Institutional Investor Fraud Roundup: 3,001 Whistleblower Tips Sent to SEC in ’12, CFTC Contends with ‘Regulatory Cliff,’ and Private Placement Failures Prompt Insurers to More Closely Examine Alternative Investments

According to the SEC’s Whistleblower Office, during fiscal year 2012 it received 3,001 tips. The categories that received the most complaints involved the areas related to manipulation, offering fraud, and corporate disclosures and financials. Although complaints came from every state, the states with the most complaints were California, with 435 whistleblower tips, 246 from New York, while 202 tips came from Florida. Tips also were sent in from 49 countries.

During this past fiscal year, there were 143 notices of covered enforcement actions that resulted in sanctions of over $1 million—the minimum amount that needs to be collected for a whistleblower to obtain a reward. (A quality, original tip may entitle a whistleblower to 10-30% of what the government recovers). The SEC said that its Investor Protection Fund, which pays these rewards to qualifying whistleblowers, is fully funded and at the end of FY 2012 contained over $435 million. In August, the SEC paid its first whistleblower reward of $50,000 under the program.

In other securities regulator news, Scott O’Malia the CFTC commissioner announced that the agency will have to contend with a “regulatory cliff” next month when the temporary no-action relief stemming from new swaps rules expires. The regulator had put out 18 no-action letters and other guidance on October 12, providing a lot of swap market participants with a brief reprieve from rules that were scheduled to go into effect the next day. The relief for most expires on the last day of the year, and O’Malia wants the agency to take action to resolve this situation. He made his comments at the DC conference sponsored by George Mason University’s Mercatus Center.

O’Malia is also pressing the agency to modify the rules it is proposing over swap execution facilities so that they regulations become more flexible. The commission had published the proposed SEF rules nearly two years ago and, if approved, they would mandate for swap execution facilities provide a “basic functionality” that would allow market participants the choice to post “firm and indicative” quotes to more than one party. SEFs would be able to choose whether to deploy any platform or trading system that provides “basic functionality.” At the time, O’Malia had voted in favor of the proposal. However, he is now taking into account the comments that have been received since then, with many expressing concern that the proposed rules would limit the options for making trades.

Meantime, insurers tasked with underwriting brokerage firms’ errors and omissions policies are now being more careful about approving the alternative investments that the latter sell. This greater exercise of underwriter authority comes after the private placement crises involving Provident Royalties LLC and Medical Capital Holdings Inc. in 2009.

Insurance companies have final say on whether they will provide insurance for a product. Alternative investment products that typically don’t get the thumbs up for coverage are ones that lack audited financial statements.

This closer scrutiny can impact the bottom line of a brokerage firm, especially with insurers putting stricter limits on claims resulting from alterative investments, leading to much higher deductibles (up to 50% higher than the standard mutual fund deductible.) Insurers also want brokerage firms to exercise a higher duty of care in terms of when it comes to nontraded REITs.

The insurer underwriter-brokerage firm relationship has changed since the economic crisis of 2008. Disputes have even arisen between both parties over coverage of claims.

Annual Report on the Dodd-Frank Whistleblower Program, Fiscal 2012 (PDF)