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SEC Review of Whistleblower Award Rules: Incentives Matter

SEC Review of Whistleblower Award Rules: Incentives Matter,” by Phillips & Cohen partners Sean X. McKessy and Erika A. Kelton, was originally published by Bloomberg Law. 

Phillips & Cohen LLP whistleblower attorneys offer recommendations to the SEC as it reconsiders rules imposed only nine months ago that limit certain whistleblower awards. Congress set up the SEC whistleblower program to incentivize as many people as possible to come forward and report securities law violations, they say.

In a welcome and unusual move, Securities and Exchange Commission Chair Gary Gensler recently instructed SEC staff to review rules that only became effective nine months ago and arbitrarily limit certain whistleblower awards.

Gensler’s decision—which most believe is a public acknowledgment that the SEC erred with adopting those rule changes—provides not only an opportunity to reverse the disincentives the new rules created but also to consider additional changes to improve a wildly successful program.

The SEC whistleblower program, created under the Dodd-Frank Act, incentivizes whistleblowers to report securities law violations by offering 10% to 30% of the sanctions collected to those who provide original information that results in a successful enforcement action, if more than $1 million is ordered by the SEC or a court.

At issue are amendments the SEC made to two rules:

  • A “clarification” that the SEC has the authority to consider the size of the sanctions collected (and the corresponding size of the whistleblower award) to set the appropriate award percentage.
  • A rule change that would allow the SEC, when determining a whistleblower’s award, to exclude sanctions collected by other government agencies in related enforcement actions that also are based on the whistleblower’s information and assistance, if those agencies have whistleblower reward programs.

Nothing in Dodd-Frank Allows These Changes

There is nothing in the Dodd-Frank Act that says the SEC has the authority to consider the dollar amount collected or the size of a whistleblower’s award in making an award. Congress intended that the SEC focus exclusively on the quality of the whistleblower’s information and conduct when deciding awards—not on the dollar amount. This is clear from the passage in the law that prohibits the SEC from taking into account the impact of the award on the fund used to pay rewards when determining the award percentage.

There also is nothing in the law that gives the SEC leeway to deny an award in a related action on the grounds that another agency’s whistleblower award program “more appropriately applies” in the SEC’s view. In fact, Dodd-Frank specifically states that the SEC shall pay awards based on “what has been collected of the monetary sanctions imposed in the [SEC] action or related actions.”

Top SEC officials in three administrations have agreed that the whistleblower program is a crucial enforcement tool. The numbers back that up: More than $3.1 billion in SEC enforcement sanctions have been due to whistleblower information and assistance. The SEC receives over 5,000 whistleblower reports each year.

While the confidentiality and anti-retaliation employment protections are critical to the program’s success, the promise of rewards is an extraordinarily powerful motivator for whistleblowers. The SEC has awarded over $950 million to 195 individuals, including the highest-to-date award of $114 million. Other Top 10 awards have ranged from $28 million to $50 million, including one exceeding $30 million paid to a Phillips & Cohen client. But most awards have been smaller—three-fourths are less than $5 million.

Given the whistleblower program’s success, the commission’s decision to revise certain rules last year made no sense—except perhaps as an effort to erode the Republican-despised Dodd-Frank Act. The changes, approved by a 3-2 party-line vote, allow the commission to arbitrarily reduce rewards to those whistleblowers whose information results in the highest sanctions and therefore involve the biggest frauds—which will certainly discourage those valuable whistleblowers from coming forward.

Improving the Efficacy of the Whistleblower Program

As part of its review, SEC staff should consider additional changes to improve the efficacy of the whistleblower program. Based on our experience building the whistleblower program and representing SEC whistleblowers, we recommend:

  • The SEC rescind its decision last year to redefine “independent analyses” uncovering wrongdoing submitted typically by non-insider whistleblowers. With the new definition, the SEC can decide someone is ineligible for an award based on an arbitrary determination that the information reported by the whistleblower “could have been inferred from the facts available in public sources.” The use of “could have been inferred” creates confusion and uncertainty, making it less likely people will conduct independent analyses to expose wrongdoing.
  • The SEC adopt rules that will facilitate communication between SEC staff and whistleblowers and encourage staff to use the expertise and resources that whistleblowers and their counsel can provide during an investigation. These steps can be taken in a measured way with appropriate protections to avoid violating SEC confidentiality requirements.
  • The SEC reconsider its overly restrictive interpretation of “unreasonable delay” in reporting violations, which has been used as a factor to unfairly decrease many whistleblower awards. A SEC rule suggests that a whistleblower “unreasonably delays” if they report wrongdoing to the SEC more than 180 days after learning of the violations. This de facto deadline fails to take into account many personal and professional reasons that a person might delay blowing the whistle, such as fear of getting fired.

Congress set up the SEC whistleblower program to incentivize as many people as possible to come forward and report securities law violations. The SEC should undertake a global review of its whistleblower program rules with that same goal in mind. More significant awards incentivize more people to come forward—and that is a win-win for everyone.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Sean McKessy is a partner at Phillips & Cohen LLP. He was the founding chief of the SEC Office of the Whistleblower and the principal architect of the SEC whistleblower program.

Erika Kelton is a partner at Phillips & Cohen LLP and has represented U.S. and international whistleblowers. She has consulted with Congress, the SEC, the Commodity Futures Trading Commission, and the IRS on the establishment of government whistleblower programs.

Reproduced with permission from Copyright 2021 The Bureau of National Affairs, Inc. (800-372-1033) bloombergindustry.com.


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