Introduction
Background
Awards to date
Ongoing transparency problems
Reforms needed


Introduction

It has been over two years since the US Securities and Exchange Commission (SEC) began operating its whistleblower programme, but substantial questions linger over its effectiveness and transparency. Under the programme, whistleblowers are entitled to recover up to 30% of the monetary sanctions collected in SEC and related enforcement actions. For the last two years, the SEC has issued several press releases touting the programme and highlighting one award that gave $14 million to one lucky whistleblower.

However, only four whistleblower awards have been made in the programme's history and the SEC has not disclosed many details about those awards to the public. So has the programme been worth it? And if the SEC is going to make a practice of awarding millions of dollars to anonymous individuals without much of a public explanation, is the programme already in need of reform?

Background

The whistleblower programme began operating in August 2011. In passing the Dodd-Frank Act, Congress mandated that the SEC make monetary awards to eligible individuals who voluntarily provide original information that leads to successful SEC enforcement actions resulting in monetary sanctions over $1 million. If granted, awards must be paid in an amount between 10% and 30% of the monetary sanctions collected by the SEC and by other government agencies such as the Department of Justice.

The Dodd-Frank Act provides whistleblowers with two important protections. First, whistleblowers have a private right of action against any employer that retaliates against them. Second, the statute prohibits the SEC from revealing "any information, including information provided by a whistleblower to the Commission, which could reasonably be expected to reveal the identity of a whistleblower".(1)

To administer the programme, the SEC established the Office of the Whistleblower (OWB) within its Enforcement Division. The OWB works with the SEC's enforcement attorneys to recommend awards, which are then preliminarily approved by senior members of the Enforcement Division. The five SEC commissioners make the final decision on the awards.

Awards to date

If the programme is judged only by the number of its pay-outs, it has not lived up to the hype. Since August 2011, besides the $14 million award, the programme has granted three awards of $150,000, $125,000 (to be shared among three whistleblowers) and nearly $50,000. Each whistleblower has remained anonymous.

SEC officials have largely based their public praise for the programme on the increase in the number and quality of the tips they receive. When the $14 million award was announced, SEC Chair Mary Jo White stated: "Our whistleblower program already has had a big impact on our investigations by providing us with high quality, meaningful tips." The OWB reported that the number of whistleblower tips increased to 3,238 for the latest fiscal year. Private attorneys have been aggressive in recruiting whistleblowers from companies, both in the United States and abroad, which has contributed to the number of tips being received. Last year, the OWB reported that it received the most tips internationally from the United Kingdom, Canada, China, Russia, Ireland and India.

Despite the modest number of awards, it is a safe bet that the number of whistleblower awards will increase in the coming years. If a whistleblower provides a tip, the pay-out is mandatory; and if the SEC has seen an increase in the number of quality tips, one would expect to see many more payments under the whistleblower programme in the near future. Through the $14 million award, the SEC has proven that it is willing to compensate whistleblowers handsomely, and its frequent press releases demonstrate its enthusiasm for the programme.

Meanwhile, for whistleblowers, there are only incentives to participate in the programme: they keep their anonymity and have the opportunity to obtain a large pay-out without much effort or exposure. The incentives for both the SEC and whistleblowers are too well aligned for future pay-outs not to happen.

Ongoing transparency problems

The real concern with the programme is the lack of transparency, which has been demonstrated in each of the four awards. The first award of nearly $50,000 was made on August 21 2012 to an anonymous whistleblower. The SEC reported that this award represented 30% of the money collection in a multimillion-dollar securities fraud that the SEC says was stopped because of the tip. But the SEC did not describe:

  • what multimillion-dollar fraud was stopped;
  • who was charged as a result of the tip;
  • what information was provided by the whistleblower; or
  • why the SEC decided to award a 30% pay-out.

The SEC did a better job in providing information about the second award of $125,000 granted to three anonymous whistleblowers on June 12 2013. The SEC identified the perpetrators (a sham hedge fund named Locust Offshore Management and its chief executive officer) and the judgment that was entered. The SEC announced that the award represented a total of 15% of the amount expected to be collected by the SEC and the Justice Department's enforcement actions. The SEC also provided more information about the type of information provided (two of the witnesses provided information that prompted the opening of the investigation and the halting of the scheme, while another whistleblower identified key witnesses and confirmed the information provided by the others). This award demonstrated that the SEC can provide more information to the public without violating the Dodd-Frank Act.

However when the $14 million award was announced in October 2013, the SEC reversed course and provided virtually no information to the public. The SEC announced only that the $14 million award was made to one anonymous whistleblower whose information helped the SEC to recover investor funds. However, the SEC again mentioned nothing about:

  • the type of violation that occurred;
  • the identity of the individual or company responsible for the violation;
  • the percentage of the award given to the whistleblower; or
  • any specifics about why the $14 million was awarded.

The final award followed the same trend of providing only bare-bones information to the public. In October 2013 the SEC announced that it had awarded "more than" $150,000 to a whistleblower whose tips helped it to stop a scheme that was defrauding investors. The SEC stated that it was able to obtain emergency relief before any other investors were defrauded, and that it gave the maximum 30% award to the whistleblower; but it gave no further details. The award also failed to identify the type of violation that occurred, who committed the violation, what judgment was entered or any meaningful information as to why the award was granted.

Reforms needed

The public has a strong interest in being able to evaluate the effectiveness of the whistleblower programme and the appropriateness of its substantial awards to private citizens, but there is currently no way to make any meaningful judgments on those issues. A whistleblower has no incentive to reveal his or her identity, and the first two years of the programme suggest that they will not do so. There is no independent oversight of the programme by the judicial branch of government, and the SEC's reports to Congress and press releases disclose no detailed information about the awards.

The programme needs two reforms to fix the transparency problems. First, the SEC should abandon its overly conservative interpretation of the Dodd-Frank Act and provide detailed information in its announcements about whistleblower awards. In every whistleblower award, the SEC should identify:

  • the type of violation that occurred;
  • the identity of the individual or company responsible for the violation;
  • the specific judgment that was entered;
  • the percentage of the award given to the whistleblower; and
  • an explanation of the general type of information given by the whistleblower and why the award was granted.

None of this information compromises the identity of the whistleblower or jeopardises the soundness of the programme. However, it would provide the public with the necessary information to understand the types of case that have been brought as a result of whistleblower tips and why it is in the public interest for the whistleblower programme to continue.

Second, Congress should consider an amendment to the Dodd-Frank Act and waive the confidentiality protections for individuals who receive an award of $1 million or more. Otherwise, there is too much potential for abuse, and the SEC should not be expected to make $14 million payments to private citizens without any scrutiny or assistance from the public as to whether the awards are appropriate. Information about past awards would assist the SEC in making future awards and detecting flaws in the process. Meanwhile, the whistleblower would still be protected by the anti-retaliation provisions of the Dodd-Frank Act – which the whistleblower may not even need after pocketing $1 million or more.

Whistleblowers should and will play an important role in the SEC's investigations in the future. However, when they are receiving pay-outs of $1 million or more of public money from the US government, the public interest requires that whistleblowers have some accountability too.

For further information on this topic please contact Michael P Kelly or Douglas B Paul at Hogan Lovells US LLP by telephone (+1 202 637 5600), fax (+1 202 637 5910) or email (michael.kelly@hoganlovells.com or douglas.paul@hoganlovells.com). The Hogan Lovells US LLP website can be accessed at www.hoganlovells.com.

Endnotes

(1) 15 USC § 78u-6(h)(2)