Tags: US | SEC | Whistleblower | Bounties

Watchdog: SEC Whistleblower Program Is Flawed

Friday, 02 Apr 2010 07:00 AM

The Securities and Exchange Commission has had a bounty program for two decades to reward outside whistleblowers. But it has made few payments and must be improved, the agency's watchdog says.

A report released Thursday by SEC inspector general David Kotz examines the bounty program in the wake of the SEC's colossal breakdown that allowed Bernard Madoff's multibillion-dollar fraud to go undetected for 16 years — despite abundant red flags raised by whistleblowers.

The review by Kotz's office found there have been very few payments made under the program, which is limited to insider trading cases. Only a total $159,537 has been paid to five people since the program began in 1989.

Few applications for bounties have come in over the same 20-year period for a little-known program, the report said.

The report also found:

— The application process for bounties needs to be made more user-friendly. Applications should be more promptly and fully reviewed by SEC staff.

— The SEC needs to put in procedures to help the staff assess the information provided by whistleblowers to determine whether awards are merited. The criteria for judging bounty applications are vague and not subject to judicial review.

— A communication plan should be developed to inform the public and SEC staff about the bounty program.

— The SEC should adopt practices of the Justice Department and Internal Revenue Service regarding applications for bounties, analysis of whistleblower information, tracking of tips and complaints, and record keeping.

The SEC already "has begun to take steps to correct the deficiencies," the report notes.

SEC Enforcement Director Robert Khuzami agreed with all the report's recommendations, Kotz said in a memo.

The report said there is evidence that bounties "are an effective tool to encourage whistleblowers to come forward."

The agency has asked Congress to expand its authority to pay bounties for whistleblower information related to any kind of case that leads to enforcement action bringing fines over $1 million. The legislative proposal is being considered by the House and Senate.

"Right now, the main reward for being a whistleblower is the good feeling you get of having done something important, because (the SEC doesn't) have the authority to pay except where the whistleblowing relates to insider trading," SEC Chairman Mary Schapiro said in congressional testimony last year. Broadening the agency's authority would enable it to "run with that kind of information and to pursue cases in a much more aggressive way," she said.

In reports by his office issued last year, Kotz chronicled in detail how the SEC bungled five investigations of Madoff's business between June 1992 and December 2008, when the prominent money manager confessed the scheme to his sons. Kotz found that the agency's enforcement staff lacked adequate guidance on how to properly analyze complaints, and therefore failed to thoroughly review a complaint on Madoff brought to them in 2001 by private fraud investigator Harry Markopolos.

Over the 16-year period, the SEC received six "substantive complaints that raised significant red flags" regarding Madoff's operations, Kotz's investigation found. The agency also received complaints from a number of other sources, all containing specific information that called for a thorough examination of Madoff's business, the inquiry found. It said SEC enforcement staff rejected whistleblowers' offers to provide additional evidence.

Madoff pleaded guilty in March 2009. He is serving a 150-year sentence in federal prison in North Carolina for what could be the biggest Ponzi scheme in history, with investor losses estimated so far at $13 billion to $19 billion — at least 13 times the SEC's request to Congress for its entire budget for the fiscal year starting Oct. 1.

Madoff's epic fraud destroyed thousands of people's life savings, wrecked charities and jolted investor confidence during the worst days of the financial crisis. Ordinary people as well as Hollywood celebrities, big hedge funds and international banks lost money investing with Madoff.

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