Key Whistleblower Changes in Bipartisan Budget Act

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The Bipartisan Budget Act of 2018, passed overnight and signed this morning by President Trump to end the second federal government shutdown of this year, includes two key provisions for whistleblowers previously introduced by Senator Charles Grassley but removed from the January budget deal.

For IRS whistleblowers, the law clarifies the term collected proceeds to include criminal fines and civil forfeitures as well as violations of reporting requirements. The IRS has previously taken the position that tax whistleblowers are only eligible for rewards based on fines pursuant to Title 26. This interpretation was rejected by the U.S. Tax Court last year and the Government appealed to the D.C. Circuit to reverse the decision. This section essentially resolves that appeal and affirms the U.S. Tax Court decision giving a broad definition to the term.

The legislation will also unify the tax treatment of whistleblower awards for the major laws. For some time, whistleblowers awarded money under the Federal False Claims Act and IRS whistleblower program were entitled to an above-the-line tax deduction for their attorney fees. The tax deduction did not clearly extend to CFTC and SEC whistleblowers, or rewards under the State False Claims Acts. These awards were subject to taxation of the entire amount received by the individual and then again for the amount paid by the client to the law firm.

In other words, IRC sections 62(a)(20) and 62(a)(21) allowed False Claims Act relators and IRS whistleblowers to only pay taxes for the amount received after paying their attorney fees. The law firm is responsible for paying tax on the amount of attorney fees that they are paid by their client. The legislation extends the above-the-line deduction to Dodd Frank Act whistleblowers and relators paid under the state False Claims Acts. Notably, it does not mention the Motor Vehicle Safety Whistleblower Act, which was

We have discussed these issues several times on this blog since the Grassley Amendments were initially introduced into the Senate’s Tax Cuts and Jobs Act in November 2017. If you have questions about these or other aspects of the whistleblower laws, please call 1-800-590-4116 to speak to a McEldrew Young whistleblower attorney.

Collected Proceeds Clarification for IRS Whistleblowers Dropped from Tax Bill

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The Wall Street Journal reported yesterday that the reconciliation of the tax legislation has dropped the definition of collected proceeds for the IRS whistleblower program introduced into the Senate version that passed. The amendment was added by Senator Chuck Grassley, an advocate for whistleblowers and responsible for introducing the legislative provision in 2007 that created the IRS whistleblower program.

The reconciliation process is used to achieve a final bill when there are differences in the bills passed by the House and Senate. The original version of the tax bill passed by the U.S. House of Representatives did not include Senator Grassley’s amendments.

The definition of collected proceeds for the IRS whistleblower law is currently under review by the U.S. Court of Appeals for the D.C. Circuit. The proposed measure would have codified an interpretation of the term collected proceeds to provide whistleblowers a percentage of both criminal fines and civil forfeitures. The IRS argued in U.S. Tax Court last year that these funds were not included in the term. The U.S. Tax Court decided a broad interpretation of the term was warranted in a decision that favored the whistleblowers. The ruling is now on appeal.

The reconciled bill also appears to have eliminated Senator Grassley’s other proposed amendment, to clarify that SEC and CFTC whistleblower awards are exempt from double taxation under the Civil Rights Tax Relief Act (adopted as part of the American Jobs Creation Act of 2004).

The potential for double taxation is created when successful whistleblowers must pay tax on the entire amount of their award and then the whistleblower’s attorney pays tax on the portion they receive from the contingency fee. The Relief Act allows for an exemption for the contingent fee portion so that only one tax payment is made. As always, consult a tax lawyer for specific legal advice with regard to tax issues.

The reconciliation was passed by the U.S. House, 227-203, and the U.S. Senate, 51-48. It will now be sent to President Trump’s desk for signature.

SEC Has Recovered Over $1 Billion Due to Whistleblower Tips

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Over the past week, the U.S. Securities and Exchange Commission has issued total rewards of over $20 million to three SEC whistleblowers. As a result, SEC enforcement actions involving whistleblowers have now recovered more than $1 billion in financial remedies against whistleblowers.

The SEC whistleblower program has been accepting tips for more than five years now and has been repeatedly acknowledged as an important tool in the government’s arsenal to detect and stop violations of federal securities laws.

In the first announcement (last week), the SEC split more than $16 million between two whistleblowers. According to the press release, the first whistleblower alerted the agency to the misconduct that became the focus of the investigation and the cornerstone of the enforcement action. The second SEC whistleblower on this matter provided significant additional information and provided ongoing cooperation that saved significant time and agency resources.

One interesting aspect of this announcement was that the second whistleblower received a similar award to the first. Although the SEC whistleblower program favors the first person to provide information to the U.S. Government, it makes clear that there is still substantial value to the Government in receiving information after the investigation has already started.

In the second announcement (two days ago), the SEC paid a former company insider more than $4.1 million for reporting a widespread, multi-year violation of the securities laws. According to the press release, the whistleblower was a foreign national working outside of the United States. The individual alerted the SEC to the fraud and provided assistance throughout the investigation.

No money has been taken or withheld from harmed investors to pay whistleblower awards. When Congress set up the whistleblower programs in the Dodd-Frank Act, it committed a certain amount of money in the budget to the payment of whistleblower awards. As a result, rewards are not paid out of the amount of funds recovered even though the amount of funds paid are expressed as a percentage of the money collected from the enforcement action.

More awards are expected. In the financial reports released about the program last month, the SEC recognized contingent liabilities of $221 million. This suggests that there are at least $200 million more in awards announcements coming.

SEC Cyber Unit Files First Action to Halt ICO Fraud PlexCoin

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The SEC today announced an enforcement action against the Initial Coin Offering (ICO) by PlexCoin. The SEC obtained a freeze on the purportedly $15 million in investor funds raised by PlexCoin from thousands of U.S. and international investors since August.

According to the complaint filed by the SEC in the emergency action, PlexCoin and its owners promised early investors returns of 1,354% in under 29 days. They also indicated the potential returns could be as high as 88,000% based on other ICOs or cryptocurrency investments. They made other misrepresentations too, including that they had a team of people operating in Singapore.

Quebec’s Financial Markets Authority obtained an injunction against the sale of PlexCoin Tokens but the Defendants continued to sell them. The U.S. alleged that the Defendants misappropriated at least $200,000 from investor funds for extravagant personal expenditures as well as would soon gain access to three accounts with more than $810,000 from their fraud.

The SEC press release praised the quick action of the Cyber Unit to protect retail investors and the Chief of the Cyber Unit said this “is exactly the kind of misconduct the unit will be pursuing.”

The SEC’s pursuit of fraud in the ICO market should come as no surprise since many have already warned about it.  Previously, Wikipedia founder Jimmy Wales told CNBC in October that many initial coin offerings were scams as he cautioned investors from participating. Brad Garlinghouse, CEO of Ripple (a large cryptocurrency), told CNBC that “a lot of what’s happening in the ICO market is actually fraud ….” Joseph Lubin, co-founder of ethereum, told CNBC that there has been “a lot of copycat projects” where the company was copying previously used materials and didn’t intend to deliver value to buyers.

In other bitcoin news, Thomas Peterffy, CEO of Interactive Brokers, expressed concerns to the CFTC that the launch of bitcoin futures could create a Lehman Brothers-style collapse of a clearing house if traders purchased too many futures and couldn’t cover the shortfall during a price decline.

The bitcoin futures contracts at the CME will start trading on December 18, 2017 and there will be a margin requirement of 35% for transactions, which is high for a currency.  CBOE trading will start on December 11th.  The Nasdaq has not yet confirmed media reports that they will soon allow trading in the digital currency.

If you have evidence of an ICO fraud, contact our SEC whistleblower attorneys by calling 1-800-590-4116. We offer a free, confidential consultation to evaluate your evidence and discuss the process of reporting to the U.S. Government.

Evaluating Cryptocurrencies for Potential Whistleblower Cases

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Cryptocurrency, led by bitcoin, has become a hot topic in the mainstream media recently. Both the CME and Nasdaq have announced plans to introduce trading in bitcoin futures. And the investing community continues to be split between those who believe it is the future of currency and those who believe it is a bubble or, worse, a fraud, as Jamie Dimon called it in September.

There are many big questions with uncertain answers about virtual currencies, including the right valuation, whether it is in a bubble, or how fraud will be dealt with given its current state of regulation. Amid these questions though, it seems almost certain that there will be more whistleblower cases involving bitcoin and other cryptocurrencies in the future. So we thought it worth beginning to talk about some of the issues that we are seeing.

In 2014, the U.S. Consumer Financial Protection Bureau (CFPB) called virtual currencies such as bitcoin the “Wild West” of financial products. However, the SEC has since made it clear that they consider qualifying ICOs subject to the registration requirements of the federal securities laws. The CFTC also came out with a publication in October 2017 that reiterated its 2015 stance that bitcoin and other such assets are commodities.

It seems likely that there will be many instances of unregistered offerings. A former lawyer for the SEC recently spoke at the ICO Forward Summit and suggested that there might be the creation of an assembly line for enforcement actions where the SEC issues a subpoena to participants in an ICO and then brings a lawsuit if the facts match a particular pattern of misconduct. As it relates to SEC whistleblowers, it is worth noting that there needs to be $1 million recovered in order to qualify for a reward.

There are also expected to be instances of ICO fraud. A company that raised nearly $375,000 through an initial coin offering, Confido, recently deleted its website and investors have lost contact with the company. According to media reports, the background of the CEO appears to be fake since two of the three companies on it have confirmed that they have no record of him. The cryptocurrency exchange which Confido used to launch its ICO has announced that it will reimburse investors.

There have also been cybercrimes. Nikkei Asian Review called digital currency thefts a record in Japan when hacking led to more than half a million dollars in reported cybercrimes in the first half of 2017. The cases involved unauthorized computer access to take bitcoin, ethereum, and Ripples’s XRP. Although the general hacking case is probably not eligible for a whistleblower reward, the hacking of a regulated entity like an investment bank to take bitcoins they are holding for customers could be a very different matter and get the attention of regulators.

There will probably also be IRS enforcement actions started as a result of IRS whistleblower tips. This is one area that the IRS has been digging into recently. A federal court has partially granted a request from the IRS for information about users of Coinbase, a cryptocurrency exchange allowing buy/sell trading functionality in 33 countries including the United States. According to the IRS in the request, less than 1,000 taxpayers identified capital gains or losses on IRS Form 8949 in each of the years 2013 through 2015. Given the popularity of virtual currency, the IRS obviously suspects that there is a great deal of tax underpayments among those earning profits from buying and selling bitcoins.

We’re keeping an eye out for other potential whistleblower cases that develop in this area. It is a topic that may seem like it is moving faster than the current regulation, but fast-growing new securities can lead to big government fines as a result of misconduct. It has not been that long since the government fined corporations billions for their conduct with respect to credit default swaps and residential mortgage backed securities from the recent financial crisis. After all, the credit default swap market was once also referred to as the Wild West.

SEC Issues Annual Whistleblower Report for 2017

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The annual SEC whistleblower report to Congress for Fiscal Year 2017 has been released. It provides information and data about the activities of the SEC Whistleblower Office (referred to in the report as OWB) from October 1, 2016 to September 30, 2017. Over the year period, the SEC received over 4,400 whistleblower tips during Fiscal Year 2017 and paid out awards totaling nearly $50 million. The SEC also brought a number of enforcement actions to address companies that unlawful retaliated against or impeded whistleblowers.

The SEC has now paid our approximately $160 million to 46 whistleblowers since the Dodd-Frank Act created the SEC whistleblower program. Three of the top four awards were announced in 2016 and two of the top 10 awards were announced in 2017. All three awards from FY2017 that were on the top 10 list involved the protection of investor funds.

As has been the case in several other reports, the annual report provided select anonymized data about the successful whistleblowers. Here is some of the data that we found interesting:

  • Two-thirds of them provided the impetus for the SEC to open the investigation. One-third of the paid whistleblowers assisted with an already-existing investigation.
  • About 62 percent of award recipients were current or former insiders of the entity they reported. Other types of insiders such as consultants or close affiliates, industry professionals, harmed or prospective investors, and other outsiders made up the rest.
  • Of the current or former employees, almost 83 percent raised their concerns internally to their supervisors, compliance personnel, through internal reporting mechanisms, or understood that one or more of these individuals were already aware of the information before they reported to the SEC.
  • The majority of individuals were represented by legal counsel at the time they initially submitted their tips to the SEC.
  • In cases resulting in awards, individuals represented 47% of the defendants, unregistered entities and companies 25%, and registered entities such as broker-dealers, investment advisors and other registered market participants were 28% of defendants
  • Nine recipients were foreign nationals or residents of foreign countries when they submitted tips.

The SEC also provided a chart of the percentage of primary securities violations in covered actions assisted by whistleblowers. Here is a summary of the chart:

Misrepresentations/omission violations: 28%
Corporate/issuer disclosure (i.e., FCPA, accounting and offering document issues): 22%
Offering fraud (including Ponzi and pyramid schemes): 22%
Trading violations (including insider trading): 11%
Sales and advisory practices violations: 8%
Other (including operational, registration and fees/markups/commissions violations): 9%

Breakdown of Whistleblower Tips Submitted in FY2017

We can also take a look at the division of tips going into the SEC according to the whistleblower’s own characterization of the violation type:

Corporate Disclosures and Financials: 954
Offering Fraud: 758
Manipulation: 468
Trading and Pricing: 271
Insider Trading: 231
FCPA: 210
Unregistered Offerings: 144
Market Event: 125
Municipal Securities and Public Pension: 67

Breakdown of International Tips

The SEC received tips in FY 2017 from individuals in 72 foreign countries. The top five countries outside of the United States for tips were:

United Kingdom: 84
Canada: 73
Australia: 48
China: 39
Mexico and Russia: 26 (tied)

Tips by State

The leading states for tips within America were:

California: 500
New York: 438
Texas: 250
Florida: 229
New Jersey: 175

The Chief’s Annual Message

The message from Jane Norberg, chief of the Office of the Whistleblower, at the beginning of the report specifically mentioned the “critical role of whistleblowers” in protecting investors. Since its inception, whistleblower tips have helped recover $671 million in disgorgement, the majority of which has or is scheduled to be returned to harmed investors. The focus on this role continues the message sent by the Enforcement Division last week in its report that protecting retail investors was a top priority of the securities regulator.

The other key aspect of Norberg’s message was Rule 21F-17 and the SEC’s enforcement of the whistleblower protections. We have written about these SEC regulation here before. Rule 21F-17 prohibits impeding communications between the SEC and whistleblowers. During the last fiscal year, the SEC brought a number of enforcement actions against corporations for efforts to uncover the identity of whistleblowers or restrictive language in severance and separation agreements. The SEC also independently brought an enforcement action for terminating an employee in violation of the Dodd-Frank whistleblower anti-retaliation provisions. Norberg said that reviewing allegations of violations of these laws would “continue to be a focus … in the upcoming fiscal year to ensure that whistleblowers can free report information … without fear of reprisal.”

The other area that was mentioned was the office’s hotline. Since the whistleblower hotline was established at the SEC, the OWB has returned over 18,600 calls from the public. In the last fiscal year, it returned nearly 3,200 calls, an increase over FY2016. We have found this to be a very helpful service that the SEC provides for whistleblowers and their attorneys.

The report also discusses the efforts of the Whistleblower Office on behalf of whistleblowers in federal court cases involving anti-retaliation provisions. It specifically mentions the U.S. amicus curiae brief filed in the Supreme Court in Digital Realty Trust, Inc. v. Somers, which is to be heard by the Court at the end of this month. Somers provides the Court the opportunity to hold that a whistleblower is protected by the Dodd-Frank anti-retaliation provisions even if they only reported internally to a manager or supervisor rather than file a Form TCR with the SEC.

The 2017 annual report is the second issued by Jane Norberg after she succeeded Sean McKessy. It marked the first full year of her leadership at the OWB. McKessy announced that he was leaving the SEC Office of the Whistleblower in July 2016.

Update

The SEC also released its financial report recognizing a contingent liability of $221 million for the year ending on Sept. 30, 2017.  This means that the SEC expects that additional whistleblower awards are probable in that amount.  The awards have not been announced yet and there is no indication at what stage the SEC will recognize a future payout as a contingent liability.

Our Offer

As always, our attorneys are available for a free, confidential initial consultation with potential SEC whistleblowers.  Please call 1-800-590-4116 to speak to an SEC whistleblower attorney at McEldrew Young.

SEC Enforcement Division Issues Annual Report on FY2017

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This week, the SEC Enforcement Division issued its annual report on its enforcement actions in Fiscal Year 2017 and its priorities for the future.

The SEC whistleblower office will put out a separate report, but the enforcement division noted that the SEC reviewed more than 16,000 tips and more than 20,000 reports of suspicious activity by broker-dealers. It will be interesting to see how many of the tips were through a Form TCR filed with the SEC whistleblower office versus tips provided through other methods. In past years, there have been roughly 4,000 Form TCRs filed.

Overall, the SEC had a good year in its enforcement actions in Fiscal Year 2017. The period of the report covers from October 2016 to September 2017, so it includes the last three months of President Obama’s term.

Over this period, the SEC brought 754 actions and obtained judgments and orders for more than $3.7 billion in disgorgement and penalties. Of the 754 actions, 446 were standalone actions in federal court or administrative proceedings, 196 were follow-on proceedings seeking criminal punishment or to bar an individual from securities involvement after another proceeding, and 112 were proceedings to deregister public companies for delinquent filings.

The SEC report also detailed the types of cases that were brought. The majority of actions were for issuer reporting (such as failure to report or accounting fraud), securities offerings and actions against investment advisors. Actions involving broker-dealers or cases involving insider trading and market manipulation made up the next tier of enforcement actions. In its list of noteworthy enforcement actions, it noted segments of cases involving a direct impact on retail investors, cyber-related misconduct, insider trading, issuer reporting/auditor misconduct, and other noteworthy actions (top two in this category were FCPA actions).

In FY2017, the SEC distributed a record $1.07 billion to harmed investors. A significant percentage of these funds were distributed from four funds setup following actions, although the total collective number of Fair Funds and Disgorgement Funds were over 50. The amount that the securities regulator is able to return to investors in the future will likely be limited by the Supreme Court’s decision in Kokesh v. SEC, which limited the period for disgorgement to the term of the statute of limitations (generally five years).

The SEC also noted noted five core principles. Of particular interest to our clients and potential whistleblowers will be three of them:

The Enforcement Division reiterated that one of its priorities is to protect the Main Street investor. The SEC formed a Retail Strategy Task Force to address harm to retail investors and announced they will continue to pursue securities fraud that impacts retail investors, including accounting fraud, pump and dump frauds, Ponzi schemes and other violations of the federal securities laws. Later in the document, it added other examples of misconduct to this list, including steering clients to higher-cost mutual funds, abuses in wrap-fee accounts, investment adviser recommendations to hold inverse exchange-traded funds, recommendations of unsuitable structured products to retail investors, and churning client accounts.

One of the priorities of the nation’s primary securities regulator is to keep pace with technology. The SEC noted that it is frequently encountering the broken of stolen inside information on the dark web and market manipulation through the hacking into of the electronic accounts of others. We continue to believe that this is going to be a fertile area for whistleblower tips in the next few years.

The SEC also plans to continue the pursuit of individuals who have engaged in wrongdoing. One or more individuals has been charged in more than 80 percent of the standalone enforcement actions brought by the SEC in the last six months. The focus on individual wrongdoers in addition to institutions will continue to be the rule, rather than the exception. The DOJ announced a similar stance two years ago encouraging an emphasis on individual accountability in the Yates Memo.

Over the next month, we’ll be getting a similar report from the CFTC and the Justice Department on the False Claims Act. Separate reports will be issued for the SEC, CFTC and IRS whistleblower programs, though the timing of these reports is a little less certain. Please stop back when they are posted to see summaries of them and our commentary.

Grassley Proposes Whistleblower Amendments to Senate’s Tax Cuts and Jobs Act

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Senator Grassley has proposed 15 amendments to the Senate bill for the Tax Cuts and Jobs Act. Two of those amendments are important to whistleblowers, so we are going to examine them in more detail here.

Amendment #1 from Grassley is intended to unify the tax treatment of whistleblower awards. The amendment seeks to extend the current above-the-line deduction available to successful whistleblowers under the Federal False Claims Act and IRS whistleblower program for attorney fees and court costs to other whistleblower programs.

What is an above-the-line deduction? It means that the US does not require the whistleblower to pay tax on the entire award (before subtracting out the portion paid under the False Claims Act or Internal Revenue Code Section 7623 (IRS Whistleblower program). This is provided for in IRC section 62(a)(20) and 62(a)(21).

If there is no above-the-line deduction, then the whistleblower pays tax on the entire amount of the reward as income and then the attorney would separately claim and pay taxes on the portion they are paid for fees as income.

The amendment would eliminate double taxation for the rewards under the State False Claims Acts, the SEC Whistleblower program, and the CFTC Whistleblower program.

Interestingly, the summary of the amendment does not mention the Motor Vehicle Safety Whistleblower Act, which was enacted in December 2015 as part of the FAST Act. This auto whistleblower law created a program at the Department of Transportation, likely to be handled by the NHTSA. As far as we have seen, the Department of Transportation has yet to issue the implementing regulations for it through. However, the NHTSA is accepting whistleblower tips according to its terms, which provide for submissions before the adoption of the final rules. We’ll be keeping a close eye when the precise language of the amendment is avaiable

Since the firm’s engagement letters do not cover tax advice on rewards and this is a complicated area of the law, we are unable to answer questions about specific situations. However, we do wholeheartedly support this amendment to avoid double taxing whistleblower award payments.

Amendment #2 by Grassley would clarify an important area of the IRS whistleblower program that has resulted in litigation in the U.S. Tax Court over the past few years. The amendment would define the term “proceeds” in IRC section 7623.

The proposed definition is: “(A) taxes, penalties, interest additions to tax, and additional amounts provided under the internal revenue laws, and (b) any proceeds arising from laws for which the Internal Revenue Service is authorized to administer, enforce, or investigate including (i) criminal fines and civil forfeitures, and, (ii) violations of reporting requirements.”

This word has been a point of contention because the U.S. is only required to pay out awards as a percentage of collected proceeds. The IRS interpretation has defined this term broadly, to exclude certain money collected by the IRS in enforcement actions. In a U.S. Tax Court lawsuit decided last year, the IRS took the position that only fines pursuant to Title 26 were collected proceeds. However, the Tax Court sided in favor of an expansive definition for whistleblowers.

Senator Grassley clearly wants to make sure that there is no more confusion over the desired scope of the whistleblower program, and has given it a broader definition than provided for in last year’s opinion. The adoption of this change would be in the interest of tax whistleblowers and we support it as well.

We’ll be closely following these amendments as their full text is published and they are debated.  Stay tuned!

Have Investors Been Harmed?

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One of the central questions that we ask in the evaluation of information from potential whistleblowers is whether there is real and actual harm as a result of the company or individual breaking the law. In other words, is it merely a technical violation of the law or are there substantial damages as a result of the corporate or individual misconduct?

In cases under the False Claims Act, the damage is often monetary as the Government paid for items from the public fisc and did not receive what it thought it was getting. For example, in the case of home health care fraud where the individual is not homebound, the Government is paying for more expensive services that the individual simply does not need. Sometimes, it can also involve harm to patients, although this is not required.

In cases involving tips from SEC whistleblowers, the harm is usually to investors. If misrepresentations are made to separate investors from their money, it can be a clear case for SEC action. An article on Investment News over the weekend identified retail investor fraud as a priority target of SEC Chairman Jay Clayton during his administration. Looking at the enforcement actions brought and settled by the SEC over the past few weeks, it is clear that most actions involve some sort of investor harm. Here are some of the actions from October and early November:

Penny Stock Fraud: Unregistered brokers were hired to pitch penny stocks based on nonexistent patents. Investors were told their money would fund R&D, but it in fact was used for personal expenditures and to pay sales commissions.

Improper Solicitation: Individual raising funds misled potential investors with false claims about a pending acquisition.

Accounting Frauds: Rio Tinto solicited substantial funds when failing to write down a bad investment. In another action, biotech company violated accounting rules to improperly recognize revenue and make it appear to investors that revenue was growing steadily.

Improper Billing: A private equity partner charged clients for personal expenses.

Illegal Short Selling: The investment advisor firm shorted stock in the public market during a restricted period before it illegally bought shares issued in a follow-on offering. The rule promotes offering prices set by supply and demand rather than allow prices to be artificially depressed by short selling.

Insider Trading: An engineer bought stock and options prior to a company’s announcement of the discovery of a new oil source.

Account Takeover: Investor accounts were hijacked and traded without investor authorization for substantial losses after hours.

Each of these examples involves a clear case of investor harm. Due to the Government’s limited resources, it is easier to get the United States to spend resources for investigation and enforcement if the investor harm is clear. By assessing investor harm ourselves in advance of filing a whistleblower tip, we are attempting to screen cases to avoid bringing information to the Government which they will not be interested in pursuing.

If you have evidence of a violation of the federal securities laws, call 1-800-590-4116 to speak to one of our whistleblower attorneys in a free, confidential initial consultation. We can help evaluate your evidence and aid you in determining whether the matter is one that the Government will want to hear about from you.

Cyber Unit and Retail Strategy Task Force Priorities According to SEC Co-Director of Enforcement Division

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We wrote a few months back about the creation of the Cyber Unit and Retail Strategy Task Force at the SEC. In the Keynote Speech at the Securities Enforcement Forum, Co-Director of the SEC’s Division of Enforcement Stephanie Avakian provided additional information about the priorities of these units and the need for them to exist.

The SEC made these changes in order to align and focus resources in these key priorities in order to better fulfill the agency’s investor protection mission.

CYBER UNIT

According to Avakian, the Cyber Unit was added because of the increased frequency of these securities violations and their increasing complexity. She identified three areas of misconduct that will be at the heart of this division. Previously, a large part of this expertise was gathered in the Market Abuse Unit during the investigation of serial insider trading schemes.

We’ve mentioned these areas here before in our discussions of cybersecurity, but they are worth mentioning again since they were explicitly laid out in the speech. First, they involve cyber-related misconduct that is used to gain an unlawful market advantage. Second, they include cases involving failures of a registered entity to take appropriate steps to safeguard information or maintain system integrity. Finally, they involve potential enforcement against a public company for failure to disclose cyber risks or incidents.

The SEC has already brought “a number of significant cases” involving cyber-related misconduct that has been used to gain an unlawful market advantage. These types of cases include (1) hacking to access material, nonpublic information in advance of an event, or to manipulate the market in a security (or group of securities); (2) account intrusions to conduct manipulative trading; and (3) disseminating false information online (EDGAR, twitter, etc.) to manipulate stock prices.

The SEC has already brought several cases in the second area, resulting from violations of Regulations S-P, S-ID, SCI and others. These regulations are designed to ensure system integrity and the appropriate safeguarding of information. In these cases, they often consider whether an examination by OCIE is more appropriate or whether an enforcement inquiry should be opened. This would obviously

Avakian noted specifically that there has yet to be a prosecution for a public company’s failure to disclose a cyber risk. However, she says that they can envision a case here enforcement would be appropriate. They just aren’t trying to “second-guess reasonable, good faith good faith disclosure decisions ….”

The new area that has been added to the Cyber Unit is responsibility for distributed ledger technology. The popularity of virtual currency and blockchain technology could “be an attractive vehicle for fraudulent conduct,” according to Avakian. The SEC has recently reminded companies and investors that Initial Coin Offerings are subject to the federal securities laws. Separately, CFTC Commissioner Brian Quintenz spoke at Georgetown University’s Fintech Week in mid-October and explained that ICO tokens could be a commodity subject to regulation by the CFTC.

RETAIL STRATEGY TASK FORCE

This Task Force will be a dedicated staff that develops ideas and strategies for protecting retail investors through data analytics and machine learning. The staff will work closely with the Office of Compliance, Inspections and Examinations (OCIE) and will refer investigative work to other Enforcement Division staff.

Avakian provided a number of specific examples of the types of conduct where they will focus, including (1) investment professionals steering customers to higher fees; (2) abuses in wrap-fee accounts such as failing to disclose costs of trading through unaffiliated brokers; (3) buying and holding inverse exchange-traded funds (ETFs), especially in retirement accounts; (4) failure to fully and clearly disclose fees in structured products sold to retail investors; and (5) churning trading accounts to generate commissions.

The Co-Director of Enforcement specifically denied that the creation of this unit showed diminished focus or resources on policing Wall Street and fighting financial fraud.

The Task Force will also be focused on investor outreach, working with other areas of the SEC to identify areas where targeted education would benefit investors and empower them to make informed decisions about investments.

IMPACT ON WHISTLEBLOWERS

The dedication of these areas to groups of SEC staff demonstrate once again that credible whistleblower tips in these areas will be strongly considered. The SEC has already rewarded several whistleblowers for providing information against misconduct that would be difficult to detect and was adversely harming investors. And given statements concerning the potential harm from hacking and cybersecurity misconduct, it seems likely that rewards will follow in this area as well.

If you have evidence of a violation of federal securities laws or SEC regulations, call 1-800-590-4116 to get a confidential consultation with a McEldrew Young whistleblower attorney representing SEC whistleblowers.

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