SEC Shows It’s Serious About Stopping Retaliation Against Whistleblowers

For several years, Sean McKessey, the head of the Securities and Exchange
Commission’s Office of the Whistleblower, has told whistleblower
lawyers like me that the SEC is really serious about putting a stop to
retaliation. When the SEC wrote its whistleblower rules under the Dodd-Frank
Act, it gave itself the right to go after companies that retaliated against
people who reported illegal conduct. But until last week, the SEC had
never used the rule.

Last week the SEC started making good on McKessey’s promises. The
Commission announced that an Albany, New York, hedge fund advisory firm
and its owner would have to pay $2.2 million to settle charges of illegal
conduct, including charges that they retaliated against the employee who
reported the misconduct. Paradigm Capital Management and its owner Candace
King Weir did not actually fire their head trader, the SEC said, but they
did everything but. The hedge fund advisory firm demoted the employee
to full-time compliance assistant. He lost his supervisory responsibilities,
and was asked to “investigate” the fraud he already had reported.
As my grandmother would have put it: “They did him wrong.”*

According to the SEC’s press release,
SEC Charges Hedge Fund Adviser With Conducting Conflicted Transactions
and Retaliating Against Whistleblower, Paradigm Capital Management was manipulating its tradings in order to
allow its clients to pay less in taxes. The hedge fund had some “realized
gains,” meaning that it had sold some stocks at a profit. Unless
Paradigm has some losses to offset against those realized gains, its investors
were going to have to pay taxes on the gains. Apparently Paradigm did
have some stocks that had gone down in value, but it either could not
or did not want to sell them. Those stocks had “unrealized losses,”
which could not be offset against the realized gains.

Paradigm apparently came up with a way to “sell” the stocks
to an affiliated company, and then buy back the same stock at a lower
price. That way, Paradigm was able to “lose” money on the
stock but still keep it.

Paradigm was affiliated with a broker-dealer, C.L. King & Associates.
According to the SEC, Paradigm sold 47 positions to a proprietary trading
account it had with C.L. King. The securities were sold at a loss, and
the fund could claim the losses. However, C.L. King turned right around
and sold 36 of those positions back to the hedge fund.

Presto, change-o! Paradigm managed to take losses and still own the stocks.

Paradigm had set up a conflicts committee to “approve” these
transactions, but the SEC was not much impressed with the committee. The
committee consisted of just two people, both of whom reported to Weir.
One of the two committee members was the CFO of both Paradigm and C.L. King.

McKessey and the SEC Enforcement Office are using this enforcement provision
for the first time, and they are on the right track. If they hope to deter
fraud, they need whistleblowers to feel confident that they won’t
lose their jobs – or, as in this case, get demoted and marginalized
– when they come forward.

Just last week in this blog I wrote an entry about the
SEC giving its eighth award under the Whistleblower Program. I said that if the SEC wanted more tips, it had to recognize that: “some
industry insiders are still sitting on the fence, waiting to see how other
whistleblowers get treated.” What the SEC did here will go a long
way toward reassuring whistleblowers that they can report illegal behavior
without risking their careers. Congratulations to this whistleblower and
his law firm for being courageous enough to be first in line. (The SEC
does not identify whistleblowers.)

* Actually the correct Southern expression is: “They done him wrong,”
but my grandmother taught middle school English grammar, so that was most
definitely not how we said it in our family!