CFTC COMMISSIONER CHILTON'S SPEECH TO THE AMERICAN GAS ASSOCIATION CONFERENCE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
“Special Purpose”
Speech by Commissioner Bart Chilton to the American Gas Association/Annual Energy Market Regulation Conference, New York, NY
October 3, 2013

Introduction

Good morning.  Thanks for the invitation to be with you today.  I used to work in the same building that houses your office in D.C., in the Hall of States.  You must be the signature tenant there because every morning walking through the lobby I saw those big silver letters on the wall spelling out “American Gas Association.” As a Commissioner, I’ve learned a lot more about you than your name and have seen the remarkable work you do in the energy industry.  So, it really is good to be here.

Maybe I'm just another speaker at another conference ... a vehicle with which to get to the next break.  Or, perhaps it is not a coincidence that we are here together.  Maybe it isn’t happenstance.  Maybe there is a reason not yet known.  So, we’re here for this little ride—whatever happens in these next few minutes.  Perhaps there is something you, or I, are supposed to remember about what we discuss.  Sometimes a discussion or dialogue may trigger bits of awesome.  Or, it might not even be something that is said, but a feeling or emotion, an instinct or an inclination to do this or that, or to not do this or that.  Something even seemingly small might alter or change things up.  It might be something important only to you or your family, or perhaps your coworkers or it could be of monumental significance.  Who knows?  I won't presume to know the true reason we might be here.  Maybe it is just a stop between point A and point B.  It probably is close to Bloody Mary:30 for some folks.

I'm gonna ask your indulgence for the next few minutes, for our talk today, right here and now ... I'm gonna ask you to do me a solid.  It may be very worthwhile.  We'll see.  Let's try something together.  Let's all assume we have a special purpose (not a special purpose like in The Jerk, "Wait a minute, what's happening to my special purpose?)  But that you have a true purpose—perhaps unknown—in being here.  Every day, even a day as mundane as October 3rd, has a special purpose.  Let's just try it.  C'mon, it'll be an adventure.  Okay?  Ready, go.

October 3rd

Look at it this way:  you never know what might happen on a day like today.  On this day, in 1951 right here in this city “The Shot Heard ‘Round the World” occurred.  Remember what that was?  Any baseball fans here?  Yep.  That’s the day the New York Giants’ Bobby Thomson hit a game-winning homerun in the bottom of the 9th to beat the Brooklyn Dodgers and win the pennant.

And given that I come here from D.C. and given what’s going on in the capitol city these days, it’s also appropriate to mention that on this day in 1955 the Mickey Mouse Club debuted on ABC.  On this day, that same year, Captain Kangaroo premiered on CBS.  Both shows had the special purpose of educating and entertaining children. Oh, and anybody like buffalo wings?  On this day, in 1964, they were first made in where? Buffalo, New York at the Anchor Bar.

But, it was also on this day—five years ago today that President Bush signed the Emergency Economic Stabilization Act of 2008 to try to keep Wall Street titans from tumbling and taking the whole economy down with them.  And yes, that’s the $700 billion dollar bailout we’re talking about.

FCIC

Whether you agreed with that bailout or not, it’s important to have a look at history.  How many of you have heard of the Financial Crisis Inquiry Commission—the FCIC?  It was set up by Congress for the very special purpose of looking back to figure out how we got into the economic fiasco that started in ’07 and ‘08.  The FCIC website asks the question:  “How did it come to pass that in 2008 our nation was forced to choose between two stark and painful alternatives—either risk the collapse of our financial system and economy, or commit trillions of taxpayer dollars to rescue major corporations and our financial markets, as millions of Americans still lost their jobs, their savings and their homes?”

That was their mission.  They noted widespread failures in financial regulation and excessive borrowing and risk-taking by Wall Street.  So regulators, after a decade of regulation-gutting, didn’t have the tools to crack down when they needed to and were instead spectators to the spectacle like everybody else.  The captains of Wall Street were cruising their ships along at full throttle and there was no governor to slow them down.

As a result, though, Congress passed and President Obama signed into law, the most sweeping set of financial reforms in our history—the Dodd-Frank Wall Street Reform and Consumer Protection Act.  (By the way, today—October 3rd is the Obamas’ anniversary—a pretty special day with a purpose for the first couple.) But, Dodd-Frank was necessary if we were ever going to protect ourselves from the kind of financial meltdown that occurred in 2008.  It had a special purpose.  It’s bringing transparency to the once dark over-the-counter (OTC) markets where complex and crazy deals went on—the very things that caused the collapse and calamity.

Bloomingdale’s

Here’s another bit of history for ‘ya.  On this day, in 1872, in this city, the Bloomingdale brothers opened their first store.  What does that have to do with anything?  Well, I bring it up because they seized on a new concept—the department store—and took off like gangbusters all because of selling hoop skirts—hoop skirts!  Today, it’s a massive company with more than 40 huge, high-end department stores and it’s a Fortune 100 company.

Well, in markets we have some players who are seizing on new concepts for special purposes. Let’s talk about a couple of them.  And, like Bloomingdale’s, the first one is massive.

Massive Passives

First, we have seen a “financialization” of commodity markets by a group of traders I call Massive Passives.  Portfolio diversification was the rage in the middle of the last decade and investors sought out the derivatives world and dumped roughly $200 billion into U.S. regulated futures markets.

Say a pension fund wanted to diversify into commodities; there’s nothing wrong with that from my perspective.  Nevertheless, the type of trading activity they undertake is different than what speculators have typically done.  Instead of getting in and out of markets these massive funds—pension funds, some hedge funds, exchange traded funds (ETFs), and the like—buy and hold their market positions.  So they are both massive in size, and fairly passive in their trading strategy.  Massive Passives.  Like Bloomingdale’s, they are a relatively new concept.

But, here’s the trouble:  too much concentration in markets can influence and contribute to price abnormalities.  Heck, just one massive passive can impact price if it’s large enough.

Take 2008, when crude went from right around $99 at the beginning of the year to more than $145 in July, then all the way back to $31 in December.  All of that took place without much change in supply or demand, right?  I am far from convinced that Massive Passives had no role in that market distortion, as some others seem to think.

Congress got worried about these guys too and included in the Dodd-Frank Act a provision for speculative position limits.  Those limits would ensure that regulators have the ability to stave off excessive speculation in markets.

To date, the limits aren’t in place.  There’s fierce opposition out there and big speculators with a lot of money and lawyers are taking us on.  But I expect that later this month we’ll put out a proposal for a new position limits rule.  You may have heard that our first one was thrown out by a court that sided with the speculators.  We’re appealing.  So, new rule and an appeal.  One way or another, I hope we will have position limits soon so that we can avoid the wild energy price swings like we saw in 2008.

By the way, if the CFTC fails to enact limits by the end of the year, I think Congress should simply take our rule that we will soon either propose or consider, and put it into the reauthorization of the Agency. There has not been the advocacy or interest in getting this done at the Agency like Congress and the President instructed. If we can’t do it, and it remains unclear if we can, Congress should do it for us.

A Brief Primer on Technology

Now, here’s something else that’s new in markets, another relatively innovative concept.  On this day in 1985, the space shuttle Atlantis made its maiden flight.  Isn’t technology wonderful?  Who would have thought we’d have an international space station someday and the technology to transport astronauts there and back?

The same goes for markets.  Even ten years ago, who would have guessed we’d be trading in milliseconds and conducting tens of millions of trades a day?

It’s about a thousand miles from New York to Chicago.  An article a while back in the Financial Times pointed out that communications cables laid between the two cities meant that a message could be delivered in 14.5 milliseconds—70 round trips per second.  Now that’s fast.  But not fast enough for some who use those cables to trade commodities—the high-frequency traders I call cheetahs because of their lightning speed.  It’s been reported that at least one company has cut that time down to 13.1 milliseconds and that microwave capability could get it under 10 milliseconds. Chipping away at those milliseconds is being done for a very special purpose, to gain a competitive advantage in markets.

Here’s some data that’s hard to get your head around, too.  Over the last year, we at CFTC analyzed 20 million trading seconds.  Of those 20 million, we pinpointed 189,000 seconds, primarily around the open and close of markets.  In those 189,000 seconds we found something astounding:  Cheetahs traded at rates of 100 to 500 trades per second in a major commodity market!

But these cats can be dangerous.  By the way, on this day in 2003, Roy Horn of Siegfried and Roy was injured by a tiger during a show in Las Vegas.  Fortunately, he recovered and ironically, it’s his birthday today, October 3rd.

So yes, these cats are dangerous.  A study late last year, which was conducted in conjunction with the CFTC, said in essence that cheetah trading imposes quantifiable costs.  Aggressive cheetahs make a lot of money, and they make the most when they trade with small, traditional traders.  A cheetah trading with a fundamental trader—like maybe some of you are—makes $1.92 on a $50,000 trade, but if that same trade is made with a small trader, the number goes up to $3.49.

But that’s not the only issue.  There’s also a concern about “wash” trading, where cheetahs (and sometimes others) trade with themselves.  They make a bid or offer and they hit it themself.  Sometimes it happens innocently enough.  Two traders on different sides of the same trading floor may hit each other.  But, it happens too much to all be accidental.  By putting a price out and hitting it yourself, you’re not taking any risk but you create the impression that a legitimate trade has occurred.  If that is the special purpose, it’s a problem. That entices others to get into markets before they realize the liquidity isn’t real and the markets may move in a direction that artificially aids that cheetah’s bottom line.  Wash trading is not only wrong; it is illegal.  That’s because it’s unfair to other traders, and it can impact price discovery which is unfair to consumers.

Wash blocker technology is available and I’ve called on the exchanges to get it put in place so we don’t have this potentially market-moving fantasy liquidity.

Let Banks Be Banks

So those are two examples of how our markets are changing and how new players have entered the fold.  Now, let’s talk about more traditional market participants and how they too are changing up our financial world.

Did you know that today is a bank holiday in Germany?  See how many things you’re learning about this special day.  It has a special purpose.  On this day, in 1990, East and West unified. It is German reunification Day.  Thus, it’s a bank holiday.

Now watch this transition:  let’s talk about banks!  Specifically, let’s discuss what the large investment banks have been able to do for the last decade as a result of amendments to the Bank Holding Company Act (of 1956).  That law was put in place to prevent excessive concentration of financial and economic power.  But that’s not the way it is today.  Banks can now be involved in activities that are obviously not “financial.”

Big banks today are into all sorts of other businesses:  commodities, warehousing of commodities, and even the delivery mechanisms associated with those commodities.  At the same time, they are heavily involved in the actual trading of the commodities.  What worries me is that they may have the capacity to influence prices through the related business ownership.  They own a warehouse.  They can charge storage.  They can impact delivery, and they can trade the commodities.

Of course the prices of commodities are supposed to be based upon supply and demand.  However, what if you control the supply or the demand?  Seems like perhaps—I don’t know—maybe there’s a conflict of interest there?  Certainly there’s the potential for a conflict.

This policy is really part of that Decade of Deregulation I talked about before that led us to the brink in 2008.  Like then, this bank ownership issue is getting dangerous in my opinion.

For me, it’s simple:  banks should get back to the special purpose of … banking.  However, for those who want to consider the policy merits of the matter in more detail, the first thing they might wanna do is get all of the ownership information.  What do the banks own?

Well, it isn’t that easy to find.  It seems like the information is something that the public should be able to easily locate and click on a link to find out.  After all, the large investment banks have access to cheap money at the Fed window and for no other reason than that they need to be transparent.

And whose fault is this?  Yep—policymakers.  See, starting in 2003, the Federal Reserve Board began issuing orders for banks that essentially allowed them to participate in commodity trading activity and actually deal in physical commodities at the same time.

Prior to that, two “special” large banks got some extraordinary treatment in the Gramm-Leach-Bliley Financial Services Modernization Act of 1999.  There is a provision in that Act, the effect of which exempted them from the bank ownership prohibitions.

I’m cool with banks making boatloads of cash, just not owning the boats; and in some cases they do, in the form of—gas people, help me out here:  that’s right, oil tankers.  They should make their profits through what they know and what they have done in the past … banking.  That’s their special purpose.  The banks built communities.  Let’s help them do that again.  Get back to making loans, helping to create jobs and assist in restoring our economy.  Congress should not only do away with the statutory exemption that has been used by those two big banks, but also do away with the ability of the Fed to allow any commodity-related ownership by the banks whatsoever.

Whistling Away

One last topic.  On this day, in 1913, the federal income tax law was signed—with a one-percent rate. Since that time, the government has closed several times. Here we are again. I mentioned the Mickey Mouse Club earlier.  I would hate to compare our government to the Club, heck I’m part of it, but D.C. sure has had some Mickey Mouse challenges in recent days.  It’s Goofy! And, it has created a crisis in and of itself.

I call it a crisis because of all the things I’ve already talked about that need the full attention of regulators, be it Massive Passives, cheetahs, banks or all the day-to-day oversight and enforcement functions we play.  Our agency needs to be at one-hundred-percent or the crooks are gonna get away.  We wouldn’t be able to track guys who were trading champagne and kickbacks for market manipulation like we did last week in the case of ICAP.  That’s why I’ve written to members of Congress asking them to consider allowing us the emergency and temporary use of our whistleblower and education fund during shutdowns. Our agency shouldn’t be shut down or crippled for even a day because of funding.  We shouldn’t take our cops off the beat.

Oh, and speaking of whistling; here’s another one:  On this day, in 1960, the Andy Griffith Show started on CBS.  Remember the theme song and the whistling?  And, in Washington, folks need to stop whistling away and work together on things like the budget and the debt ceiling.

Conclusion

So you see, you never know what’s gonna happen on any given day.  Will someone hit a homerun in the bottom of the ninth today?  Will any new TV shows premiere tonight?  (I’d be willing to bet it’ll be a reality show if it happens.)

I had a special purpose in coming here today: to discuss with you some important topics that affect you and your great association every day.  Every day has a special purpose.  What will yours be today as an individual and an association?  I appreciate you letting me carry out my special purpose by inviting me here.  Thank you and happy October 3rd.

U.S. SETTLES FALSE CLAIMS ACT ALLEGATIONS AGAINST LIFEWATCH SERVICES INC.

The following excerpt is from the U.S. Department of Justice website:
Friday, March 23, 2012
United States Settles False Claims Act Allegations Against Illinois-Based Lifewatch Services Chicago-Area Firm Allegedly Improperly Billed Medicare for Ambulatory Cardiac Telemetry Services
WASHINGTON - LifeWatch Services Inc., a Rosemont, Ill.-based company, has agreed to pay the United States $18.5 million to resolve allegations that the company submitted false claims to federal health care programs, the Justice Department announced today.   The settlement resolves two lawsuits filed under the qui tam, or whistleblower, provisions of the False Claims Act.

The two complaints allege that LifeWatch improperly billed Medicare for ambulatory cardiac telemetry (ACT) services.  ACT services are a form of cardiac event monitoring that use cell phone technology to record cardiac events in real time without patient intervention.   Traditional event monitoring requires the patient to press a button when he or she notices a cardiac event to record the cardiac rhythms.   Medicare reimbursed ACT services at between $750 and $1200 and traditional event monitoring services at roughly $250 during the relevant time period.        

According to the complaints, LifeWatch was aware that ACT services were not eligible for Medicare reimbursement for patients who had experienced only mild or moderate palpitations.  The complaints allege that LifeWatch nonetheless submitted claims to Medicare for ACT services for such patients using a false diagnostic code in order to have the claims paid.   In addition, according to the complaints, LifeWatch improperly induced Medicare claims for monitoring services by providing valuable services in the form of full-time employees to several
hospitals and medical practices, without charge.  The relators (whistleblowers) in their lawsuits alleged that these services amounted to kickbacks.

“False claims on federal health care programs drive up the costs of health care for all of us,” said Stuart F. Delery, Acting Assistant Attorney General for the Civil Division of the Department of Justice.   “Today’s settlement furthers the Department of Justice’s commitment to making sure that those who benefit from Medicare play by the rules.”

Ryan Sims, a former LifeWatch sales representative, filed a lawsuit in the U.S. District Court for the Western District of Washington in December 2009.   In May 2011, Sara Collins, another former LifeWatch sales representative, filed a complaint in the U.S. District Court for the Southern District of Ohio.

Under provisions of the False Claims Act, individuals can bring a lawsuit on behalf of the government and receive a portion of the proceeds of any settlement or judgment that may result.     Sims and Collins together will receive approximately $3.4 million plus interest as their share of the settlement proceeds.

“The False Claims Act is a critical tool for weeding out fraud and protecting the taxpayers,” said U.S. Attorney Jenny A. Durkan, of the Western District of Washington.  “We must ensure tax dollars go to intended programs, not to line the pockets of those who seek to cheat the programs.”

“The settlement underscores the need for physicians to be able to make care decisions without undue influence,” said Carter M. Stewart, U.S. Attorney for the Southern District of Ohio.  “The settlement is also the result of close cooperation between our office, the Justice Department’s Civil Division and U.S. Attorney Durkan’s office.”

In addition to the monetary settlement, LifeWatch has entered into a comprehensive Corporate Integrity Agreement (CIA) with the Office of Inspector General of the U.S. Department of Health and Human Services to ensure its continued compliance with federal health care benefit program requirements.

“The chief executive officer at LifeWatch as well as other corporate executives will be required to personally certify compliance with our five-year CIA, which includes provisions to monitor LifeWatch’s claim submission process, sales force activities and relationships with some types of business referrals,” said Daniel R. Levinson, Inspector General of the U.S. Department of Health and Human Services.  “LifeWatch allegedly tried to boost profits at taxpayer expense, and, ultimately, paid $18.5 million back to the government.”

The claims resolved by the settlement are only alleg ations and do not constitute a determination of liability.

In addition to the efforts of attorneys from the U.S. Attorney’s Offices for the Western District of Washington and Southern District of Ohio and the Commercial Litigation Branch of the Civil Division of the Department of Justice in Washington, D.C., investigators from the Office of Inspector General of the Department of Health and Human Services, Defense Criminal Investigative Service and Office of Inspector General for the Office of Personnel Management assisted the government’s investigation of the whistleblowers’ allegations.

This resolution is part of the government's emphasis on combating health care fraud and another step for the Health Care Fraud Prevention and Enforcement Action Team (HEAT) initiative, which was announced by Attorney General Eric Holder and Kathleen Sebelius, Secretary of the Department of Health and Human Services in May 2009.   The partnership between the two departments has focused efforts to reduce and prevent Medicare and Medicaid financial fraud through enhanced cooperation.   One of the most powerful tools in that effort is the False Claims Act, which the Justice Department has used to recover nearly $6.7 billion since January 2009 in cases involving fraud against federal health care programs.   The Justice Department's total recoveries in False Claims Act cases since January 2009 are over $8.9 billion.

U.S. INTERVENED IN WHISTLEBLOWER SUIT AGAINST HOSPICE PROVIDERS

The following excerpt is from the Department of Justice website:

Tuesday, January 3, 2012
“WASHINGTON – The United States has intervened and filed a complaint in a whistleblower suit against AseraCare Hospice, the Justice Department announced today. Golden Gate Ancillary LLC, dba AseraCare Hospice, is a for-profit business with approximately 65 hospice providers in 19 states, including Alabama, Georgia, Pennsylvania and Wisconsin. In its complaint, filed in U.S. District Court for the Northern District of Alabama, the government alleges that AseraCare violated the False Claims Act when it misspent millions of taxpayer dollars intended for Medicare recipients who have a prognosis of six months or less to live and need hospice care.

While elderly patients may qualify for a variety of other medical services paid by Medicare, for-profit hospice companies like AseraCare are entitled to receive Medicare dollars only for Medicare recipients who are terminally ill. When a business admits a Medicare recipient to hospice care, that individual is no longer entitled to receive services that would help to cure his or her illness. Instead, the individual receives what is called palliative care, or care that is aimed at relieving pain, symptoms or stress of terminal illness, which includes a comprehensive set of medical, social, psychological, emotional and spiritual services. In this lawsuit, the government contends that AseraCare Hospice knowingly submitted false claims to Medicare for hospice care for patients who were not terminally ill.

“Medicare benefits, including the hospice benefits, are intended only for those individuals who are appropriately qualified,” said Joyce White Vance, U.S. Attorney for the Northern District of Alabama. “We must protect the public welfare and tax-funded benefits programs.”

The whistleblower suit was originally filed by Dawn Richardson and Marsha Brown, former employees of AseraCare Hospice, and named United States ex rel. Richardson and Brown v. Golden Gate National Senior Care LLC dba Golden Living et al., No. 2:09-cv-00627 (N.D. Ala.).  The False Claims Act allows private citizens with knowledge of fraud to file whistleblower suits on behalf of the United States and to share in any recovery. If the United States intervenes in an action and proves that a defendant has knowingly submitted false claims, it is entitled to recover three times the damage that resulted and a penalty of $5,500 to $11,000 per claim.

“Congress intended that the hospice care benefit be used during the last several months of an individual’s life,” said Daniel R. Levinson, Inspector General of the Department of Health and Human Services. “We will continue to recover misspent Medicare funds from companies that abuse the hospice benefit."

This matter was investigated by the Commercial Litigation Branch of the Justice Department’s Civil Division, the U.S. Attorney’s Office for the Northern District of Alabama, the U.S. Attorney’s Office for the Eastern District of Wisconsin and the Department of Health and Human Services’ Office of Inspector General.”

ACCENTURE LLP PAYS OVER $63 MILLION FOR ALLEGEDLY DEFRAUDING THE U.S. GOVERNMENT

The following is an excerpt from the Department of Justice website:

Monday, September 12, 2011
WASHINGTON – Accenture LLP has agreed to pay the United States $63.675 million to resolve a whistleblower lawsuit, the Justice Department announced today. The lawsuit, filed in the U.S. District Court for the Eastern District of Arkansas, alleges that Accenture submitted or caused to be submitted false claims for payment under numerous contracts with agencies of the United States for information technology services.
Accenture has agreed to resolve allegations that it received kickbacks for its recommendations of hardware and software to the government, fraudulently inflated prices and rigged bids in connection with federal information technology contracts.
“Kickbacks and bid rigging undermine the integrity of the federal procurement process,” said Tony West, Assistant Attorney General for the Justice Department’s Civil Division. “At a time when we're looking for ways to reduce our public spending, it is especially important to ensure that government contractors play by the rules and don’t waste precious taxpayer dollars.”
“We strive each and every day to bring justice to the citizens of the Eastern District of Arkansas,” stated Christopher R. Thyer, U.S. Attorney for the Eastern District of Arkansas. “Fraudulent business practices that steal hard earned and much needed tax dollars from appropriate use will not be tolerated. The United States Attorney’s Office is committed to pursuing these cases to the full extent of the law.”
The lawsuit was initially filed by Norman Rille and Neal Roberts under the qui tam or whistleblower provisions of the federal False Claims Act, which permit private individuals, called “relators” to bring lawsuits on behalf of the United States and receive a portion of the proceeds of a settlement or judgment awarded against a defendant. The portion of the proceeds to be paid in this case has not yet been resolved.
“Companies profiting off the breach of their government contracts will pay,” said Brian D. Miller, General Services Administration Inspector General.
The case was handled by the Department of Justice’s Civil Division and the US Attorney’s Office for the Eastern District of Arkansas, with the assistance of the Defense Criminal Investigative Service and the Offices of Inspector General of the Department of Energy, the Department of Education, Department of Treasury Tax Administration (TIGTA), General Services Administration, Department of State and Transportation Security Administration.”

The following is an excerpt from the SEC web site:

Remarks at Open Meeting — Whistleblower ProgrambyRobert S. Khuzami, Director, Division of EnforcementU.S. Securities and Exchange CommissionWashington, D.C.
May 25, 2011Thank you, Chairman Schapiro, and good morning Commissioners. I am very pleased to present for your approval today final rules that would establish the Commission’s new whistleblower program. This program is part of a broader initiative undertaken by the Division in the last two years to further strengthen our enforcement program by expanding our arsenal of investigative tools designed to detect and combat fraud and other violations of the securities laws. As with our Cooperation Initiative that we announced last year, the whistleblower program is designed to incentivize insiders and others who possess useful information regarding unlawful conduct to come forward early and assist the SEC with identifying and bringing enforcement actions against companies and individuals that have violated the securities laws.
The rules proposed by the Commission last November attempted to strike a balance between various policy considerations around implementation of a whistleblower program. To name just a few examples, among these policy considerations included —
To what extent should the program award individuals who provide information about matters already under investigation by the SEC?
Should the program exclude certain types of information; for example, information obtained through communications subject to the attorney-client privilege? and
Should the rules require employees to first report possible violations through their employer’s internal compliance procedures before coming to the SEC? Our proposal provoked strongly held and diverse views on these and a number of other significant topics. We received hundreds of comment letters expressing a range of views and ideas from various interested constituencies, including individual investors, whistleblower advocacy groups, public companies, corporate compliance personnel, academics, professional associations and audit firms. Perhaps the most vigorously-debated issue was the effect of the whistleblower program on internal corporate compliance processes. Many commenters recommended that the Commission require that whistleblowers report through their employers’ internal compliance systems before or at the same time they report to the SEC, in order to qualify for an award. The concerns expressed were that without mandatory internal reporting, the program would, among other things:
Encourage whistleblowers to bypass internal compliance programs;
Undermine the ability of an entity to detect, investigate and remediate securities violations, particularly as to those complaints over which the Commission has no jurisdiction or that are too small for the Commission to investigate;
Create adverse incentives for whistleblowers to see their companies sanctioned or to delay reporting potential violations; and
Reduce the incentive for corporations to establish and maintain effective internal compliance programs. After much study, and even more discussion, we concluded that an absolute requirement that whistleblowers report internally to qualify for an award would be detrimental to the enforcement program, and seemingly inconsistent with the statute’s goal of motivating individuals to come to the Commission with evidence of securities law violations.
Four primary reasons supported our conclusion. First, we were not presented with, nor are we aware of, any empirical data supporting the view that the absence of mandatory internal reporting would undermine internal compliance programs. Second, companies that take their fiduciary obligations and corporate citizenship responsibilities seriously will design and implement effective compliance programs regardless of whether a whistleblower is required to internally report wrongdoers to qualify for an award — and, companies with effective compliance programs and cultures of compliance are actually more likely to attract whistleblower information as a result of the incentives in today’s rules, which I will outline shortly. Third, Congress intended the statute to incentivize insiders to provide the SEC with high-quality tips that reveal fraud and other wrongdoing, and to protect them from retaliation in the process. As such, it is, first and foremost, a tool designed to increase the effectiveness of the enforcement program.
The information from whistleblowers will allow us to build stronger cases and move more quickly, thus increasing the chance of stopping frauds early, of locating and returning more money to victim-investors, and of preventing small frauds from growing into bigger frauds with even more victims, more losses and more ruined lives. Fourth, there is nothing in the statute requiring internal reporting as a condition of eligibility, and an internal reporting requirement — particularly in situations where the compliance function is not effective or is controlled by managers that are the subject of the whistleblower’s claims — could easily undercut the purpose of the statute.
Consider boiler room operations where the principals are all running a “pump and dump” scheme. Requiring internal reporting in these situations, where the entity is entirely or largely corrupt, where the wrongdoers control the operation, would serve no beneficial purpose, and certainly would not undermine any legitimate corporate compliance programs. The same is true for Ponzi schemes, offering frauds and similar scams that we confront all too often. Some of the same considerations apply where the violation is carried out by principals that are largely law-abiding, working within an entity that takes compliance seriously. Requiring under all circumstances — and that is the key here, requiring — that the whistleblower first reveal the incriminating information to the same persons that the whistleblower is suggesting acted unlawfully, would create, in our view, an imbalance between the statutory mandate to incentivize whistleblowers to report wrongdoing to the SEC, and the desire not to undermine the efforts of internal compliance programs.
Mandating internal reporting as a condition of eligibility would, in our view, place an undue and additional burden on a whistleblower prior to presenting evidence of unlawful conduct to the SEC, and likely would deter others from coming forward to do the same. That is why our rules leave the decision as to whether or not to report internally in the hands of the person best equipped to make that decision — the whistleblower, considering the circumstances of his or her individual situation. But, because we recognize the extremely significant value that effective corporate compliance programs deliver in identifying, remediating, and deterring wrongdoers, we have refined and revised the proposed rules so that the whistleblower is incentivized — not mandated, but incentivized — to utilize their companies’ internal compliance and reporting systems, when appropriate.
First, as Chairman Schapiro noted, the rules contain a provision under which a whistleblower can receive an award for reporting original information to an entity’s internal compliance and reporting systems, if the entity then reports information to the Commission that leads to a successful enforcement action. Under this new provision, all the information provided by the entity to the Commission will be attributed to the whistleblower, which means that the whistleblower will get credit — and potentially a greater award — for any additional information generated by the entity in its investigation. In fact, because the whistleblower gets credited under this provision with the information generated by the entity, reporting internally to an effective compliance program may permit an individual to qualify for an award where they otherwise would not. We also hope that this powerful new incentive for employees to report internally will have the added benefit of incentivizing companies to implement robust compliance programs, as a whistleblower likely will only report internally where he or she believes the company will act promptly and responsibly.
Second, with respect to the criteria for determining the amount of an award, the final rules expressly provide that (1) a whistleblower’s voluntary participation in an entity’s internal compliance and reporting systems is a factor that can increase the amount of an award; and (2) a whistleblower’s interference with internal compliance and reporting is a factor that can decrease the amount of an award.
Third, the final rules extend from 90 to 120 days the time for a whistleblower to report to the Commission after first reporting internally and still be treated as if he or she had reported to the Commission at the earlier reporting date. The release makes clear, however, that the 120-day grace period applies only to whistleblowers, and that the final rules do not change the fact-based analysis that each entity should conduct when considering whether and when to report potential securities violations to the Commission. We will continue to expect companies to self-report on a timely and responsible basis.
We believe that these incentives sufficiently address the concerns raised in comments regarding the value of internal corporate compliance receiving information about possible violations of the law, but without discouraging the flow of insider tips that we believe will increase our agency’s ability to identify more frauds, and to move earlier and more quickly to stop them when we do.
The final rules also clarify the scope of the limitations on awards set forth in the proposed rules relating to persons with legal, compliance, audit, supervisory or governance responsibilities for an entity that receive information about a potential violation of the securities laws. This was another area that generated vigorous comments. The final rules retain the exclusion for certain individuals and certain categories of information from eligibility for whistleblower consideration. Information obtained through communications subject to the attorney-client privilege generally cannot be used, in order not to weaken the benefits that consultation with counsel often contributes to an effective compliance program and the development of corporate best practices. Nor can information be used to support a claim if it was obtained in the course of engagements required of independent public accountants under the securities laws and relating to the engagement client.
Lastly, certain categories of company officials also cannot qualify for whistleblower status, such as officers, directors, trustees or partners of an entity, if they are informed by another person of allegations of misconduct, or who learn the information in connection with the entity’s processes for identifying, reporting and addressing possible violations of law. This exclusion is necessary to ensure that persons most responsible for compliance are not incentivized to promote their own self-interest at the expense of an entity’s ability to detect, address and self-report wrongdoing.
Our proposal to allow awards to culpable whistleblowers is another area that elicited a substantial number of sharply-divided comments. Many commenters argued that the rules should not place any limits or restrictions on eligibility or award amounts for culpable whistleblowers beyond what is already contained in the statute for individuals who are criminally convicted. Many other commenters argued that culpable whistleblowers should be excluded completely from eligibility for awards. In our view, the rules as proposed represent the appropriate balance on this issue. The final rules therefore leave the proposed rules unchanged. The final rules substantially limit awards based on the conduct attributable to the culpable whistleblower — both the whistleblower’s own conduct as well as an entity’s conduct that the whistleblower directed, planned, or initiated. The final rules also provide that culpability of a whistleblower is a factor that can decrease the amount of an award.
At the same time, the final rules allow certain less-culpable whistleblowers to receive awards, assuming they otherwise satisfy the requirements set forth in the rule. This simply recognizes the established reality in law enforcement that often only those who are part of the fraud can provide evidence of unlawful conduct, and equally importantly can make the case against the biggest threats to investors — the organizers and leaders of a scheme who, if not pursued, will resurface in the future to commit new frauds.
Of course, the rulemaking, though a significant undertaking, is but one aspect of the creation of our whistleblower program. Since the enactment of Dodd-Frank, the Division has been hard at work creating the agency’s Office of the Whistleblower. In February, we welcomed back to the Commission Sean McKessy to oversee our whistleblower program. In a moment, you will hear from Sean, who will brief you on the status of the office and his vision for the program.
Before turning it over to Sean and to Steve Cohen, who will present additional details about our recommendation, I would like to thank Chairman Schapiro, Commissioner Casey, Commissioner Walter, Commissioner Aguilar and Commissioner Paredes for their valuable insights and input on these and other issues. I would also like to thank Commissioner’s Counsel Christian Broadbent, Anil Abraham, Scott Kimpel, and James Cappoli for their cooperation and assistance.
In addition, I want to echo the Chairman’s remarks and thank the Division staff, in particular the work of Steve Cohen, Sarit Klein, Sean McKessy, Jordan Thomas, and Sam Waldon. Their efforts have been in the finest tradition of the Agency — diligence, dedication and uncompromising professionalism. It is an honor to have them as colleagues.
I would also like to thank the staff from the Office of General Counsel who partnered with us, particularly Rich Levine, Brian Ochs and Brooks Shirey, on this very important initiative, for their tireless work on this recommendation.
I would also like to thank the staff from the Office of Risk, Strategy and Financial Innovation for their contribution and assistance, as well as staff from the Division of Corporation Finance; Office of Compliance, Inspections and Examinations; Division of Investment Management; Division of Trading and Markets; Office of the Chief Accountant; Office of International Affairs; and the Office of Legislative and Intergovernmental Affairs for their input and assistance."