Category: Corporate law

SEC Brings Multiple Enforcement Actions Relating to Beneficial Ownership and Other Reporting Obligations

On September 25, 2024, the Securities and Exchange Commission (the SEC) announced that it had instituted and settled enforcement actions under Section 13(d), Section 13(g) and Section 16(a) of the Securities Exchange Act of 1934 (as amended, the Exchange Act). The actions involved 21 individuals and entities that allegedly had failed to timely file Schedule 13D or 13G to report beneficial ownership of greater than 5% of the registered equity securities outstanding and/or amendments to such reports, and/or to timely file Form 3, 4 or 5 to report ownership of, and transactions in, registered equity securities by executive officers, directors and greater-than-10% beneficial owners (collectively, insiders). As part of the settlements, individual respondents agreed to pay civil monetary penalties ranging from $10,000 to $200,000, and entities agreed to pay civil penalties ranging from $40,000 to $750,000. As part of the same set of settlements, the SEC also instituted and settled two enforcement actions against public companies for allegedly causing certain of their insiders’ Form 3, 4 or 5 filing failures or for failing to report such filing delinquencies. Just a week earlier, the SEC had announced the institution and settlement of enforcement actions under Section 13(f) and Section 13(h) of the Exchange Act against 11 institutional investment managers that allegedly had failed on a timely basis to file one or more quarterly Form 13F reports and/or periodic Form 13H reports.

The Bottom Line

The foregoing actions are part of an SEC enforcement initiative aimed at ensuring compliance with ownership disclosure and other reporting rules. Insofar as the beneficial ownership and insider actions are concerned, the most recent set of settlements suggest a possible willingness on the SEC’s part to bring enforcement actions even for minor and technical violations. Insofar as the institutional investor enforcement actions, the recent “sweep” appears to mark the first such broad action by the SEC. Notably, for two of the sanctioned institutional investment managers that were based outside the US and where the managers self-reported their errors to the SEC, no monetary penalties were assessed. A third institutional investment manager did not pay a monetary penalty for its Form 13H filing delinquency, which had been self-reported to the agency. Further, the SEC’s public announcement of the settlements indicated that the SEC staff used data analytics to identify the delinquent filings. The SEC has occasionally used various technological solutions to search for late filings and other violations of law in the vast EDGAR database, and as artificial intelligence and similar applications become more widespread and economical, we expect the SEC to make greater use of automated techniques in the future as part of its ongoing filing review process.

The Full Story

5% Beneficial Owners, Insiders and Public Company Issuers

Under Section 13(d)(1) of the Exchange Act and Rule 13d-2(a) promulgated thereunder, any person who acquired beneficial ownership of more than 5% of a public company’s stock must, within 10 calendar days of the relevant acquisition,[1] file an initial set of disclosures on Schedule 13D with the SEC. The beneficial owner must then file updates with the SEC to report any material changes to its position or other facts disclosed in prior filings. Certain investors (mostly passive ones) are eligible to file a simplified set of disclosures on Schedule 13G. The deadline to file a Schedule 13G was also within 10 calendar days of acquiring more than 5% beneficial ownership, but certain institutional investors were permitted to defer disclosing their passive holdings on Schedule 13G until 45 days after the end of the calendar year.[2]

Under Section 16(a) of the Exchange Act and Rule 16a-3 promulgated thereunder, officers and directors of public companies, and any beneficial owners of greater than 10% of stock in a public company, were (and currently are) required to file initial statements of holdings on Form 3 either within 10 calendar days of becoming an insider or on or before the effective date of the initial registration of the stock. Such insiders are then obligated to keep this information current by reporting subsequent transactions on Forms 4 and 5 (in most instances, within two business days of any change). In addition, Section 13(a) of the Exchange Act and Item 405 of Regulation S-K promulgated thereunder require issuers to disclose information regarding delinquent Section 16(a) filings by insiders in their annual reports.

Here, the SEC alleged that 14 persons, who were obligated to file Forms 3/4/5, failed to timely file or update such reports required under Section 16(a), that two public companies caused some of those late filings and/or did not disclose the late filings when required, and that 18 persons who were obligated to file and/or amend Schedules 13D/13G failed to do so timely as required under Sections 13(d) and (g). In most of the non-issuer settlements, there appear to have been repeated failures over multiple issuers, sometimes over several years. However, not all persons settling with the SEC had failures that were repeated or otherwise egregious. Each of two of the matters that settled for $25,000 or less alleged only a few violations (and one of those included two alleged Schedule 13D violations that arguably are supported by a compliance and disclosure interpretation but not by the actual wording of Section 13 and its implementing rules). By contrast, among the 11 beneficial ownership settlements that the SEC announced nearly a year ago, none were below $66,000. This suggests that the SEC may once again be bringing less serious enforcement actions and pursuing even minor infractions.

Institutional Investment Managers

Under Section 13(f) of the Exchange Act and Rule 13f-1 promulgated thereunder, entities with investment discretion over at least $100 million worth of specified US publicly-traded securities (and certain securities exercisable for or convertible into such securities) (institutional investment managers) are required to file quarterly Form 13F reports detailing their ownership of such securities regardless of the percentages owned. Reports can omit certain de minimis positions, though the de minimis level is set quite low so relatively few positions are typically excluded from Form 13F on this basis. The $100 million threshold was originally set in 1975, is not indexed for inflation and has not been adjusted since. Each report for a calendar quarter must be filed no later than 45 calendar days after the end of the preceding quarter.

Under Section 13(h) of the Exchange Act and Rule 13h-1 promulgated thereunder, persons who trade US publicly-traded securities equal to or exceeding two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month (collectively, large traders) are required to file required Form 13H reports with the SEC. Unlike the beneficial ownership reports and Form 13F, Form 13H reports are confidential and viewable only by the SEC. While the specific reporting thresholds for Form 13F and Form 13H are different, most (but not all) large traders will also be institutional investment managers. But most institutional investment managers will not necessarily be large traders.

The SEC alleged that nine institutional investment managers failed to timely file required Form 13F reports—often over a long period of years. Those nine firms (not including one which was part of the beneficial owner settlements discussed above but had also not filed Form 13F for a number of years) agreed to pay in aggregate more than $3.4 million to settle those cases. Notably, two additional settling parties (both institutional investment managers located outside the US) were not assessed penalties relating to their delinquent Form 13F’s because they self-reported their failure to report directly to the SEC.

Two of the parties settling Form 13F failures also were charged with failing to timely file required Form 13H reports. Because both of these parties self-reported their Form 13H filing failures, neither was assessed a penalty relating to Section 13(h).

[1] The deadlines described here were in effect during the relevant periods in the settled actions. Effective on and after February 5, 2024, the initial Schedule 13D must be filed within five business days of the relevant acquisition.

[2] The deadlines described here were in effect during the relevant periods in the settled actions. Effective on and after September 30, 2024, the filing deadline for an initial Schedule 13G (other than for certain institutional investors) is within 5 business days of the relevant acquisition; certain institutional investors are permitted to delay their initial filing of Schedule 13G to 45 calendar days after the end of relevant calendar quarter.

Copyright © 2024, Hunton Andrews Kurth LLP. All Rights Reserved.
For more on SEC Enforcement Actions, visit the NLR Securities SEC section.

The Corporate Transparency Act Requires Reporting of Beneficial Owners

The Corporate Transparency Act (the “CTA”) became effective on January 1, 2024, requiring many corporations, limited liability companies, limited partnerships, and other entities to register with and report certain information to the Financial Crimes Enforcement Network (“FinCEN”) of the U.S. Department of Treasury (“Treasury”). The CTA marks a substantial increase in the reporting obligations for many U.S. companies, as well as for non-U.S. companies doing business in the United States.

IN SHORT:
Most corporate entities are now required to file a beneficial ownership information report (“BOI Report”) with FinCEN disclosing certain information about the entity and those persons who are “beneficial owners” or who have “substantial control.” BOI Reports for companies owned by trusts and estates may require significant analysis to determine beneficial ownership and substantial control.

The CTA imposes potential penalties on entities that fail to file BOI Reports with FinCEN by the prescribed deadline. For entities formed prior to January 1, 2024, a BOI Report must be filed by January 1, 2025. For entities formed on or after January 1, 2024, but prior to January 1, 2025, a BOI Report must be filed within 90 days of the entity’s formation. For entities formed on or after January 1, 2025, a BOI Report must be filed within 30 days of the entity’s formation.

Entities formed after January 1, 2024, must also report information regarding “company applicants” to FinCEN. If certain information within a BOI Report changes, entities are required to file a supplemental BOI Report within 30 days of such change.

While Winstead’s Wealth Preservation Practice Group will not be directly filing BOI Reports with FinCEN, our attorneys and staff will be available this year, by appointment, to answer questions regarding reporting requirements if scheduled by Friday, November 22, 2024. We strongly recommend that company owners begin analyzing what reporting obligations they may have under the CTA and schedule appointments with their professional advisors now to ensure availability.

BACKGROUND:
Congress passed the CTA in an effort to combat money laundering, fraud, and other illicit activities accomplished through anonymous shell companies. To achieve this objective, most entities operating in the United States will now be required to file BOI Reports with FinCEN.

The CTA applies to U.S. companies and non-U.S. companies registered to operate in the United States that fall within the definition of a “reporting company.” There are certain exceptions specifically enumerated in the CTA, which generally cover entities that are already subject to anti-money laundering requirements, entities registered with the Securities and Exchange Commission or other federal regulatory bodies, and entities that pose a low risk of the illicit activities targeted by the CTA.

REPORTING OBLIGATIONS:
Entity Information. Each reporting company is required to provide FinCEN with the following information:

  1. the legal name of the reporting company;
  2. the mailing address of the reporting company;
  3. the state of formation (or foreign country in which the entity was formed, if applicable) of the reporting company; and
  4. the employer identification number of the reporting company.

Beneficial Owner and Applicant Information. Absent an exemption, each reporting company is also required to provide FinCEN with the following information regarding each beneficial owner and each company applicant:

  1. full legal name;
  2. date of birth;
  3. current residential or business address; and
  4. unique identifying number from a U.S. passport or U.S. state identification (e.g., state-issued driver’s license), a foreign passport, or a FinCEN identifier (i.e., the unique number issued by FinCEN to an individual).

DEFINITIONS:
Reporting Company. A “reporting company” is defined as any corporation, limited liability company, or any other entity created by the filing of a document with a secretary of state or any similar office under the law of a State. Certain entities are exempt from these filing requirements, including, but not limited to:

  1. financial institutions and regulated investment entities;
  2. utility companies;
  3. entities that are described in Section 501(c) of the Internal Revenue Code;
  4. inactive, non-foreign owned entities with no assets; and
  5. sizeable operating companies that employ more than 20 full-time employees in the United States that have filed a United States federal income tax return in the previous year demonstrating more than $5,000,000 in gross receipts or sales.

A reporting company that is not exempt must register with and report all required information to FinCEN by the applicable deadline.

Beneficial Owner. A “beneficial owner” is defined as any individual who, directly or indirectly, (i) exercises substantial control over such reporting company or (ii) owns or controls at least 25% of the ownership interests of such reporting company.

Substantial Control. An individual exercises “substantial control” over a reporting company if the individual (i) serves as a senior officer of the reporting company, (ii) has authority over the appointment or removal of any senior officer or a majority of the board of directors (or the similar body governing such reporting company), or (iii) directs, determines, or has substantial influence over important decisions made by the reporting company, including by reason of such individual’s representation on the board (or other governing body of the reporting company) or control of a majority of the reporting company’s voting power.

Company Applicant. A “company applicant” is any individual who (i) files an application to form the reporting company under U.S. law or (ii) registers or files an application to register the reporting company under the laws of a foreign country to do business in the United States by filing a document with the secretary of state or similar office under U.S. law.

DEADLINES:
Entities Formed Before January 1, 2024. A reporting company that was formed prior to the effective date of the CTA (January 1, 2024) is required to register with FinCEN and file its initial BOI Report by January 1, 2025.

Entities Formed After January 1, 2024, but Before January 1, 2025. A reporting company that was formed after the effective date of the CTA (January 1, 2024), but before January 1, 2025, must register with FinCEN and file its initial BOI Report within 90 calendar days of formation.
Entities Formed After January 1, 2025. A reporting company formed after January 1, 2025, will be required to register with FinCEN and file its initial BOI Report within 30 calendar days of formation.

Supplemental BOI Reports. If any information included in a BOI Report changes, a reporting company must file a supplemental report with FinCEN within 30 days of such change. This includes minor changes, such as an address change or an updated driver’s license for a beneficial owner or someone who has substantial control over the reporting company.

PENALTIES FOR NON-COMPLIANCE:
The CTA and Treasury regulations impose potential civil and criminal liability on reporting companies and company applicants that fail to comply with the CTA’s reporting requirements. Civil penalties for reporting violations include a monetary fine of up to $500 per day that the violation continues unresolved, adjusted for inflation. Criminal penalties include a fine of up to $10,000 and/or two years in prison.

REPORTING REQUIREMENTS RELATED TO TRUSTS AND ESTATES:
When a trust or estate owns at least 25% of a reporting company or exercises substantial control over the reporting company, the BOI Report must generally include (i) the fiduciaries of the trust or estate (i.e., the trustee or executor), (ii) certain individual beneficiaries, and (iii) the settlor or creator of the trust. If the trust agreement gives other individuals certain rights and powers, however, such as a distribution advisor, trust protector, or trust committee member, the reporting company may also be required to disclose such individuals’ information in the BOI Report. Similarly, if a corporate trustee or executor is serving, the BOI Report must contain the names and information of the employees who actually administer the trust or estate on behalf of the corporation. Due to these nuances, it is often necessary to engage in additional analysis when a trust or estate is a beneficial owner of or has substantial control over a reporting company.

CONCLUDING REMARKS:
The CTA and its BOI Report filing requirement are still relatively new, and although FinCEN continues to publish additional guidance, many open questions remain. All companies formed or operating in the United States should carefully review whether they are required to file an initial BOI Report in accordance with the CTA, and take further steps to identify all individuals who must be included in such BOI Report.

© 2024 Winstead PC.
For more news on Corporate Transparency Act Reporting Requirements, visit the NLR Financial Institutions Banking section.

DOJ Announces Changes to Guidance on Corporate Compliance Programs, Updates on Whistleblower Program

In an address this week to the Society of Corporate Compliance and Ethics, Principal Deputy Assistant Attorney General Nicole M. Argentieri of the Department of Justice’s (“DOJ”) Criminal Division, highlighted several updates relevant to corporate compliance programs, including the DOJ’s new whistleblower programs and incentives.

Sufficient Compliance: Updated Areas to Consider

The Evaluation of Corporate Compliance Programs (“ECCP”) is the compass by which the DOJ measures the efficacy of a corporation’s compliance program for potential credit or mitigation in the event an organization is potentially subject to prosecution.[1] Ms. Argentieri highlighted several key updates to the ECCP that the DOJ will now consider when evaluating whether a corporation’s compliance program is “effective” and thus deserving of credit and/or mitigation of criminal penalties.

These new factors include whether:

  • the resources and technology with which a company does business are applied to its compliance program, and whether its compliance program fully considers the risks of any technologies it utilizes (such as generative AI)[2];
  • the company had a culture of “speaking up” and protecting those who report on corporate misdeeds;
  • a company’s compliance department had access to adequate resources and data to perform its job effectively; and
  • a company learned from its past mistakes—and/or the mistakes of other companies.

Encouraging Self-Reporting: Presumptive Declination and Reduced Penalties

In her remarks, Ms. Argentieri stated that the previously announced Whistleblower Awards Program[3] had so far been successful in the eyes of the DOJ, but did not point to any specific case or outcome. Likely, it is too soon for the public to see the fruits of the program, given its nascent state and the time that usually elapses between the initiation of an investigation and its resolution. The DOJ appears to be stating, though, that it is receiving and following up on whistleblower reports already.

This new policy encouraging whistleblowing through financial incentives, however, was combined with an amendment to DOJ’s Corporate Enforcement and Voluntary Self-Disclosure Policy, which provides that there is a presumptive declination to prosecute should a company make a disclosure of wrongdoing within 120 days of receiving an internal report of alleged misconduct and before DOJ contacts the company regarding that matter. In short, DOJ is seeking to incentivize a “race to DOJ” to report potential misconduct – perhaps before the company can even confirm whether the allegation is credible.[4]

Organizations that opt to not take the early self-disclosure route can still reduce any criminal penalties they may face by up to half by fully cooperating with the DOJ in its investigation. Considerations DOJ will factor in when evaluating whether an organization “fully cooperates” include, among other things, how timely the cooperation was and if the company took appropriate remedial action (such as improving compliance programs and disciplining employees). The DOJ continues to emphasize the importance of clawing back compensation and/or reducing compensation and bonuses of wrong-doers (if not also terminating them).[5]

Tipping the Scales

In sum, these programs are clearly intended to materially alter the disclosure calculus of whether a company should disclose misconduct by putting quantifiable incentives on the side of timely disclosure and cooperation, namely declination. Combined with the DOJ’s updates to the ECCP, these programs attempt to bring clarity and consistency to the world of corporate criminal penalties (and possibly how to avoid them altogether). Companies are well-advised to review their existing compliance programs in light of these new incentives and guidance from the DOJ to ensure that they address the new factors enumerated by the DOJ, but also account for increased incentives for corporate whistleblowers.

FOOTNOTES

[1] The U.S. Sentencing Guidelines also define what constitutes an “effective compliance and ethics program” for credit under the guidelines. U.S.S.G. §8B2.1.

[2] This is not the first time, and unlikely to be the last, where DOJ has emphasized the use of AI to enhance corporate compliance. See Lisa Monaco, Deputy Attorney General, Department of Justice, Remarks at the University of Oxford on the Promise and Peril of AI (Feb. 14, 2024).

[3] Under the Criminal Division’s whistleblower pilot program (and like those of other U.S. Attorney’s Offices who have thus far adopted similar programs), whistleblowers are financially rewarded—through criminal forfeiture orders—for bringing forward information on specific alleged violations, so long as that person first reports the misconduct to the company and DOJ has not already learned of it. The Criminal Division’s Pilot Program on Voluntary Self-Disclosure for Individuals also provide culpable individuals who report to receive non-prosecution agreements in exchange for reporting their own conduct and the conduct of the company.

[4] The “race to DOJ” incentivized by these programs may indeed alter the corporate disclosure calculus—by moving up the date for any disclosure in light of the threat that an employee or third-party, aware of any investigation, may choose to report the matter to DOJ. Likewise, it may also change the nature of the internal investigation in ways to limit knowledge of the investigation early-on, like limiting early interviews until documents and data can be reviewed and analyzed.

[5] Indeed, DOJ will permit companies to earn a dollar-for-dollar reduction of a criminal penalty for each dollar a company successfully claws back from a wrong-doer to further incentivize companies to seek to claw back compensation paid.

Copyright © 2024, Sheppard Mullin Richter & Hampton LLP.
For more on the Corporate Compliance Programs, visit the NLR Corporate Business Organizations section

Supreme Court Holds Life Insurance Proceeds Paid to Closely-Held Corporation to Fund Buy-Sell Agreement Increases Estate Tax on Deceased Shareholder’s Estate

In Connelly v. U.S., 144 S.Ct. 1406 (June 6, 2024), the United States Supreme Court upheld an estate tax deficiency of $889,914 in a decision that will impact many families and closely-held businesses. A Buy-Sell Agreement is often used to ensure that a closely-held company will remain within the family after the deaths of its owners or otherwise ensure the continuity of the business after an owner’s death. Many Buy-Sell Agreements, such as the one in Connelly, provide that upon the death of an owner, the surviving owner has the option to purchase the deceased owner’s interest in the company, and if the surviving owner declines, the company must redeem the deceased owner’s interest. To ensure that the company will have funds for the redemption, the company will often obtain life insurance for its owners. For years, planners thought it possible to structure such an arrangement so that life insurance proceeds would not increase the value of the company for estate tax purposes. However, in Connelly, the Court held that the life insurance proceeds paid to a corporation upon the death of a shareholder do increase the value of the corporation’s stock for estate tax purposes and that the corporation’s obligation under a Buy-Sell Agreement to redeem the deceased shareholder’s shares does not offset the life insurance proceeds. Under the Court’s decision, the type of entity does not appear to be relevant, and the holding will equally apply to partnerships and limited liability companies. Thus, if any Buy-Sell Agreement is structured as a redemption funded with entity-owned life insurance, the insurance proceeds may increase the value of the deceased business owner’s interest for estate tax purposes.

In Connelly, two brothers, Michael and Thomas Connelly, owned a business supply corporation. Michael owned 77.18% of the company, and Thomas owned 22.82% of the company. The brothers entered into a Buy-Sell Agreement as described above. The brothers ignored provisions under the agreement that required them to value the company annually and obtain an appraisal upon a shareholder’s death. After Michael’s death in 2013, Thomas and Michael’s son simply agreed to a redemption price of $3 million for Michael’s shares. The company used $3 million of life insurance proceeds to redeem Michael’s shares, and Thomas, as Michael’s executor, reported the value of Michael’s shares as $3 million on Michael’s estate tax return without completing an appraisal. Upon audit of the estate tax return, Thomas belatedly obtained an appraisal that determined the fair market value of 100% of the company at Michael’s death to be $3.86 million, excluding the life insurance proceeds. Based on the valuation of the company at $3.86 million, Thomas argued that the value of Michael’s ownership interest was $3 million ($3.86 million x 77.18%).

Connelly rejects the position of the 11th Circuit Court of Appeals in Blount v. Comm’r., 428 F. 3d 1338 (CA11 2005), that the life insurance proceeds paid to a company are offset by the company’s contractual obligation to redeem a deceased owner’s interest. Rather than allowing an offset for the redemption obligation, the Court focused on the value of the company before and after the redemption. If the entire company was worth $3.86 million, as claimed in Connelly, the value of Michael’s 77.18% would be $3 million and the value of Thomas’ 22.82% would be $860,000. The Court reasoned that upon redemption of Michael’s shares, Michael’s estate would receive $3 million, leaving Thomas with 100% ownership of a company worth $860,000. However, Thomas’ argument meant that post-redemption, 100% of the company that Thomas owned was worth $3.86 million. The Court refused to accept that a company which pays out $3 million to redeem shares was worth the same overall amount before and after the redemption. The Court found that the company’s value should be increased from $3.86 to $6.86 million, accounting for the insurance proceeds, increasing the value of Michael’s ownership from $3 to approximately $5.3 million ($6.86 million × 77.18%). The net result was an additional estate tax of $889,914.

Although the implications of Connelly are wide, there are limitations to the Court’s decision. Connelly will have little impact on a business owner whose estate is well under the estate tax exemption, which is currently $13.61 million for each individual and scheduled to be decreased by 50% in 2026. In addition, the Court did not address the application of Section 2703 of the Internal Revenue Code, which provides in relevant part that the value of a deceased owner’s interest in a business may be established by a Buy-Sell Agreement if certain requirements are met. Perhaps the Court did not review Section 2703 because the shareholders did not follow the valuation terms of the Buy-Sell Agreement and arbitrarily determined the redemption price instead. But because Section 2703 was not addressed in Connelly, it may yet be possible to avoid its impact with a properly structured and adhered to, Buy-Sell Agreement.

The Court also explicitly stated in a footnote that the holding does not mean that a redemption obligation can never decrease a corporation’s value. The Court implies that if a company is required to sell an operating asset to redeem shares, the redemption obligation might reduce the company’s value.

The Court acknowledged that a differently structured Buy-Sell Agreement can avoid the risk that insurance proceeds would increase the value of a deceased shareholder’s shares. Specifically, the Court referenced a “cross-purchase agreement” in which business owners, rather than the company, agree to purchase the others’ ownership upon death using proceeds from non-company owned policies. In addition to avoiding the Connelly result, a cross-purchase agreement provides an increased tax basis for the surviving owners who purchase a deceased owner’s interests. However, the more owners a business has, the more complicated a life insurance-funded cross-purchase will be. Other options to avoid the Connelly result may include a life insurance partnership or limited liability company or creatively structured split-dollar arrangements.

After Connelly, all business owners with Buy-Sell Agreements funded with entity-owned life insurance, or with other entity-owned insurance vehicles (split-dollar plans, key-person life insurance, etc.) should evaluate and consider restructuring their arrangements. In some cases, the restructuring of a Buy-Sell Agreement may require the transfer of life insurance policies which raises other tax issues, such as in-kind corporate distributions, S corporation elections, transfer-for-value rules, and incidents of ownership.

© Polsinelli PC, Polsinelli LLP in California
For more news on Life Insurance and Estate Taxes, visit the NLR Estates & Trusts section.

Filing Requirements Under the Corporate Transparency Act: Stealth Beneficial Owners

The Corporate Transparency Act (“CTA”) requires most entities to file with the Financial Crimes Enforcement Network (“FinCEN,” a Bureau of the U.S. Department of the Treasury) Beneficial Ownership Information (“BOI”) about the individual persons who own and/or control the entities, unless an entity is exempt under the CTA from the filing requirement. There are civil and criminal penalties for failing to comply with this requirement.

A key issue: WHO are the Beneficial Owners?

FinCEN has issued a series of Frequently Asked Questions along with responses providing guidance on the issue of who the beneficial owners are.

Question A-1, issued on March 24, 2023, states that “[BOI] refers to identifying information about the individuals who directly or indirectly own or control a company.”

Question A-2, issued on Sept. 18, 2023: Why do companies have to report beneficial ownership information to the U.S Department of the Treasury? defines the CTA as “…part of the U.S. government’s efforts to make it harder for bad actors to hide or benefit from their ill-gotten gains through shell companies or other opaque ownership structures.”

Question D-1, updated April 18, 2024: Who is a beneficial owner of a reporting company? states that “A beneficial owner is an individual who either directly or indirectly (i) exercises substantial control over a reporting company” and, in referring to Question D-2 (What is substantial control?), “owns or controls at least 25 percent of a reporting company’s ownership interests.”

Question D-1 goes on to note that beneficial owners must be individuals, i.e., natural persons. This guidance is extended by Question D-2 on Substantial Control, where control includes the power of an individual who is an “important decision-maker.” Question D-3 (What are important decisions?) identifies “important decisions” with a pictorial chart of subject matters that FinCEN considers important, such as the type of business, the design of necessary financings, and the structure of the entity. Question D-4 explores ownership interests (again with a pictorial) including equity interests, profit interests, convertible securities, options, or “any other instrument, contract, arrangement, understanding, relationship, or mechanism used to establish ownership.”

Who, in FinCEN’s view, has “substantial control”?

Question D-2 lists four categories of those who have substantial control:

  1. A senior officer, including both executive officers and anyone “who performs a similar function;”
  2. An individual with “authority to appoint or remove certain officers or directors;”
  3. An individual who is an important decision-maker; or
  4. An individual with “any other form of substantial control.”

“Silent partners” and/or other undisclosed principals, including some who may be using the reporting company for nefarious purposes, might be discussed here, but that is not the intended subject of this writing. Rather, this piece is intended to warn businesspersons and their advisers of potential “stealth beneficial owners” – those whose status as beneficial owners is not immediately obvious.

First, consider the typical limited liability company Operating Agreement for an LLC with enough members and distribution of ownership interests so that no member owns over 25% of the LLC’s equity. If the LLC is manager-managed, then the manager(s) is/are Beneficial Owners, but the other members are not. But what if the Operating Agreement requires a majority or super-majority vote to approve certain transactions? Assuming that those transactions are “important” (as discussed in Question D-3), then possessing a potential veto power makes EACH member a beneficial owner. Such contractual limitations on executive power necessarily raise the issue of “beneficial ownership” in corporations, in limited liability companies, and even in limited partnerships where the Limited Partners have power to constrain the general partner (who clearly is a beneficial owner).

Second, consider the very recent amendments to the Delaware General Corporation Law (“DGCL”) in response to the Delaware Chancery Court’s holding in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co (“Moelis”) Feb. 23, 2024. In Moelis, the CEO had a contract with the Company that materially limited the power of the Board of Directors to act in a significant number of matters. Vice Chancellor Travis Laster issued a 133-page opinion finding the agreement was invalid, as it violated the Delaware Law that placed management and governance responsibilities in the Board. Because such arrangements are frequently used in venture capital arrangements as part of raising capital for new enterprises, the Delaware Legislature and the State’s Governor enacted amendments to the DGCL that expressly authorize such contracts. In the Moelis situation itself, Ken Moelis was a major owner and CEO so he would have had to be disclosed as a Beneficial Owner if Moelis & Co. had not been exempt from the filing requirements of the CTA because it is a registered investment bank.

But what of a start-up venture entity where a wealthy venture investor owns a 10% interest in the entity, but has a stockholder agreement that gives him substantial governance rights including the ability to veto or even overrule board decisions? Is that venture investor not a “beneficial owner”? Somewhat even more Baroque, what about the private equity fund controlled by a dominant investor, say William Ackman or Nelson Peltz? If that fund invests in the same start-up entity and holds a 10% interest, but also has a stockholder agreement giving the fund substantial governance rights, isn’t the controlling owner of the fund a “beneficial owner” of the start-up?

Finally, consider financing with a “bankruptcy remote entity” where the Board of that entity includes a contingent director chosen by the finance source. The contingent director does not participate in any part of the governance of the entity unless the entity finds itself in financial distress. The organizational documents of the entity provide that at that point, the contingent director can veto any decision to file for bankruptcy protection. At that point, the contingent director apparently becomes a “beneficial owner” of the entity, with the CTA filing requirements applicable. A more interesting question is whether the contingency arrangement in the organizational documents makes the contingent director a “beneficial owner” from the inception of the financing. Further, with respect to bankruptcy, key questions remain unanswered, such as whether the trustee in a Chapter 7 bankruptcy proceeding or a liquidating trustee in a Chapter 11 bankruptcy proceeding has a reporting obligation under the CTA.

This piece is not intended to identify all the situations that may give rise to “Stealth Beneficial Owners.” Rather, its intent is to raise awareness of the complexities involved in answering the initial question – WHO is a “beneficial owner”?

©2024 Norris McLaughlin P.A., All Rights Reserved

DOJ Implements New Whistleblower Reward Program

Companies who submit healthcare claims to private payors, provide financial services to customers, interact with domestic or foreign public officials, or otherwise operate in highly regulated industries should take note that the Department of Justice (DOJ) has taken another significant step in its ongoing effort to encourage new whistleblowers with information about potential corporate criminal malfeasance to report that information to the government. On August 1, 2024, the DOJ announced its long awaited Corporate Whistleblower Awards Program. The program seeks to fill “gaps” in existing whistleblower programs by providing awards of up to 30% of forfeited proceeds for reporting criminal conduct that is not otherwise covered by an existing system for awarding whistleblowers. The silver lining for companies is that the program incentivizes the whistleblowers to cooperate with the company’s internal compliance function. DOJ also provides for a presumptive declination of criminal charges for companies that self-report to DOJ within 120 days of the time the issue is first raised internally by the whistleblower, providing strong incentives for companies to investigate issues quickly.

The program represents the DOJ’s latest effort to increase the number of voluntary self-disclosures of corporate criminal activity. In January 2023, the DOJ announced its revised Corporate Enforcement and Voluntary Self Disclosure Policy, which sought to expand the incentives for companies to voluntarily self-disclose misconduct, cooperate with DOJ investigations, and take prompt and full remedial measures. The policy’s primary incentive was the prospect of a presumed declination for companies who followed its mandates.

As we discussed in a previous post, efforts to increase voluntary self-disclosures continued in April 2024 when the DOJ launched a Pilot Program on Voluntary Self Disclosures for Individuals. That initiative expanded the scope of potential whistleblowers by including those complicit in wrongdoing, granting them eligibility for immunity from prosecution in return for reporting the activity. In substance, that structure incentivized both individual wrongdoers and the corporations for whom they worked to be the first to report criminal activity. By pitting the would-be whistleblowers and the companies against each other, the DOJ effectively constructed a prisoners’ dilemma where the government stood to benefit regardless of which party acted first.

The program is a different verse from the same hymnal. It offers a different (but more traditional) incentive for whistleblowers – the opportunity for financial reward – while maintaining the goal of increasing the number of voluntary self-disclosures. The program seeks to achieve that objective by motivating those who are aware of misconduct, but perhaps are otherwise unable to qualify for a bounty under the current framework or otherwise uninterested in reporting the activity without a personal benefit.

The Basic Framework

Under the program, eligible individuals who voluntarily provide original information to the government in certain areas of focus and cooperate with the resulting investigation stand to receive 30% of any criminal or civil forfeitures over $1 million in accordance with a defined payment priority. The program lays out a basic structure for determining whether an individual is entitled to an award, but also affords the DOJ substantial discretion in deciding whether to make such awards, and in what amount. The key elements are:

  • Areas of focus – The program identifies four subject matter areas: 1) violations by financial institutions, their insiders and agents involving money laundering, fraud, and fraud against or non-compliance with regulators; 2) foreign corruption and bribery and violations of money laundering statutes; 3) domestic corruption violations including bribes and kickbacks paid to domestic public officials; and 4) healthcare offenses involving private or non-public healthcare benefit programs and fraud against patients, investors or other non-governmental entities in the healthcare industry, or other violations of federal law not covered by the federal False Claims Act (FCA).
  • Eligible individuals – The program excludes several categories of individuals, including those eligible to report under other whistleblower programs and those who “meaningfully participated” in the criminal activity reported (although those who played a “minimal role” can still participate).
  • “Original information” – Essentially, independent non-public knowledge or analysis in the individual’s possession is considered “original” information. Notably, information can be deemed “original” if it “materially adds to the information that the Department already possesses.” Information that the individual has already reported through the company’s internal whistleblower, legal or compliance procedures can still be deemed “original,” provided the individual also reports that information to the government within 120 days of reporting internally. Privileged information is not considered “original” unless the crime, fraud or other exception to state attorney conduct rules apply.
  • “Voluntary” submission – The information must be reported before the DOJ or any federal law enforcement or civil enforcement agency initiates any inquiry relating to the subject matter.
  • “Cooperation” – Individuals who report must also cooperate fully with the DOJ’s investigation, including by participating in interviews, testifying before a grand jury or at trial, producing documents and, if requested, working in a “proactive manner” with federal law enforcement. This could include clandestine activities to gather evidence, such as recording phone calls or wearing a wire.
  • Criteria for determining amount of award – The program lists several factors that could militate in favor of increasing or decreasing the whistleblower’s financial award. Increases may be justified by the significance of the information provided, by the nature and extent of assistance provided, and, notably, by participation in internal compliance programs. Decreases may be appropriate where the reporting individual was a minimal participant in the underlying activity, or where the individual unreasonably delayed reporting, interfered with the company’s internal compliance and reporting systems, or had management or oversight responsibilities over the offices or personnel involved in the conduct.
  • Payment priority – When the victim is an individual, he or she must first be compensated “to the fullest extent possible” before a whistleblower can recover. When the victim is a corporate entity or government agency, the whistleblower jumps the line and is compensated first.
  • Relationship to the Corporate Enforcement and Voluntary Self Disclosure Policy – While the program incentivizes whistleblower reports to the DOJ, a simultaneous amendment to the self-disclosure policy provides that “if a whistleblower makes both an internal report to a company and a whistleblower submission” to the DOJ, companies who self-report that conduct within 120 days of the internal report “will still qualify for a presumption of a declination[.]” This amendment underscores the DOJ’s focus on increasing self-disclosures, inasmuch as it effectively removes the need for them to be truly “voluntary.” A company that receives a complaint through its whistleblower program may still be eligible under the self-disclosure policy even if the individual has already reported the conduct to the DOJ, but it has a limited time to investigate and decide whether to self-report the conduct.

Key Takeaways

Reading the tea leaves, we see several potentially significant takeaways for companies evaluating the program’s likely impact.

  1. As a starting point, companies should evaluate whether and to what extent their operations create new reporting opportunities under the program, and thus necessitate action. That process should involve answering the following questions:
    • Does the company operate in one of the areas of focus? If so, the program creates new opportunities and incentives for whistleblowers, and the company must assess whether it is prepared to address an increase in reports and to recognize that a reporter may have already disclosed information to the DOJ.
    • Is the company publicly traded? If so, the company is already subject to the Sarbanes-Oxley Act (SOX), which should mean that systems are already in place to receive, investigate and determine whether to take action, including potentially making a voluntary self-disclosure. The program provides an opportunity to reassess the efficacy of those systems but should not necessarily require the creation of new ones. Note that even those companies with existing whistleblower programs should consider the need to expand those systems to cover new areas of focus. For example, a company with a SOX whistleblower policy should consider the need to expand its scope to cover domestic corruption violations, which may not otherwise be covered.
    • Does the company submit claims to government payors? If so, it is already subject to the FCA and should already have a system in place to analyze internal compliance concerns. If that system focuses on or prioritizes issues regarding government payors, the company should expand its focus to include claims and conduct regarding private payors, which may now be subject to whistleblower bounties under the program.
  2. For privately held companies operating in the areas of focus that are not subject to the FCA, the program necessitates a thorough and candid assessment of the risk the program creates. Depending on the extent of that danger, companies should consider the following measures:
    • Create, or enhance as necessary, internal reporting mechanisms to receive and evaluate whistleblower reports.
    • Publicize the company’s expectation that employees should promptly report concerns internally about potential violations of law or company policy, making clear that no retaliation will result from reports made in good faith.
    • Design a process for investigating whistleblower reports based on their nature and seriousness. Establish criteria for identifying those that can be investigated by HR, those that require the involvement of in-house counsel, and those that must be handled by outside counsel. If there is any possibility of criminal exposure, ensure an appropriate investigation is conducted and concluded in time to allow the company to determine whether to self-report in the 120-window for a presumptive declination.
  3. All companies should have in place a system for quickly and accurately evaluating whether to voluntarily self-disclose violations. This process is a multi-factor calculus that considers a range of factors, including primarily the merits of the underlying information and the amount of financial loss or gain that resulted. While decision-making in this context varies by situation, one essential element remains constant: the need for accurate information regarding the nature, scope and effect of the underlying conduct.

Only time will tell exactly how the program will impact the number and nature of whistleblower reports. But companies can take practical steps now to gauge whether and to what extent they are likely to be affected and begin installing the measures necessary to minimize the risk that might otherwise result.

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© 2024 Bradley Arant Boult Cummings LLP
For more on Whistleblowers, visit the NLR Criminal Law Business Crimes section

DOJ Launches Corporate Whistleblower Awards Pilot Program

The Department of Justice (“DOJ”) released its Corporate Whistleblower Awards Pilot Program on August 1, 2024. This initiative, which is expected to last three years, aims to enhance corporate crime detection, expand enforcement and prosecution efforts, and encourage reporting by incentivizing whistleblowers with the potential of significant payouts. Going forward, companies should pay close attention to DOJ’s  statements  and  guidance  and assess their existing compliance program to ensure that they are encouraging internal reporting and have procedures in place to quickly investigate, remediate, and potentially disclose misconduct.

For years, the Securities and Exchange Commission, Commodity Futures Trading Commission, and the Financial Crimes Enforcement Network have maintained whistleblower programs. When announcing the DOJ’s Pilot Program last March, Deputy Attorney General Lisa Monaco said these programs, while successful, do not address “the full range of corporate and financial misconduct” that DOJ prosecutes. Monaco emphasized that DOJ’s new program aims to fill the gaps in the existing patchwork. The Pilot Program goes into effect immediately.

Impacting the Pilot Program is DOJ’s recent  amendment  to its Corporate Enforcement and Voluntary Self-Disclosure (“VSD”) Policy. Under the amendment, a company that receives an internal report of misconduct from a whistleblower and reports that misconduct to DOJ within 120 days is eligible for a presumption in favor of declining prosecution. To be eligible for the presumption, the company must also cooperate fully and commit to remediation of the wrongdoing. Along with the whistleblower awards program, this amendment provides DOJ with more tools to encourage companies to strengthen internal reporting systems and to incentivize voluntary self-disclosure of corporate crimes and misconduct.

Foreign and domestic companies should reassess anti-corruption, trade compliance, and other compliance programs and should consider revising existing programs as needed to encourage internal reporting of concerns regarding potential non-compliance with company policies and applicable laws.

Covered Violations 

To qualify for an award, the information provided by a whistleblower must be related to one of the following types of criminal conduct:

  • Violations by financial institutions, their insiders, or agents, including schemes involving money laundering, anti-money laundering compliance violations, registering of money transmitting businesses, fraud statutes, and fraud against or non-compliance with financial institution regulators.
  • Foreign corruption and bribery violations under the Foreign Corrupt Practices Act, the Foreign Extortion Prevention Act, or money laundering statutes.
  • Violations related to the payment of bribes or kickbacks to domestic (U.S.) public officials.
  • Federal health care offenses not covered by the False Claims Act, including federal health care offenses and related crimes involving private or other nonpublic health care benefit programs and health care fraud schemes involving private insurance plans.

Eligibility and Rewards 

  • Whistleblowers may be eligible for an award under the Pilot Program if, alone or jointly with other individuals, the whistleblower provides DOJ with original information, in writing, which leads to criminal or civil forfeiture exceeding $1 million in connection with a successful prosecution, criminal resolution, or civil forfeiture action. The whistleblower must cooperate fully with DOJ’s investigation.
  • Whistleblowers must provide truthful, original, non-public information about corporate misconduct to qualify for potential compensation under the program.
  • Whistleblowers may report suspected misconduct internally before reporting to DOJ but are not required to do so in order to be eligible under the pilot program. If the whistleblower reports the alleged misconduct internally through company reporting channels, they must subsequently report it to DOJ within 120 days. A whistleblower may therefore choose to go directly to DOJ without first reporting through internal channels.
  • Information will not be considered original if it was obtained through communications subject to attorney-client privilege, or if the whistleblower’s principal duties include compliance or audit responsibilities. Whistleblowers who work for third-party firms conducting or supporting internal investigations will also not be eligible for any rewards.
  • Whistleblowers that would be eligible for an award through another U.S. whistleblower, False Claims Act qui tam, or similar program will not be eligible for an award under the Pilot Program if they report the same misconduct. However, DOJ encourages whistleblowers to submit information to multiple programs to allow DOJ and other agencies to decide which program is best suited to address the alleged misconduct.

Whistleblowers are eligible for an award even if they initially report information through their employer’s internal reporting procedures. However, the whistleblower must also report the same information to DOJ within 120 days of making an internal report. Whistleblowers may receive up to 30 percent of the first $100 million in net proceeds forfeited, and up to 5 percent of net proceeds between $100 million and $500 million. There is no award on net proceeds forfeited above $500 million. The maximum potential award is set at $35 million. The payment of any award is subject to DOJ’s discretion. DOJ will take into consideration, among other things, the significance of the information provided and the whistleblower’s cooperation and level of assistance. A whistleblower’s level of culpability, unreasonable delay in reporting, and interference with internal compliance and reporting systems may decrease award amounts. A whistleblower is not eligible for payment if they meaningfully participated in the misconduct or criminal activity. DOJ may, however, determine that a whistleblower is eligible if he or she played a minimal role and any misconduct was “sufficiently limited” in scope.

VSD Policy Amendment 

The VSD Policy amendment provides that, where a whistleblower makes both an internal report and a report to DOJ, a company may qualify for a presumption of declination under the VSD Policy even if the whistleblower reports the misconduct to DOJ before the company does. The company, however, must report the conduct to DOJ within 120 days of receiving the internal report  and  before DOJ contacts the company about the misconduct. Thus, the “declination window” may be shorter than 120 days, as DOJ could reach out before then. The amended VSD Policy and the Pilot Program effectively require companies to swiftly investigate and disclose misconduct to avoid steep penalties and prosecution.

What Companies Can Do Now 

The Pilot Program will be administered by the Criminal Division’s Money Laundering and Asset Recovery Section (“MLARS”). MLARS has taken a leading role in prosecuting foreign corruption and other international crimes in recent years but will likely expand its role into domestic corruption and national security issues as a result of its mandate here. MLARS will certainly place increased focus on the seizure and forfeiture of money.

Companies can take proactive steps to mitigate risk by re-evaluating their voluntary self-disclosure decision making and to improve existing compliance policies and procedures.

A few steps companies can take include:

  1. Clear Policies and Procedures: 
    • Establish clear guidelines and encourage employees to report misconduct.
    • Communicate these policies to all employees through training sessions, handbooks, and regular reminders.
  2. Anonymous Reporting Channels: 
    • Provide confidential or anonymous reporting channels (such as hotlines or online platforms).
  3. Non-Retaliation Assurance: 
    • Assure employees that they will not face retaliation for reporting.
    • Implement strong anti-retaliation policies and enforce them consistently.
  4. Leadership Support: 
    • Leadership should actively promote a culture of integrity and transparency.
  5. Incentives and Recognition: 
    • Consider offering incentives for early reporting or successful outcomes.
    • Recognize and appreciate employees who report misconduct.
  6. Training and Awareness: 
    • Regularly train employees on recognizing red flags and reporting procedures.
    • Foster awareness about the importance of reporting for the company’s well-being.
  7. Testing of Internal Controls: 
  • Ensure that existing compliance policies and procedures are working and are accurately identifying risks and detecting potential misconduct.
  1. Voluntary Disclosure: 
  • Review and strengthen internal investigation policies and procedures.
  • Conduct thorough, timely investigations into alleged misconduct.
  • Companies have 120 days or less to review internal complaints and reports of misconduct and to disclose to DOJ to qualify for declination under the amended VSD Policy.
© 2024 Blank Rome LLP
For more on Whistleblower Award Programs, visit the NLR Criminal Law Business Crimes section

The DOJ’s New Corporate Whistleblower Awards Pilot Program: A Victory for Wall Street – A Setback for Accountability

On August 1, 2024, the U.S Department of Justice announced the rules governing its new corporate whistleblower program. Unfortunately for whistleblowers, the Justice Department based its new program on proposals long advocated by the U.S. Chamber of Commerce and Wall Street special interests.

These Wall Street-friendly features contain most of the major elements of a long dreamed of “wish list” sought by the very companies that have been successfully prosecuted as a result of whistleblower disclosures. This wish list includes: making the payment of awards discretionary, capping the amount of awards, blocking the best informants from coverage, pushing whistleblowers into internal compliance programs instead of having them report directly to the government, and placing a major caveat on the right to file anonymous claims.

In adopting this Wall Street wish-list, the Justice Department ignored the empirical data demonstrating that programs which reject these proposals, such as the Dodd-Frank Act, have proven to be the most successful fraud-detection whistleblower laws.

New Program Announced

Deputy Attorney General (DAG) Lisa Monaco first announced the DOJ’s decision to establish  a new whistleblower award program during her keynote remarks at the American Bar Association’s 39th National Institute on White Collar Crime on March 7. She recognized the importance of paying monetary awards to whistleblowers and how such programs have created massive opportunities to pursue major fraud prosecutions:

“Ever since Dodd-Frank created whistleblower programs at the SEC and the CFTC, those agencies have received thousands of tips, paid out many hundreds of millions of dollars, and disgorged billions in ill-gotten gains from corporate bad actors.”

“These programs have proven indispensable — but they resemble a patchwork quilt that doesn’t cover the whole bed. They simply don’t address the full range of corporate and financial misconduct that the Department prosecutes.

“So, we are filling these gaps.”

Monaco detailed that the Pilot Program would use existing statutory authorities under the little-used Asset Forfeiture Whistleblower Award Law, 28 U.S.C. § 524, as a basis for paying whistleblower awards. This law, in existence since 1984, was, for years, ignored by the DOJ. For example, in FY 2023, the United States obtained $3.4 billion from asset forfeitures but only used $13 million to compensate whistleblowers or informants. All whistleblower payments were made by the Drug Enforcement Authority ($12 million) or the FBI ($1 million)).

The failure to pay whistleblowers from the Fund has contributed to the Fund’s massive balance. As of the end of FY 2023, the Fund had $8.5 billion in assets. The Justice Department’s annual Asset Forfeiture Fund report confirmed that whistleblower-initiated cases were a major driving force in adding billions to the Fund. The report identified income from the Danske Bank money laundering case as the largest contributor to increasing the Fund’s assets. As Danske Bank itself admitted, that scandal, and the resulting enforcement actions were initiated by a whistleblower report, and the DOJ admitted that $1.2 billion was deposited into the Fund from that case.

Significantly, Congress entrusted the Justice Department to establish rules for paying whistleblowers or other informants. Unlike other whistleblower award laws such as the False Claims or Dodd-Frank Acts, Congress did not establish mandatory guidelines limiting the ability of the Department to compensate whistleblowers. Instead, the Justice Department could establish progressive and pro-whistleblower regulations to fully achieve the goals behind establishing the Fund. As explained by the Justice Department, the Fund is supposed to be “an essential component of the Department’s efforts to combat the most sophisticated criminal actors and organizations – including terrorist financiers, cyber criminals, fraudsters, human traffickers, and transnational drug cartels.”

Thus, whistleblower advocates were optimistic when the DAG announced the DOJ’s intent to use its authority under the Asset Forfeiture Fund to build a new corporate whistleblower program. Not only had the DAG acknowledged the success of the Dodd-Frank model for incentivizing informants, but the DOJ also clearly understood the international nature of many of the crimes resulting in asset forfeiture (including the DOJ’s acknowledgment that the Fund was created to combat “transnational drug cartels,” “human traffickers” and “terrorist financiers”). Advocates hoped that the Justice Department would incorporate policies outlined in the United States Strategy on Countering Corruption into the new program. Under this Strategy, the United States pledged to act in “solidarity” with whistleblowers and bolster human rights defenders, investigative journalists, and other key players in the worldwide fight against corruption.

After the DAG’s announcement,, the Justice Department engaged in “listening sessions” to “gather information” so they could “design a thoughtful, well-informed program.” Numerous whistleblower experts met with the Justice Department team crafting the new program and provided input. Additionally, written guidance was provided by leading whistleblower law firms, a former SEC Commissioner with expertise on the Dodd-Frank whistleblower law, and all the major whistleblower advocacy groups, including 23 international anti-corruption organizations, the National Whistleblower Center, Transparency International (USA), The Anti-Fraud Coalition (TAF), and the Government Accountability Project. These persons and groups endorsed a framework modeled on the Dodd-Frank Act consistent with the legal structure explained in the paper “Why Whistleblowing Works: A New Look at the Economic Theory of Crime.” 

The groundwork was set for the creation of a highly effective, transnational anti-corruption whistleblower program, that was designed to close gaps in existing laws, and use the billions in assets sitting in the Asset Forfeiture Fund to incentivize reporting and ensure that whistleblowers were properly compensated.

What Happened? The DOJ Adopts Proposals Advocated by Anti-Whistleblower Corporate Lobbyists

For years, the U.S. Chamber of Commerce and numerous corporations (many of which have pleaded guilty to committing frauds) have lobbied against highly successful qui tam whistleblower award laws. They actively lobbied to water-down both the Dodd-Frank and False Claims Act. Given the unquestionable effectiveness of these qui tam laws, the Chamber and its numerous members that were found to have committed frauds promoted tactics that would impede the ability of whistleblowers to use the laws or obtain compensation.

In December 2010, the Chamber urged the SEC to implement proposed rules that would have crippled the Dodd-Frank Act, but the SEC rejected those proposals. In 2013, the Chamber issued a comprehensive report, entitled “Fixing the False Claims Act,” which likewise urged Congress to enact legislation that would cripple the False Claims Act. Congress ignored these proposals.

However, the Justice Department adopted the main proposals advocated by the Chamber, all of which have been discredited by empirical evidence. By following the lead of the Chamber of Commerce, Justice ignored guidelines Congress incorporated into the leading whistleblower award laws, and instead yielded to the lobbying power of Wall Street.

MANDATORY AWARDS

All of the successful whistleblower award laws require the government to pay qualified whistleblowers a mandatory award if they adhere to the criteria established by law or regulation. The mandatory nature of the award laws is the single most important feature of every successful whistleblower qui tam law. The most successful whistleblower laws in the United States require the payment of an award, not less than 10% and not more than 30% of the monies collected by the United States. Thus, whistleblowers are not compensated by taxpayer funds, but instead monies obtained from the fraudsters they report are used to pay the awards.

What did Justice Do?

Although the Justice Department had the discretion to follow the precedent under Dodd-Frank, False Claims, and AML laws, it ignored these precedents and created a discretionary program. In other words, the Justice Department can deny a fully qualified whistleblower, for any reason or no reason. There is no appeal. The Justice Department’s written regulations are clear: “The Department’s Award Determination is entirely discretionary, and neither appealable nor subject to judicial review.”

A whistleblower whose information results in hundreds of millions of dollars in recoveries, but who suffers tremendous retaliation, simply has no right to an award.

Not surprisingly, all discretionary whistleblower award laws have failed. Why should a whistleblower risk everything if the government has no obligation whatsoever to live up to its end of the bargain?

LIMITS ON AWARD AMOUNTS

The successful whistleblower award laws have no caps on the amount of an award. Awards are based on the quality of information provided, the cooperation a whistleblower provides to the government, the risks or sacrifices of the whistleblower, and the size of the frauds or crimes the whistleblower uncovers and reports. All awards are tied to the amount of actual recovery collected from the fraudster.

The Chamber of Commerce has tried, for years, to cap or limit the amount of an award. They fully understand that the handful of very large awards drives thousands of whistleblowers to come forward. Large awards publicize the programs, send a message that the government will honor its commitments, and incentivizes well-paid and high-level executives to become whistleblowers. Thus, capping the amount of an award is the number one goal of the corporate lobbyists attempting to weaken or undermine whistleblower rights.

In 2018 the SEC instituted a rulemaking proceeding which would have limited the amount of awards paid to whistleblowers in large cases. The initial proposal was approved in a 3-2 vote (all of the SEC Commissioners more supportive of Wall Street interests voted for limiting the size of awards). The proposal was debated internally within the SEC for two years, and leading whistleblower experts and advocates provided empirical evidence that large awards were a cornerstone to the program, incentivized some of the most important whistleblowers, and had a deterrent effect on wrongdoing.

Based on the objective evidence the Commission, 5-0, withdrew the proposal and rejected a rule that would have limited awards in large cases.

What did Justice Do?

Breaking with 35-years of Congressional legislation and ignoring the empirical evidence concerning the importance of large awards, the Justice Department, in an unprecedented move, decided to cap the amount of awards. This was the most significant victory Wall Street, and the Chamber of Commerce obtained, and it sets a terrible precedent.

Incredibly, the Justice Department instituted a rule that was even more regressive than the proposal made by the Chamber of Commerce. In its report Fixing the False Claims Act, the Chamber advocated changing the False Claims Act’s mandatory minimum 15% award, to a sliding scale that would create a “Graduated Reduction” in a whistleblower’s award. The amount of awards would be slowly reduced, and ultimately whistleblowers would only obtain “1 to 3 percent of amounts recovered above $100 million.”

The Justice Department took an even more extreme position. They adopted the Chamber’s recommendation to gradually reduce the size of an award, but instead of permitting tiny awards in large cases, they decided to zero these awards out, and pay nothing. Under the DOJ criteria, a whistleblower would not be entitled to any compensation based on recoveries that topped $500 million and would be subjected to a 5% cap on recoveries above $100 million. These caps need to be understood in the context of the right of the DOJ to reduce or deny awards at will. The DOJ capped the maximum amount of awards, yet established no minimum award, and provided itself with authority to pay no awards to fully qualified whistleblowers. The Chamber of Commerce never went this far in its proposal to undermine the False Claims Act.

CRIMINAL CULPABILITY

All the existing award laws have addressed the issue of the potential criminal culpability of the whistleblower. The original False Claims Act fully recognized this issue when it was signed into law by President Abraham Lincoln on March 2, 1863. The Senate sponsors of the bill explicitly called for participants in the frauds to step forward and use the law to assist the government in detecting these types of crimes. The Senate sponsor of the original False Claims Act recognized that it “takes a rogue to catch a rogue” and the primary intent of the award laws was to induce persons involved in the criminal conspiracy to turn on their fellow conspirators.

Thus, all successful whistleblower award laws permit participants in the frauds to turn in their co-conspirators and collect an award. This aspect of the law is perhaps the most important tool in incentivizing highly placed whistleblowers to step forward. In the context of asset forfeiture, there are no better sources of who the bad actors are who are hiding their assets than the bankers who opened their accounts. All of the laws prohibit persons convicted of the crime they are reporting from collecting an award. But likewise, all of the laws encourage participants, such as international bankers, to step forward.

What did Justice Do?

The Chamber of Commerce and its corporate allies have long advocated against the primary goal of the qui tam laws, i.e. to induce conspirators to turn on their co-conspirators. The fact that “trusted” persons sitting around a corporate board when the company is discussing paying a bribe sends chills within corporate America. In 2010,, the Chamber of Commerce made its position on this issue perfectly clear: “Exclude culpable individuals from award eligibility . . . corporate employees should not be rewarded if they engage in, perpetuate, or fail to take action to stop internal wrongdoing. Individuals who participated in wrongdoing should be excluded from award eligibility.”

Although Congress has continuously rejected such a broad disqualification, and the SEC explicitly rejected this proposal submitted by the Chamber and numerous corporate allies, the Justice Department has now adopted the essence of this position. Under the DOJ’s rules, the vast majority of participants in any fraud are now blocked from obtaining an award.

The DOJ regulation bars anyone who “meaningfully participated” in the fraud. This would cover the overwhelming majority of the best sources of information, and would give comfort to corporate insiders knowing that their co-conspirators could not obtain an award if they turned them in. The only exception would be for those who had a “minimal role,” i.e. those who would have the least valuable information, such as a secretary who may have mailed a letter related to the fraud. The regulation states: “An individual is not eligible for payment if they meaningfully participated in the criminal activity, including by directing, planning, initiating, or knowingly profiting from that criminal activity” (emphasis in original).

CONFIDENTIAL REPORTING

Dodd-Frank and the new AML whistleblower award law permits confidential and anonymous filing.

What did Justice Do?

Although the Justice Department permits anonymous filings, the regulations require that an anonymous whistleblower be identified whenever the Justice Department requests it. The regulation states: “The Department reserves the right to require information regarding your identity at any time the Department, in its sole discretion, deems it necessary to the prosecution of a case or to meet the Department’s legal obligations, policies, or procedures.”

Thus, DOJ can waive confidentiality and anonymity at-will, unbound by the legal restraints contained in Dodd-Frank and the AML whistleblower laws.

INTERNAL REPORTING

The DOJ’s new program strongly encourages whistleblowers to make internal reports to the very companies they suspect are violating the law. Similarly, the program provides companies who “self-report,” even after whistleblowers disclose violations of law to the government, major benefits and radical reductions in the amount of fines and penalties.

According to the DOJ factsheet:

“DOJ recognizes the value of companies’ internal compliance programs and has designed the pilot program to encourage employees to report misconduct internally before submitting information to DOJ.” (emphasis added).

This focus on encouraging whistleblowers to report to their companies ignored the fact that the very companies that benefit from these internal reports have lobbied and successfully fought in court to strip whistleblowers of protection against retaliation. In other words, the DOJ is encouraging employees to engage in a behavior that is not protected under federal law, and can result in their being fired and harassed, without legal protections.

All whistleblower laws protect employees who report to the government. But the following laws do not:

  • Commodity Exchange Act: No protection for internal disclosures.
  • Security Exchange Act/Foreign Corrupt Practices Act: No protection for internal disclosures.
  • Federal Obstruction of Justice Whistleblower Law: No protection for internal disclosures.
  • Anti-Money Laundering and Sanctions Whistleblower Law: No protection for internal disclosures for any employees who work for FDIC insured institutions or credit unions.
  • Asset Forfeiture Whistleblower Award (Fund): No protection for internal disclosures.

A recent study published in SSRN demonstrated that 92% of all corporate whistleblower retaliation cases arise from employees who make internal disclosure, while only 5% of retaliation cases arise from employees who report to the government, but avoid internal compliance programs.

It is extremely troubling that the DOJ would encourage whistleblowers to engage in behaviors that are not protected under federal law, will result in many of them losing the ability to report confidentially, and that the empirical evidence demonstrates is the most dangerous method for an employee to report concerns.

Moreover, the DOJ ignored the fact that Wall Street, led by the Chamber of Commerce, strongly argued that internal reporting should not be protected under the Dodd-Frank Act. The Chamber succeeded in having the Supreme Court overturn an SEC regulation that protected internal whistleblower disclosures from protection under law and resulted in stripping employees who reported to corporate counsel, corporate boards, corporate audit committees, or corporate compliance programs from all protections against retaliation under Dodd-Frank.

Options for Whistleblowers

The DOJ’s Corporate Whistleblower Awards Pilot Program represents a colossal lost opportunity to use a Fund created by Congress to combat major financial crimes to incentivize and compensate whistleblowers and otherwise encourage human rights defenders to assist in reporting domestic and international corruption. The Fund has billions of dollars that could have been creatively, aggressively and effectively utilized to fill loopholes in current laws and implement the important recommendations of the United States Strategy on Countering Corruption.

However, existing whistleblower award laws, that do not share the defects of the DOJ Pilot Program, can still be used by whistleblowers. Given the broad scope of these laws, much of the negative impact of the Justice Department’s regulations can be mitigated. Dodd-Frank can be used to report foreign bribery by most corporations worldwide; the Anti-money laundering laws can be used to hold banks and financial exchanges accountable, and to report violations of U.S. sanctions; the IRS program can be used to report tax evasion and permits awards for IRS investigations related to asset forfeiture; and finally, the Commodity Exchange Act can be used to report foreign corruption in the international commodities markets.

Employees who report directly to federal law enforcement authorities are also fully protected under the federal obstruction of justice laws. Under the obstruction law passed as part of the Sarbanes-Oxley corporate reform law, employers who fire employees for reporting to federal law enforcement are subjected to fines and up to ten years in prison.

These numerous (and highly effective) laws do not contain the problems that undermine whistleblower rights under the DOJ Pilot Program, and they should be used whenever available.

Conclusion

The Justice Department adopted proposals long sought after by Wall Street special interests and the Chamber of Commerce and created a program that delivered on the corporate wish-list for undercutting the effectiveness of whistleblower award programs. By making the program discretionary, capping the amount of awards, blocking the best informants from coverage, and placing a major caveat on the right to file anonymous claims, the Justice Department’s program runs counter to the significant amount of empirical evidence concerning the specific policies and procedures necessary to operate a successful program. Worse still, it creates a dangerous precedent for future whistleblower laws.

To understand just how terrible discretionary programs with compensation caps are and why Congress has repeatedly rejected them since 1986, one need only look at older and discredited award programs.

For example, between 1989 and 2010, the SEC had a discretionary award program covering whistleblowers who disclosed insider trading. The SEC Inspector General reviewed that program and found that it was a total failure and was unable to stop frauds like the ENRON scandal or frauds associated with the 2008 financial collapse.

The Inspector General described the program and its operation over its eleven years of existence as follows:

“All bounty determinations, including whether, to whom, or in what amount to make payments, are within the sole discretion of the SEC.”

“Since the inception of the SEC bounty program in 1989, the SEC has paid a total of $159,537 to five claimants.”

Thus, in July 2010, Congress repealed this discredited law and passed Dodd-Frank, which has mandatory award laws, no caps, and no discretion to deny qualified whistleblowers compensation.

The old IRS law and the False Claims Act of 1943 had similar problems, and both laws were amended to make the payment of awards mandatory, eliminate all caps, and end the discretion of government agencies to deny awards. All of the modern award laws also permit whistleblowers to challenge any denial in court.

The Justice Department had the discretion to create a highly effective program based on the Dodd-Frank Act. They dropped the ball. Now Congress needs to fix the mess Justice created.

In the meantime, whistleblowers should continue to use the highly effective award laws: the False Claims Act, the Dodd-Frank Act, the AML Whistleblower Improvement Act and the Foreign Corrupt Practices Act. Whistleblowers should also take advantage of the strong protections offered under the federal obstruction of justice statutes by reporting concerns directly to law enforcement.

The Justice Department did get one thing right. As part of its pilot program, Justice ruled that whistleblowers who are covered under the existing highly effective whistleblower laws cannot obtain any awards under the pilot program. Intentionally or not, this was the best advice Justice could give to whistleblowers: Make sure you use the existing laws and not rely on the pilot program.

Copyright Kohn, Kohn & Colapinto, LLP 2024. All Rights Reserved.
For more on Whistleblowers, visit the NLR Criminal Law Business Crimes section

Top Competition Enforcers in the US, EU, and UK Release Joint Statement on AI Competition – AI: The Washington Report

On July 23, the top competition enforcers at the US Federal Trade Commission (FTC) and Department of Justice (DOJ), the UK Competition and Markets Authority (CMA), and the European Commission (EC) released a Joint Statement on Competition in Generative AI Foundation Models and AI products. The statement outlines risks in the AI ecosystem and shared principles for protecting and fostering competition.

While the statement does not lay out specific enforcement actions, the statement’s release suggests that the top competition enforcers in all three jurisdictions are focusing on AI’s effects on competition in general and competition within the AI ecosystem—and are likely to take concrete action in the near future.

A Shared Focus on AI

The competition enforcers did not just discover AI. In recent years, the top competition enforcers in the US, UK, and EU have all been examining both the effects AI may have on competition in various sectors as well as competition within the AI ecosystem. In September 2023, the CMA released a report on AI Foundation Models, which described the “significant impact” that AI technologies may have on competition and consumers, followed by an updated April 2024 report on AI. In June 2024, French competition authorities released a report on Generative AI, which focused on competition issues related to AI. At its January 2024 Tech Summit, the FTC examined the “real-world impacts of AI on consumers and competition.”

AI as a Technological Inflection Point

In the new joint statement, the top enforcers described the recent evolution of AI technologies, including foundational models and generative AI, as “a technological inflection point.” As “one of the most significant technological developments of the past couple decades,” AI has the potential to increase innovation and economic growth and benefit the lives of citizens around the world.

But with any technological inflection point, which may create “new means of competing” and catalyze innovation and growth, the enforcers must act “to ensure the public reaps the full benefits” of the AI evolution. The enforcers are concerned that several risks, described below, could undermine competition in the AI ecosystem. According to the enforcers, they are “committed to using our available powers to address any such risks before they become entrenched or irreversible harms.”

Risks to Competition in the AI Ecosystem

The top enforcers highlight three main risks to competition in the AI ecosystem.

  1. Concentrated control of key inputs – Because AI technologies rely on a few specific “critical ingredients,” including specialized chips and technical expertise, a number of firms may be “in a position to exploit existing or emerging bottlenecks across the AI stack and to have outside influence over the future development of these tools.” This concentration may stifle competition, disrupt innovation, or be exploited by certain firms.
  2. Entrenching or extending market power in AI-related markets – The recent advancements in AI technologies come “at a time when large incumbent digital firms already enjoy strong accumulated advantages.” The regulators are concerned that these firms, due to their power, may have “the ability to protect against AI-driven disruption, or harness it to their particular advantage,” potentially to extend or strengthen their positions.
  3. Arrangements involving key players could amplify risks – While arrangements between firms, including investments and partnerships, related to the development of AI may not necessarily harm competition, major firms may use these partnerships and investments to “undermine or coopt competitive threats and steer market outcomes” to their advantage.

Beyond these three main risks, the statement also acknowledges that other competition and consumer risks are also associated with AI. Algorithms may “allow competitors to share competitively sensitive information” and engage in price discrimination and fixing. Consumers may be harmed, too, by AI. As the CMA, DOJ, and the FTC have consumer protection authority, these authorities will “also be vigilant of any consumer protection threats that may derive from the use and application of AI.”

Sovereign Jurisdictions but Shared Concerns

While the enforcers share areas of concern, the joint statement recognizes that the EU, UK, and US’s “legal powers and jurisdictions contexts differ, and ultimately, our decisions will always remain sovereign and independent.” Nonetheless, the competition enforcers assert that “if the risks described [in the statement] materialize, they will likely do so in a way that does not respect international boundaries,” making it necessary for the different jurisdictions to “share an understanding of the issues” and be “committed to using our respective powers where appropriate.”

Three Unifying Principles

With the goal of acting together, the enforcers outline three shared principles that will “serve to enable competition and foster innovation.”

  1. Fair Dealing – Firms that engage in fair dealing will make the AI ecosystem as a whole better off. Exclusionary tactics often “discourage investments and innovation” and undermine competition.
  2. Interoperability – Interoperability, the ability of different systems to communicate and work together seamlessly, will increase competition and innovation around AI. The enforcers note that “any claims that interoperability requires sacrifice to privacy and security will be closely scrutinized.”
  3. Choice – Everyone in the AI ecosystem, from businesses to consumers, will benefit from having “choices among the diverse products and business models resulting from a competitive process.” Regulators may scrutinize three activities in particular: (1) company lock-in mechanisms that could limit choices for companies and individuals, (2) partnerships between incumbents and newcomers that could “sidestep merger enforcement” or provide “incumbents undue influence or control in ways that undermine competition,” and (3) for content creators, “choice among buyers,” which could be used to limit the “free flow of information in the marketplace of ideas.”

Conclusion: Potential Future Activity

While the statement does not address specific enforcement tools and actions the enforcers may take, the statement’s release suggests that the enforcers may all be gearing up to take action related to AI competition in the near future. Interested stakeholders, especially international ones, should closely track potential activity from these enforcers. We will continue to closely monitor and analyze activity by the DOJ and FTC on AI competition issues.

©1994-2024 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.
For more on AI Competition, visit the NLR Communications Media Internet section.

Triggers That Require Reporting Companies to File Updated Beneficial Ownership Interest Reports

On January 1, 2024, Congress enacted the Corporate Transparency Act (the “CTA”) as part of the Anti-Money Laundering Act of 2020 and its annual National Defense Authorization Act. Every entity that meets the definition of a “reporting company” under the CTA and does not qualify for an exemption must file a beneficial ownership information report (a “BOI Report”) with the US Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”). Reporting companies include any entity that is created by the filing of a document with a secretary of state or any similar office under the law of a state or Indian tribe (this includes corporations, LLCs, and limited partnerships).

In most circumstances, a reporting company only has to file an initial BOI Report to comply with the CTA’s reporting requirements. However, when the required information reported by an individual or reporting company changes after a BOI Report has been filed or when either discovers that the reported information is inaccurate, the individual or reporting company must update or correct the reporting information.

Deadline: If an updated BOI Report is required, the reporting company has 30 calendar days after the change to file an updated report.

What triggers an updated BOI Report? There is no materiality threshold as to what warrants an updated report. According to FinCEN, any change to the required information about the reporting company or its beneficial owners in its BOI Report triggers a responsibility to file an updated BOI Report.

Some examples that trigger an updated BOI Report:

  • Any change to the information reported for the reporting company, such as registering a new DBA, new principal place of business, or change in legal name.
  • A change in the beneficial owners exercising substantial control over the reporting company, such as a new CEO, a sale (whether as a result of a new equity issuance or transfer of equity) that changes who meets the ownership interest threshold of 25%, or the death of a beneficial owner listed in the BOI Report.
  • Any change to any listed beneficial owner’s name, address, or unique identifying number provided in a BOI report.
  • Any other change to existing ownership information that was previously listed in the BOI Report.

Below is a reminder of the information report on the BOI report:

  • (1) For a reporting company, any change to the following information triggers an updated report:
    • Full legal name;
    • Any trade or “doing business as” name;
    • A complete current address (cannot be a post office box);
    • The state, territory, possession, tribal or foreign jurisdiction of formation; and
      TIN.
  • (2) For the beneficial owners and company applicants, any change to the following information triggers an updated report:
    • Full legal name of the individual;
    • Date of the birth of the individual;
    • A complete current address;
    • A unique identifying number and the issuing jurisdiction from one of the following non-expired documents; and
    • An image of the document.

It is important to note that if a beneficial owner or company applicant has a FinCEN ID and any change is made to the required information for either individual, then such individuals are responsible for updating their information with FinCEN directly. This is not the responsibility of the reporting company

© 2024 Winstead PC.