To Crack Down on Securities Fraud, States Reward Whistle-Blowers

In the aftermath of the financial crisis, a growing army of confidential informants — better known as whistle-blowers — has helped federal securities regulators identify and prosecute wrongdoers.

Now the same thing is happening at the state level: Securities regulators in two states (so far) are enlisting the aid of these informants to enforce their own fraud statutes and protect residents from financial harm. And the whistle-blowers are reaping rewards.

On Aug. 19, for example, an informant was awarded $95,000 for helping Indiana securities regulators bring an enforcement action against JPMorgan Chase for failing to disclose certain conflicts of interest to clients about the way the bank invested their money. The monetary award was the first given under that state’s whistle-blower program aimed at securities law violators.

The informant supplied information about improprieties in JPMorgan Chase’s asset management unit, including its practice of steering clients to in-house funds that carried higher costs or generated greater fees to the bank. In a July settlement, the bank paid $950,000 to Indiana, whose officials characterized JPMorgan’s practices as “outside the standards of honesty and ethics generally accepted in the securities trade and industry.”

Connie Lawson, the Indiana secretary of state, said in an interview, “We would not have been able to develop this case had it not been for the information that was provided to us.”

Indiana’s program was created in 2012 by the state legislature and is overseen by Ms. Lawson. State officials can award up to 10 percent of monetary sanctions received in an enforcement action to a person who provided original and significant information that led to the case.

Utah is the other state with a whistle-blower program aimed at identifying securities law violations. Lawyers who represent whistle-blowers say such programs allow states to leverage their limited resources to crack down on fraud.

“There’s no way these state regulators can ferret out Wall Street’s latest crime,” said Edward Siedle, a forensic fraud investigator at Benchmark Financial Services who represented the Indiana informant. “Leveraging the power of the whistle-blower is tremendously helpful, and it’s not costing the state anything.”

Indiana’s case against JPMorgan parallels a recent Securities and Exchange Commission enforcement action against the bank. Late last year, the regulator said that JPMorgan had reaped $127 million in ill-gotten gains by directing clients into affiliated funds. The bank paid $307 million to resolve the matter, neither confirming nor denying the accusations.

In a phone interview, Michael Fusco, a spokesman for JPMorgan, provided the following statement about the Indiana settlement: “We have always strived for full transparency in client communications, and in the last two years have further enhanced our disclosures in support of that goal.”

The statement continued: “The disclosure weaknesses cited in the settlements were not intentional, and we regret them. We remain confident in our investment process and are proud of the way we manage money.”

Secretary Lawson of Indiana said the anonymity provided to whistle-blowers in her program allowed people with information to come forward without fear of reprisals from powerful financial institutions. “That will prevent potential harm to other investors,” she said.

Under Utah’s whistle-blower program, which took effect in May 2011, people providing information leading to the collection of at least $50,000 from a violator can receive up to 30 percent of those proceeds as an award.

Keith M. Woodwell, director of the Utah Division of Securities, oversees the whistle-blower program. In an interview, he said the program had resulted in 15 successful prosecutions across the state.

Utah issued its first award in 2014 to an investment adviser who tipped off state officials to approximately $150,000 in questionable transactions he had seen when analyzing an elderly client’s holdings. Utah followed up by bringing a securities fraud case and recovering the money. The whistle-blower received $20,000.

The main benefit of the program, Mr. Woodwell said, is that it encourages people to identify wrongdoing in real time, not after a fraud has occurred and restitution is unlikely.

“The problem we routinely face,” he said, “is we get lots of complaints, but well after the crime has been committed. If we can get people in the door sooner, we have a much better chance of freezing the assets and getting victims’ money back.”

The topic of possibly expanding state whistle-blower programs came up at a recent meeting of the North American Securities Administrators Association, the state securities regulators group. Laura Posner, chief of the New Jersey Bureau of Securities, said in an interview that the programs were viewed as a tool that both state and federal securities regulators could use to improve enforcement and deter financial fraud.