Is it a Crime? What Happens When Whistleblowers Report Potentially Criminal Misconduct to the SEC

The SEC, although it wields enormous power in the securities markets, has a built-in limitation on its authority: it’s a civil law enforcement agency, meaning that it can charge and penalize wrongdoers for civil violations of the securities laws, but it can’t prosecute them for crimes or put them in jail.

However, as SEC Chair Mary Jo White highlighted in a recent speech, that doesn’t mean the SEC has no role in criminal enforcement: instead, because nearly every violation of the securities laws can be a crime if done willfully (a higher standard than what is required for civil liability), the fraud investigated by the SEC often has the potential to be both a crime and a civil violation. The same holds true for investigations prompted by whistleblowers: when a whistleblower comes forward to report insider trading, FCPA violations, accounting fraud or other potential wrongdoing, there is often a good chance that significant misconduct will give rise to both criminal and civil claims.

So, what happens in this situation? The SEC would typically alert the appropriate criminal law enforcement agency – usually the Department of Justice and/or FBI – and collaborate with it to conduct parallel investigations. In our experience, that means that the whistleblower’s information would likely be shared (on a strictly confidential basis) with the DOJ, and the DOJ might participate in any interviews or briefings the whistleblower chooses to provide.

Such coordination can be enormously beneficial to law enforcement agencies because it allows them to share and save resources, use a broader range of enforcement tools, and ensure that wrongdoers are prosecuted to the greatest extent the law allows. Parallel proceedings by the SEC and other agencies also benefit whistleblowers, since these investigations may lead to two sets of monetary sanctions being obtained from the defendant.

For example, in the notorious Raj Rajaratnam insider trading prosecution, the SEC obtained a $92.8 million penalty against Rajaratnam in its civil case, and Rajaratnam was then fined $10 million in his criminal case (he’s also serving a lengthy prison sentence). According to the rules of the SEC Whistleblower Program, whistleblowers involved in such parallel actions may be eligible to receive a monetary award based on both the SEC action and the “related action” by the DOJ or other regulator, provided that certain criteria are met, including that “the same original information that the whistleblower gave to the Commission also led to the successful enforcement of the related action….”

This rule recognizes that whistleblowers can make contributions to law enforcement actions beyond just those prosecuted by the SEC, and should benefit when they do so. Look for this rule to take on increasing importance in the years ahead, as coordination between the SEC and criminal authorities continues to grow.

By Jordan Thomas and Vanessa De Simone