How SEC's Policy Pivot Supports Whistleblowers
In this article for Law360, Kirkland attorneys Dan Kearney, Daniel Chaudoin and John Byrnes discuss developments to the U.S. Securities and Exchange Commission's whistleblower program.
Recent actions by the U.S. Securities and Exchange Commission are set to breathe new life into the SEC's robust whistleblower program, which could lead to increased whistleblower complaints against public companies and greater commission enforcement activity in the coming years.
The commission actions concern amendments to whistleblower program rules that were adopted during the final year of then-President Donald Trump's administration.[1]
In September 2020, the commission promulgated a series of amendments to the program, two of which became the focus of criticism and ultimately litigation: One amendment clarified that the commission has discretion to consider the dollar amount of the award, not just the percentage recovery, when applying the award factors (Rule 21F-6); another clarified that whistleblowers may not recover for related actions where the commission determines a separate whistleblower award program more appropriately applies (Rule 21F-3(b)(3)).[2]
Early this year, a whistleblower attorney filed suit in Thomas v. SEC in the U.S. District Court for the District of Columbia, challenging both amendments, arguing among other things that the commission failed to consider "the enormous harms [the amendments] will cause the whistleblower program" and that the amendments are contrary to the statutory provisions establishing the whistleblower program.[3]
On Aug. 2, SEC Chair Gary Gensler issued a statement taking aim at these amendments and announcing that commission staff would prepare potential rule revisions "to address the concerns that these recent amendments would discourage whistleblowers from coming forward."[4]
Days later, on Aug. 5, the SEC adopted a statement of policy that seeks to blunt the effect of the 2020 amendments.[5] The statement — and the commission's plan for a new rulemaking — represent a major victory for the whistleblowers' bar, and served to put the lawsuit challenging the amendments on hold.[6]
If the commission proceeds as planned, SEC whistleblower activity is likely to increase in the coming years with additional enforcement activity to follow.
Background
The SEC whistleblower program was established by Section 21F of the Securities Exchange Act,[7] which was added in 2010 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Under the whistleblower program, whistleblowers whose original information leads to a successful enforcement action are entitled to at least 10% and up to 30% of any monetary sanction imposed by the commission or by other authorities in a related action.[8]
Subject to certain statutory criteria, determination of the amount of the award is "in the discretion of the commission."[9] In May 2011, the commission adopted a comprehensive set of rules to implement the whistleblower program, including procedures for determining awards and identification of criteria for setting the percentage amount of an award.[10]
Since its inception, the SEC's program has been viewed as successful and has resulted in some very large monetary awards to individuals. The commission has received over 40,000 tips since the program began, and has awarded approximately $956 million to 195 individuals.[11]
In just the past year, the commission awarded approximately $450 million, with a record $114 million award to a single individual in October 2020 and another award of over $50 million to two individuals in April 2021.[12]
On July 20, 2018, the commission proposed several amendments intended to ensure that "eligible, meritorious whistleblowers" are rewarded for their efforts while also ensuring that funds are paid as "reasonably necessary to advance the program's goals."[13]
Some of the amendments aimed to expand the relief available to whistleblowers, including allowing recovery for amounts paid as part of deferred prosecution agreements and nonprosecution agreements, and adjusting smaller awards upward to the 30% statutory maximum by default.
Other amendments, however, were intended to avoid excessive and unnecessary payouts, including an amendment to Rule 21F-3, which would prevent multiple recoveries from separate whistleblower schemes in related actions[14] and an amendment to Rule 21F-6, which would permit the commission to adjust the award percentage downward for large awards, subject to a floor of $30 million.[15]
After an extensive public comment process,[16] on Sept. 23, 2020, the commission voted 3-2 to approve the amendments, with certain revisions.[17] The commission adopted the multiple recovery amendment largely as proposed.[18]
The amendment limiting large rewards was not adopted.[19] Instead, the commission determined that the amendment was not necessary, because the commission "has had and continues to have broad discretion in applying the Award Factors and setting the Award Amount, including the discretion to consider and apply the Award Factors in percentage terms, dollar terms or some combination thereof."[20]
To clarify this authority, the commission adopted several rule revisions affirming that dollar amounts may be considered in the commission's exercise of discretion.[21] The dissenting Democratic commissioners expressed serious concerns about these revisions, which, unlike the initial proposal, would apply to all awards, regardless of size.[22]
Shortly after the final rule went into effect, a whistleblowers attorney at Labaton Sucharow LLP brought suit against the SEC, in Thomas v. SEC, challenging the multiple recovery amendment and amendment affirming discretion to consider dollar amounts.[23] The matter was set to be fully briefed on cross-motions for summary judgment by October 2021.[24]
On Aug. 2, the week before the plaintiff's summary judgment motion was due, Gensler issued a statement noting that "[v]arious members of the whistleblower community, as well as commissioners [Allison Herren] Lee and [Caroline Abbey] Crenshaw" had expressed concern that the two challenged amendments "could discourage whistleblowers from coming forward" and that the staff would be preparing potential revisions for the commission to consider later in the year.[25]
On Aug. 5, the commission followed with a statement establishing procedures during the interim policy review period, to ensure that "whistleblowers with claims pending … are not disadvantaged under the components of Rule 21F-3(b)(3) and Rule 21F-6 that may be revised."[26]
With the amendments effectively stayed, and likely to be amended, the whistleblowers attorney agreed to stay his lawsuit until Feb. 5, 2022, or the promulgation of final rule amendments.
The Interim Procedures
The commission characterized the Aug. 5 interim procedures as relating "only to agency procedures" and "not substantially affect[ing] the rights or obligations of nonagency parties."[27] But the practical effects are significant.
The interim procedures effectively create two carve-outs to the multiple recovery amendment, directing the staff to recommend use of the commission's exemptive authority where the alternative whistleblower program (1) has a disadvantageous award cap or award range — e.g., the Financial Institutions Reform, Recovery and Enforcement Act's award cap of $1.6 million, or (2) may exclude the whistleblower from recovering.[28]
Reliance on the commission's exemptive authority would effectively override the 2020 amendment's directive to consider alternative whistleblower programs in many cases. And even where these carve-outs do not apply, the interim procedures permit whistleblowers to request that their related-action award claims be held in abeyance while the commission's policy review is ongoing.
As to the commission's discretion to consider dollar amounts, the interim procedures provide that the commission will "continue its practice of considering dollar amounts" only to raise awards.
The Republican commissioners sharply criticized the interim procedures as "a troubling and counterproductive precedent" that the commission "may immediately abandon proposed, noticed and adopted rules at the majority's will via public statements" whenever a presidential administration changes.[29]
More generally, the commissioners expressed concern that this approach sends the message that commission rules are "interim at best, and transitory at worst," which "reduces the certainty of the law."
The Republican commissioners characterized these actions as part of a pattern of the commission abandoning the prior administration's rules without proper process, citing actions recently taken with respect to recently adopted requirements for proxy voting advice businesses.[30]
Implications
The commission's recent actions send a strong signal that the whistleblower program will be a priority of the commission, and that the commission will be responsive to the concerns of the whistleblower community, most notably whistleblower law firms.
Even before these recent steps, the whistleblower program has been growing in significance: The Office of the Whistleblower reported that fiscal year 2020 was a record-breaking year in terms of total dollar amount and individuals awarded — $175 million to 39 individuals; fiscal year 2021 will more than double those amounts — $396 million to 89 individuals, as of August.[31]
It is likely the commission will continue to adopt whistleblower-friendly rules, exercise its discretion under the program to make larger and more numerous awards, and seek to use whistleblowers to drive more aggressive enforcement activity.
The trend of increasing awards and the promise of a favorable regulatory environment will further encourage development of the whistleblowers' bar. Companies should continue to be alert to the risk that potential whistleblowers may be attracted by the blockbuster payouts of the whistleblower program, and will directly report to the SEC instead of reporting concerns internally.[32]
The commission's action also highlights the agency's reliance on agency discretion — whether in carrying out programs, interpreting procedures, or exercising enforcement authority — to achieve short-term policy objectives without awaiting the outcome of notice-and-comment rulemaking.
Together with the recent action concerning proxy voting advice, the commission's action may serve as a template for the commission and other regulatory agencies to quickly implement policy objectives through the creative exercise of agency discretion.
