Dodd-Frank Whistleblower Provisions

Key considerations for asset managers

Originally published in the June 2012 issue

It’s hard to imagine a more enticing incentive to dish dirt on one’s employer than the whistleblower provisions of the Dodd-Frank Act. U.S. government enforcement actions could probably lead to recovery of tens-to-hundreds of millions of dollars in fraud and corruption cases. A whistleblower who provides original information leading to a conviction can receive a bounty of 10-to-30 percent of the recovery amount. Such substantial monetary incentives, combined with the government’s commitment to prevent a repeat of the fraud and scandals of recent years, suggest that more whistleblower cases are likely to come. And, fraud and corruption will remain a prevalent topic among investors.

Asset managers will likely feel more pressure to demonstrate that they have taken appropriate steps to help safeguard the money they invest from losses caused by fraud. Investors will expect strong anti-fraud and anti-corruption programmes and controls. By developing an action plan that demonstrates necessary measures are in place, and instilling trust among employees that their concerns can be properly handled internally, fund managers can position themselves to possibly avoid potentially crushing governmental penalties.

How the whistleblower programme works
Under the programme, the U.S. Securities and Exchange Commission (SEC) will pay a bounty from the monetary sanctions it recovers from a company if the whistleblower provides original information leading to enforcement action and the recovery exceeds $1 million.Given the potential magnitude of such payments, it is arguable that few economic incentives exist that are more valuable than those this programme could possibly yield.

Whistleblowers can remain anonymous until the time they receive their award, and the programme provides strong anti-retaliation protections. Anyone working for the targeted company who is responsible for preventing or detecting infractions reported under this programme are not eligible to receive an award.The Dodd-Frank whistleblower rule does not require employees to report possible infractions to the company first, but it does provide economic incentives to do so. Employees who report through internal company channels and then to the SEC within 120 days will be credited for award purposes based on the initial internal reporting date. In determining the amount of each award, the SEC will consider to what extent the whistleblower effectively used or hindered, a company’s internal control programme.

Potential programme impact
The Dodd-Frank Act requires the SEC to issue an annual report on the activities of the whistleblower programme at the end of each fiscal year ending September 30. The first report, issued in 2011, reflected only seven weeks of activity from inception to September 30. During that time, the commission received 334 tips, which extrapolates to an annual rate of around 2,500 tips.

This calculation may understate the potential activity because seven weeks is too short a time period to produce a representative sample. In attempting to staff up and create an office to administer the programme, the SEC estimated it would receive approximately 30,000 tips, complaints, and referrals each year. Regardless of the actual number of submissions, it is highly likely that the volume will be far greater than the commission has ever received before.

Potential mistakes by fund managers
Like other companies, asset managers are trying to assess the impact of the whistleblower programme and determine what, if anything, they should do to proactively respond. Some fund managers may not view fraud as a specific risk management issue to be analyzed. They may assume that by addressing investment, operating, and compliance risks they have indirectly solved for fraud and corruption risks.

Psychological forces are also a factor. People may believe that material fraud could not happen at their company and do not see it as a real risk. Also, many may feel that if an insider really wants to commit a fraud, there is little management can do to prevent it.

With the likelihood of many more SEC investigations, as well as fraud and corruption remaining prevalent news topics, institutional investors could feel increasing pressure to demonstrate that they have taken appropriate steps to help safeguard the money they invest from losses caused by schemes. Because investors are not likely to uncover fraud or corruption at a fund during the due diligence process, they may focus more intensely upfront on the existence of strong prevention and detection programmes and controls before making an investment decision.

An effective whistleblower programme
Individual asset managers will want to tailor their anticorruption and antifraud controls to their risks and their culture. However, some general characteristics of a whistleblower programme are applicable across fund management firms, including:

• The program is well publicized and easy to use by employees.
• Top management conveys a strong message that employees should use the program when they are aware of a problem.
• Tips are kept anonymous and administered by an independent third party.
• The program includes a strong anti-retaliation policy that employees can trust.
• Employees receive annual training on ethics policies and regulatory compliance.
• An annual fraud risk assessment is conducted that includes gap analysis of existing controls and plans for remediation.
• A report on the control program is provided annually to the company’s governance committee.
• Key controls are continuously monitored and tested.

One vital programme feature is a mechanism for receiving whistleblower tips and complaints and reporting back the status of management’s response. This is usually done by assigning a case number that the employee can use to anonymously track progress.

Whistleblower programmes only work when employees are well aware of and not afraid to use them. Said another way, non-anonymous programmes, for the most part, do not work. Also, properly functioning whistleblower programmes are only one of the elements in well designed and executed anti-fraud and anti-corruption programmes.

Preparation is key to prevention and control
Historically, the best thing that could happen to asset management employees would be to receive a promotion and raise, indicators of a long and prosperous career ahead at the firm. Today, however, one could argue that the best thing that could happen to asset management employees would be to discover a material fraud at their employer and receive a highly lucrative bounty from the SEC. So if the employees of most asset managers are highly incentivized to publicly report potential fraud or corruption where they work, should not asset managers be at least equally motivated to implement strong antifraud and anticorruption controls? Such controls could significantly impact an asset manager’s ability to stay in business if a fraud does occur, if those controls are sufficient enough to allow the asset manager to demonstrate to regulators and investors that proper steps were taken to detect and prevent fraud and corruption.

Adam Weisman is a partner in the Forensic & Dispute Services group of Deloitte Financial Advisory Services LLP where he leads the Asset Management Industry Sector practice.