Hot Tips: Whistleblowers and Financial Fraud

April 2010

IN THIS ISSUE

— Seeking Whistleblowers: Behind SEC Call for Financial Fraud Tips
— Managing Assets: How to Handle Whistleblowers
— In the next issue

GREETINGS!

Welcome to the April edition of our newsletter! In this issue, we’ll look at the U.S. Securities and Exchange commission’s efforts to increase whistleblower tips concerning financial fraud, its effectiveness, and how to best handle whistleblowers.

SEEKING WHISTLEBLOWERS: BEHIND SEC CALL FOR FINANCIAL FRAUD TIPS

In the wake of the Bernie Madoff scandal, where the SEC was chastised for not heeding the warnings of Certified Fraud Examiner Harry Markopolos until it was too late, the commission’s inspector general, David Kotz, has publicly contemplated creating “incentives,” monetary or otherwise, for whistleblowers who lead officials to financial frauds. Although such a system exists to a degree within the “qui tam” / false claims actions in federal courts, where a whistleblowing “relator” receives a portion of the fine levied against a fraudster, it is unusual for enforcement agencies to consider doing such things in-house. (Although the SEC now has a web site to file complaints.)

Whistleblowers, of course, can provide a unique perspective on frauds that occur, as many of them are fellow employees, customers or clients of the fraudsters themselves. Recent research suggested that whistleblowers tipped off authorities to 17 percent of frauds (in the group of 216 cases examined from 1996 until 2004), compare with 14.5 percent of tips coming from short sellers (looking for information to drive a stock price down), and analysts 13.8 percent. The SEC itself, offering a carrot to the whistleblowers? Only 6.6 percent of cases.

MANAGING ASSETS: HOW TO HANDLE WHISTLEBLOWERS

There are risks associated with whistleblowers, of course — and not just to the whistleblowers themselves. one drawback to employee tip lines is that they can be a forum for petty complaints, making it time consuming to separate legitimate complaints from gossip and office retribution. Negative events can affect whistleblowers and their colleagues, especially as layoffs occur after a major financial fraud is unearthed. Although federal protections exist to punish employers who retaliate against whistleblowers, there are some rules of thumb for fraud examiners to remember when evaluating whistleblower information.

While maintaining a proper chain of custody is essential in documenting any investigative effort, it is even more crucial in whistleblower situations, where bits of information can often be the initial thread of a fuller investigative effort. (Also be aware of right to counsel for union employees where appropriate.) Well-documented interview memos, supplemented as needed by telephone or e-mail review (to help convert a witness’ recollection of events into a factual time line) can turn vague accounts into a more formal report about which you can testify in open court if the need arises. Be sure to work with counsel to maintain privilege over investigative work product, and “trust but verify” when it comes to a whistleblower’s account of events. With a skeptical but cooperative eye, allegations can become investigative findings that can save your company money, time, and public relations nightmares.

IN THE NEXT ISSUE

In the May issue, we’ll examine the money laundering technique known as “smurfing” and how suspicious activity reports and other documentation can help catch an often cash-based fraud scheme.