Category Archives: SEC

SEC Awards Whistleblower-Executive A Half-Million Dollars For “Reporting Out.”

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The SEC has doled out over $50 million in awards to 15 individuals since it inaugurated the Dodd-Frank mandated whistleblower program 3 years ago. That program permits whistleblower awards of 10% to 30% of the total money recovered from a securities law violator provided the sanctions exceed $1 million. Whistleblower awards are usually restricted to individuals who provide original information derived from their independent knowledge or analyses. Failure to be deemed an “original” source of information is ordinarily the end of a whistleblower claim.

On March 2, 2015, however, the SEC approved an award of $475,000 to $575,000 to an unnamed executive who merely passed along original information.[1] That award stemmed from a special carve-out designed to incentivize officers and directors to report out where the company fails to take corrective action. Specifically, an executive may be entitled to a whistleblower award if he or she reports information to the SEC 120 days after alerting upper management of the problem. Similarly, if upper management is already aware of the problem at the time the executive learns of it, the executive-whistleblower must wait 120 days before reporting to the SEC.

The rationale for the 120-day rule is two-fold. On the one hand, the SEC wants to protect companies that have robust compliance programs in place and a strong compliance tone from the top. After all, companies who invest in compliance programs and take potential violations seriously should be afforded a safe harbor whereby they are protected from individuals hoping to make a quick buck by passing information along before the 120-day period expires.

On the other hand, the SEC realizes that executives and directors are uniquely placed to take action when upper management will not remedy the problem. Executives regularly receive management and compliance reports and are often the first persons to whom an employee will turn to report an issue. The SEC wants to incentivize such executives to step forward when upper management refuses to take corrective action.

However, an executive considering becoming a whistleblower risks significant reputational and financial harm. Although the whistleblower process is anonymous, upper management at the company may be able to figure out who reported out and may take retaliatory action against that individual.   Or, the individual may have already resigned due to irreconcilable differences with the company. In either case, there is no guarantee of a whistleblower award. Accordingly, executives and directors thinking about “reporting out” should carefully consider the quality of the information they possess and the potential financial and reputational risks.

[1] https://www.sec.gov/news/pressrelease/2015-45.html#.VP79EIHF87M

Federal Judge Reminds Plaintiff Investors That Securities Laws Are Not Broad Insurance Against Market Losses

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On September 30, a federal judge dismissed a putative class action against New Energy Systems (“New Energy”), a lithium battery company with Chinese operations, finding that plaintiffs had failed to connect the dots between the alleged misrepresentation (overstated earnings) and any drop in stock price when the “fraud” was revealed.[1] Because there was no material change in stock price when New Energy amended its SEC filings thereby “revealing” the company’s problems, the plaintiffs attempted to tie their losses to an earnings press release, issued 8 months after the amended filings. The Court flatly rejected this later, “materialization of concealed risk” theory.

The Complaint focused on income discrepancies between New Energy’s 2008-2009 filings with the SEC and its filings with the Chinese equivalent of the SEC. Plaintiffs alleged that the revenue and earnings numbers in the SEC filings were hundreds and sometimes thousands of percentage points higher than the numbers in the Chinese filings. Both sets of numbers were publicly available to investors.[2]

Then, in March 2011, New Energy amended its Chinese filings such that they conformed to the higher numbers in its SEC filings. The market had no reaction whatsoever to the amended filings. In November 2011, however, New Energy issued a press release announcing a 42% decline in year-over-year revenues for the third quarter of 2011. The stock dropped 48.6%.[3]

Plaintiffs argued that the late 2011 drop after the press release was connected to an ongoing fraud dating back to 2008 and that New Energy had merely covered up past problems by moving such losses into its late 2011 numbers, rather than coming forth and admitting that the 2008-2009 amended filings were false. The Court rejected this late “materialization of concealed risk” as too tenuous, finding no link between the loss in late 2011 and the alleged misstatements about income for 2008-2009. Among other things, the Court noted that, “private securities fraud actions are available not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause.”[4]

Importantly, it does not appear that the Court completely shut the door – the Order does not state the complaint is dismissed with prejudice. It may be that the plaintiffs can try to amend or re-file with sufficient allegations to better tie the November 2011 “corrective disclosure” to a particular fraud. But the message is clear, would-be plaintiffs must allege facts sufficient to show that their losses are at least “within the zone of risk concealed by the misrepresentations and omissions” about which the plaintiff complains.

[1] In re: New Energy Systems Securities Litig., 12-cv-01041 (LAK), Dkt. No. 49 (S.D.N.Y. Sept. 30, 2014).

[2] See id. at 3-4.

[3] See id. at 4.

[4] See id. at 7.