SEC Whistleblower – Dodd Frank Revisions to be Proposed
On August 2, 2021, Gary Gensler, the new chair of the Securities and Exchange Commission (SEC), announced that because he wasn’t entirely pleased with the amendments to the rules governing the agency’s whistleblower program that became final in September 2020, he had:
… directed the staff to prepare for the Commission’s consideration later this year potential revisions to these two rules that would address the concerns that these recent amendments would discourage whistleblowers from coming forward. In particular, the staff is considering whether our rules should be revised to permit the Commission to make awards for related actions that might otherwise be covered by an alternative whistleblower program that is not comparable to the SEC’s own program and to clarify that the Commission will not lower an award based on its dollar amount.
Gensler’s feelings about the recent amendments to the whistleblower rules were already known; only a few days before, he’d delivered brief remarks at the National Whistleblower Center’s National Whistleblower Day 2021 celebration in which he alluded to his plans.
He also pointed out that the program was of particular interest to him because when the Dodd-Frank Act provided for its creation in 2010, he’d been chair of the Commodity Futures Trading Commission (CFTC) and had worked on setting up the whistleblower program there.
The Dodd-Frank Wall Street Reform and Consumer Protection Act
The Recession of 2008, described by some as the worst since the Depression that followed the Wall Street crash of 1929, struck during a presidential election year, leaving the new Obama Administration scrambling to deal with it. In its wake, there was a general feeling that Wall Street institutions had a lot to answer for and that what was needed was, as President Obama put it, “a sweeping overhaul of the United States financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression.”
The Great Depression had resulted in the election of Franklin Delano Roosevelt, who was responsible for the two foundational laws that created securities regulation and the SEC itself, the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act). The financial markets of 2008 were far more sophisticated than those of 1929 and contained elements not adequately addressed by the establishment of new regulatory agencies or amendments to existing laws. A new bill was prepared and shepherded through Congress with unusual speed. It was named after its chief creators, Christopher Dodd and Barney Frank, and signed into law on July 21, 2010.
One of Dodd-Frank’s innovations was the SEC’s whistleblower program, which was in part inspired by the successful qui tam provisions of the 1986 Amendments to the False Claims Act, a whistleblower law enforced by the Department of Justice (DOJ) and the Internal Revenue Service (IRS) whistleblower reward program created by Congress in 2006. At the same time, the CFTC set to work on its own program under Gensler’s leadership.
To create the SEC program, in Section 922 of Dodd-Frank, Congress amended the Exchange Act to add a new Section 21F, entitled “Securities Whistleblower Incentives and Protection.” At its most basic, the agency was empowered to reward individuals who provide information leading to an enforcement action in which more than $1 million in sanctions is ordered. The rewards may range from 10 to 30 percent of the amount recovered. The law also offered job protections for whistleblowers who feared retaliation by their employers and confidentiality for those who wished to remain anonymous. The SEC worked up its program quickly and issued Final Rules on May 25, 2011. The Final Rules became effective on August 12, 2011.
The new program was highly successful. By the end of the agency’s fiscal year 2017 (September 2017), the Commission had received more than 22,000 tips. The information provided had led to enforcement actions in which the Commission had, it said, “obtained over $1.4 billion in financial remedies, including more than $740 million in disgorgement of ill-gotten gains and interest.” It is not clear whether the regulator had actually collected on all of those financial remedies. It did explain that it had paid more than $266 million in awards to 55 individuals who’d helped it bring successful enforcement actions and, in some instances, “other enforcement authorities in bringing related actions against wrongdoers.” But the Commission seemed displeased that $112 million of that was paid to “just four individuals in connection with two Commission enforcement actions and a related action.”
While pleased by the program’s performance, the Commission was concerned by the possibility of an increase in the number of large awards and a decrease in the amount of money available to pay them. Whistleblower awards are paid by the SEC’s Investor Protection Fund, which was statutorily established in the U.S. Treasury. If the balance held by the IPF falls below $300 million, a statutory replenishment mechanism is triggered. It isn’t difficult to see why the $112 million paid to only four whistleblowers was worrisome.
And so, on June 29, 2018, the Commission proposed a number of amendments to the rules governing the whistleblower program. The proposed amendments went through a comment period, and a final version of the new rules was produced on September 23, 2020, and became effective on December 7 of the same year.
Amended Rules for the Whistleblower Program
Though the adoption of the amended rules came quickly, they were not met with universal support. Within the Commission, support divided down party lines, with Chairman Jay Clayton and the two other Republican Commissioners, Elad Roisman and Hester Pierce, voting for adoption, and the two Democrats, Caroline Crenshaw and Allison Herren Lee, voting against. In an unusual move, all five Commissioners offered public statements that they presented as if they were drawn from their discussion at the meeting in which they voted on the final rules.
There was general agreement that the whistleblower program was a great success, with tips pouring in and enforcement actions being won thanks to the information offered. By September 2020, the amount paid out by the program and risen to $523 million, and the number of rewarded whistleblowers to 97. No one disagreed with one novel suggestion made to cut down on processing time for small claims: henceforth, when the maximum authorized award is $5 million or less, and no “negative factors”—such as culpability in the matter on which the whistle is being blown—are present, the whistleblower will automatically receive the statutory maximum of 30 percent.
Dodd-Frank required that whistleblowers provide “original information” based on “independent knowledge or analysis.” In the past, that had sometimes been misunderstood as meaning tipsters had to be in possession of some form of insider information. The new rules make clear that a good citizen may qualify for an award based on information-gathering from public sources that leads him to report possible wrongdoing that will later be proved by SEC investigators. Caroline Crenshaw, however, felt that didn’t go far enough. As she put it:
In the guidance, we describe “independent analysis” as information that is not reasonably accessible and that is not “reasonably inferable by the Commission. Our focus, instead, should be on the quality of the information and the analysis provided by the whistleblower. The amount of data and information available to the Commission is extensive. Given that, we should not focus on whether the staff “could have” inferred the information from what was provided, but whether the staff did infer the information prior to getting the submission.
The Commissioners all saw great value in what whistleblowers do and understood that many of them risk their livelihoods, and sometimes even their lives, by coming forward. They believe large awards are appropriate because many who step up to the plate will sacrifice decades of future earnings. Crenshaw believed not enough was done to protect whistleblowers from retaliation in the new rule, as did Allison Herren Lee, who made her feelings clear in her own impassioned presentation: “All too often …those whistleblowers face retaliation from the powerful figures they expose. They help create accountability. Unfortunately, today’s rules do not serve these individuals well.”
Both Lee and Crenshaw were troubled by a provision that was added to the proposed rules and then removed in the final rules but was dealt with in another, and to their minds, disturbing way. Originally, the commission was granted discretion to adjust the size of an award simply if it thought it was too high. In that case, it could set the award at the statutory minimum of 10 percent rather than the maximum of 30 percent. In the end, it was apparently thought that went too far, or perhaps was stated too bluntly. Instead, the new rules offered the Commission the same discretion but called it a “clarification” of Dodd-Frank. Lee believes it to be worse than the original 2018 provision,
…[b]ecause when this discretion is used, it will most likely be in exactly the circumstances posed by the 2018 hypothetical – to adjust what would otherwise have been a very large award downward (without any notice to the whistleblower or the public). We don’t need this discretion to adjust a small award upward, as we have a mechanism in the new rule to do that with the new presumption applying to awards of $5 million or less. The clear concern expressed by the 2018 hypothetical and inherent in the new rule is how to adjust very large awards downward if a majority of Commissioners simply feel an award amount is “too high.”
Another point of contention was the definition of “related action.” According to Dodd-Frank:
The term ‘related action’, when used with respect to any judicial or administrative action brought by the Commission under the securities laws, means any judicial or administrative action brought by an entity described in subclauses (I) through (IV) of subsection (h)(2)(D)(i) that is based upon the original information provided by a whistleblower pursuant to subsection (a) that led to the successful enforcement of the Commission action.
That seems clear enough: an award could be made by the Commission based on information the whistleblower had provided in connection with a “judicial or administrative action,” which would include, for example, a DOJ prosecution that leads to a successful resolution. In that case, a whistleblower who’d provided information to the SEC could be rewarded for the outcome of a criminal case that is “related” to the SEC’s covered action. According to Lee, “it encourages whistleblowers to bring information to us, knowing they will still receive an award if the information is directed to a different agency.”
The amended rules changed that by “clarifying” the definition of “related action”:
This amendment codifies the Commission’s approach to determining whether an action is a related action, including clarifying that a law-enforcement or separate regulatory action does not qualify as a “related action” if the Commission determines that there is a separate award scheme that more appropriately applies to such law-enforcement or separate regulatory action. The presence of such a separate award scheme would not affect the Commission’s determination of the award based on the monetary sanctions collected by the Commission in the covered SEC action and any related action where such an award scheme was not present.
That meant the SEC now had the power to decide whether a whistleblower qualified for an award if it felt law enforcement or another regulatory agency offered a more “appropriate” program. Clayton, Roisman, and Pierce defended the new definition as a means of preventing whistleblowers from seeking—and perhaps obtaining—rewards for the same information from multiple sources. Lee disagreed, noting that whistleblowers might be forced to participate in programs that do less to protect confidentiality than the SEC or that have much lower maximum awards, some with statutory caps at a specific dollar amount. An example of particular relevance to would-be SEC whistleblowers is the DOJ’s program relating to the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which offers a statutory maximum award of $1.6 million. Lee reports that it has been “widely cited as ineffective at producing high-quality tips for that program.”
A New Administration, a New Chairman, and New Whistleblower Proposals
The most recent final rules for the whistleblower program became effective less than nine months ago, in early December 2020. But a new presidential administration means a new SEC chair, in the person of Gary Gensler, and a Democratic majority of Commissioners. As we’ve seen, Gensler feels so strongly about some parts of the new rules that he seeks to change them in the very near future.
Commissioners Pierce and Roisman expressed their displeasure even before Gensler got specific about the whistleblower program. On June 11, the SEC’s Office of Information and Regulatory Affairs released its Spring 2021 Unified Agenda of Regulatory and Deregulatory Action, which includes the Chair’s agenda. Not all the items on the list are of special interest to Gensler; many have been in the works for some time, including, no doubt, all of those in the final rule stage. (To digress for a moment, it is encouraging to see that Rule 144 Holding Period and Form 144 Filings is on the list as in the final rule stage. As presented in its proposed form, it would require that a new holding period begin every time the owner of market-adjustable securities not listed on an exchange converts said securities. We hope no significant alterations will be made to it.)
Badly-needed new regulations for transfer agents, proposed as a concept release in 2015 and not heard of since is said finally to have made it to the proposed rule stage. Amendments to Regulation ATS, proposed in September 2020, have reached the final rule stage. Pierce and Roisman are enthusiastic about those two but believe some critical items are missing from the list and suggest that “the absence of these rules is attributable to the regrettable decision to spend our scarce resources to undo a number of rules the Commission just adopted.”
Strong words and they get stronger:
The Agenda makes clear that the Chair’s recent directive to SEC staff to consider revisiting recent regulatory actions taken with respect to proxy voting advice businesses was not an isolated event, but just the opening salvo in an effort to reverse course on a series of recently completed rulemakings. On the agenda are proposals to further amend Rule 14a-8 and Rule 14a-2(b) under the Securities Exchange Act of 1934 (together, the “Proxy Updates”); Rule 13q-1 (the “Resource Extraction Payments Rule”); the rules pertaining to the accredited investor definition and the integration framework (together, the “Harmonization Rules”), and our whistleblower rules. Not only are the Commission’s most recent amendments to each of these rules less than a year old; they have only been effective for a range of three to seven months. As far as we can tell, the agency has received no new information which would warrant opening up any of these rules for further changes at this time. We are disappointed that the Commission would dedicate our scarce resources to rehashing newly completed rules.
The two Republicans acknowledge that there’s been a change in administration, and that brings with it policy changes, but “past Commissions have generally refrained from engaging in a game of seesaw with our rulebook.”
Only three days after Gensler announced his plans to take a fresh look at the whistleblower program, Pierce and Roisman issued a Statement on the Commission’s Action to Disregard Recently-Amended Whistleblower Rules. The two commissioners were genuinely angry and with reason. They’d been provoked by Gensler’s next move. Normally, amendments to rules are first presented as a formal proposal. A comment period follows and may be extended if the proposal is of particular interest to market participants and the general public. Then the rulemakers consider the comments, discuss some of the issues raised with the Commission, and present a final rule that is voted on by the Commission. The chair decided to short-circuit all that.
On August 5, Gensler issued a statement in the name of the SEC titled: PROCEDURES FOR THE COMMISSION’S USE OF CERTAIN AUTHORITIES UNDER RULE 21F-3(B)(3) AND RULE 21F-6 OF THE SECURITIES EXCHANGE ACT OF 1934. Its intention, the cover sheet explained, was to “clarify how the SEC will proceed when addressing certain issues under Exchange Act Rule 21F-3(b)(3) and Exchange Act Rule 21F-6 while the staff is preparing and the Commission is considering potential amendments to those rules (“Interim Policy-Review Period”). These procedures will remain in effect until withdrawn by the Commission.”
The statement begins with a brief explanation of the provisions in Dodd-Frank that provided for the SEC’s whistleblower program. It then introduces the amendments adopted in September 2020, pointing to two that “whistleblower advocates and others have asserted are unfair to whistleblowers and may risk reducing the willingness of individuals to blow the whistle.” The two amendments in question are the one that redefines, or at least muddles the definition of, a “related action,” and the one allowing the Commission to consider, at its discretion, the dollar amount of an award when making an award determination.
Gensler has, as we’ve seen, directed staff to prepare potential changes to the rules cited above and to present them for the Commission’s consideration later this year. In the meanwhile—which the statement calls the “Interim Policy-Review Period”—workarounds are suggested.
As to Exchange Act Rule 21F-3(b)(3):
Before providing a preliminary determination to a claimant, or a proposed recommendation to the Commission, the staff shall consider whether to recommend that the Commission’s exemptive authority under Section 36(a) of the Exchange Act should be utilized to permit an award on a potential related action irrespective of the limitations of Rule 21F-3(b)(3) if:
(a) the alternative whistleblower program has an award cap or award range that could disadvantage the particular claimant; or
(b) the Commission is aware or the claimant demonstrates a likelihood that a condition or exclusion would apply to his or her award claim under the alternative award program and the staff determines that the claimant would likely obtain an award were he or she permitted to proceed under the SEC’s award program.
For any other award claim under Rule 21F-3(b)(3) for which the staff determines that an alternative whistleblower program has a “more direct or relevant connection” to the potential related action than the Commission’s award program does, the staff will inform the claimant of its assessment. The claimant may then request that the related-action award claim held in abeyance during the Interim Policy-Review Period.5 Further, any related-action award claim that is held in abeyance shall not impact the timely processing of any award claim arising from a covered Commission enforcement action that is successfully litigated using the claimant’s same original information.
As to Exchange Act Rule 21F-6:
With respect to Rule 21F-6, the Commission at the time it adopted the 2020 rulemaking amendments explained that the amendment in question was a clarification of discretionary authority the Commission already possessed.6 The Commission anticipates that going forward, it will continue its practice of considering dollar amounts only in connection with provisions of the rules that explicitly contemplate the use of such discretion to raise awards (i.e., law enforcement interest prong of 21F-6(a)(3) and the application of the presumption embodied in Rule 21F-6(c)). In the unlikely event that the staff or the Commission should consider deviating from this practice, the staff will inform the claimant that such action is being considered. The claimant may then request that the matter be held in abeyance during the Interim Policy-Review Period.
The statement ends by noting that publication for notice and comment is not required under the Administrative Procedure Act (APA). It recommends an effective date be set in the very near future, though we don’t yet know what that date will be. Obviously, Gensler has taken his own route to getting what he (and those unidentified whistleblower advocates) wanted. It is an extremely unusual way to handle a disagreement with colleagues on the Commission.
New rules will be proposed within the next few months, and they will presumably be judged on their merits. But what Gensler did was highhanded, and any concessions he may make in the proposals could very well fail to mollify the incensed Pierce and Roisman. And incensed they are. They finished their own statement from August 5 with a warning: “Abandonment of duly-adopted rules without notice and request for comment raises the prospect that the rules the Commission adopts in compliance with the Administrative Procedure Act may be interim at best, and transitory at worst. This reduces the certainty of the law, a consequence that does not bode well for the Commission or those it regulates.”
Allison Herren Lee and Caroline Crenshaw did not offer any comment. Presumably, they await the appearance of the new proposed whistleblower rules, as do we.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.