Thursday, July 14, 2011

Former SEC Chief Accountant Says Dodd-Frank Act Enhances Investor Protection; SEC Got Whistleblower Rules Right

While he would have preferred a Pecora-style investigation, former SEC Chief Accountant Lynn Turner said that the Dodd Frank Act contributed to a stronger foundation upon which the capital markets can function more effectively. In testimony before the Senate Banking Committee, he noted that the Act increased transparency and accountability, improved the effectiveness of the SEC and PCAOB which, in turn, should give a boost to investors confidence in the markets. The former SEC official particularly praised the whistleblower provisions of Dodd-Frank and the SEC regulations implementing those provisions.

The SEC has regulations implementing the whistleblower provisions of Dodd-Frank that would incentivize rather than require prospective whistleblowers to use internal company compliance programs. SEC Chair Mary Schapiro said that the final regulations strike the correct balance between encouraging whistleblowers to pursue the route of internal compliance when appropriate, while providing them the option of heading directly to the SEC. This makes sense, she reasoned, because it is the whistleblower who is in the best position to know which route is best to pursue.

Mr. Turner testified that it is important that the SEC become aware of securities law violations at the earliest possible date, he posited, so that the Commission can act to stop the violation before further harm to investors and the markets occur and also hold people accountable . Obtaining credible information is vital to early action and successful prosecution by law enforcement agencies.

The former Chief Accountant noted a 2010 Global Fraud Study by the Association of Certified Fraud Examiners stating that, on average, it took 27 months for companies to detect financial statement fraud. That is over two years investors would be unknowingly investing based on false and misleading financial information, said Mr. Turner. The report also notes that the number one way in which frauds are detected is not a management review, internal audit or external auditors. Rather, it is through tips.

Consistent with these findings, Dodd Frank allows the SEC to reward those who provide it with a wide range of information of securities laws violations resulting in successful prosecutions. The SEC had very limited authority to do so before passage of the Act. In fact, observed the former SEC official, since 1989 and prior to Dodd Frank, the SEC had only made seven payouts to five whistleblowers for a total of $159,537.

Some elements of the business community feel that the SEC whistleblower regulations will encourage people to report to the SEC without going through the normal hot lines and compliance program a company sets up. Noting that he has served on the audit committees of public companies, Mr. Turner believes that the SEC took a reasonable and balanced approach to the final rules it adopted. Hot lines will not work unless employees have confidence their identity will remain anonymous and protected, he opined, and the complaint will be addressed in an unbiased thorough manner.

According to the former official, this is especially important as the business groups forming the Committee of Sponsoring Organizations of the Treadway Commission (COSO), noted in a May 2010 report that in the 347 cases of fraudulent reporting brought by the SEC from 1998 through 2007, the CEO and/or CFO were named in 89 percent of the cases, up from 83 percent in the prior decade. The former Chief Accountant believes that Dodd Frank and the new SEC regulations will result in companies reexamining their hot lines and compliance programs, ensuring employees can put their faith in them.

In his view, the SEC regulations provide reasonable protections for public companies. The SEC encouraged those who provide tips to go through the normal company compliance channels. It did so stating that reporting internally will be considered when the size of an award is determined by the SEC. The Commission also provided individuals the opportunity to first report to the company, and then if they chose, reporting to the SEC. This is very beneficial, said Mr. Turner, because it allows the company to act on the information and where appropriate, self report to the SEC. In addition, the SEC excluded payments to certain employees such as in house counsel, compliance personnel, internal auditors, certain executives and external auditors.

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