SEC proposes changes to its rules: what are the pros and cons of rewarding whistleblowers?

01/08/2018 – WINSEC-logo.png is delighted to publish this GAP blog on the proposed changes to the SEC whistleblower reward program rules. The piece highlights some of the pros and cons of financial rewards or “incentives” to individuals who report wrongdoing in the financial sector. Those who report to the SEC can come from any company listed on the US Stock Exchange, which means whistleblowers approach the SEC from all around the world with information on corporate wrongdoing. This international reach along with the successful and high profile prosecutions the SEC has been able to mount against companies who breach SEC rules, and the high monetary value of some of the rewards paid out to whistleblowers, has sparked the interest of financial regulators in other jurisdictions in the concept of financial incentives as a means to increase their regulatory effectiveness.

Financially rewarding or offering bounties to those who can provide specific regulatory or criminal information is often juxtaposed against the compensation that should be provided to whistleblowers for any losses they suffer when speaking out about a range of wrongdoing. Though rewards and compensation are both financial in nature, they clearly serve different ends. Likewise other tools—also developed in the US system—that specifically empower whistleblowers by actively engaging them in the resolution of the wrongdoing or in holding the wrongdoers to account, as in the US False Claims Act approach to tackling fraud from government or the rules governing how the US Federal Office of Special Counsel reviews investigative findings with whistleblowers, are often overlooked in the “rewarding whistleblowers” debate.

WIN will continue to host discussions and debates on these issues (and more!) to encourage wider and better informed debate on good practices in promoting public interest whistleblowing and protecting whistleblowers around the world.

By Jason Gardiner, Legislation Intern, Government Accountability Project, 1 August 2018

The Securities and Exchange Commission (SEC) decided in late June to propose changes to its reward program for whistleblowers. The potential changes provide a good opportunity to look at the pros and cons of the system.

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The motivating idea behind the reward program is simple: there aren’t many incentives to be a whistleblower besides doing the right thing. Many whistleblowers lose their jobs or drown in legal fees, or both. The relief offered in most statutes tends to be small, even if the whistleblower wins the case. The SEC, however, offers rewards between 10% and 30% of the amount the SEC recovers as a result of the whistleblower’s tip. Providing a financial incentive to report misconduct encourages employees with important information to come forward when the risk would otherwise be too great.

The law that created the SEC’s whistleblower reward program is in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), at 15 U.S.C. § 78u-6. The process for whistleblowers to receive an award has several steps:

  • First, an employee submits a tip to the SEC Office of the Whistleblower (OWB). Tips can be submitted anonymously, but to receive a reward, the whistleblower must either reveal their identity or be represented by an attorney.
  • When OWB successfully recovers $1 million or more from an enforcement action, it posts a Notice of Covered Action (NoCA) online regarding the enforcement action.
  • Whistleblowers who believe their tip contributed to the successful enforcement can submit an application to OWB to be considered for a reward.
  • OWB attorneys review each application and prepare a recommendation, which they send to the Claims Review Staff, who issue a preliminary determination.
  • If the award is denied, whistleblowers have 60 days after the preliminary determination is issued to request reconsideration; if they do not, the preliminary determination becomes the final order.
  • If the preliminary determination contains a reward for the whistleblower, it becomes the proposed final determination. Commissioners have 30 days to request another review; if they do not, the proposed final determination becomes the final order.

The program has both advantages and drawbacks. From a quantitative perspective, the program’s results are impressive: the SEC reports that the number of tips it receives annually has grown by almost 50% since FY 2012 to 4,484 tips in FY 2017. Since the program began in 2010, the SEC has received over 22,000 tips leading to more than $1.4 billion recovered. The Commission receives tips from all over the world, and there has been an unprecedented surge of law firms willing to represent whistleblowers. All are promising indicators of success.

However, the flood of tips the SEC receives can also be a disadvantage. In reality, very few actually receive a reward from the program. In FY 2017, for example, only twelve whistleblowers received awards. Over the course of the program, the SEC has issued 50 rewards to 55 whistleblowers, some of whom filed together. As a result, some groups feel that programs like the SEC’s offer whistleblowers false hope with infinitesimal chances of recovery.

Further, the “bounty” program has not had comparable success to the False Claims Act, under which whistleblowers do more than give evidence to the government. Under that law, they file lawsuits to fight and win the battles on behalf of taxpayers. That law has averaged some $1.5 billion in recoveries annually, compared to the bounty program’s $1.4 billion in six years.

Addressing this imbalance is one intent of the changes the Commission has proposed, although groups disagree over how effective the changes will be. In the SEC press release regarding the proposal, SEC Chairman Jay Clayton stated, “The proposed rules are intended to help strengthen the whistleblower program by bolstering the Commission’s ability to more appropriately and expeditiously reward those who provide critical information that leads to successful enforcement actions.”

Some of the changes relate to internal processes and would make the award disbursement process more efficient. Other proposals more directly affect whistleblowers seeking a reward. Some of the most important proposed changes include the following:

  • Give the Commission discretion to make certain awards larger. If a whistleblower’s award would be less than $2 million according to the current guidelines, the Commission would be able to increase the award to a maximum of $2 million, subject to the 30% limit. The intent of this change is to incentivize whistleblowers to report smaller instances of fraud. The SEC hopes that this change would encourage potential whistleblowers for whom the monetary reward of reporting a tip would otherwise be too small to be worth the risk.
  • Allow the Commission to establish a separate system to reward whistleblowers whose disclosures do not qualify for an award under the statutory program.
  • Give the Commission discretion to lower awards related to sanctions of $100 million or more (without dropping them below the 10% minimum). The Commission hopes the awards would be large enough to continue to incentivize whistleblowers while freeing up more of the funds from which awards are distributed.
  • Require that whistleblowers report their tips to the SEC in order to be eligible for an award (under the current guidelines, internal reporting can qualify an employee for a reward). This change is the SEC’s response to the recent Supreme Court decision in Digital Realty Trust, Inc. v. Somers, in which the court determined that employees who report only internally do not qualify as whistleblowers under the statute.

The SEC is holding a public comment period on the proposals until September 18. The Commission encourages people to submit comments about the proposed changes, including alternatives to any of the proposals.

Instructions for submitting comments can be found at: www.sec.gov/rules/submitcomments.htm

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