Opinion: SEC reforms offer mixed bag for whistleblowers

Sep 25, 2020
Katherine Krems, Matthew Stock and Jason Zuckerman say new amendments will strengthen some aspects of the whistleblower program but also reduce large awards and limit retaliation protection

The SEC on Wednesday voted 3-2 to adopt amendments to the rules governing the agency’s whistleblower program. Now about a decade old, the program has proven to be successful in generating high-quality information regarding securities laws violations that have enabled the SEC to halt fraud schemes and protect investors.

Although we are pleased that the SEC took the time to adopt reforms that promote efficiency and expedite the processing of whistleblower tips and whistleblower award applications, we are troubled by the SEC’s assertion of vague discretion to take into account the amount of an award in determining award percentage.

The Dodd-Frank Act sets forth specific criteria that the SEC should employ in determining an award percentage between 10 percent to 30 percent of the collected proceeds in a covered enforcement action. Criteria that justify a higher award include the significance of the tip, the extent of the assistance that the whistleblower provided to the SEC, the law-enforcement interest in deterring the specific violation and the extent to which the SEC reported the violation to their employer’s internal compliance and reporting system.

Negative factors that could lower an award include culpability for the violation, unreasonable delay in reporting and interfering with a company’s internal compliance system.

Nowhere in the statute did Congress suggest that the SEC should consider the amount of an award when it determines the appropriate award percentage. Although we are glad the SEC withdrew the soft cap on whistleblower awards that it proposed in June 2018, the amended rules adopt a vague and subjective approach to lowering awards without offering any transparency as to how the SEC would apply that discretion. This uncertainty could dissuade whistleblowers from coming forward.

Here we look at some of the key amendments approved this week. 

Presumption of the maximum award percentage for awards of $5 million or less
Under the SEC whistleblower program, the commission is required to issue awards to eligible whistleblowers who provide original information that leads to enforcement actions with total monetary sanctions in excess of $1 million. In exchange for the valuable information, a whistleblower may receive an award of between 10 percent and 30 percent of the total monetary sanctions collected in the enforcement action.

As amended this week, Rule 21F-6(c) now provides that for awards of $5 million or less, the SEC will pay the statutory maximum award – 30 percent of the total monetary sanctions collected in the enforcement action – where none of the negative award factors are present.

This amendment is a win for most whistleblowers. According to the SEC, roughly 75 percent of its whistleblower awards have been $5 million or less. As such, most future meritorious SEC whistleblowers can expect to receive a boost in their award percentage under the amendments, assuming that none of the negative award factors are present.

SEC asserts discretion to reduce large awards
A controversial proposal in the SEC’s June 28, 2018 proposed amendments would have given the commission discretion to reduce an award in a covered action that yielded collected monetary sanctions of at least $100 million if the SEC finds that the potential award exceeds what is ‘reasonably necessary to reward the whistleblower and to incentivize other similarly situated whistleblowers.’ The SEC would not, however, have the discretion to award less than 10 percent of the collected sanctions, the minimum award percentage set forth in the statute. Some commentators asserted that this proposed rule would effectively result in larger awards being capped or set at the statutory minimum.

In the face of significant opposition to this proposed soft cap, the SEC did not adopt this proposal, but instead asserted that it has the discretion to take into account the award amount in determining award percentage. In a press release announcing the amended rules, the SEC notes that it can determine award amounts ‘in its discretion… in percentage terms, dollar terms or some combination.’

Fortunately, the SEC noted that ‘[b]ased on the historical application of the award factors, if none of the negative criteria… are present [for an award above $5 million], the award amount would be expected to be in the top third of the award range.’ It is unclear from the rulemaking how the SEC will exercise its discretion to lower large awards.

Commissioners Caroline Crenshaw and Allison Herren Lee took a firm stance against the SEC considering the dollar amount when determining award percentage. This week’s vote might not be the last word on this issue. A whistleblower may challenge the reduction of an award in a large covered action by bringing a challenge under the Administrative Procedure Act, and Congress could amend the statute to clarify that the SEC should not take into account the size of an award in determining the appropriate award percentage.

Increased efficiency in claims review process
After the SEC brings a successful enforcement action in excess of $1 million, the commission posts the action on its notices of covered action page. Once posted, whistleblowers have 90 calendar days to apply for an award. Thereafter, the SEC assesses the applications (known as the ‘claims review process’) to determine: (i) whether a whistleblower is eligible for an award; and (ii) the amount of the award.

In recent years, the agency has struggled to efficiently review whistleblowers’ applications for awards. In most cases, the claims review process has taken more than two years. The amended rules include several provisions that should increase efficiency in the claims review process.

First, new subparagraph (e) to Exchange Act Rule 21F-8 codifies the SEC’s practice of barring applicants who submit materially false, fictitious or fraudulent statements in their whistleblower submission, in their other dealings with the SEC or in related actions, and provides an important new tool for the SEC in processing frivolous award applications.

Before this amendment, the SEC was forced to assess frivolous applications for awards, which was a drain on its resources and delayed the timely assessment of potentially meritorious whistleblowers’ applications.

Next, new Rule 21F-18 gives the SEC a summary disposition procedure for certain types of common denials, such as untimely award applications, applications that involve a tip that was not provided to the SEC in the form and manner that the rules require and applications where the claimant’s information was never provided to or used by staff responsible for the investigation.

Like the above-mentioned amendment, this will allow the SEC to bypass obvious denials and utilize its limited resources to timely assess potentially meritorious whistleblowers’ applications.

Finally, the SEC’s new presumption of the statutory maximum award amount for certain awards of $5 million or less will significantly speed up the claims review process. As mentioned, roughly 75 percent of the awards given out in the whistleblower program have been $5 million or less. As such, this presumption will allow the SEC to quickly make determinations in a majority of cases by only assessing the negative factors, which will in turn free up SEC resources to timely assess larger cases.

Requiring written whistleblower submissions
In response to the US Supreme Court’s holding in Digital Realty Trust, Inc v Somers, where the court held that Dodd-Frank’s definition of whistleblower requires a report to the SEC as a requirement for retaliation protection, the SEC amended Exchange Act Rule 21F-2(a) to provide a uniform definition of whistleblower status. This definition applies for all purposes under Section 21F: award eligibility, confidentially and retaliation protection.

Under Rule 21F-2(a) as amended, the commission will only grant whistleblower status to:

  • An individual
  • Who provides the commission with information ‘in writing,’ and
  • ‘The information relates to a possible violation of the federal securities laws (including any law, rule, or regulation subject to the jurisdiction of the [c]ommission) that has occurred, is ongoing or is about to occur.’

In adopting this definition, the SEC stated that it determined the ‘in writing’ requirement does not place an onerous burden on whistleblowers, as some commenters had suggested. The commission cited flexibility in meeting the requirement: that submission online, by email, facsimile or US mail would qualify. The commission explained that this requirement would help it preserve administrative efficiency and reliability while addressing external reports from across the country and around the globe.

Limiting the scope of Dodd-Frank whistleblower protection
Before the adoption of amended rules, the SEC broadly construed the whistleblower protection provision of Dodd-Frank, which authorizes it to take enforcement action to combat retaliation and permits whistleblowers to sue in federal court to recover damages for retaliation.

Indeed, the SEC filed amicus curiae briefs arguing that the Dodd-Frank whistleblower protection provision protects internal disclosures, and it took enforcement actions to punish retaliation and bar companies from impeding whistleblowing to the agency. But this week the SEC adopted amendments that limit Dodd-Frank whistleblower protection.

Under amended Rule 21F-2, the SEC will protect whistleblowers only if they report a potential violation of the federal securities laws in writing. As we argued in comments drafted in conjunction with the Government Accountability Project, the National Employment Lawyers Association and Public Citizen, this interpretation is contrary to the plain meaning of Dodd-Frank.

Indeed, the second form of protected conduct set forth in the whistleblower protection provision of Dodd-Frank – ‘initiating, testifying in or assisting in any investigation or judicial or administrative action of the [c]ommission’ – expressly contemplates protection for oral disclosures.

The writing requirement is also a significant departure from a well-developed body of precedent construing similar whistleblower protection laws. For example, courts have uniformly held that the whistleblower protection provision of the Sarbanes-Oxley Act protects persons providing information, orally or in writing, about potential securities violations.

Moreover, excluding oral disclosures from the ambit of Dodd-Frank whistleblower protection is inconsistent with the remedial purpose of the statute – to provide robust protection to whistleblowers – and the SEC’s interest in encouraging whistleblowers to come forward.

If a whistleblower co-operates with an SEC investigation by providing important information during an interview with agency staff without providing a written disclosure, the SEC would apparently look the other way if the whistleblower suffers retaliation due to their co-operation with an SEC investigation. That is an odd position for a civil law enforcement agency that has a strong interest in ensuring that employees of registrants and other entities subject to SEC jurisdiction can testify without fear of reprisal.

Rule 21F-2(d)(1)(iii)(B) further limits the scope of Dodd-Frank whistleblower protection by clarifying that protection will attach to a lawful act performed by a whistleblower – for example, reporting a potential violation of federal securities law to the whistleblower’s employer – only if the act ‘relate[s] to the subject matter of’ the whistleblower’s report to the commission.

That limitation on whistleblower protection is not compelled by the text of the statute. Indeed, none of the parties or amici curiae in Digital Realty proposed reading this limitation into the statute. As Justice Ruth Bader Ginsburg noted in the majority opinion: ‘Moreover, nothing in Subsection (a)’s definition of whistleblower, or in petitioner’s interpretation of the statute, requires a temporal or topical connection between the violation reported to the [c]ommission and the internal disclosure for which the employee suffers retaliation.’

The court also noted that petitioner Digital Realty acknowledged that Congress ‘could reasonably have made the policy judgment that individuals who report securities-law violations to the SEC should receive broad protection over time against retaliation for a variety of disclosures.’

Fortunately, the amended Rule 21F-2 provides some helpful clarifications for whistleblowers about the scope of whistleblower protection:

  • The SEC would protect whistleblower disclosures to an employer even if done before reporting to the SEC when the retaliation takes place after a person qualifies as a ‘whistleblower’ by providing information directly ‘to the [c]ommission’ consistent with Section 21F(a)(6)
  • The SEC declined to limit retaliation protection strictly to persons who satisfy the procedures and conditions for award eligibility; for example, the whistleblower would be protected even if their submission to the SEC did not qualify as ‘original information’
  • Citing the Burlington Northern standard, the SEC is defining retaliation to encompass what ‘a reasonable employee [would find] materially adverse,’ which means ‘it well might have dissuade[d] a reasonable worker’ from engaging in any lawful act encompassed by Section 21F(h)(1)(A).

 Katherine Krems, Matthew Stock and Jason Zuckerman are attorneys with Zuckerman Law

The full text of the authors’ article can be read here.


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