Articles Posted in Whistleblower Issues

The SEC announced on October 1, 2013 that it awarded a whistleblower over $14 million for original information that led to the recovery of “substantial investor funds.” The whistleblower program was established after the enactment of the Dodd-Frank Act, which rewards individuals who provide original information that leads to sanctions exceeding $1 million. The SEC has the authority to award from 10 to 30 percent of the money collected in a case.

One of the most important things about information provided by a whistleblower is that such information is “original.” This means that the information must be derived from the whistleblower’s original knowledge or analysis, that it is not known by the SEC from some other source, and that it is not derived solely from a publicly available source, including allegations made in a different judicial setting.

The size of the current award appears to indicate two things: first, the quality of information and extent of cooperation provided by the whistleblower to the SEC, whose identity remains confidential; and second, the SEC’s eagerness to grow and benefit from the whistleblower program. Without disclosing the size of the award, in its Order, the SEC noted that the size of the award was based on the significance of the information provided by the whistleblower and the assistance the whistleblower provided to the SEC in the action, in part. The SEC, under its new Chairperson Mary Jo White, has shown a desire to become more aggressive in pursuing individuals and to get companies to admit to wrongdoing. It is no surprise then, that the SEC appears to be providing increasingly larger awards to whistleblowers, to provide individuals the incentive to waive red flags about wrongdoing at a time when the SEC may be able to recover and/or safeguard investor funds.

An intriguing new instance of whistleblowing has emerged from Clifford Jagodzinski, an ex-employee of Morgan Stanley Smith Barney LLC who claims that at least one highly successful broker for the firm was churning preferred securities in 2011. Churning in this case would violate not only state law, but also rules in place under the Dodd-Frank Act. For a further definition of churning, visit the Investors section of our company website. The Whistleblowers section of the site additionally identifies the nature of such cases and the firm’s unique interest in them.

The accused broker, wealth manager Harvey Kadden, was allegedly making tens of thousands of dollars in commissions despite supposedly taking actions which created minimal advances or even losses for his clients. Mr. Jagodzinski claims these moves “were obviously designed to bilk customers”. Mr. Kadden is said to have been recruited from Bank of America/Merrill Lynch, where he had worked for 30 years to great success, often appearing in Barron’s list of the Top 100 Financial Advisors.

Jagodzinski claims he was told to stop investigating Kadden by higher-ups within Morgan Stanley. Kadden is reported to have run a team of four brokers who had brought $14 million in profits to the company within the last 12 months, while managing a total of over $1 billion in customer portfolios.

A headline of the New York Times’ Sunday Business section published May 19th, Gretchen Morgenson asks “Is Insider Trading Part of the Fabric?“, raising a potentially distressing question for regulators and market analysts alike. Morgenson profiles the woes of one Ted Parmigiani, a Lehman Brothers investment analyst whose career was apparently placed in peril in 2004, when his research was allegedly leaked by a colleague in his research department. Parmigiani was then planning to raise his assessment of computer chip producers Amkor Technology. The leak was apparently discovered by Parmigiani on the planned date of his announcement, when Amkor’s price quickly shot up that morning, an hour before his new assessment was to be broadcast. Such are the dangers those working in investment too often face, and therein lies the potential for such figures to become brave whistleblowers. Visit the Practice Areas section of Malecki Law’s website to learn more about the firm’s work in aiding whistleblowers of fraud and further financial corruption.

Parmigiani responded by spending years providing information to the Securities and Exchange Commission (SEC) about the trading and research climate at Lehman, where suspicious trades were all too common, and sales reps and analysts illegally shared both office space and data. As part of 1.4 billion collective settlement paid by Lehman and nine other firms following an Eliot Spitzer-induced inquiry into insider trading, Lehman agreed to separate analysts from sales teams. Parmigiani says he was asked to ignore this supposed divide, write praise for investment banks whether it was merited or not, and explicitly told not to make negative comments about Lehman-favored companies and executives.

Parmigiani alleged that Lehman traders were often advised of changes to analysts’ company ratings before the revisions were publicly announced, and that traders were tipped off by analysts so that they would make hedge bets with Lehman’s own money. According to reports, announcement of Parmigiani’s recommendations were delayed by sales management for days at a time for no justified reason. In the Times article Parmigiani compares his actions to his time in the U.S. military, where the duty to disobey unlawful orders was instilled. Following his outrage over the Amkor incident, Parmigiani was fired from Lehman and found himself unable to find work at comparable Wall Street firms.

Today, the SEC‘s new whistleblower program under the Dodd-Frank Act becomes effective, and is on the minds of many New York securities lawyers. These new rules were devised in such a way to provide an incentive for would-be whistleblowers to come forward and assist the SEC with investigations of possible securities law violations. Under these new rules, if an individual provides the SEC with original information about possible federal securities laws violations, and that information leads to a recovery by the SEC of $1 million or more, that individual would be entitled to receive up to 30% of the sanctions received by the SEC.

Under the new rules, internal reporting is encouraged, but it is not required. Individuals may instead go directly to the SEC. However, the value of internal compliance programs is addressed in the release, and there are incentives in place in the new rules to urge whistleblowers to report internally first.

There are also a few groups of individual who, for public policy reasons, are excluded from participation under the new rules. These include: compliance and internal audit personnel; officers, directors, trustees and partners who only discover the violations as a result of internal compliance procedures; public auditors who learn of the violations in the course of an engagement. However, these people may be eligible under certain circumstances, such as: they reasonably believe that disclosure is necessary to prevent the company from causing substantial injury to the property or financial interests of the company or investors; they reasonably believe that the company is impeding an investigation of the misconduct; or at least 120 days have passed since the initial internal report. Attorneys are also excluded, provided that they learned of the violations directly from attorney-client communications.

The Wall Street Journal reported over the weekend about how one New York resident investor who lost his small stake in Washington Mutual once it was seized by the United States government in 2008 played a pivotal role in protecting the rights of similarly places investors. New York securities and whistleblower lawyers know there too be all too many investors in the same boat.

Nate Thoma, a self-taught trader who was wiped out when the U.S. government intervened in WaMu, discovered that he could recoup his losses by investing in trust preferred securities, which he bought through online trading account when they became available. The trust preferred securities essentially places the holder in the front of the line for any money distributed from WaMu’s estate once it emerged from bankruptcy. The Wall Street Journal reported that Mr. Thoma suspected hedge funds were buying substantially more blocks of these trust preferred shares while also owning the bank’s bonds.

And in December 2010, Mr. Thoma explained his theory to the Delaware bankruptcy court judge in the case In re Washington Mutual, Inc.: since the hedge funds were both bond holders in settlement talks, and owners of substantial swaths of trust preferred shares, were the hedge funds acting in the trust preferred holders’ best interest when they negotiated on their behalf?

On Wednesday May 25, 2011, the SEC approved new rules to flesh out a provision of the Dodd-Frank Act which provides for large cash rewards for employees who report suspected securities fraud through internal compliance programs or directly to the SEC. Under the new law, employees who report securities fraud either directly to the SEC or internally may be eligible, provided the firm passes on the information to the agency. The provision is thought by many a victory for New York whistleblowers and whistleblower attorneys alike.

Many firms were concerned that direct reporting to the SEC would make the large compliance programs these firms put in place in response to Sarbanes-Oxley essentially obsolete. In response, the SEC agreed to consider an employee’s participation in her company’s internal compliance program as a factor that could increase the amount of the reward. Under these new rules, some rewards can be as high as 30% of the penalty paid.

To be eligible for the reward, an individual must be a whistleblower. To be treated as a whistleblower from the date they report violations internally, an employee must also report the information to the SEC within 120 days.