As compliance officers wait to see how the Trump Administration might try to change patterns of SEC enforcement, you may want to consider a case last week where the SEC fined a consumer bank for accounting improprieties and whistleblower pre-taliation at the same time.
The firm in question is HomeStreet, a bank based in Seattle with $5.4 billion in assets and 113 branches across the Northwest. The SEC fined the bank $500,000 on Jan. 19 for bending the accounting rules arounding hedging instruments HomeStreet carried on its books, and for forcing employees to waive their rights to whistleblower rewards, once bank executives realized the SEC was on their case.
The accounting misconduct gets rather arcane. The bank’s chief investment officer and treasurer, Darrell van Amen, changed the inputs of a test accounting departments are supposed to use to determine the value of hedging securities carried on the books. By altering the inputs, the test then found that those hedging instruments were “highly effective”—a technical but important term, because it let the bank offset those supposedly effective instruments against other, more risky swaps that lingered elsewhere on the balance sheet.
The practical result: HomeStreet’s financial volatility appeared lower to investors than it actually was, if the hedging tests had been applied correctly.
HomeStreet used this flawed accounting treatment for nearly three years, from late 2011 into 2014. That was against the company’s stated accounting procedures, and created a books-and-records violation under the Exchange Act.
Enter the Whistleblower Angle
In October 2014, van Amen told a junior employee in the bank’s treasury department to adjust the effectiveness tests for hedging as we described above. That employee was uncomfortable with the idea, so he and a fellow employee first reported their concerns to HomeStreet’s HR department; and then informed “Executive A” at the bank (we don’t know who Executive A is), who passed along their concerns to senior management.
Senior management then did the usual: its board formed a special committee, which hired outside counsel to conduct an investigation. By November 2014 the committee decided that the hedging treatments were inappropriate, but that van Amen didn’t act with any intent to commit fraud. Meanwhile, in the spring of 2015, both treasury employees and Executive A all resigned from HomeStreet.
HomeStreet did disclose its hedging problems to investors in November 2014. They weren’t large enough to warrant restatement of its financials, but they were serious enough that the bank admitted a material weakness in its internal control over financial reporting.
Sure enough, by April 2015, staffers in the SEC Enforcement Division came calling to the bank. Bank executives assumed that the SEC would only be nosing around their books because a whistleblower had alerted the agency. So the bank executives started nosing around their employees, trying to identify the supposed whistleblower. (I know, I know—insert eyeroll emoticon here.)
One employee interviewed was Executive A, just before he quit. Executive A assured the bank that he wasn’t the whistleblower, and didn’t know who was. Still, HomeStreet executives kept peppering him with questions (“Are you sure you’re not the whistleblower?”) and then they dragged their feet in covering Executive A’s legal expenses related to the SEC probe—which, per his severance agreement, the bank was obligated to pay. Eventually it did, after months of lawyer letters back and forth.
Then, to top everything off, HomeStreet also was caught using severance agreements that included clauses waiving employees’ rights to whistleblower rewards. Apparently the bank only used those clauses twice, and never actually tried to enforce them. Still, it’s icing on the cake.
Lessons to Learn
Lots of people (me included) wonder whether new Trump-ish leadership at the SEC might try to curtail the Office of the Whistleblower in 2017 and beyond. Pre-taliation seems like a valid enforcement issue to me under Rule 21F-17(a), which governs whistleblower protection. But it’s also just the sort of novel concept likely to annoy President Trump, who is just the sort of chief executive who might bark at his SEC chair to stop enforcing it.
We could, therefore, see more enforcement actions like HomeStreet: one sanction for a “traditional” securities law violation, plus an extra sanction for any stifling of whistleblowers that happened along the way. In that sense, this HomeStreet sanction is quite similar to other cases we’ve seen involving FCPA offenses. It’s not a new model of SEC enforcement, but it is one that could withstand the onslaught of whatever Trump will try to unleash on the agency.
As to other types of whistleblower enforcement, we’ll need to see what happens. The pre-taliation sweep that the SEC launched last year has certainly paid off in numerous enforcement actions lately, although I wonder how many more cases are in that pipeline, and whether new leadership will continue to push pre-taliation as an offense worth of future sweeps and sanctions.
Then there are the whistleblower rewards themselves, doled out for help that leads to SEC settlements. The agency gave out another one just on Monday, a combined $7 million split among three whistleblowers. Will those go away in the Trump Era too? I doubt it, because they help the agency look good no matter which party is in charge—but the rewards are a percentage of total settlement collected. If the new regime believes in smaller penalties generally, smaller whistleblower rewards will surely follow.