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Jason Rosenthal

Lesley Smith

Should CPAs Be Financially Rewarded As Whistleblowers?

The SEC recently implemented a whistleblower program that would financially reward a CPA. Possible problems this controversial program may raise for the public accounting industry and their clients revealed.

July 11, 2011
by Jason Rosenthal, Esq. and Lesley Smith, Esq.

In the wake of several widely-publicized Ponzi schemes, including Bernie Madoff’s, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 (Dodd-Frank). One of the goals of Dodd-Frank was to extend whistleblower protection beyond the Sarbanes-Oxley Act of 2002 to further incentivize whistleblowers to expose securities fraud. On May 25, 2011, the U.S. Securities and Exchange Commission (SEC) approved final rules to implement a program to pay individual whistleblowers who provide information relating to possible securities law violations that lead to successful SEC enforcement actions.

While CPAs are not permitted to receive a reward under Dodd-Frank by reporting possible violations of a client, they are permitted to receive a reward by reporting possible violations of their accounting firms in the performance of audit services for a client. This raises a number of ethical and practical considerations for CPAs and their clients.

Overview of the Whistleblower Program

To be eligible for a reward under the whistleblower provisions, a whistleblower must:

voluntarily provide the U.S. Securities and Exchange Commission (SEC) with original information that leads to a successful enforcement action by the SEC and that results in monetary sanctions of more than $1 million.

Where the SEC recovers at least $1 million, the whistleblower must be awarded anywhere from 10 percent to 30 percent of amounts recovered, although the SEC has broad discretion in determining the exact amount of the award. If the SEC does not ultimately recover at least $1 million, the whistleblower receives nothing.

To receive the award, the whistleblower must agree to provide sworn testimony if needed and other assistance and cooperation with the SEC’s investigation. As a result, whistleblowers may be faced with years of ongoing cooperative obligations before receiving any payment. Although initial whistleblower reports can be made anonymously via an attorney, a whistleblower must identify himself or herself to the SEC before collecting any reward.

Although the reward to a whistleblower may be increased if the whistleblower has first reported the suspected violation internally, the provisions do not require whistleblowers to report internally before coming to the SEC. There is, therefore, likely to be a significant increase in external whistleblower activity. The whistleblower provisions apply retroactively to information provided to the SEC on or after July 21, 2010, the date that Dodd-Frank was enacted.

Eligibility of Accountants to Receive Whistleblower Awards

The whistleblower provisions exclude two categories of accountants from award eligibility because of their pre-existing legal duty to report securities violations:

  1. Individuals with internal compliance or audit responsibilities at an entity, including CPAs, who receive information about potential violations, cannot receive whistleblower awards since it is part of their job responsibilities to report suspicion of illegal acts to management. However, these individuals will not be excluded from receiving a whistleblower award where:

    1. Disclosure to the SEC is needed to prevent “substantial injury” to the financial interest of an entity or its investors,
    2. The whistleblower reasonably believes the entity is impeding investigation of the misconduct or
    3. The whistleblower has first reported the violation internally and at least 120 days have passed.
  2. CPAs who receive information about potential violations of a client or its directors or officers through an audit or other engagement required under the federal securities laws are not eligible to receive whistleblower awards. The SEC included this exclusion so as not to undermine the legal duty that auditors have under Section 10A of the Securities and Exchange Act of 1934 to report illegal acts by officers, directors, and other client personnel up the chain of command. If the issues are not addressed adequately by management, the auditor must then resign from the engagement and file a report with the SEC.

Other categories of individuals that are ineligible to receive whistleblower awards include:

  1. Officers, directors, trustees, or partners of an entity,
  2. Attorneys, both in-house lawyers and outside counsel, who report information they obtained in the course of representing a client,
  3. Foreign government officials and
  4. Any other individual with a pre-existing legal duty to report information about potential violations to the SEC or other authorities.

Notably, the whistleblower exclusions do not apply to CPAs who report information about potential violations regarding their own firms’ performance of audit services for a client. This is true even where the CPA’s information about his or her firm leads to a successful enforcement action against one of the firm’s clients.

Is the Accountant Exclusion Too Narrow?

Several members of the public accounting industry, including KPMG, Ernst & Young, PricewaterhouseCoopers and the Center for Audit Quality, have expressed concerns to the SEC that the accountant exclusion in the whistleblower provisions is too narrow. Those entities believe that permitting CPAs to obtain monetary rewards by blowing the whistle on their own firms’ performance of services for clients could create several significant problems:

  1. The whistleblower provisions could create a financial incentive for CPAs to breach their duties of confidentiality and integrity to clients, imposed by regulatory and professional bodies, including the AICPA and the Public Company Accounting Oversight Board (PCAOB). Whistleblower reports from CPAs relating to their firms’ performance of services would likely include confidential client-specific information, particularly given that the accountant is eligible for a reward if a successful enforcement action is brought against the client (rather than just the accounting firm). Thus, the whistleblower provisions could undermine a CPA’s ethical obligations by financially rewarding him or her for breaching client confidences.
  2. The whistleblower provisions could harm the quality of external audits. If a client suspects that accounting firm personnel may be financially incentivized to report client-specific information to the SEC, the client may not allow the accounting firm to have unconditional access to the client information that is necessary to conduct an effective audit.
  3. The whistleblower provisions could undermine the current policing programs already in place in the public accounting industry. For example, the PCAOB has prescribed means by which disagreements in the course of an audit should be reported through an internal “reporting up” process. Additionally, most firms already have internal reporting processes, including hotlines, to allow whistleblowers to report potential violations of firm policies, professional standards, regulatory requirements and the securities laws. Financially incentivizing individuals to bypass these programs to report to the SEC could jeopardize these programs.

Conclusion

Despite the concerns expressed by the public accounting community, the current whistleblower provisions that the SEC is implementing do allow a CPA who reports potential securities law violations with respect to his or her own firm’s performance of an audit to be eligible for a financial reward. Although it is too soon to know the impact this provision will have on the accounting industry, CPAs should be prepared to address concerns their clients may have about the whistleblower provisions and their impact on the duties their external auditors owe them.

View a complete copy of the whistleblower provisions here (PDF). You can also view the AICPA’s comments stand on whistleblowers here and the SEC’s press release relating to the whistleblower provisions here.

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Jason M. Rosenthal, Esq., is the managing partner of Schopf & Weiss LLP, a national business litigation firm based in Chicago. Lesley G. Smith, a partner at Schopf, represents clients in complex securities matters, including handling corporate investigations relating to alleged violations of securities laws.