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Part One
The Whistleblowers and the Dodd-Frank Incentives
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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 āmandatedā 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 ādiscretionaryā 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: āPeople on Wall Street are not Mother Teresas. They are not going to the S.E.C. unless there is something in it for them.ā3
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 āinvestment strategyā 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 āoriginal informationā (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 āordered to be paidā 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.
| Claimant 1 | 1989 | $ 3,500 |
| Claimant 2 | 2001 | $ 18,152 |
| Claimant 3 | 2002 | $ 29,079 |
| Claimant 4 | 2005 | $ 17,500 |
| Claimant 4 | 2006 | $ 29,920 |
| Claimant 4 | 2009 | $ 55,220 |
| Claimant 5 | 2007 | $ 6,166 |
| Total | | $159,537 |
WHAT IS āORIGINAL INFORMATIONā?
To hit the jackpot under Dodd-Frank, the whistleblower must provide what is called āoriginal information.ā 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; and
- Is 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 āoriginal information.ā
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; or
- Any 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 ācorruptā; 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 autho...
