Risk & Compliance

Can CFOs Be Whistle-blowers?

A new House bill could leave finance chiefs out of an SEC bounty program that rewards informants.
Sarah JohnsonMay 13, 2011

Draft legislation would exclude CFOs from collecting a whistle-blower bounty created under the Dodd-Frank Act. The law passed last year aimed to give witnesses to securities fraud a monetary incentive — starting at $100,000 — to report wrongdoing to the Securities and Exchange Commission. Under an SEC proposal made in December, informants would collect 10% to 30% of wrongdoers’ payout to the commission for enforcement cases that involve penalties worth more than $1 million.

However, the forthcoming bill, to be proposed by freshman congressman Michael Grimm (R-N.Y.), would make “any whistleblower who has legal, compliance, or similar responsibilities for . . . an entity and has a fiduciary or contractual obligation to investigate or respond to internal reports of misconduct” ineligible for the bounty.

Limiting the ability of a company’s top executives to cash in on fraud that happened on their watch — even if they are not culpable — makes sense, says Luigi Zingales, a professor at the University of Chicago’s Booth School of Business who has studied the issue of whistle-blowers. “It would be reasonable to say that if you are the CFO and find something that doesn’t work, you should resign,” he says. “You shouldn’t profit.”

The first person to win protection under the Sarbanes-Oxley Act’s whistle-blower provision was a CFO. David Welch, a former finance chief of Cardinal Bancshares, had claimed he was fired after raising questions about the bank’s accounting policies and internal controls. A government review board later rejected the Department of Labor’s initial decision that Welch should get his job reinstated and collect back pay. Dodd-Frank’s whistle-blower rules were designed to make the process more favorable to informants.

At a congressional hearing earlier this week to discuss Grimm’s bill, Kenneth Daly, president and CEO of the National Association of Corporate Directors, said Dodd-Frank has created “a perverse incentive” for whistle-blowers to let a problem fester in order to collect a higher reward. His organization wants all internal and external compliance employees to be exempt from the bounty, including external and internal auditors, government employees, and attorneys. (Dodd-Frank specifically excludes regulators, people convicted of a crime related to the tip, and anyone “who gains the information through the performance of an audit of financial statements.”)

In addition, Grimm’s bill would reduce the potential payout, to between zero and 30% of the penalties, and require whistle-blowers to report problems in-house before going to the SEC.

The legislation would also negate a pending rule by the SEC, which has been processing many complaints since its November proposal to establish a new whistle-blower program, as required under Dodd-Frank. Among the concerns cited by business advocates: the pending rule calls on whistle-blowers to bypass their internal reporting ranks and go straight to the SEC to report suspected misdeeds. Critics contend that would put companies at a disadvantage to correct problems and could crimp the progress made in establishing integrated compliance departments. “We believe that the company who has put in proper procedures and have made their employees aware of such procedures, should be afforded the opportunity to resolve the matter,” wrote Sterling McDonald, CFO of Evolution Petroleum Corp., in a letter to the SEC.

It’s unlikely that many companies will need to worry. The restrictions for the monetary incentive create a tough hurdle, according to Geoffrey Rapp, law professor at the University of Toledo. Based on historic data of the minuscule number of SEC enforcement actions that have involved monetary penalties — of which the median sanction fell below the $1 million threshold — rarely would a whistle-blower be eligible to collect. “I don’t think [the bounty] will lead to a rush to the SEC,” Rapp said at the hearing.

Moreover, the SEC has infrequently rewarded whistle-blowers under its current system, which focuses on insider trading. In the past 20 years, the regulator has paid out only $159,537 to five claimants. The commission is scheduled to finalize its new rule this summer.

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