Mutual fund companies are bracing for the expected passage this month of a proposed Securities and Exchange Commission rule that they say would completely undermine their internal compliance processes
Mutual fund companies are bracing for the expected passage this month of a proposed Securities and Exchange Commission rule that they say would completely undermine their internal compliance processes.
The SEC on April 22 is expected to adopt a whistle-blower rule that was mandated by the Dodd-Frank financial reform law. The rule would offer bounties to employees and managers of investment management companies for reporting improprieties at their firms.
Whistle-blowers whose tips resulted in prosecution could receive 10% to 30% of an SEC fine if the fine exceeded $1 million.
Compliance officers are worried that the rule would not provide any incentive for employees to take concerns to their compliance departments before turning to the SEC. Although the release of the rule mentions the importance of compliance procedures, the actual rule doesn't address it.
“This is the biggest issue my clients are talking about right now,” Joshua B. Sterling, an attorney with Bingham McCutchen LLP, said at the Investment Company Institute's Mutual Funds and Investment Management conference last week.
Since the rule was proposed last fall, a host of websites such as secsnitches.com and secwhistle blower.com have cropped up, offering potential whistle-blowers the chance to win millions of dollars in rewards.
“Every regulated entity has processes in place to encourage employees to report to their chief compliance officers through hotlines or whatever means,” Craig S. Tyle, general counsel at Franklin Resources Inc., said during a panel discussion at the conference.
“Now you have all of these websites that are asking, "Who wants to be a millionaire?' If this rule stands, it completely undermines our compliance efforts,” Mr. Tyle said.
Karrie McMillan, general counsel of the ICI, called on regulators to rethink the proposed rule.
'DANGLING' A REWARD
“How can you maintain that strong compliance program if your employees know that the SEC is dangling a rich reward for those who bypass internal reporting?” she asked during a speech at the conference.
Last Monday, fund executives grilled Jennifer McHugh, senior adviser to SEC Chairman Mary Schapiro, about why the commission's rule provides no incentives for employees to go to their compliance departments first.
In coming up with its rule, the SEC wanted to establish a “balance” between the role of compliance with the legitimate need for some employees to be able to go straight to the commission, Ms. McHugh said.
The SEC is worried about situations where employees aren't comfortable going to their internal compliance departments, executives familiar with the SEC's stance said.
“They don't want to give deference to all compliance programs,” said one official who has spoken to the SEC on the matter, and who asked not to be identified.
In response to a question from Natalie Bej, a principal at The Vanguard Group Inc., Ms. McHugh said that the $450 million allocated by Dodd-Frank to pay whistle-blower bounties hasn't been affected by the SEC's budget cuts. The SEC's total operating budget is $1.1 billion, but the money allocated to pay whistle-blowers is separate from that.
Other concerns about the proposal include confusion about whether a whistle-blower who engaged in the illicit activity is still able to recoup a reward through the program, and whether employees can use the program and then take part in private litigation against the firm.
EMPLOYEE HOTLINES
In the meantime, firms that don't have employee hotlines are scurrying to set them up, attorneys said. “It's the first line of defense,” said David Thelander, managing director at Promontory Financial Group LLC.
Many firms are also stepping up their compliance training.
“There's not much firms can do, other than create a culture where employees feel comfortable reporting issues,” Mr. Sterling said. One thing that firms shouldn't do is talk to employees about the “bounty hunter” sites that are cropping up, he said.
“You don't want to have a record of discouraging employees from reporting incidents,” he said.
On the lobbying front, the ICI has written a comment letter to the SEC suggesting that whistle-blowers shouldn't be allowed to go directly to the commission if their companies allow them to report incidents anonymously.
The ICI asked that in order for a whistle-blower to be eligible for an award, there has to be evidence that the employer's compliance reporting systems didn't meet standards.
Ms. McMillan said that the ICI is “hopeful” that the SEC will revamp the rule in the next few weeks to address its concerns.
E-mail Jessica Toonkel at jtoonkel@investmentnews.com.
