A Memo to the Congress
One of the more hotly contested issues with Dodd-Frank was that the Act would encourage misconduct – that the promise of ample compensation for whistleblowers would in fact incentivize individuals to direct or participate in criminal behavior, then reward those culpable for the wrongdoing. But the authorities have made clear they’ll take culpability into account.
For the last several months many “stakeholders” in the Dodd-Frank Act have been cautiously waiting to see if the “other shoe” will drop in the form of changes to that law initiated by the Trump Administration and/or the newly energized Republican Congress. An area of concern to this writer, who represents SEC whistleblowers, is whether this highly successful program will come under scrutiny by those seeking to curtail it, for whatever reason. Numerous objections to various provisions of the program originally came from many quarters, mostly in the corporate community, when the SEC first issued Rules to implement the whistleblower law set forth in the Dodd-Frank Act. Now, the program has established itself, and in the last five years has produced more than 10,000 tips, 49 awards for a total over $149 million and the recovery of nearly $1 billion in monetary penalties for the benefit of the U.S. government. If every government program was this successful, we would have no federal deficit.
To date, not much flak has been aimed in the direction of the program, but as new SEC Commissioners take their seats and certain members of Congress get to work on “revising” the Dodd Frank Act, it would not be surprising to see a revival of legislative or rule-making efforts to enact changes to the whistleblower program which, however well-intentioned, could make the whistleblower process more difficult, less attractive and thus less effective. The point of this article is to strongly suggest that the program was carefully crafted, underwent considerable “vetting” in the rule-making process, is working quite well and should be maintained and encouraged. Any program that costs the government almost nothing to operate, generates nearly $1 billion in financial penalties over its first five years and assists the government in deterring and prosecuting corruption and fraud is well worth keeping intact.
The Proposal: Barring “Co-Conspirator” Whistleblowers from Getting SEC Awards
As of this writing, the only announced effort to directly impact the program is coming from Rep. Jeb Henserling, R-Tex., Chairman of the House Financial Services Committee. According to several published reports, he recently issued a memo outlining a plan to revise Dodd-Frank and curtail SEC powers via changes in his bill introduced last year called the Financial Choice Act. In a memo of February 6, 2017 titled “CHOICE Act 2.0 Changes” he mentioned the SEC Whistleblower program only once. “Title IV—CAPITAL MARKET IMPROVEMENTS,” item 9 (of 23) states: “Prohibit a co-conspirator from receiving a SEC Whistleblower rewards program.”
This item revives what was a contested provision in the SEC Final Rule establishing the program in 2010. The Dodd-Frank Act itself set forth a short list of individuals who are ineligible for an award, one of whom was “any whistleblower who is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower otherwise could receive an award under this section.” Sec. 21F(c)(2)(B). This provision established a bright line barring anyone convicted in a criminal case (e.g., a DOJ prosecution, not an SEC civil enforcement action) from obtaining an award from the SEC in connection with the related SEC matter.
The Dodd-Frank Act thus allowed an individual to seek and, if otherwise qualified, obtain an award as a whistleblower in an SEC matter involving a securities law violation in which he had some demonstrable degree of culpability, but who had not been prosecuted criminally by any federal or state authority. The SEC however, was careful to limit the potential of such an award in several respects. In its Final Rule, the SEC established four “factors” which it could consider to justify a decrease in the award of less than the maximum 30 percent of the financial penalty assessed in the case (the SEC has discretion to give an award of 10 to 30 percent of the penalties, as long as they exceed $1 million). One of the “downward factors” was related to the “culpability” of the applicant whistleblower.
The SEC indicated it would assess “the culpability of involvement of the whistleblower in matters associated with the Commission’s action or related actions.” In considering this factor, the Commission may take into account, “among other things,” the whistleblower’s:
- “role in the securities violations”
- his “education, training, experience and position of responsibility at the time the violations occurred”
- whether he acted “with scienter, both generally and in relation to others who participated in the violations”
- whether he “financially benefited from the violations”
- whether he is a “recidivist”
- the “egregiousness of the underlying fraud committed by the whistleblower,” and
- whether he “knowingly interfered with the Commission’s investigation of the violations or related enforcement actions.”
Thus, in deciding the amount of any award, the SEC left itself considerable latitude to consider every facet of the case and the whistleblower’s actions, involvement and personal background (much as federal judges had the ability to do in sentencing in the days before their discretion was hampered by the Federal Sentencing Guidelines). The “culpability factor” has played a role in the setting of at least one award amount to date. On February 28, 2017, the SEC issued an Order, heavily redacted, indicating that it had “reduced the award…from what it might otherwise have been because of both the Claimant’s culpability in connection with the securities law violations at issue in the [case] and the Claimant’s unreasonable delay in reporting the wrongdoing to the Commission.” The award was set at 20 percent of the monetary sanctions collected, well below the maximum possible of 30 percent. The Order did not disclose the amount of the award, nor describe in any way the facts of the case or the degree or nature of the “culpability.” The claimant could have lost a substantial amount. Presumably, if the claimant had been a truly bad actor, he or she would have received little or no more than the minimum 10 percent.
Likewise, the SEC tried to further lessen the chances of a “bad actor” whistleblower getting a significant award by enacting a companion rule regarding awards to “whistleblowers who engage in culpable conduct,” Rule 21F-16. It specifies that the Commission, in determining if the minimum threshold of $1 million in penalties has been met to allow an award, will not take into account any monetary sanctions that the whistleblower himself is ordered to pay or that are ordered against any entity “whose liability the whistleblower directed, planned or initiated.” Nor will the Commission consider any penalty paid by the whistleblower himself or any such entity to be included “in the calculation of the amounts collected for purposes of making payments.”
Taken together, these provisions would most likely result in denial of any award to a truly bad actor whistleblower, particularly since the SEC can (and has in at least one case) given an award but simultaneously deducted from it an amount sufficient to offset the penalty rendered against him. And if, as is highly likely, the entity involved has paid all or the large portion of the penalties (as is the situation in nearly all cases), it is very unlikely that more than $1 million will be left in the pot to qualify the whistleblower for any award if he had “planned, directed or initiated” the illegal activity.
Thus, while it remains theoretically possible for a whistleblower with major involvement in a fraud scheme to qualify for an award, the SEC in its infinite discretion has multiple ways to make it highly unlikely that awkward result will ever occur – or if it does, the SEC can structure the penalties imposed to take away with one hand that which it has given with the other.
The Continuing Sentiment Against Giving a “Culpable” Whistleblower Any Award
The inconvenient fact remains that the Rule does, on its face, permit an award to a culpable, albeit nonconvicted, whistleblower. This may be something of a lightening rod to those observers looking to weaken the program. To them, giving an award to anyone who has been involved in a fraud scheme, however tangentially, seems inappropriate at best, and outrageous at worst. At the time the Final Rule was issued in 2011, the SEC was besieged with pleas from various corporate representatives and interest groups to deny any award to a “culpable” whistleblower, period. For example, a group of corporate executives describing itself as representing “the largest global companies in the United States dedicated to the highest standards of integrity and ethics in business” submitted comments to the SEC in December 2010 during the rule-making process. They wrote, in part:
“We recognize that culpable whistleblowers may have access to potentially helpful information, but believe that countervailing public policy considerations argue against making such individuals eligible for bounty payments. Moreover, other tools are available to incentivize culpable individuals to report information to the Commission, such as offering immunity from prosecution. Incentivizing individuals to violate the securities laws in pursuit of bounty payments, and providing awards to individuals who do so, are contrary to the Commission’s goal of promoting ‘greater deterrence’ through implementation of the whistleblower program.” (italics supplied)
Over the last five years since establishment of the SEC whistleblower program, I have represented or discussed representation of quite a few whistleblowers. I have never met, and never expect to meet, anyone who would deliberately set out to violate those laws in order to then pursue a whistleblower award. Imagining such a devious group to justify the current Congressional proposal is a classic straw-man argument. A similar misguided objection was posed by the Securities Industry and Financial Markets Association in their submission of December 17, 2010 to the SEC:
“If a person is involved in or knew about and could have prevented misconduct, then that person should not be able to profit from the violation as a whistleblower…. Allowing a person to participate in misconduct and then profit as a result, by making a whistleblower report concerning that misconduct, is directly contrary to the clear intent of Congress to reduce the overall number of securities law violations. Paying awards to participants in the misconduct would be an absurd result Congress could not have intended.”
In fact, the “clear intent of Congress” was to create incentives to get individuals with inside knowledge of corporate wrongdoing to muster the courage to report it. To the extent a few such people may have participated in the misconduct, Congress “made clear” that those convicted of a crime (i.e., the truly culpable) would be disqualified, and the SEC has “made clear” that it will carefully consider such conduct in setting the award amount. Likewise, there is no guarantee of immunity to a whistleblower that prevents the SEC from ultimately charging him with a violation, even if based in part on his own disclosures. In truth, any potential whistleblower with significant culpability should seek out a skilled defense lawyer and try to arrange a “cooperation agreement” with the SEC at or before considering a whistleblower submission.
 United States Securities and Exchange Commission, “Order Determining Whistleblower Award Claim,” File No. 2017-7, Feb. 28, 2017.
 Among the signers of the letter were senior executives of Tyco, Pfizer, JP Morgan Chase, Johnson & Johnson, Citigroup and Alcoa. Over the six years since that letter was sent, these self-proclaimed “high integrity” firms collectively have paid the SEC and DOJ over $2.3 billion in fines and penalties in various SEC and DOJ enforcement actions.
 I was disheartened to read that the American Bar Association, in its comment letter to the SEC of January 4, 2011, shared these sentiments: “We believe the absence of a more stringent standard may, in fact, create an incentive for persons to promote or engage in unlawful acts solely for the purpose of seeking awards and protections. Persons who have ‘crossed the line’ and engaged in violations (or possible violations of the securities laws may in fact have an incentive under the proposed whistleblower rules to maximize the seriousness of the violation in order to increase the potential amount of their awards.” (italics supplied). I am still waiting to be contacted by that devious whistleblower, much as I await seeing my first unicorn.