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.

SEC Proposes Rule 22e-4 on Fund Liquidity

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The SEC Commissioners today voted 5-0 to propose a rule requiring asset managers of mutual funds and exchange traded funds to disclose additional information about their liquidity risk and redemption practices. Rule 22e-4, if adopted, would also require open-end funds to assess and periodically review their liquidity risk.

The regulation is designed to bolster the Investment Company Act of 1940 requirement that mutual funds honor redemption requests within seven days. Earlier this year in a talk at the Brookings Institution, Commissioner Kara Stein expressed concern that some funds are promising investors high liquidity in their fund where the underlying investment is in illiquid assets.

The proposed law would require fund managers to establish a minimum requirement for investments in cash and three-day liquid assets. It would also codify the current SEC guideline that only 15 percent of positions can be invested in illiquid assets.

We have been talking about liquidity in the bond market and ETFs for some time here as a potential area for reports by SEC whistleblowers, and this proposal indicates the SEC is listening to the same concerns from the marketplace.

The proposed rule will need additional approval from the SEC Commissioners as well as to pass through the notice and comment rulemaking process before it is implemented.

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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 Investigates Channel Stuffing at British Liquor Company

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The British liquor company that makes Smirnoff, Johnnie Walker, Baileys and Guinness is under investigation by the Securities and Exchange Commission for shipping excess inventory to distributors to boost revenue.

The company, Diageo PLC, is based in Britain but has issued American Depository Receipts which trade here in the United States on the New York Stock Exchange. The company is the largest producer of spirits in the world and a major beer and wine producer. Its shares trade on the London Stock Exchange and the company has a market capitalization of more than $45 billion GBP.

Diageo ships its product to wholesalers who then distribute the product to retailers. Prior to an accounting change in January, it recorded revenue when it shipped its product to the wholesalers. It is accused of shipping them more inventory then they wanted.

The SEC will take insider tips about revenue recognition problems and shareholder fraud like these through its whistleblower office. An individual does not need to be an employee of the public company that is reported. An individual at a distributor and aware that it is being forced to take more inventory than it would like to purchase would also be able to submit a TCR. A successful tip would entitle an eligible individual to receive a 10 to 30 percent reward of monetary sanctions recovered in excess of $1 million.

If you have evidence of accounting fraud, contact one of our whistleblower attorneys for additional information on reporting it to appropriate agency at the U.S. Government. An attorney can be reached by our contact form or calling 1-800-590-4116.

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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.

Switch from GAAP to IFRS could expose accounting fraud to whistleblowers.

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Last week, James Schnurr, the new chief accountant for the Securities and Exchange Commission, told reporters that he was reviewing prior agency work on the potential accounting switch from Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS). The transition, which the SEC has been considering since at least 2007, will be revisited again by Scnhurr, a partner at Deloitte LLP prior to starting at the SEC a month ago. No decision has been made on the ultimate course of action the agency will pursue, although it will have implications for the method of accounting used by public companies distributing financial statements to shareholders.

The Wall Street Journal identified computer software and wireless communications as two industries where this transition could lead to dramatic changes in corporate accounting. In areas where GAAP and IFRS differ, there is the possibility that the rule switch could potentially expose accounting irregularities at large corporations as historical treatments are re-examined or lead to new situations of accounting fraud if companies attempt to adopt more favorable treatments during the transition.

More than 100 countries including the European Union currently use IFRS. The United States still uses GAAP in company-issued financial statements. When measured by market capitalization, more than half of the world’s companies still use US GAAP.

DEVELOPMENT OF ACCOUNTING STANDARDS

GAAP has been used extensively in the United States since the 1930s. Development started during the Great Depression as the country needed a way to restore confidence in the financial statements of corporations. The SEC encouraged the private sector to develop the accounting standards in 1938.

The movement for development of a set of international accounting standards started to grow in the 1960s. In the 1970s, the Financial Accounting Standards Board was created and began developing the International Accounting Standards. In 2001, the International Accounting Standards Board took over development and the name change to IFRS happened.

In 2005, companies began using IFRS in the European Union. Canada replaced its GAAP with IFRS in 2011. Japan has been promoting greater use of IFRS on a voluntary basis.

The SEC began exploring convergence with the IFRS set by the IASB in 2007. The initial roadmap published in 2008 suggested the potential for use by US issuers as early as 2014. However, according to the Wall Street Journal, “concerns about cost, implementation and the burden on smaller companies” stalled momentum.

IMPLICATIONS FOR WHISTLEBLOWERS

If new rules are adopted, the transition may expose problematic accounting treatments currently on the books or lead to new cases of accounting fraud. If the transition happens, and accountants are asked to adopt questionable accounting practices, they should consider the appropriate response given available options at their employer, the company and the SEC. The SEC whistleblower program or even the IRS program are options.

The IESBA is still working on a new code of ethics for professional accountants but the proposed guidelines currently open the door for an accountant to follow their conscience and report suspected noncompliance with laws and regulations.

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 and CFTC Gain, IRS Loses in FY 2015 Budget Bill

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The Senate passed the $1.1 trillion budget bill on Saturday evening and President Obama has signalled that he will sign the budget for Fiscal Year 2015 later this week.  As Congress allocated resources in the Consolidated and Further Continuing Appropriations Act for 2015, both the CFTC and SEC got significant increases.  The IRS, on the other hand, lost 3 percent of its budget.

The bill is important because it provides funding for the agencies charged with enforcing the nation’s whistleblower laws. As only the False Claims Act allows qui tam lawsuits, whistleblowers to the Internal Revenue Service, Securities & Exchange Commission, and Commodity Futures Trading Commission are dependent upon enforcement actions brought by the government agencies. Their ability to have the resources to take on some cases may be dependent on their budget and personnel.

The  also repealed the swaps push out rule from the Dodd-Frank Act and prohibits federal payments to corporations which prohibit whistleblowers from reporting fraud, waste and abuse to the U.S. Government.

Here’s a more extensive discussion of each aspect mentioned above:

CFTC

The CFTC budget for Fiscal Year 2015 was increased to $250 million. It will receive $35 million more than the $215 million it got in FY 2014. The nation’s derivatives regulator sought an additional $30 million for a total budget request of $280 million. The request primarily called for more personnel at the Commission.

The CFTC has faced problems with declining employee morale due to its inadequate budget over the past few years. The percentage of people who would recommend the CFTC as a good place to work fell from 64 percent last year to 45 percent this year. Overall job satisfication at the agency has declined substantially from 2010, when Dodd-Frank was passed.

The CFTC budget has been constrained by certain legislators as they attempted to prevent implementation of parts of the Dodd-Frank Act. CFTC Chairman Timothy Massad essentially stated that the low budget put the agency in regulatory triage. Even at the higher levels for 2015, Senator Debbie Stabenow, Chairwoman of the Senate Committee on Agriculture, Nutrition and Forestry, called the budget inadequate to allow the CFTC to do its job. Derivatives trading has grown from a $500 billion business to a $700 trillion industry without a corresponding increase in CFTC funding.

SEC

The SEC received an increase of $250 million in its budget for FY 2015 from FY 2014 levels. Its total FY 2015 budget will be $1.5 billion, $200 million short of the agency request of $1.7 billion. The budget request for a total increase of $450 million sought to hire additional employees, invest in technology solutions and complete rulemaking required by the Dodd-Frank Act and the JOBS Act.

IRS

The budget deal cut IRS funding by three percent to $10.9 billion for 2015. The reduction in funding by $345.6 million will need to come from an agency that has already reduced spending by more than $1 billion because of budget cuts since 2010. The FY 2014 level was $11.29 billion.

President Obama asked for Congress to provide the agency with $12.477 billion. The IRS Oversight Board estimated that the President’s budget would allow the U.S. Government to collect an additional $2.1 billion in revenue and avoid the loss of $360 million a year due to identity theft. Every dollar decrease in IRS funding allows roughly $7 in taxes to go uncollected.  With implementation of FATCA proceeding, the budget decrease does not come at an opportune time.

One aspect of the President’s budget proposal not in the final bill: The Treasury Department’s request for IRS whistleblower protections against retaliation. This section has been removed by Congress annually for the past few years.

Dodd-Frank Swaps Push Out

The SEC and CFTC budget increases can be attributed to a deal made to repeal section 716 of the Dodd-Frank Act. The section was commonly referred to as the swaps push out rule. It required banks to move derivatives trading out of their federally insured subsidiaries. The financial health of subsidiaries protected by federally insured deposits allows them significant advantages while trading and could put federal funds at risk. The measure was largely written by Citigroup in advance of the 2015 deadline for implementing the section of the law.

The reversal of the swaps push out rule was one of the most controversial aspects of the entire budget. Its addition to the law used the impending deadline for government shutdown. Senator Elizabeth Warren (D-Mass), who was involved in the creation of the U.S. Consumer Financial Protection Bureau, nevertheless marshalled a tremendous amount of opposition to it. A White House statement opposed the section but did not indicate that President Obama would veto the bill because of it.

Confidentiality Agreements

Employment agreements have proven to be a common tool used by employers to attempt to restrict whistleblowers. Congress took a step in the right direction with the bill by restricting payments to corporations which prohibit reporting waste, fraud or abuse to the Federal Government. Money from the FY 2015 budget can not be paid to corporations requiring employees to sign confidentiality agreements that prevent them from blowing the whistle.

The provision reads:

SEC. 743. (a) None of the funds appropriated or otherwise made available by this or any other Act may be available for a contract, grant, or cooperative agreement with an entity that requires employees or contractors of such entity seeking to report fraud, waste, or abuse to sign internal confidentiality agreements or statements prohibiting or otherwise restricting such employees or contractors from lawfully reporting such waste, fraud, or abuse to a designated investigative or law enforcement representative of a Federal department or agency authorized to receive such information.

It is great to see Congress take a step in the right direction with the insertion of this section into the budget. The section may create additional litigation under the False Claims Act as it operates as a condition for payment to federal contractors. Companies which violate the law by imposing one of these agreements on its employees could be subject to treble damages under the False Claims Act if they misrepresent the compliance of their employment contract with this rule in order to receive payment on their government contract. In addition to businesses fulfilling government contracts, it also implicates the health care industry because hospitals or other health organizations with these contracts would not be able to receive funds from Medicare.

The SEC has also already taken aim at this practice in the securities industry. According to the Washington Post in March, the SEC opened an investigation into confidentiality agreements created by KBR that potentially violate Rule 21F-17(a). The rule prohibits any action to impede an individual from communicating with the SEC about a possible securities law violation including enforcing, or threatening to enforce, a confidentiality agreement.

There has been several calls for changes to this employer practice. In October, eight U.S. Representatives on the House Committees on Financial Services and Oversight and Government Reform (OGR) urged the SEC to take additional enforcement actions against corporations using workplace secrecy agreements to chill whistleblowing.

Other Items of Interest to Employees

There were also small increases (less than $1 million) to the EEOC and OSHA budgets. The OSHA budget had sought an appx. $3 million increase in the amount of money for enforcement of whistleblower protections from retaliation and an appx. $30 million increase in the funding for the Wage and Hour Division to protect workers from FLSA violations related to worker misclassification, overtime and other pay rules. I haven’t independently verified it in the bill, but according to one report I have seen, wage and hour enforcement got an extra $3.2 million dollar increase and whistleblower protections had a small, less than $1 million increase.

Following the Toshiba Accounting Fraud, More Scandals in Japanese Companies Expected

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An article in Bloomberg View suggests that the accounting issues at Toshiba and Olympus are just the start of what could be equivalent to the more than dozen accounting frauds revealed in the United States after the Tech bubble burst in 2000. The article expressly indicates that there will probably be more revelations of problems due both to corporate governance and culture in Japanese businesses.

According to the article, most boards of Japanese public companies are made up of employees of the company. The lack of external oversight encourages them to expand employee perks instead of maximize shareholder value. The stagnant economy has allegedly led them to fake profitability in order to keep their lifestyle and bank loans going. The conclusion of this section of the article is that if one of the shining stars of the Japanese economy has been cooking the books, then the less successful companies are likely doing so as well.

The U.S. response to the scandals was the Sarbanes-Oxley Act. Japan’s Prime Minister Shinzo Abe has apparently introduced a new corporate governance code requiring outside directors on boards. The opinion piece indicates it is an important but encourages the Japanese Government to take additional action.

We were contacted last week from a reporter in Japan asking for our opinion of whistleblower law in Japan and the Toshiba scandal. The essential question was why an individual had not come forward to report this scandal before now.

Japan has a law protecting whistleblowers from retaliation that was enacted in 2006. According to our research, the fines in the law are so small that companies would rather just pay the fines than comply with the law.

Japan also hasn’t historically treated its whistleblowers well, so there was probably reluctance to come forward. The whistleblower who brought a case against Olympus under this anti-retaliation law did not fare well. This was the first to reach Japan’s highest court. Additionally, Michael Woodford, the whistleblower in the Olympus accounting scandal, was also fired after blowing the whistle. Until Japan is able to reassure whistleblowers that they will be protected, they won’t come forward to stop scandals like the one at Toshiba.

However, there are options. Employees in Japan of companies listed on a U.S. stock exchange may decide instead to avail themselves of the confidentiality of the Dodd-Frank whistleblower program instead of reporting to either the company or the Japanese government. The SEC whistleblower reward program has provided a financial incentive encouraging thousands to come forward every year to report violations of US securities laws. If the SEC takes action and recovers a monetary penalty of more than $1 million, an eligible whistleblower is due between 10 and 30 percent of the recovery.

There are nineteen examples already of whistleblowers coming forward to this program and helping to put a stop to problems before investors lost all of their money, and receiving an award. The US has received tips from around the globe about violations but since the program is still new, people are still being educated about it. Four people from overseas have received rewards.

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