGIBILITY

§ 240.21F-9 PROCEDURES FOR SUBMITTING ORIGINAL INFORMATION

§ 240.21F-10 PROCEDURES FOR MAKING A CLAIM FOR A WHISTLEBLOWER AWARD IN SEC ACTIONS THAT RESULT IN MONETARY SANCTIONS IN EXCESS OF $1,000,000

§ 240.21F-11 PROCEDURES FOR DETERMINING AWARDS BASED UPON A RELATED ACTION

§ 240.21F-12 MATERIALS THAT MAY FORM THE BASIS OF AN AWARD DETERMINATION AND THAT MAY COMPRISE THE RECORD ON APPEAL

§ 240.21F-13 APPEALS

§ 240.21F-14 PROCEDURES APPLICABLE TO THE PAYMENT OF AWARDS

§ 240.21F-15 NO AMNESTY

§ 240.21F-16 AWARDS TO WHISTLEBLOWERS WHO ENGAGE IN CULPABLE CONDUCT

§ 240.21F-17 STAFF COMMUNICATIONS WITH INDIVIDUALS REPORTING POSSIBLE SECURITIES LAW VIOLATIONS

About the Author

Index

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Asia, and Australia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.

The Wiley Corporate F&A series provides information, tools, and insights to corporate professionals responsible for issues affecting the profitability of their companies, from accounting and finance to internal controls and performance management.

Copyright © 2012 by Frederick D. Lipman. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Lipman, Frederick D. Whistleblowers : incentives, disincentives, and protection strategies / Frederick D. Lipman. p. cm. – (Wiley corporate F&A series) Includes index. ISBN 978-1-118-09403-7 (hardback); ISBN 978-1-118-16848-6 (ebk); ISBN 978-1-118-16857-8 (ebk); ISBN 978-1-118-16858-5 (ebk)

1. Whistle blowing–United States. 2. Business ethics–United States. 3. Whistle blowing–Law and legislation–United States. 4. Whistle blowing– Case studies. I. Title. HD60.5.U5L57 2012 344.7301′2598–dc23

2011029141

To my grandchildren, Tyler Keith Lipman and Jordan Sienna Lipman

Other Works by Frederick D. Lipman

The Family Business Guide: Everything You Need to Know to Manage Your Business from Legal Planning to Business Strategies

International and U.S. IPO Planning: A Business Strategy Guide

Executive Compensation Best Practices

Corporate Governance Best Practices: Strategies for Public, Private, and Not-for-Profit Organizations

Valuing Your Business: Strategies to Maximize the Sale Price

Audit Committees

The Complete Guide to Employee Stock Options

The Complete Guide to Valuing and Selling Your Business

The Complete Going Public Handbook

Financing Your Business with Venture Capital

How Much Is Your Business Worth?

Going Public

Venture Capital and Junk Bond Financing

Foreword

by Dr. Gaytri D. Kachroo, Esq.

A FEW YEARS AGO, the term “whistleblower” called to mind odd and sporadic anecdotes about one or two courageous individuals who dared confront and expose wrongdoing within political and corporate halls. However, two events over the last few years have overhauled whistleblowing into an industry, capable of diverse creative frameworks and modeling of the kind I am engaged in with my plethora of whistleblowing clients and incentivized by a burgeoning regulation encouraging reform and a new form of internal audit that is discussed in detail in the pages you are about to turn. These two events are the exposure of the Madoff fraud by Harry Markopolos and Julian Assange's WikiLeaks. Markopolos's testimony before the House Finance Committee in large part fueled the new whistleblower legislation, part of the Dodd-Frank Reform Act, analyzed in this book, and WikiLeaks is touted by many to have catalyzed the popular political uprisings throughout the Middle East. Each event marks major changes in the global transition to greater transparency and accountability of financial and political institutions.

When Madoff gave up his immense fraudulent endeavor on December 11, 2008, he sealed not only his own fate but also that of Harry Markopolos, the shadow that had chased him for almost a decade alongside his stellar team of fraud fighting detectives, Frank Casey, Neil Chelo, and Michael Ocrant, and persisted in blowing the whistle about Madoff to the U.S. Securities and Exchange Commission. I was privileged to join that team in 2005 as the attorney for Harry's new business, when he decided that fraud fighting through whistleblowers would become his life's work. It is therefore fitting and a great honor to introduce this text by Fred Lipman to the world, as it becomes clearer than ever before that rules and regulations relating to whistleblowing are changing, becoming ever-pervasive and affecting a multitude of industries. Without doubt, there is an added need to consult texts that simply and clearly explicate these reforms and also the background for these changes.

Fred Lipman in this text claims that had the independent directors of Enron, WorldCom, and Lehman “established a robust whistleblower mechanism . . . they might have been able to obtain the information necessary to prevent these scandals.” (See Chapter 7.) Too often, senior management and boards in public and private companies insulate themselves from information to their own detriment. In addition to the risks and exposure to shock, scandal, illegal activity, and the liability inherent in such endeavors underscored by Lipman, these directors may find corporate misdealing exposed on sites such as WikiLeaks now, if greater internal transparency and compliance measures supporting whistleblowers are not adopted.

Step by step, as a wise and learned guide, Mr. Lipman takes us through the legislation and institutional frameworks allowing whistleblowers a voice. He asserts and attempts to change the current notion in corporate boardrooms that the whistleblower is the company's enemy and not a best friend. In his systematic approach, Mr. Lipman demonstrates the possibility of an aligned company policy to reward and successfully protect corporate interests through public and private schemes incentivizing whistleblowers. He highlights the large penalties paid by such pharmaceutical companies as GlaxoSmithKline to the U.S. government on the basis of a whistleblower complaint triggered to protect the public. He also summarizes, in an easy-to-read fashion for attorneys, corporate compliance officers, and whistleblowers alike, whistleblower protections, incentives, and complaint submission procedures of the Dodd-Frank Reform Act of July 2010 as well as other statutes. Combining policy and regulatory analysis in this one text provides a powerful message to U.S. corporations to seriously overhaul their compliance measures and use the best practices necessary to create internal informants protected by management, who can in turn advise management of internal wrongdoing and oust perpetrators.

I encourage you to begin this journey into whistleblowing law. From stories of outstanding whistleblowers, analysis of the Dodd-Frank reforms, and other whistleblowing statutes including those relating to the Internal Revenue Service, to best practices in dealing with whistleblowers, to providing whistleblowers with appropriate forms to submit information to the SEC, Fred Lipman leaves no stone unturned in his A-to-Z account of whistleblower law in the United States.

Dr. Kachroo is a contributing author of No One Would Listen, by Harry Markopolos.

Acknowledgments

THE AUTHOR wishes to acknowledge the assistance of these attorneys at Blank Rome LLP in preparing this book: Jennifer L. Bell, Esq.; Jeanne M. Grasso, Esq.; Joseph Gulant, Esq.; Anthony B. Haller, Esq.; Joseph G. Poluka, Esq.; and W. Scott Simmer, Esq. Several of my partners, including Richard H. McMahon, Esq., and David Gitlin, Esq., properly challenged me on some of the recommendations made in this book and helped me to sharpen my own thinking. My partners do not necessarily agree with all of the statements contained in this book, and I absolve them of any errors that I committed.

Jeffrey M. Taylor, Esq., is the coauthor of Chapter 11 of this book. Jane K. Storero, Esq., was helpful in reviewing Chapter 1.

I want to thank Eugene C. Fazzie for explaining to me the nature of an effective internal audit process that some public companies have.

Dr. Gaytri D. Kachroo, Esq., a contributor to No One Would Listen (John Wiley & Sons, Inc., 2010), who represents Harry Markopolos (the Madoff whistleblower) and other whistleblowers, was kind enough to write a foreword to this book.

The author would also like to thank Kathleen Kirchner, Lynn Bogina, June Polito, and Rosemarie Rao for their help with proofreading the manuscript.

Finally, the author would like to acknowledge the excellent and invaluable service of Barbara Helverson, who served as typist and an editor of this book. Her suggestions and comments were very useful and helpful in the preparation of the book.

Introduction

I once asked a room full of compliance officers if their company had ever made an internal whistleblower “employee of the month” or given them a raise. The room burst out laughing.

—Patrick Burns, Director of Communications of Taxpayers Against Fraud Education Fund

BOTH THE FEDERAL GOVERNMENT and many states have statutes reflecting a public policy that rewards and protects whistleblowers.1 None of these statutes requires employee whistleblowers to abide by internal corporate compliance policies as a condition for receiving the reward, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which became effective in July 2010. Despite these new public incentives for employee whistleblowing, few companies have reexamined the effectiveness of their current compliance policies.

Although the Sarbanes-Oxley Act of 2002 mandated that listed public companies establish an anonymous whistleblower policy, some companies have established good whistleblower policies while many others have created only ineffective paper policies. These public companies have done just the minimum amount required to comply with the law, partly because although some complaints by whistleblowers are legitimate, many are spurious. Many public company whistleblower policies are largely unpublicized, do not provide adequate protection for internal whistleblowers, and afford no meaningful reward or recognition for them. Even the supposedly “good” whistleblower policies provide no meaningful reward or recognition for legitimate employee whistleblowers and use internal auditors or compliance officers to investigate complaints, even though these persons may not be viewed as independent and are not experienced forensic investigators.

Potential internal legitimate whistleblowers face daunting cultural disincentives from their fellow workers, supervisors, and management who ostracize so-called snitches. Most potential internal whistleblowers, including executive-level ones, will not jeopardize their careers without an absolute guarantee of anonymity, a meaningful reward, and an independent investigation of their allegations.

The scandals and financial disasters of the twenty-first century have one thing in common: The independent members of the boards of directors of Enron, WorldCom, and Lehman Brothers Holdings, Inc., among others, were completely surprised by the impending scandal. The primary reason that the board was clueless was because it relied solely on information supplied by top management and incorrectly assumed that the independent or internal auditors would detect illegal activity or major risk exposure. Every scandal, starting with Enron, resulted in a claim that the board was duped by management.2 Even the most recent disaster involving Lehman resulted in a claim that management withheld key information from the board until immediately before its bankruptcy filing.3 Had the independent directors of these companies established a robust whistleblower mechanism, as described in this book, they might have been able to obtain the critical information necessary to prevent these scandals.

Whistleblowing works. Indeed, according to the Association of Certified Fraud Examiners (ACFE), tips were the source of information for more than 40 percent of reported instances of occupational fraud.4Figure I.1 reflects the fact that tips are more effective in detecting occupational fraud than the collective total of management review, internal audit, and external audit.

Figure I.1 Initial Detection of Occupational Frauds

Source: ACFE, 2010 Global Fraud Study, “Report to the Nations on Occupational Fraud and Abuse,” www.acfe.com/rttn/rttn-2010.pdf.

Figure I.2 shows that organizations without employee hotlines receive substantially fewer tips.

Figure I.2 Impact of Hotlines

Source: ACFE, 2010 Global Fraud Study, “Report to the Nations on Occupational Fraud and Abuse,” www.acfe.com/rttn/2010-conclusions.asp.

Unfortunately, most organizations have ineffective hotlines and policies that do not encourage legitimate whistleblowers. Directors and senior executives tend to greatly underestimate the disincentives to the disclosure of wrongdoing and have not provided sufficient protection to whistleblowers and adequate rewards for what may be a career-ending decision. Directors and management may incorrectly assume that the lack of hotline reports of illegal activity means that nothing illegal is happening, never appreciating that there is no incentive for employees to use the hotline.

Conscientious directors and CEOs who value their business reputations should insist on an effective whistleblower system, administered by independent counsel or another independent party (an ombudsman)5 who reports directly to the independent directors. It is time for every organization to stop treating legitimate whistleblowers as pariahs rather than heroes. Good corporate governance practices require a robust, proactive approach by the independent directors to encourage legitimate internal whistleblowing. The system, which is an important internal control, should include meaningful rewards for internal whistleblowers, provide for anonymous reports of both potential law violations and significant risk exposures of the organization, and mandate that independent counsel investigate such reports while providing complete anonymity for whistleblowers to avoid retaliation. An effective whistleblower system would have the internal auditor or director of corporate compliance report directly to the independent directors and become the eyes and ears of those directors within the organization.

Recent media publicity concerning large bounty payments to whistleblowers in the pharmaceutical industry, using private qui tam actions (suits on behalf of the government under the False Claims Act), has heightened the interest in this topic. A few examples are presented next.

In October 2010, Cheryl Eckard, a former GlaxoSmithKline employee, won $96 million, which is believed to be the largest reward ever given to an individual U.S. whistleblower. The award is part of a $750 million settlement the pharmaceutical company paid to settle U.S. government fraud charges over its manufacturing practices in Puerto Rico. Eckard's $96 million may well be increased by bounties paid by various states.

In September 2009, John Kopchinski, a former Pfizer sales representative, earned more than $51 million as a result of a whistleblower lawsuit against Pfizer relating to the company's sales tactics in marketing the pain drug Bextra. Including a criminal fine, Pfizer's settlement in the case totaled $2.3 billion. Five other whistleblowers will earn an aggregate total of over $50 million as their rewards. Kopchinski, a Gulf War veteran who was dismissed by Pfizer after raising his concern in this case, stated: “In the Army I was expected to protect people at all costs. At Pfizer I was expected to increase profits at all costs, even when sales meant endangering lives.”6 The large fines, penalties, and other payments paid by these and other corporations may well have been averted by using best practices described in this book in dealing with the whistleblowers.

In April 2011, the Internal Revenue Service paid a $4.5 million bounty to an anonymous accountant who blew the whistle on his employer, a financial services firm.

These huge awards are not typical. According to the Taxpayers Against Fraud, a nonprofit organization, the median average reward for a whistleblower is about $150,000.7 In return, these whistleblowers may be socially ostracized, their employment may be terminated, and they will have a hard time getting another job in the same industry. Who wants to hire a snitch? Is it any wonder that no whistleblower system can be effective unless the identity of whistleblowers is fully protected from disclosure?

Incentives to whistleblowers have been increased dramatically as a result of Dodd-Frank and the changes to the Internal Revenue Code in December 2006 mandating whistleblower rewards. Dodd-Frank provides rewards to whistleblowers with respect to violations of the federal securities laws (including the Foreign Corrupt Practices Act), without regard to whether there was any false claim made against the government, and requires the Securities and Exchange Commission (SEC) to create whistleblower rewards, without the necessity of a private qui tam action permitted under the False Claims Act. Dodd-Frank incorporates whistleblower incentives for violations of securities laws by private companies as well as public companies since capital raising by private companies is subject to various provisions of securities laws. The law has expanded the potential for whistleblower bounties enormously.

Many whistleblower complaints are without merit. Some employees blow the whistle on perfectly legal company activities because of a misunderstanding of the facts or the law. Other employees, in an attempt to manipulate the system, decide to blow the whistle when they believe that their employment is about to be terminated. Doing so gives employees the protections of whistleblowers and typically prevents or delays the employment termination. Discovering who is a legitimate whistleblower and who is not is one of the most difficult tasks facing businesses today.

CLASSIFICATION OF WHISTLEBLOWERS

Whistleblowers may be classified in various ways. In this book, the term “internal whistleblower” refers to an employee of an organization who provides information to the organization. If the information is provided to governmental authorities or publicly, the internal whistleblower is regarded as having made a public disclosure. An “external whistleblower” is a nonemployee or ex-employee of the organization who may provide information either to authorities or publicly or to the organization itself.

ORGANIZATION OF BOOK

This book is organized into four parts. Part I (Chapters 1 through 3) discusses identified whistleblowers and the rewards they receive and reviews in detail the dramatic expansion of whistleblower rewards under Dodd-Frank. Part II (Chapters 4 and 5) discusses the disincentives to internal whistleblowing and the factors that motivate public disclosure by whistleblowers. Part III (Chapters 6 and 7) describes the reasons why boards of directors should adopt robust whistleblower systems and a description of such a system. This is the heart of the book. Part IV (Chapters 8 through 11) contains a review of other statutory incentives to whistleblowing, including Internal Revenue Service (IRS) and state awards and contains a detailed step-by-step guide to SEC whistleblowing awards under Dodd-Frank.

A brief description of the chapters of this book follows.

Chapter 1 discusses the $1 million reward made to Glen and Karen Kaiser by the SEC for providing information on insider trading by Karen's ex-husband. This chapter also provides an introduction to the enormous scope of the new statutory incentives to whistleblowing under Dodd-Frank that were effective in July 2010.

The remarkable story of Cheryl Eckard, the $96 million bounty winner, is detailed in Chapter 2.

Chapter 3 contains the story of the Pfizer whistleblowers who received collectively over $100 million in bounties, out of which John Kopchinski personally received more than $51 million.

The payments to Cheryl Eckard and the Pfizer whistleblowers are all based on provisions of the False Claims Act, a statute that became law in 1863 during the American Civil War and is known as Lincoln's Law. The False Claims Act authorized the U.S. Justice Department to pay awards to those who report fraud against the federal government in an amount ranging from 15 to 30 percent of what is recovered based on the whistleblower's report, subject to certain exceptions.

Chapter 4 analyzes the disincentives to whistleblowers and contains an empirical study of retaliation against whistleblowers.

Chapter 5 discusses why so many women are whistleblowers and the factors motivating employees to make public disclosure to regulators.

Chapter 6 explains why every organization should adopt a more robust whistleblower system. This chapter contains an empirical study of the adverse long-term financial consequences of illegal corporate behavior. A robust whistleblower system will permit the independent directors of a company to obtain information from lower-level executives and employees. This will better enable the directors to detect and prevent corporate wrongdoing and major risk exposures, thereby enabling them to better perform their fiduciary duties. The chapter contains the story of Eugene Park, an AIG executive who, in March 2005, discovered the huge AIG exposure on credit default swaps and whose warning was dismissed by the chief deputy to Joseph Cassano (AIG's executive in charge of swaps). This chapter also reviews the potential civil and criminal liability of the organization and its CEO and directors.

Chapter 7 gives a blow-by-blow account of exactly how an organization can establish a robust whistleblower policy. The chapter begins with an analysis of the deficiencies in the current whistleblower systems established under the Sarbanes-Oxley Act of 2002 (SOX). The chapter also includes a list of major “Dos and Don'ts” for CEOs. This is the most important chapter in the book.

Chapter 8 contains a history of the False Claims Act and the actions that may be brought under that Act, which are called qui tam suits. This chapter also contains a memorandum from the U.S. Department of Justice that provides a brief, general overview of qui tam litigation under the False Claims Act.

Chapter 9 reviews the current IRS bounty program. Unlike the False Claims Act, private litigation is not permitted under this statute. Appendix 1 of this book contains the form (Form 211) for applying for an IRS whistleblower bounty.

Chapter 10 discusses other federal and state statutory incentives and protections for whistleblowers. The state statutory incentives are generally based on provisions similar to the False Claims Act of the federal government. The statutory incentives in certain major states are covered in this chapter.

Chapter 11 contains a detailed review of the SEC's new whistleblower rules proposed under Dodd-Frank. Proposed forms for making SEC whistleblower claims are also discussed in this chapter and are contained in Appendixes 2 and 3 of this book. Appendix 4 contains the SEC's whistleblower rules.

NOTES

1. Anthony Heyes and Sandeep Kapur, “An Economic Model of Whistle-Blower Policy,” Journal of Law, Economics, & Organization 25, no. 1; doi:10,1093/jeo/ewim049, advance access publication January 3, 2008; Robert Howse and Ronald J. Daniels, “Rewarding Whistleblowers: The Costs and Benefits of an Incentive-Based Compliance Strategy,” University of Pennsylvania, Scholarly Commons, Departmental Papers (School of Law), January 1, 1995.

2. Andrea Redmond and Patricia Crisafulli, Comebacks: Powerful Lessons from Leaders Who Endured Setbacks and Recaptured Success on Their Terms (San Francisco: Jossey-Bass, 2010). See also Benson Smith and Tony Rutigliano, “Enron and You—A Lesson for Sales Execs: You Don't Have the Luxury of Invoking the Fifth,” Gallup Management Journal, February 25, 2011. http://gmj.gallup.com.

3. See “Report of Anton R. Valukas, Examiner,” March 11, 2010, pp. 1460–1465.

4. Association of Certified Fraud Examiners, 2010 Global Fraud Study, “Report to the Nations on Occupational Fraud and Abuse.” http://www.acfe.com/rttn/rttn-2010.pdf.

5. The use of an organizational ombudsman was suggested by Francis J. Milliken, Elizabeth W. Morrison, and Patricia F. Hewlin in “An Exploratory Study of Employee Silence: Issues that Employees Don't Communicate Upward and Why,” November 4, 2003. http://w4.stern.nyu.edu/emplibrary/Milliken.Frances.pdf.

6. Bill Berkrot, “Pfizer Whistleblower's Ordeal Reaps Big Rewards,” Reuters, September 2, 2009.

7. Conversation with Patrick Burns, Director of Communications, Taxpayers Against Fraud Education Fund, based on a review of whistleblower claims on the website: www.taf.org/abouttaf.htm.

Part One

The Whistleblowers and the Dodd-Frank Incentives

CHAPTER ONE

The Dramatic Expansion of Whistleblower Awards under Dodd-Frank

ON JULY 23, 2010, the Securities and Exchange Commission (SEC) announced an award of $1 million to Glen Kaiser and Karen Kaiser (formerly Karen Zilkha) of Southbury, CT, for providing information on alleged illegal insider trading in Microsoft Corp. by a hedge fund advisor (Pequot Capital Management, Inc.); its chief executive, Arthur J. Sanberg; and David E. Zilkha. Mr. Zilkha was previously a Microsoft employee who was married to Karen and who accepted an employment offer at Pequot. Karen subsequently married Glen Kaiser, an anesthesiologist. While Pequot was in the process of hiring him, Mr. Zilkha allegedly tipped Pequot and Sanberg about an upcoming earnings report from Microsoft that indicated that the company would beat its earnings target. Sanberg allegedly traded on this inside information, reaping $14.8 million in profits, and the SEC won a judgment (including interest) against Pequot and Sanberg for $17,938,468. Documents in the Zilkhas' divorce proceedings revealed that Pequot agreed to make a $2.1 million payment to David Zilkha several years after his departure from Pequot in November 2001.1

How did Karen Kaiser uncover the specific evidence that resulted in her $1 million award? When Karen and David Zilkha divorced, Karen had kept the hard drive from the family's computer because it contained family photos. During the divorce and child support proceedings, David Zilkha listed a $2.1 million settlement that had never appeared before in any of his affidavits to the court. Karen's attorney searched the hard drive to try to find the origin of the $2.1 million and discovered that the payment came from Pequot. Also on the hard drive were the e-mails from a Microsoft employee to Mr. Zilkha, which indicated that he had advance notice that Microsoft would beat its earnings target. These e-mails were turned over to the SEC, which earlier had closed its investigation of Pequot. On the basis of these e-mails, the SEC decided to reopen the investigation.2

The reward to the Kaisers preceded the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). Under Dodd-Frank, Glen Kaiser and Karen Kaiser would have received a minimum of 10 percent of the recovery or $1,793,847 to a maximum of 30 percent of the recovery, or $5,381,540. Congress decided that the SEC was not being generous enough to whistleblowers and “mandated” much higher rewards and extended the bounty program beyond illegal insider trading violations to any violation of the federal securities laws. This decision was influenced by the failure of the SEC to uncover the Madoff Ponzi scheme for more than 20 years after investors had been bilked of approximately $65 billion. Dodd-Frank also mandated the payment of such bounties that were “discretionary” prior to its enactment.

The theory for the bounties is that people will not reveal frauds unless there is something in it for them. Laura Goldman, a money manager who claims to have figured out the Madoff fraud in about 45 minutes, justified her not blowing the whistle in this way: “People on Wall Street are not Mother Teresas. They are not going to the S.E.C. unless there is something in it for them.”3

Harry Markopolos, a quantitative financial analyst, first blew the whistle on Bernard Madoff's multibillion-dollar Ponzi scheme in 2000 and, over the ensuing eight years preceding Madoff's arrest, sent detailed accusations to various SEC offices. Each report met with a thundering silence. Markopolos's investigation started when his bosses at the money management firm he worked for wanted him to design a financial product that was as consistently profitable and low risk as the one offered by Madoff. It took Markopolos only a few minutes to study Madoff's supernaturally consistent rate of return and “investment strategy” to realize it was most likely a fraud.

To get his bosses off his back about creating a similar product, Markopolos had to get the SEC to put Madoff out of business. It is not surprising that the SEC ascribed Markopolos's initial and subsequent accusations to that of a jealous competitor trying to tear down a more successful rival, one who had formerly headed the Nasdaq Stock Market. Markopolos's utterly tone-deaf and repeated requests to be paid a bounty if Madoff's fraud qualified under whistleblower statutes didn't help his credibility either. Markopolos never received a bounty from the SEC, but he did get a book deal after the Madoff scandal was publicized.4

WHISTLEBLOWER PROVISIONS OF DODD-FRANK

Prior to Dodd-Frank and the 2006 amendments to the Internal Revenue Code, whistleblower rewards were pretty much limited to the violations of the False Claims Act, similar state statutes, and miscellaneous other laws described in Chapter 10. The False Claims Act basically required that there be a false claim against a government, such as Medicare or Medicaid fraud.

Dodd-Frank greatly expands the violations for which a whistleblower bounty may be awarded. This chapter reviews the broad scope of Dodd-Frank. The last chapter of this book and Appendixes 2 through 4 describe, in detail, how whistleblowers can obtain rewards under the SEC bounty program mandated by Dodd-Frank.

Under Dodd-Frank, whistleblowers who provide “original information” (discussed later) leading to a successful enforcement action by a judicial or administrative body under the securities and commodities laws receive not less than 10 percent or more than 30 percent of the total recovery “ordered to be paid” if it is greater than $1 million, including penalties, disgorgement,5 and interest. The SEC was required to implement whistleblower provisions by rules and regulations described in detail in Chapter 11 of this book.

Thus, the minimum bounty a whistleblower can receive is effectively $100,000. However, the maximum jackpot is enormous. For example, Siemens paid $800 million for violation of the Foreign Corrupt Practices Act (FCPA), which is part of the securities laws. Had original information been given to the SEC that led to the recovery from Siemens, the whistleblower could have collected a minimum of $80 million and a maximum of $240 million. That amount is a lot higher than any state lottery normally provides, and the odds are a lot better than the state lottery. Other groundbreaking settlements for violation of the FCPA include a $579 million sanction and disgorgement against Kellogg Brown & Root LLC (part of which was paid by Halliburton Co.), a $365 million payment by Snamprogetti Netherlands B.V. and its parent, and a $185 million payment by Daimler AG.

The drafters of Dodd-Frank believe that the SEC had not been sufficiently generous in the past to whistleblowers. Indeed, it had paid less than $160,000 in total since 1989, excluding the $1 million payment to the Kaisers. This poor bounty payment history is illustrated in Table 1.1.6

Table 1.1 Bounty Payments to Whistleblowers

Source: Generated by the Office of the Inspector General.

Bounty ClaimantYearBounty AmountClaimant 11989$ 3,500Claimant 22001$ 18,152Claimant 32002$ 29,079Claimant 42005$ 17,500Claimant 42006$ 29,920Claimant 42009$ 55,220Claimant 52007$ 6,166Total $159,537

WHAT IS “ORIGINAL INFORMATION”?

To hit the jackpot under Dodd-Frank, the whistleblower must provide what is called “original information.” This means information that:

Is derived from the independent knowledge or analysis of a whistleblower;Is not known to the SEC from any other source, unless the whistleblower is the original source of the information; andIs not exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report, hearing, audit, or investigation, or from the news media, unless the whistleblower is a source of the information.7

A potential whistleblower will likely need the assistance of an attorney, preferably one specializing in securities law, to identify what is original information and then submit the information to the SEC. In the Karen Kaiser case, it was an attorney working on her divorce and property settlement who discovered the damaging information.

A whistleblower is not entitled to an award if the whistleblower knowingly and willfully makes any false, fictitious, or fraudulent statement or representation or uses any false writing or document knowing the writing or document contains any false, fictitious, or fraudulent statement or entry. Likewise certain compliance personnel are not eligible, as described more fully in Chapter 11.

WHAT ARE VIOLATIONS OF THE FEDERAL SECURITIES LAWS?

The federal securities laws contain numerous provisions that can be violated and can result in monetary sanctions8 exceeding $1 million. Keep in mind when reading this chapter that any violation of these provisions resulting in monetary sanctions exceeding $1 million can produce a reward for a whistleblower who provides the SEC with “original information.”

Some of the more important provisions and examples of how they have been violated in the past are discussed next.

FCPA Violations

Generally speaking, the Securities Exchange Act of 1934 (1934 Act) makes it illegal for any public company, as well as any officer, director, employee, or stockholder acting on behalf of the company, to pay, promise to pay, or authorize the payment of money or anything of value to:

Any official of a foreign government or instrumentality of a foreign government;Any foreign political party;Any candidate for foreign political office; orAny person whom the company knows or has reason to know will make a proscribed payment or will promise to make or authorize payment of a proscribed payment

if the purpose is to induce the recipient to: (a) use his or her influence with the foreign government or instrumentality; (b) influence the enactment of legislation or regulation by that foreign government or instrumentality; or (c) refrain from performing any official responsibility, in each case, for the purpose of obtaining or retaining business for or with, or directing business to any person.9

In order to fall within the 1934 Act's proscriptions, the payment, or promise or authorization of payment, must be “corrupt”; that is, whether it is legal under the laws of the foreign jurisdiction or not, it must be intended to induce the recipient to use his or her official position for the benefit of the person offering the payment or his client. The 1934 Act prohibits not only the payment of, but also the promise or authorization of, a corrupt foreign payment. Therefore, the law can be violated even if the payment is never in fact made. Since a corrupt payment that is requested by the foreign official (rather than offered to him or her) involves a decision to accede to the request, it is not a defense that the payment was requested. However, payments that are extorted and are made to protect physical assets from capricious destruction are not within the ambit of the 1934 Act. In addition, so-called grease payments (e.g., payments to ministerial or clerical employees of foreign government or agencies, to speed them in the performance of or encourage them to in fact perform their duties) are not prohibited by the 1934 Act.

It is clear that, if authorized, the making of a foreign corrupt payment by a foreign subsidiary of a U.S. company is prohibited by the 1934 Act. Also prohibited are payments to an agent (even one who is not him- or herself subject to the 1934 Act) when it is known or should be known that they will be used to make corrupt payments.

Violations of the corrupt payment provisions of the 1934 Act are punishable by fines and civil penalties against corporations or business entities of up to $2 million ($10,000 civil penalty in an action brought by the SEC). In addition, officers, directors, employees, agents, and shareholders can be fined up to $100,000 (plus a $10,000 civil penalty in an action brought by the SEC) or imprisoned for not more than five years, or both, for violations of the corrupt payment provisions of the 1934 Act. The 1934 Act further provides that fines imposed on an individual violator cannot be paid, directly or indirectly, by the company for whose benefit the bribe was paid or promised.

The FCPA applies to bribes of “any official of a foreign government or instrumentality of a foreign government.” In a number of countries, the government is an owner or partial owner of all sorts of ventures. In China, the government is an owner or government officials are owners of what appear to be commercial ventures, and that government ownership creates major issues from an FCPA perspective. For example, in May 2005, a wholly owned Chinese subsidiary of Diagnostic Products Corp. (DPC), a U.S.-based medical equipment firm, pled guilty to criminal charges arising out of approximately $1.6 million in sales “commissions” made by DPC, through its subsidiary, to doctors and laboratory staff employed by state-owned hospitals in China in order to generate business. The doctors and laboratory staff were considered officials of a foreign government or its instrumentality.10

The broad scope of the foreign bribe provisions of the FCPA is best illustrated by the next case dealing with travel and entertainment expenses for Chinese foreign officials:

In SEC v. Lucent Technologies, Inc.,11 the Commission's complaint alleged that over a three year period Lucent, through a subsidiary, paid over $10 million for about 1,000 Chinese foreign officials to travel to the U.S. The SEC concluded that about 315 of the trips had a disproportionate amount of sightseeing, entertainment and leisure. Some of the trips were, in fact, vacations to places such as Hawaii, Las Vegas, the Grand Canyon, Disney World and similar venues. These expenses, for officials Lucent was either doing business with or attempting to do business with, were booked to a factory inspection account. The company failed over the years to provide adequate FCPA training.

To resolve the SEC's case, Lucent consented to an injunction prohibiting future violations of the FCPA books and records provisions. In addition, the company agreed to pay a $1.5 million civil penalty.12

Theoretically, an FCPA violation consisting of a significant bribe to a foreign official can produce a double-dip reward for the whistleblower. The whistleblower could receive one reward from the SEC and a second bounty from the Internal Revenue Service if the company improperly deducted the bribe payment for federal income tax purposes. (See Chapter 9.)

Ponzi Schemes

As the SEC defines it, a Ponzi scheme is:

an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.13

Ponzi schemes require a consistent flow of funds from new investors to continue and usually collapse when it becomes difficult to recruit new investors or when old investors want to cash out.

Ponzi schemes are named after Charles Ponzi. In the 1920s, Ponzi convinced thousands of New England residents to invest in a postage-stamp speculation scheme. He promised investors that he could provide a 50 percent return in just 90 days and initially purchased a small number of international mail coupons in support of his scheme. However, Ponzi soon switched to using new funds to pay off earlier investors.14

Ponzi schemes can involve substantial amounts of money, as in the case of Madoff, which involved approximately $65 billion. Unfortunately, the fraudster typically cannot pay any significant part of the monetary sanctions imposed by the SEC as a result of the whistleblower's actions. However, as in the Madoff Ponzi scheme, usually other persons who are involved can pay monetary sanctions.

Illegal Insider Trading

The term “illegal insider trading” refers generally to purchasing or selling a security in breach of a fiduciary duty or other relationship of trust and confidence while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information to third persons, securities trading by the person tipped, and securities trading by those who misappropriate such information.

Examples of insider trading cases that have been brought by the SEC are cases against:

Corporate officers, directors, and employees who traded the corporation's securities after learning of significant, confidential corporate developments;Friends, business associates, family members, and other “tippees” of such officers, directors, and employees, who traded the securities after receiving such information;Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;Government employees who learned of such information because of their employment by the government; andOther persons who misappropriated, and took advantage of, confidential information from their employers.15

It is the SEC's position that the insider trading “undermines investor confidence in the fairness and integrity of the securities markets.” Accordingly, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.16

The Kaisers received their $1 million bounty because Pequot and Sanberg allegedly received and traded on confidential information belonging to Microsoft that was revealed to them by David Zilkha in breach of his fiduciary duty to Microsoft.

RULE 10b-5: MARKET MANIPULATION

Section 10(b) of the 1934 Act and Rule 10b-5 thereunder protect against a wide variety of securities fraud and manipulation. They are the most important provisions of all of the federal securities laws. Ponzi schemes and illegal insider trading, previously discussed, violate these antifraud rules.