Financial Institution Fraud

The Dodd–Frank Wall Street Reform and Consumer Protection Act was passed and signed into law in 2010 in response to the U.S. financial crisis that began in 2007. The large, ambitious bill was intended as a comprehensive reform of securities regulation and enforcement that would prevent future abuses of the kind that led to the current crisis. Title IX of the Act is devoted to increasing investor protections and, among other provisions, establishes a “whistleblower bounty program” modeled after the False Claims Act. Like the FCA, Dodd–Frank provides generous awards for whistleblowers whose information leads to successful enforcement by the Securities and Exchange Commission (SEC) as well as protections designed to prevent retaliation against whistleblowers by employers.

Dodd–Frank’s whistleblower provisions are specifically aimed at providing financial industry insiders with an incentive to step forward and report violations of U.S. securities law. It authorizes the SEC to pay potentially large awards to persons who provide original information leading to successful enforcement. To qualify as “original,” the information provided by a whistleblower must “be derived from [his] independent knowledge or analysis” and not be “exclusively derived from an allegation made” in other forums, such as the media or judicial proceedings. However, if the whistleblower provided the information that led to media reports or judicial proceedings, he or she may still qualify as an original source of information.

In order to qualify for the awards and protections of the Dodd–Frank Act, sanctions made as a result of the information provided by a whistleblower must exceed $1 million including penalties, the return of illegal profits, and interest. If the SEC collects more than $1 million in an action against the violator, the whistleblower will be entitled to an award of 10% to 30% of the total recovered. The exact amount of the whistleblower award is determined at the discretion of the SEC. The primary factors determining the size of the award are the significance of the information provided and the degree of assistance provided to the SEC by the whistleblower in a covered lawsuit. If a whistleblower feels the award is inadequate, he or she may file an appeal in an appropriate U.S. Court of Appeals within 30 days after the award is determined.

Dodd–Frank also provides protections for whistleblowers covered under the Act designed to prevent retaliation by employers. The Act states that “[n]o employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower.” Should an employer illegally retaliate against a covered whistleblower, the Act provides a cause of action allowing the employee to sue his or her employer. If retaliation is proven, the employee may be entitled to reinstatement, doubled back pay, attorney’s fees, litigation costs, and interest.

False Statements

The most common type of securities fraud allegation is that a broker or agent made unsupported claims or promises to induce a client to make an investment. The Securities Act of 1934 (15 U.S.C. § 78i) makes it unlawful for a broker to make any statement that is false or misleading with respect to any material fact if he knows or has reasonable ground to believe it is false or misleading. Also, a broker may commit fraud by withholding knowledge of an investment’s risks from a client. A broker is required to inform clients of known risks (or risks that should be known) and not to “sell” a client on an investment by omitting or glossing over potential dangers. To willfully deceive a client or potential investor by omitting important information is no different than affirmative deception.

In order to qualify as fraudulent, a false statement or omission must be both “willful” and “material,” meaning that the statement must be intended to deceive and is significant enough that it could be expected to influence an investor’s decisions. False statements may be made regarding numerous aspects of a company’s finances and future prospects.

Accounting Fraud

The SEC investigates accounting irregularities in publicly traded companies connected to the sale of a company or of its securities. False information regarding a company’s revenue, expenses, assets, or liabilities may be provided to potential investors to make the company appear a safer investment than it is in reality. Major companies are frequently found to provide inaccurate information to the public and the assets misrepresented by such companies can reach staggering proportions.

Insider Trading

Insider trading occurs when a publicly held company’s employees buy or sell stocks and other securities based on information they acquire as a result their employment and that is not publicly available. Insider trading also occurs when an individual outside of a company knowingly trades securities based on knowledge gained from a party with insider information. The securities traded need not necessarily be those of the company of one’s employer as any trades made with the benefit of insider information are held to be illegal.

Following the accounting scandals of 2002 involving a number of prominent American companies, Congress passed the Sarbanes–Oxley Act in an attempt to reign in fraudulent corporate financial practices. With respect to insider trading, Sarbanes–Oxley limited the periods in which employees may trade their employer’s securities and specified the requirements for reporting of trades made by company insiders. Nevertheless, significant loopholes in the law continued (and continue) to exist, and abuses by companies and individuals determined to take advantage of insider information for gain continue.

Ponzi Schemes

A Ponzi scheme—named after the early 20th century swindler Charles Ponzi—is a type of investment fraud in which investors are paid returns taken from subsequent investors rather that from actual growth in value. Ponzi schemes are inherently unstable and will eventually collapse when new investors cannot be found or many investors withdraw their investments. They may, however, grow to great size before collapse or being discovered by government investigators. Promising high rates of return, a Ponzi scheme operator may take advantage of inexperienced investors who are promised little risk and large profits. A Ponzi scheme’s apparent initial profitability may convince lay investors to reinvest their entire savings into the scheme before ultimately losing everything.

Commodities Fraud and Market Manipulation

Because the commodities futures/derivatives market played a large role in the 2008 financial crisis, the Dodd–Frank Wall Street Reform and Consumer Protection Act was passed in 2010 with the aim of reforming these previously unregulated markets. Specifically, Dodd–Frank authorizes the Commodities Futures Trading Commission (CFTC) to regulate commodity swap markets, improve transparency in pricing, and increase competition. In addition to the SEC’s securities fraud whistleblower program, Dodd–Frank also established an equivalent commodities fraud whistleblower program to be overseen by the CFTC. The requirements for commodities fraud whistleblowers to qualify for awards and protections are essentially the same as under the SEC’s whistleblower program.

Commodities fraud takes many forms and commonly includes making false statements and omissions, making unneeded trades to generate higher commissions, and misappropriating investor funds.

Foreign Corrupt Practices Act Violations

The whistleblower provisions of the Dodd–Frank Act authorizes the SEC to reward those who provide original information concerning violations of the Foreign Corrupt Practices Act (FCPA), an anti-bribery statute that governs the conduct of U.S. citizens and companies as well as foreign companies that list securities on a U.S. stock exchange. The FCPA prohibits covered individuals and companies from paying money or anything of value to foreign officials to obtain or retain business. The FCPA also prohibits foreign citizens from causing prohibited payments to be made within the U.S. Foreign officials may be officers or employees of foreign governments or government departments and agencies. Additionally, the FCPA requires that companies issuing securities traded on a U.S. stock exchange provide the SEC with periodic accounting reports accurately recording business transactions and ensuring internal accounting controls. This requirement is intended to ensure that a business’ transactions are in compliance with the anti-bribery provisions of the Act.

Each violation of the anti-bribery provisions of the FCPA can result in criminal fines of as great as $2 million for a company and $250,000 for an individual. Violations of the FCPA’s accounting and reporting requirements carry separate fines, which can be as great as $25 million and $5 million for companies and individuals, respectively. As the Dodd–Frank Act provides for whistleblower awards of 10% to 30% of monetary sanctions, awards for information concerning FCPA violations can potentially be enormous.

The information provided above is a very general summary of the law governing financial institution fraud at the time this text was prepared. Because this analysis is subject to change depending upon recent cases and legal developments, you should not rely on this summary as legal advice. As with any important legal question, you should always consult a lawyer licensed to practice in your jurisdiction. Our lawyers are licensed to practice in all state and federal courts in Georgia.