By MICHAEL SMALLBERG
A House panel voted along party lines yesterday to approve legislation that would eviscerate the whistleblower incentive and protection programs at the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC).
Congress created these new programs as part of the Dodd-Frank financial reform legislation, recognizing that whistleblowers play a vital role in uncovering corporate fraud but are often reluctant to come forward due to fears of retaliation. Despite coming under significant pressure from industry groups seeking to gut these measures, the SEC and CFTC approved regulations to provide significant incentives and protections to whistleblowers.
Having failed to gut these programs through the rulemaking process, industry groups and their congressional allies are now trying to undo the original whistleblower provisions in Dodd-Frank. Yesterday, the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises gave law-breaking companies an early Christmas present by passing the “Whistleblower Improvement Act of 2011” (H.R. 2483), introduced by Rep. Michael Grimm (R-NY).
Earlier this week, POGO and its allies wrote to the Subcommittee expressing our strong opposition to Rep. Grimm’s legislation. The letter was entered into the record at yesterday’s mark-up. We argued that H.R. 2483 is an “extreme approach that would silence would-be whistleblowers, endanger critical inside informants, undermine investigations, hamstring enforcement at the SEC and CFTC, and provide lawbreaking financial firms with an escape hatch from accountability.”
Specifically, H.R. 2483 would require most whistleblowers to report problems internally to their employer before coming to the government in order to qualify for an award. It would require the SEC and CFTC to tip off companies under investigation before commencing an enforcement action based on a whistleblower tip. It would remove a provision that guaranteed a minimum award amount for tips leading to a successful enforcement action. And it would allow companies to force their employees into contractual agreements that would prevent them from reporting to the government.
Rep. Grimm’s proposals have garnered support from the Chamber of Commerce and other industry groups. But whistleblowers, agency officials, and other experts are pushing back, arguing that H.R. 2483 would hamstring the SEC and CFTC’s enforcement efforts, shield law-breaking companies from accountability, and place whistleblowers in harm’s way.
Harry Markopolos—who repeatedly tried to warn the SEC about Bernard Madoff’s Ponzi Scheme—wrote that H.R. 2483 “reads as if it were a wish list from those who once designed the Enron, Madoff, Global Crossing, Stanford, and WorldCom frauds.” And SEC Chairman Mary Schapiro pointed out that the agency’s rules already include provisions aimed at supporting internal compliance programs. She also reported that the program is “providing significant benefits to the SEC, both in terms of the high-quality tips of potential securities law violations we are receiving and the efficiencies it is creating in our enforcement of the securities laws.”
At yesterday’s mark-up, Rep. Grimm offered a passionate defense of his legislation, which was slightly modified by a manager’s amendment. He pointed out that many companies have invested significant resources to establish their compliance programs after the passage of Sarbanes-Oxley. Most of the time, he argued, corporate fraud is an isolated incident that internal compliance programs are well-equipped to address. He highlighted a provision in his legislation that would allow whistleblowers to come directly to the government if the SEC or CFTC determines that internal reporting is not a viable option for the whistleblower, such as cases where senior management is complicit in the alleged misconduct. He observed that the SEC has often mishandled whistleblower tips and allowed investigations to languish, resulting in even greater losses for investors and shareholders. And he noted that the SEC already informs companies of pending investigations on a regular basis and gives them an opportunity to handle the problem internally.
To be sure, the SEC is still cleaning the egg off its face from previous debacles in which the agency mishandled whistleblower tips or failed to protect whistleblowers from retaliation. Just ask the tipsters who tried to warn the agency about the Madoff and Stanford Ponzi schemes, market timing at Putnam Investments, JPMorgan’s failure to comply with an SEC probe, or overvalued investments at Allied Capital, just to name a few. Senator Charles Grassley (R-IA) wrote to Chairman Schapiro earlier this year raising concerns about the agency’s long-standing “hostility towards and skepticism of whistleblowers.”
In recent years, however, the SEC has made significant improvements to its whistleblower intake system. For instance, Dodd-Frank required the agency to establish a new Whistleblower Office to handle the intake process. Congress should be conducting regular oversight to ensure that these reforms are working, rather than outsourcing the SEC’s investigations to the companies accused of wrongdoing. In fact, Rep. Grimm’s legislation would only exacerbate the problems that he identified. For instance, he would only allow whistleblowers to go directly to the SEC or CFTC if the agencies determine that internal reporting is not a viable option. But as Chairman Schapiro pointed out, this would require the agencies to conduct an extra preliminary investigation into the company’s governance and compliance policies, diverting resources away from investigations into the underlying misconduct and giving law-breaking companies an early heads up that they’re under investigation.
Rep. Grimm is correct that the SEC and CFTC routinely give companies an opportunity to conduct their own internal investigations into allegations of misconduct. The problem is that his legislation would require them to do so in nearly every case, removing any element of regulatory or prosecutorial discretion. One would think that Rep. Grimm, a former undercover FBI agent, could appreciate the need for federal agencies to occasionally keep their investigations a secret from the companies under investigation.
Along these lines, many employees have and will continue to utilize their employer’s internal compliance programs as a first step, as highlighted in a study by the Ethics Resource Center and in recent testimony before the Subcommittee. In fact, the SEC and CFTC’s regulations already incentivize internal reporting. But Rep. Grimm’s legislation would force employees to report problems internally, unless they can pass the high barrier to prove that internal reporting is not a viable option. This proposal demonstrates a remarkable lack of trust in the rank-and-file employees who know the most about the ethical culture within their companies.
We appreciate that many members of the Subcommittee fought back against the proposals in H.R. 2483. Rep. Carolyn Maloney (D-NY) argued that the legislation should be called the “Throw the Whistleblowers to the Wolves Act,” and pointed out that Congress should give the SEC Office of Inspector General a chance to complete its Dodd-Frank-mandated review of the agency’s whistleblower program before agreeing to make any changes. Subcommittee Ranking Member Maxine Waters (D-CA) introduced an amendment to remove the requirement for agencies to tip off companies under investigation before commencing an enforcement action based on a whistleblower tip, but it was rejected along party lines. The Subcommittee did approve another amendment introduced by Ranking Member Waters that would expand the scope of a proposed GAO review of the whistleblower programs, but the most dangerous provisions in the legislation still remain.
All told, Rep. Grimm’s legislation would hobble SEC and CFTC enforcement, chill the flow of high-quality insider tips, imperil the safety and livelihood of whistleblowers, and give law-breaking companies an accountability escape hatch. We urge the full Committee to put a stop to this dangerous bill before it advances any further.
Michael Smallberg is a POGO Investigator.
Image via U.S Embassy Kabul Afghanistan.