Whistle-Blowing Insiders: ‘Game Changer’ for the S.E.C.

Although there have been many complaints about the Dodd-Frank Act, one area generally hailed as a success is the whistle-blowing program at the Securities and Exchange Commission. Since the program’s creation in 2011, the S.E.C. has received more than 14,000 tips, including almost 4,000 last year.

That number falls well short of the original estimate of 30,000 submissions each year, but quality is far more important than quantity. Not surprisingly, agency officials heap praise on the program. Mary Jo White, the S.E.C. chairwoman, called it “a game changer for the agency,” while the director of the enforcement division, Andrew J. Ceresney, said that whistle-blowers “had a transformative impact.”

Figuring out how well a program is doing is always difficult because the sponsor has every reason to claim success. As the scandal caused by Bernard L. Madoff’s Ponzi scheme shows, it is as much a matter of taking whistle-blowers seriously as it is getting them in the door.

Five years into the program, it is clear that some of the best information comes from corporate insiders. They can give the S.E.C. a map to how a firm operates and where to look for wrongdoing.

A $22 million award to an internal whistle-blower at Monsanto announced last week is a good example of the impact an internal whistle-blower can have in showing the S.E.C. where there may be problems inside a company.

Monsanto in February settled charges of violating accounting rules related to the recording of the costs of a rebate program for Roundup, one of its leading consumer products. The company offered rebates to its distributors to increase sales but shifted those costs into the next fiscal year. By not recognizing the expenses right away, it was able to push up its revenue while delaying the reduction caused by recognizing the costs, something that investors would certainly want to know in evaluating how a company is doing.

Accounting shenanigans are notoriously difficult to uncover, especially for a company like Monsanto, which has annual sales of more than $10 billion and multiple product lines. The amount of the rebates was comparatively small, less than $100 million over two years, so it is unlikely it would have been noticed by the S.E.C. without a whistle-blower saying where to look.

The agency knows well that accounting problems at a company usually start small and then can grow to take on a life of their own, so catching a violation early on is the best way to keep a business from veering into bigger problems. In announcing the $22 million award, which is one of the largest given by the commission, the head of the whistle-blower office, Jane A. Norberg, said that “without this whistle-blower’s courage, information and assistance, it would have been extremely difficult for law enforcement to discover this securities fraud on its own.”

When the rules for the whistle-blower program were first announced, companies objected that there was no requirement for an employee to report wrongdoing internally before providing information to the agency. Internal whistle-blowers account for nearly half of those receiving awards, and the S.E.C.’s most recent annual report to Congress on the program notes that 80 percent of them either reported their concerns to management or said that the corporate compliance office was aware of the issue.

The internal whistle-blower presents a real threat to a company, not only from the S.E.C., but also from the Justice Department, because any violation of the securities law can result in a criminal prosecution. The winding-down of Visium Asset Management, a multibillion-dollar hedge fund, shows how a disgruntled former employee who goes to the government can wreak havoc on a firm.

Stefan Lumiere, a former portfolio manager at Visium, was charged in June with a scheme to mismark securities held in a credit fund that he helped manage, which invested in the debt securities of health care companies. He is accused of inflating the value of the investments and not identifying how some were highly illiquid. His boss, Christopher Plaford, has already pleaded guilty to securities fraud and insider trading charges, and is cooperating in the case.

A major feature of the government’s case against Mr. Lumiere are recordings made by a junior trader at the firm of more than 125 conversations with colleagues, totaling almost 200 hours, after agreeing to cooperate in the investigation. Visium itself has not been charged with any wrongdoing.

The indictment calls the trader “CC-1,” the typical nomenclature for a cooperating co-conspirator, who Bloomberg News reported is Jason Thorell. According to an affidavit filed by a F.B.I. agent, Mr. Thorell received immunity from prosecution and the case “could indirectly result in a financial benefit” to him. The S.E.C. filed a parallel lawsuit against Mr. Lumiere and Mr. Plaford, so the financial benefit is likely to come from a whistle-blower claim Mr. Thorell might have for providing information that led to the cases.

The prerequisite to receiving a whistle-blower award is that the S.E.C. will recover more than $1 million from enforcement actions based on the information provided, so any payment will have to await the resolution of the cases. At the Justice Department’s request, the S.E.C. lawsuit against Mr. Lumiere has been delayed until the criminal charges are resolved.

One factor that could increase an award, which can range from 10 to 30 percent of any monetary sanctions recovered, is whether the case involves an area that is an agency priority, such as misconduct involving a regulated entity or an industrywide practice. That certainly applies to this case, because the S.E.C. has been focusing its attention recently on how hedge funds value illiquid investments, and Visium was an investment adviser that owed a fiduciary duty to its clients.

Any claim Mr. Thorell makes as a whistle-blower raises the interesting question about whether someone who participates in wrongdoing can receive an award. Mr. Thorell, according to Bloomberg, helped obtain sham quotes used to inflate the price of the securities in the Visium credit fund that were an important part of the mismarking, so he was in the middle of any violations.

The answer is that even a violator can receive an award, but it may be reduced or denied based on the person’s level of involvement in the violations. Under the S.E.C. rules, a whistle-blower’s “role in the securities violations” and whether the person financially benefited from the conduct can be taken into consideration in the final decision.

As is often the case, the best information comes from someone involved in the misconduct who left the company and may hope to cash in by turning over information to the government. The S.E.C. may be willing to overlook the acts of a lower-level trader in deciding how much it might give if the recovery exceeds $1 million.

The S.E.C. no doubt hopes that large awards will draw the attention of corporate employees who can provide information; for some, the awards are almost like winning the lottery. The $22 million payment to the Monsanto employee is the second-largest in the history of the program, after a $30 million award in September 2014.

But much like buying a Powerball ticket, the chances of scoring a big whistle-blower award appear to be quite low, at least when one considers the number of tips the agency receives and the likelihood that it will lead the S.E.C. to obtain a significant recovery from a company.

Just as important, not every internal whistle-blower is in it for the money. Eric Ben-Artzi, a former risk manager at Deutsche Bank, turned down an $8.25 million award for information he provided about how the bank inflated the value of its credit derivatives portfolio during the financial crisis that resulted in the payment of a $55 million penalty in May 2015.

In an op-ed article in The Financial Times on Aug. 19, he said that the bank and its shareholders were the victims of the misconduct by having to pay the fine while “top executives retired with multimillion-dollar bonuses based on the misrepresentation of the bank’s balance sheet.”

Mr. Ben-Artzi’s refusal signals that whistle-blowing has truly come of age when someone shows that it is more than just the potential reward that motivates the revelation of misconduct. That sends a signal to companies that wrongdoing in the ranks will not go unnoticed for long, with the S.E.C.’s awards an additional motivation.