SEC Awards Another Whistleblowing Compliance Officer

On April 22, 2015, the Securities and Exchange Commission (SEC) announced an award between $1.4 and $1.6 million to a compliance officer who provided information that assisted the SEC in a successful enforcement action that resulted in sanctions exceeding $1 million. This marks the second time that an employee with internal audit or compliance responsibilities has received an award under the SEC’s whistleblower program. The SEC announced the first such award on March 2, 2015. The SEC indicated that the recipient of the award “had a reasonable basis to believe that disclosure to the SEC was necessary to prevent imminent misconduct from causing substantial financial harm to the company or investors.”

Andrew Ceresney, the director of the SEC’s Division of Enforcement, in commenting on the award, declared that “When investors or the market could suffer substantial financial harm, our rules permit compliance officers to receive an award for reporting misconduct to the SEC.” Mr. Ceresney further stated that this particular compliance officer “reported misconduct after responsible management at the entity became aware of potentially impending harm to investors and failed to take steps to prevent it.” This most recent award, the second of its kind in less than two months, should serve as a reminder that even employees with internal audit or compliance responsibilities can be whistleblowers.

Sixth Circuit Adopts Lenient Standard for SOX Whistleblowers

In Rhinehimer v. U.S. Bancorp Investments, Inc., 2015 WL 3404658 (6th Cir. May 28, 2015), the United States Court of Appeals for the Sixth Circuit affirmed a $250,000 verdict for a plaintiff who alleged that he was terminated in violation of the Sarbanes-Oxley Act (SOX). In so doing, the Sixth Circuit joined other Circuits by rejecting the “definitively and specifically” standard for proving protected activity that it had previously articulated in Riddle v. First Tennessee Bank, National Association, 497 F. App’x 588 (6th Cir. 2012).

In Rhinehimer, the plaintiff (Rhinehimer), a certified financial planner at U.S. Bancorp Investments, Inc. (Bancorp), alleged that he was fired in retaliation for alerting his superiors to unsuitable trades made by a co-worker covering one of his elderly clients while he was on disability leave. According to Rhinehimer, after he complained about the trades, he returned to work and was told by his supervisors that his complaints had prompted an investigation by the Financial Industry Regulatory Authority (FINRA). Rhinehimer then claimed that his job was threatened, he was placed on a performance plan that he could not achieve, and he was terminated as a result of failing to meet the performance plan goals. Rhinehimer commenced action against Bancorp alleging retaliation in violation of SOX. Id. In 2013, a federal jury in Kentucky returned a verdict in his favor and awarded him $250,000.

Bancorp appealed the decision arguing that the evidence did not support a finding that Rhinehimer could have had an objectively reasonable belief that the individual conducting trades on his client’s behalf was engaged in securities fraud. 2015 WL 3404658, at *6. Based on the Department of Labor’s Administrative Review Board’s (ARB) decision in Platone v. FLYi Inc., ARB Case No. 04-154 (Sept. 29, 2006), Bancorp argued that to meet the reasonable belief standard, Rhinehimer was “required to establish facts from which a reasonable person could infer each of the elements of an unsuitability fraud claim” — including the “misrepresentation or omission of material facts, and that the broker acted with intent or reckless disregard for the client’s needs.” Id.

The Sixth Circuit, however, found the ARB’s reasoning in Sylvester v. Parexel International LLC, No. 07-123 (ARB May 25, 2011), persuasive and rejected the “definitively and specifically” standard that it had previously adopted. 2015 WL 3404658, at *11. In doing so, the Sixth Circuit joined other circuits in finding that the “reasonable belief” standard requires the complainant “to have a subjective belief that the complained-of conduct constitutes a violation of relevant law, and also that the belief is objectively reasonable” in light of the factual circumstances, including the “training and experience” of the complainant. Id. Applying this fact-based standard, the Sixth Circuit concluded that the evidence was “more than adequate to sustain the judgment” against Bancorp where Rhinehimer “knew the structure of his client’s estate plans” and “learned of trades that a reasonable investment professional would recognize as inconsistent with those plans.” Id. at *11-12. This was so even though Rhinehimer had no specific knowledge of whether anyone omitted or misrepresented information in communicating with his client nor whether the broker executing the trades did so intentionally or with reckless disregard. Id. at *12.

Tax Court Rules IRS Wrongly Denied Whistleblower Claims as Untimely

On June 2, 2015, the United States Tax Court ruled that the U.S. Internal Revenue Service (IRS) erred in denying two whistleblowers awards on the basis that their claims were filed late. See Whistleblower 21276-13W v. C.I.R., 2015 WL 3465660, at *8 (T.C. 2015). The two whistleblowers were husband and wife.¹ Id. at *2. The husband was arrested for participating in a conspiracy to launder money. Id. at *1. To receive leniency, the husband informed the government, including IRS agents, that a foreign business (Targeted Business) assisted U.S. taxpayers in evading federal income tax. Id. The husband did not have enough documentation to inculpate the Targeted Business, but he knew of an individual who did and the husband and wife convinced that individual to cooperate. Id. Based in part on the individual’s assistance, the Targeted Business pled guilty and paid the United States $74 million. Id.

After the Targeted Business pled guilty, the husband and wife sought separate awards under I.R.C. section 7623(b) with the IRS Whistleblower Office, an institution created by the Tax Relief and Health Care Act of 2006 (TRHCA), seeking awards. Id. Because the requests were filed after the Targeted Business paid the $74 million, the IRS Whistleblower Office summarily rejected the award applications as untimely and did not review, investigate, or evaluate the merits of their claims. Id. The husband and wife whistleblowers appealed, and the Tax Court addressed the very narrow issue presented by their case: whether they were required as a matter of law to file their request before providing information to the IRS in order to qualify for an award under section 7623(b). Id. at *8.

The IRS contended that the Whistleblower Office has the ability to investigate a matter or assign it to the appropriate IRS office only if whistleblower information is first provided. Id. at *9. In addition, the IRS claimed that the Whistleblower Office’s discretion to seek assistance from the whistleblower would be jeopardized if it did not receive information first. Id. The Tax Court rejected the IRS’ arguments. Id. at *8. The Tax Court ruled that the fact that the husband and wife whistleblowers supplied their information before submitting their request does not render them ineligible for an award and that the Whistleblower Office improperly denied their applications on the basis that their claims were untimely. Id. at *12. The Tax Court required the Whistleblower Office to file a status report on the merits of their claims for award. Id.

Whistleblower Cut From $322M False Claims Act Case for Providing Non-Original Information

On June 1, 2015, Judge John F. Walter for the U.S. District Court for the Central District of California ruled that a whistleblower, who was attempting to claim part of a $322 million False Act Claim (FCA) settlement Scan Health Plan (Scan) paid, had failed to demonstrate that he was the original source of information. See United States of America v. Scan Health Plan, CV 09-5013-JFW (JEMx) (C.D. Cal. June 1, 2015).

James Swoben left Scan and went to a state senator with information about overpayments by Medi-Cal (California’s Medicaid program) for patients’ long-term care. The senator referred the information to the State Controller’s Office, which opened an investigation. The Controller’s Office issued a report that was sent to Swoben prior to him filing an FCA complaint in 2009. In August 2010, Scan paid $322 million to settle a U.S. Department of Justice investigation into overpayments. Swoben sought a relator’s share of the settlement.

The federal government opposed Swoben’s request, contending that the allegations in his complaint were substantially the same as those in the Controller’s report and that his claim triggered the FCA’s public disclosure bar. Swoben contended that his complaint was not based on the report because it contained a fraud allegation that Scan received inflated payments under Medicare Part C’s managed care system and inflated patients’ risk adjustment scores.

Judge Walter, in denying Swoben’s partial summary judgment motion, found that the State Controller’s Office report and Swoben’s complaint “allege the same duplicative Medicare and Medi-Cal payments made to Scan, and the complaint’s key allegations repeat and are supported by various conclusions contained in the report.” Slip. Op. at 6. The additional fraud allegations were insufficient to overcome the public disclosure bar because Swoben’s complaint “merely restates various conclusions of the report and is, thus, at least partially based upon the report.” Id. Thus, Swoben had not demonstrated that he was the “original source” of the information.

The “original source” doctrine continues to evolve, with more and more courts being asked to opine about whether a particular issue, previously known to someone, was sufficiently disclosed such that the FCA case is merely “piling on.” Defense counsel and defendants are responsible for this evolution; courts cannot weigh in on the debate without the defense bar continuing to press the issue.

SEC Chair Describes the SEC as “The Whistleblower’s Advocate” in Speech

On April 30, 2015, the Chair of the SEC, Mary Jo White, spoke at the Ray Garrett, Jr. Corporate and Securities Law Institute at Northwestern University School of Law. In her speech, “The SEC as the Whistleblower’s Advocate,” Chair White spoke of the SEC’s whistleblower awards program which she described as a “game changer.” In reviewing the four-year track record of the program, Chair White made clear that the SEC sees itself as the “whistleblower’s advocate” and admonished companies to stop wringing their hands about whistleblowers and instead support them.

Chair White’s remarks provided some clarification of the SEC’s recent enforcement action against a company for violating Rule 21F-17 by using confidentiality agreements in a way that could “stifle the whistleblowing process.” http://www.foley.com/sec-brings-enforcement-proceeding-relating-to-confidentiality-agreements-that-may-stifle-whistleblowers-04-02-2015/ While acknowledging that the action “prompted considerable discussion,” she denied that the decision created any uncertainty about the enforceability of confidentiality agreements. In her view, Rule 21F-17 does not prohibit the use of confidentiality agreements: “Companies conducting internal investigations can still give the standard Upjohn warnings that explain the scope of the attorney-client privilege in that setting.” However, confidentiality provisions must be clear so that non-attorney employees who are signing them understand that they can always report securities law violations to the Commission.

Chair White also shared that the SEC believes that some companies may be trying to require employees to sign agreements whereby they forgo any whistleblower award or require them to represent, in order to obtain a severance payment, that they have not made a prior report of misconduct to the SEC. She made clear that the SEC would take a dim view of such provisions.

Chair White also commented on the effect that the SEC’s whistleblower program has had on companies’ internal compliance programs. She recalled that when the whistleblower rules were being considered, there was a concern that if reporting internally was not a pre-condition to an award, that company’s internal compliance programs would be undermined. Even though reporting internally was not made mandatory, employees were incentivized to report internally as that can increase the amount of an award. Chair White noted that 80 percent of those receiving awards first reported their concerns internally to their compliance personnel or to their supervisors. The SEC has heard from lawyers and compliance professionals that the SEC’s program has caused many companies to enhance their internal reporting mechanisms to further encourage employees to report internally.

Chair White’s comments make clear that the SEC is committed to assisting whistleblowers both by encouraging them to come forward and by protecting them when they do. Her comments also confirm that the SEC will aggressively pursue companies that discourage or impede whistleblowers. Notably, other agencies (e.g., Department of State) also have actively been reviewing confidentiality agreements to ensure they do not discourage whistleblowing.

Seventh Circuit Rules Against Implied Certification False Claims Act Theory

The Seventh Circuit Court of Appeals recently joined the circuit courts wrestling with the issue of whether an implied certification that a company will comply with the law may be a “claim” that violates the FCA. This doctrine treats an invoice submitted by a contractor as an implicit representation that the contractor has complied with any relevant contract terms, laws, or regulations, a representation that is false if the contractor knows it has not actually complied. In United States ex re. Nelson, No. 14-2506 (June 8, 2015), the relator sued a for-profit education company, alleging among other things that the company had submitted false certifications of compliance with Title IV, despite knowing that it had unlawfully recruited students, paid unlawful incentive payments, failed to remain accredited, and committed other violations of the statute. The District Court judge granted summary judgment in the schools’ favor, and the Seventh Circuit upheld the ruling.

The court ruled the relator’s theory does not lead to FCA liability, for two reasons. First, the relator did not sufficiently demonstrate the defendant knew the certifications were false at the time of submission. See also United States ex rel. Grenaydor, No. 13-3383 (7th Cir. Dec. 3, 2014). Second, the court held that a breach in a condition of participation in a federal program does not mean that claims for payment submitted after the breach were themselves false. For example, a claim submitted after a false certification could have been for services that were appropriately rendered, and for which the defendant was eligible to receive payment.

Nelson settles (for now) the question of whether an implied certification theory by a relator may give rise to FCA liability. It also widens a split among appellate courts who have addressed the issue. Currently, the First, Second, Third, Fourth, Sixth, Eighth, Ninth, Tenth, Eleventh, and D.C. Circuit all have ruled the FCA has been triggered by submission of a false certification of legal compliance. The Fifth and Seventh Circuits do not recognize the doctrine.

^{1While the decision does not reveal the identity of the two whistleblowers, based upon the facts, some have speculated that the husband whistleblower is Stefan Seuss who assisted the U.S. in a case against Wegelin & Co. Wegelin, formerly Switzerland’s oldest bank, pleaded guilty in 2013 to helping Americans hide $1.2 billion in assets from the IRS. Richard Rubin, “U.S. Tax Informant Dodged Prison, Now Seeks $22-Million Reward,” (June 5, 2015) available here.}