On November 3rd, the Securities and Exchange Commission (the “SEC”) published proposed Regulation 21F (the “proposed rules”), establishing a program designed to reward individuals who provide the SEC with information leading to successful enforcement actions.2 The proposal was mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)3 and sets out procedures under which potential informants (“whistleblowers”) can qualify for significant monetary awards4 by providing information to the SEC regarding violations of the federal securities laws.
Among those rules is Proposed Rule 21F-13, which provides the procedures applicable to the payment of the whistleblower awards. 21F-13(a) provides that all whistleblower awards made pursuant to Rule 21F must be paid from the Securities and Exchange Commission Investor Protection Fund (the “Fund”).5 21F-13(d) sets out the rules governing the timing of payment in the situation in which the Fund lacks a sufficient amount to satisfy the payment of a whistleblower award. At this point, it is natural to wonder how the Fund—the main purpose6 of which is to satisfy whistleblower awards—could ever possess an insufficient amount to pay a whistleblower. The mechanism for adding money to the Fund offers the answer.
Section 21F(g)(3)(A) of the Exchange Act provides the mechanism for allocating sanctions to the Fund. Under this section, the Fund receives “any monetary sanction collected by the Commission in any judicial or administrative action brought by the Commission under the securities laws that is not added to a disgorgement fund or other fund under section 308 of the Sarbanes-Oxley Act of 2002 or otherwise distributed to victims of a violation of the securities laws.”7 The emphasized portion of Section 21F(g)(3)(A) is the key, its application means that only the excess amount of a monetary sanction—that amount not added to a disgorgement fund or otherwise given to victims—is actually added to the Fund. Since a whistleblower’s award represents 10 to 30 percent of the entire amount of the monetary sanction,8 a situation may arise in which more money is being withdrawn from the Fund than deposited.
To illustrate this situation, consider the following hypothetical. Whistleblower, an employee of Company, provides original information to the SEC that leads to a $100 million sanction against Company. Under the terms of the sanction, $90 million is to be distributed to the victims of Company’s securities violations. The SEC also determines that, based on the importance of the information provided by Whistleblower, a 30 percent whistleblower award is appropriate. Thus, Whistleblower is awarded 30 percent of $100 million, or $30 million. However, because $90 million is already being distributed to the victims, only $10 million remains to be added to the Fund. Thus, once Whistleblower is paid the $30 million award from the Fund and the excess $10 million is deposited to the Fund, the net result is that the Fund decreases $20 million. Over time, therefore, it is hypothetically possible that the combination of large awards to victims and large awards to whistleblowers could deplete the Fund’s reserves.
Section 21(F)(g)(3)(B) of the Exchange Act addresses the situation by providing that if the Fund contains an insufficient amount to satisfy a whistleblower award, an amount equal to the unsatisfied portion must be added to the Fund from the total monetary sanctions collected in the action. In other words, in this situation, the whistleblower’s interest outweigh the victims’ interests, and the whistleblower award is satisfied at the expense of the victims’ disgorgement fund. In its proposed Rule 21F-13, the SEC acknowledges this situation and requests comments on how to resolve the “tension between the competing interests of paying an award to a whistleblower (as provided in Section 21F) and compensating victims with monies collected from wrongdoers (as recognized in Section 308 of the Sarbanes-Oxley Act).”9
One potential solution is foreclosed by the Dodd-Frank Act itself. Section 21(c)(1)(B)(ii) of the Exchange Act (as amended by Dodd-Frank) states that the SEC may not consider the balance of the Fund when determining the amount of a whistleblower award. Therefore, if the SEC determines that circumstances warrant a 30 percent whistleblower award, the fact that the Fund currently lacks sufficent funds to satisfy the award is not a relevant concern, and the whistleblower must receive the 30 percent award. Consequently, the whistleblower sits in the best position: the amount of the award granted cannot be reduced due to a lack of funds, and the payment of the award takes precedence over the victims of the securities violations.
The concern for companies, however, is the extent to which the SEC will attempt to shift the burden from the victims to the companies. The SEC possesses wide discretion in the assessment of monetary sanctions, and it is conceivable that the SEC could solve the tension between the whistleblowers and the victims by assessing larger sanctions generally, in order to keep the fund solvent. This would allow the SEC to continue to distribute large amounts to the victims of securities violations, while maintaining enough excess sanction money to deposit into the Fund to satisfy whistleblower awards.10 Such a step would be unfair in that companies would be forced to pay larger sanctions based on SEC administrative needs —factors entirely extraneous and unrelated to their conduct of offense— and is particularly troubling to a company that faces sanctions stemming from an action that does not involve a whistleblower. Since the Fund collects the excess sanctions “collected by the Commission in any judicial or administrative action brought by the Commission under the securities laws,”11 the SEC’s incentive to increase sanctions will be present regardless of whether the action is based on information provided by a whistleblower. Every action offers an opportunity to add money to the Fund. Therefore, a company facing SEC-imposed sanctions might legitimately worry that it will be required to pay an inflated amount to help pay for other companies’ whistleblowers. In essence, Section 21F(g)(3) of the Exchange Act and Proposed Rule 21F-13 may be providing the SEC with the opportunity to institute a “Whistleblowers Tax.” The Dodd-Frank Act makes one thing clear: whistleblowers must be paid. The troublesome question now is who will be required to bear that cost.