How Can Hedge Fund Managers Incentivize Employees to Report Compliance Issues Internally in Light of the SEC’s Whistleblower Bounty Program?

The “Securities Whistleblower Incentives and Protection” provisions of the Dodd-Frank Act require the SEC to pay significant monetary awards to whistleblowers that voluntarily provide “original information” leading to certain successful SEC enforcement actions.  Before the whistleblower provisions became effective on May 25, 2011, many companies expressed concern in public comments that the whistleblower program would incentivize employees to bypass internal reporting channels and report suspected wrongdoing and compliance concerns directly to the SEC.  Hedge fund managers were particularly vocal in expressing this concern because of the unique susceptibility of the hedge fund business model to bad news.  Hedge fund managers can suffer – and, with alarming regularity, have suffered – conclusive harm based on inconclusive allegations.  An examination or enforcement action triggered by a whistleblower complaint can cause hedge fund investors to redeem, and redemptions based on regulatory developments tend to beget additional redemptions.  The time from a whistleblower complaint to regulatory action to unraveling of a hedge fund business can be lightning fast; the manager’s ability to control events in such circumstances can be attenuated or nonexistent; and the harm to the business can be irrevocable.  Whether or not the manager is ultimately vindicated is often moot from a business perspective.  On the other hand, a manager’s ability to control events is dramatically increased when employees report suspected wrongdoing and compliance concerns internally.  In such circumstances, managers can, among other things: assess the credibility of the complaint; pinpoint the sources of any genuine issues; address such issues; determine whether, when and how to report the issues to investors or regulators; and otherwise act according to a game plan devised by the manager itself.  Not surprisingly, hedge fund managers are very interested in designing mechanisms to incentivize internal reporting while discouraging whistleblowing in a manner consistent with law and regulation.  This article provides a how-to guide for hedge fund managers looking to do so.  Specifically, this article discusses: background on the SEC’s whistleblower bounty program; specific actions hedge fund managers can take to incentivize internal reporting of compliance issues; guidance for hedge fund managers that want to measure the effectiveness of their internal reporting programs; and recommended actions for hedge fund managers that are confronted with internal reports of wrongdoing.

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