The “Great Recession” of 2007–2009 was caused by weak regulation of the financial industry, which allowed financial institutions to press creative and aggressive mortgage lending practices (i.e., the growth of subprime mortgage market). Lenders of these products commonly bundled these subprime mortgages into portfolios and sold them as investments to other financial institutions. When the housing market collapsed, it triggered an extensive default on subprime mortgages, a significant investment portfolio for major investment banks including Bear Stearns and Lehman Brothers. This led to the financial crisis and subsequent bailout of U.S. banks. Although the recession ended in June 2009, many feared that the U.S. economy remained exposed to repeat the same disaster. As a result, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The act provides stronger regulation of the financial industry intended to curtail future corporate fraud and prevent future financial disaster.
Dodd-Frank Whistle-blower Rule
To encourage prompt reporting of corporate fraud directly to the SEC, the Dodd-Frank Act created a whistleblower program. Under Dodd-Frank, a whistleblower is defined as a person who provides information relating to a violation of the securities laws to the SEC. Two provisions in the law encourage and protect whistleblowing.
First, Dodd-Frank contains a bounty provision. A whistleblower is entitled to an award if original information is provided to the SEC and it leads to successful enforcement action. The award can be lucrative: A qualifying whistleblower can receive a cash award equal to 10% to 30% of sanctions collected by the SEC from the violating company.
Second, Dodd-Frank contains an anti-retaliation provision, which provides protections to encourage individuals to take the career risk associated with whistleblowing. If an employer fires, demotes, suspends, harasses, threatens, or discriminates against an employee in retaliation for whistleblowing, the whistleblower is entitled to sue the employer in federal court. The whistleblower is not required to exhaust a series of administrative requirements before the suit, as is required under the rules established by SOX. An individual has up to six years to sue. The whistleblower’s recovery for successfully suing an employer is receipt of double back pay plus interest, as well as job reinstatement and compensation for litigation costs, expert witness fees, and reasonable attorneys’ fees.
A Twist from the Supreme Court
In February 2018, the U.S. Supreme Court rendered a decision that has a significant impact on the process of recovering under the anti-retaliation provisions of the Dodd-Frank Act. In Digital Realty Trust, Inc. v. Somers [138 S. Ct. 767 (2018)], the vice president of portfolio management at Digital Realty, Paul Somers, reported suspected securities-law violations to senior management. This internal report, made about his immediate supervisor the senior vice president of the Asian Pacific region for Digital Realty, stated that his immediate supervisor had eliminated internal controls over certain corporate actions in violation of SOX. Reported acts of misconduct included the hiding of $7 million in cost overruns on a Hong Kong development project.
Somers was shortly fired after making this report. Before being terminated, Somers did not make an external report to the SEC, or any other external enforcement agency, nor did he file an administrative complaint within 180 days of his termination as required to obtain relief under SOX. Because Somers failed to follow the required SOX administrative procedures to recover for retaliation, he filed a retaliation suit against his employer using the Dodd-Frank Act.
The case reached the Supreme Court, where a final decision was rendered that impacts the recovery rights of all whistleblowers who have been retaliated against by an employer. The Court unanimously held that the anti-retaliation protections of the Dodd-Frank Act are limited to those whistleblowers who report securities violations directly to the SEC while they are still employees. Somers did not fall within the scope of a protected whistleblower under Dodd-Frank because he failed to inform the SEC of the violations while he was an employee of Digital Realty. In short, he was left with no federal remedy to recover for his wrongful termination.
Prompt Response by the SEC
The SEC quickly responded to the Court’s interpretations in the Digital Realty case. Before the case, the SEC interpreted the anti-retaliation protections to be applicable regardless of whether a report was made to the SEC, another government agency, or internally to an employer. It also allowed telephone tips to qualify. In 2018, the SEC proposed changes to Rule 21F-2 that would bring its enforcement in conformity with the holding of the case. Under the proposed rules a person is afforded anti-retaliation protection only when the person is, first, granted whistleblower status.
To obtain whistleblower status a person must meet three conditions: First, the whistleblower must be an individual; entities do not qualify. Second, the individual must provide information in writing to the SEC. The form can be through the online portal at http://www.sec.gov or by mailing or faxing the Form TCR (Tip, Complaint, or Referral) to the SEC’s Office of the Whistleblower. Third, the information must relate to a possible violation of the federal securities laws.
To be eligible for employment retaliation protection, proposed Rule 21F-2(d)(1)(i) requires that a person qualifies as a whistleblower (i.e., has whistleblower status) prior to experiencing the retaliation for which redress is sought. As noted above, the Court denied Somers’s anti-retaliation protection because he did not provide information to the SEC before being fired. His termination was the retaliation he was seeking to recover for, but the retaliation occurred before he obtained whistleblower status.
The decision appears to create a clear path for employers to minimize the monetary damages that could result from their misdeeds.
Implications for Employers
There are two possible consequences for employers with regard to the ruling in Somers. First, the decision appears to create a clear path for employers to minimize the monetary damages that could result from their misdeeds. An employer can avoid the severe anti-retaliation punishments found in the Dodd-Frank Act by promptly terminating an employee making an internal report of suspected violations. To accomplish this feat, as was done in Somers, the termination must simply occur before to the employee makes an external report to the SEC. This may not be much of a hurdle if the employee makes his or her identity known by first expressing concerns to a supervisor. Employers set on protecting the company’s bottom line, themselves, and company reputation would be motivated to immediately retaliate against the internal whistleblower by terminating their employment. This could reduce financial exposure to severe penalties of Dodd-Frank.
Second, this ruling appears to encourage behavior that would deprive an employer of the ability to demonstrate self-correction. If an employee makes an external report to the SEC, which is then followed by an internal report to the employer, while the employer is considering the complaint, the SEC could step in while the employer is considering the complaint with an official investigation and prevent the company from correcting the problem. Even worse, if the employee chooses to make an external report only, senior executives may be blindsided by the SEC. In such a scenario, the employer is denied the opportunity to hear, investigate, and take corrective action.
Implications for Employees
From an employee’s perspective, the ruling in Somers may encourage less desirable employee behavior. First, employees would be motivated to disregard internal reporting procedures and promptly report any perceived violations directly to the SEC. Second, faithful and well-intentioned employees who properly follow internal reporting procedures are at risk of being immediately terminated and deprived of the retaliation protections of the Dodd-Frank Act. Before this ruling, a study demonstrated that 46% of employees do not blow the whistle for fear of retaliation and 21% of those who did internally report misconduct faced some form of retaliation (Mintz and Morris, Ethical Obligations and Decision Making in Accounting: Text and Cases, 4th Edition, McGraw-Hill Education, 2020, p.164). This rule serves as a further disincentive for employees to internally whistle-blow.
The intent of the Dodd-Frank whistleblower provisions is to encourage prompt reporting of suspected violations directly to the SEC. However, the recent Court ruling appears to have significant unintended consequences. Somers may inadvertently contribute to worsening employer-employee relations and corporate culture. Employers need to develop and maintain a company culture where employees feel comfortable reporting wrongdoing internally and are protected after they have done so.
The Court ruling does not incentivize the development of such a corporate culture; instead, it appears to encourage distrust. For example, what if an employer puts in place detailed rules for reporting violations and a strict code of conduct that includes consequences for breaking these rules? An employee must decide whether to follow these rules. If an employee chooses to report the employer’s violations externally, couldn’t an employer argue that it terminated the employee, not in retaliation for the act of whistleblowing to the SEC, but as a consequence of the employee not following company policy for internal reporting of misconduct?
Additional Implications for CPAs
CPAs are commonly looked to as the financial watchdogs of business. They are often in the best position to recognize and expose fraud within their company. Certain CPAs within a company have a pre-existing legal obligation to report securities violations and therefore do not qualify for whistleblower awards. For example, CPAs with internal compliance or internal audit responsibilities who are whistleblowers are not eligible to recover the bounty award because it is their duty to report misconduct to management.
There are three exceptions to this rule whereby these individuals can receive awards. One, SEC disclosure must be needed to prevent substantial injury to the financial interest of the company or its investors. Two, the whistleblower must reasonably believe that the company is hindering an investigation of misconduct. Three, the whistleblower must first report the violation internally and wait at least 120 days to report the violation externally.
This ruling appears to encourage behavior that would deprive an employer of the ability to demonstrate self-correction.
Although certain whistleblowers are not entitled to recover the bounty, they can still qualify for the anti-retaliation protections under Dodd-Frank. However, in considering such an option, a CPA is placed in a precarious situation. CPAs are legally bound to report violations to senior management, but in order to receive retaliation protection under Dodd-Frank, they must report the violations to the SEC and do so before the occurrence of retaliation.
The Institute of Management Accountants (IMA) revised its Statement of Ethical Professional Practice (SEPP) in July 2017. SEPP provides some general guidance on resolving ethical issues in “Resolving Ethical Issues.” It provides that IMA members should follow the established policies of their organization, including an anonymous reporting system if available. However, considering the decision in Somers, this may not be in the best interest of the accountant-employee. The new integrity standard in SEPP requires that IMA members not ignore unethical issues and seek to resolve the issues. The IMA also advises that “in determining which steps to follow, the member should consider all risks involved and whether protections exist against retaliation.” In choosing whom to report to first, the accountant should consider many variables, including the risk of retaliation by the employer, the employer’s inclination to destroy evidence or cover up a violation, the extent that senior management is profiting from the violation, and the adequacy of the company’s compliance program.
Because of the complexities of the whistleblower laws, any potential whistleblower should seek the counsel of an experienced attorney before making internal or external reports of securities violations. Failure to consult expert legal counsel before taking action could leave the whistleblower in the same situation as Paul Somers—no federal remedy to compensate for retaliation.