United States: Memo To The Congress: Don't Mess With The SEC Whistleblower Program

For the last several months many "stakeholders" in the Dodd-Frank Act have been cautiously waiting to see if the "other shoe" will drop, in the form of changes to that law initiated by the Trump Administration and/or the newly energized Republican Congress. An area of concern to this writer, who represents SEC whistleblowers, is whether this highly successful program will come under scrutiny by those seeking to curtail it, for whatever reason. Numerous objections to various provisions of the program originally came from many quarters, mostly in the corporate community, when the SEC first issued Rules to implement the whistleblower law set forth in the Dodd-Frank Act. Now, the program has established itself, and in the last five years has produced more than 10,000 tips, 41 awards for a total over $149 million, and the recovery of nearly one billion dollars in monetary penalties for the benefit of the U.S. Government. If every government program was this successful, we would have no federal deficit.

To date, not much flak has been aimed in the direction of the program, but as new SEC Commissioners take their seats and certain members of Congress get to work on "revising" the Dodd Frank Act, it would not be surprising to see a revival of legislative or rule-making efforts to enact changes to the whistleblower program which, however well-intentioned, could make the whistleblower process more difficult, less attractive, and thus less effective. The point of this article is to strongly suggest that the program was carefully crafted, underwent considerable "vetting" in the rule making process, is working quite well, and should be maintained and encouraged. Any program that costs the government almost nothing to operate, generates nearly a billion dollars in financial penalties over its first five years, and assists the government in deterring and prosecuting corruption and fraud, is well worth keeping intact.

The Proposal: Barring "co-conspirator" Whistleblowers from Getting SEC awards

As of this writing, the only announced effort to directly impact the program is coming from Rep. Jeb Henserling, R-Tex., Chairman of the House Financial Services Committee. According to several published reports, he recently issued a memo outlining a plan to revise Dodd-Frank and curtail SEC powers via changes in his bill introduced last year called the Financial Choice Act. In a memo of February 6, 2017 titled "CHOICE Act 2.0 Changes" he mentioned the SEC Whistleblower program only once. "Title IV—CAPITAL MARKET IMPROVEMENTS", item 9 (of 23) states: "Prohibit a co-conspirator from receiving a SEC Whistleblower rewards program."

This item revives what was a contested provision in the SEC Final Rule establishing the program in 2010. The Dodd-Frank Act itself set forth a short list of individuals who are ineligible for an award, one of whom was "any whistleblower who is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower otherwise could receive an award under this section." Sec. 21F(c)(2)(B). This provision established a bright line barring anyone convicted in a criminal case (i.e. a DOJ prosecution, not an SEC civil enforcement action) from obtaining an award from the SEC in connection with the related SEC matter.

The Dodd-Frank Act thus allowed an individual to seek and, if otherwise qualified, obtain an award as a whistleblower in an SEC matter involving a securities law violation in which he had some demonstrable degree of culpability, but who had not been prosecuted criminally by any federal or state authority. The SEC however, was careful to limit the potential of such an award in several respects. In its Final Rule, the SEC established four "factors" which it could consider to justify a decrease in the award of less than the maximum 30% of the financial penalty assessed in the case (the SEC has discretion to give an award of 10 to 30% of the penalties, as long as they exceed $1 million). One of the "downward factors" was related to the "culpability" of the applicant whistleblower.

The SEC indicated in would assess "the culpability of involvement of the whistleblower in matters associated with the Commission's action or related actions." In considering this factor, the Commission may take into account, "among other things", the whistleblower's:

  1. "role in the securities violations"
  2. his "education, training, experience, and position of responsibility at the time the violations occurred"
  3. whether he acted "with scienter, both generally and in relation to others who participated in the violations"
  4. whether he "financially benefited from the violations"
  5. whether he is a "recidivist"
  6. the "egregiousness of the underlying fraud committed by the whistleblower, and
  7. whether he "knowingly interfered with the Commission's investigation of the violations or related enforcement actions."

Rule 21F-6(b)(1)(i)-(vii).

Thus, in deciding the amount of any award, the SEC left itself considerable latitude to consider every facet of the case and the whistleblower's actions, involvement, and personal background (much as Federal judges had the ability to do in sentencing in the days before their discretion was hampered by the Federal Sentencing Guidelines). While it is impossible to know if the "culpability factor" has played much of a role in the setting of any award amounts to date, it can be safely assumed that whistleblowers who had some minor or peripheral role in the fraud have not been docked in any substantial way. As for truly bad actors, if any have become successful whistleblowers, it is also safe to assume they have received little or no more than the minimum 10%.

Likewise, the SEC tried to further lessen the chances of a "bad actor" whistleblower getting a significant award by enacting a companion rule regarding awards to "whistleblowers who engage in culpable conduct," Rule 21F-16. It specifies that the Commission, in determining if the minimum threshold of $1 million in penalties has been met to allow an award, will not take into account any monetary sanctions that the whistleblower himself is ordered to pay, or that are ordered against any entity "whose liability the whistleblower directed, planned, or initiated." Nor will the Commission consider any penalty paid by the whistleblower himself or any such entity to be included "in the calculation of the amounts collected for purposes of making payments."

Taken together, these provisions would most likely result in denial of any award to a truly bad actor whistleblower, particularly since the SEC can (and has in at least one case) given an award but simultaneously deducted from it an amount sufficient to offset the penalty rendered against him. And if, as is highly likely, the entity involved has paid all or the large portion of the penalties (as is the situation in nearly all cases), it is very unlikely that more than $1 million will be left in the pot to qualify the whistleblower for any award if he had "planned, directed, or initiated" the illegal activity.

Thus, while it remains theoretically possible for a whistleblower with major involvement in a fraud scheme to qualify for an award, the SEC in its infinite discretion has multiple ways to make it highly unlikely that awkward result will ever occur, or if it does the SEC will structure the penalties imposed to take away with one hand that which it has given with the other.

The Continuing Sentiment Against Giving a "Culpable" Whistleblower Any Award

The inconvenient fact remains that the Rule does, on its face, permit an award to a culpable, albeit non-convicted, whistleblower. This may be something of a lightening-rod to those observers looking to weaken the program. To them, giving an award to anyone who has been involved in a fraud scheme, however tangentially, seems inappropriate at best, and outrageous at worst. At the time the Final Rule was issued in 2011, the SEC was besieged with pleas from various corporate representatives and interest groups to deny any award to a "culpable" whistleblower, period. For example, a group of corporate executives describing itself as representing "the largest global companies in the United States dedicated to the highest standards of integrity and ethics in business" 1 submitted comments to the SEC in December 2010 during the rule making process. They wrote, in part:

"We recognize that culpable whistleblowers may have access to potentially helpful information, but believe that countervailing public policy considerations argue against making such individuals eligible for bounty payments. Moreover, other tools are available to incentivize culpable individuals to report information to the Commission, such as offering immunity from prosecution. Incentivizing individuals to violate the securities laws in pursuit of bounty payments, and providing awards to individuals who do so, are contrary to the Commission's goal of promoting "greater deterrence" through implementation of the whistleblower program." (italics supplied).2

Over the last five years since establishment of the SEC whistleblower program, I have represented, or discussed representation with, quite a few whistleblowers. I have never met, and never expect to meet, anyone who would deliberately set out to violate those laws in order to then pursue a whistleblower award. Imagining such a devious individual to justify the current Congressional proposal is a classic straw man argument. A similar misguided objection was posed by the Securities Industry and Financial Markets Association in their submission of Dec. 17, 2010 to the SEC:

"If a person is involved in or knew about and could have prevented misconduct, then that person should not be able to profit from the violation as a whistleblower.... Allowing a person to participate in misconduct and then profit as a result, by making a whistleblower report concerning that misconduct, is directly contrary to the clear intent of Congress to reduce the overall number of securities law violations. Paying awards to participants in the misconduct would be an absurd result Congress could not have intended."

In fact, the "clear intent of Congress" was to create incentives to get individuals with inside knowledge of corporate wrongdoing to muster the courage to report it. To the extent a few such people may have participated in the misconduct, Congress "made clear" that those convicted of a crime (i.e. the truly culpable) would be disqualified, and the SEC has "made clear" that it will carefully consider such conduct is setting the award amount. Likewise, there is no guarantee of immunity to a whistleblower that prevents the SEC from ultimately charging him with a violation, even if based in part on his own disclosures. In truth, any potential whistleblower with significant culpability should seek out a skilled defense lawyer and try to arrange a "cooperation agreement" with the SEC at or before considering a whistleblower submission.

The SEC Correctly Rejected the Total Denial of Awards to "Culpable" Whistleblowers

One cannot deny the basic argument that in general wrongdoing should not be rewarded, at least in financial terms, in any government program. It is the sentiment that may well drive Rep. Henserling's proposed restriction. However, the SEC carefully considered these and similar objections at the time the program was created, and responded to them, in the Final Rule adopting release: "[W]e do not believe that a per se exclusion for culpable whistleblowers is consistent with Section 21F of the Exchange Act. As commentators noted, the original Federal whistleblower statute—the False Claims Act—was premised on the notion that one effective way to bring about justice is to use a rogue to catch a rogue. This basic law enforcement principle is especially true for sophisticated securities fraud schemes which can be difficult for law enforcement authorities to detect and prosecute without insider information and assistance from participants in the scheme or their coconspirators. Insiders regularly provide law enforcement authorities with early and invaluable assistance in identifying the scope, participants, victims, and ill-gotten gains from these fraudulent schemes. Accordingly, culpable whistleblowers can enhance the Commission's ability to detect violations of the Federal securities laws, increase the effectiveness and efficiency of the Commission's investigations, and provide important evidence for the Commission's enforcement actions." 3 Based in part on these considerations, the SEC adopted the several reasonable, and effective, limitations on awards to culpable whistleblowers described above.

The SEC has it right. Most whistleblowers come to the process with "clean hands." Most have observed or otherwise heard about wrongdoing, some have reported it to superiors, and have decided to "do the right thing" and report it to the regulators through the whistleblower program. I have never represented, or even spoken to, a whistleblower I could objectively have considered to be a "co-conspirator." Some, including several clients I have represented, had some very limited involvement in the underlying conduct, such a going along with a scheme for a time as a minor participant, refraining for a time from objecting to the conduct (usually for fear of retaliation, such as losing their job or facing demotion or job transfer), or recording at the explicit direction of a superior some misleading or inaccurate information. Almost all had raised questions, concerns, or objections to superiors, to no avail. In context, these actions are typical, reflect human nature, and upon a full and reasonable analysis of the facts are justifiable or at least understandable under the circumstances. These individuals should not in any sense be considered "co-conspirators." They would not be charged as such by any rational government prosecutor or enforcement lawyer. Their actions should not result in the loss, or potential loss, of the ability to obtain an award.

In that respect, I must comment that until one has "walked in the shoes" of a whistleblower, it can be difficult to appreciate the pressure and anxiety these courageous individuals endure in making the decision to do what most others would avoid—reporting wrongdoing against powerful corporations who hold the whistleblower's career in their hands, or have the ability to destroy it at will. Their livelihood, their family's well-being, sometimes their personal safety, may be at stake. While it may be "cleaner" if they have no involvement in that wrongdoing, their willingness, particularly in the isolated cases of those who may have some degree of personal exposure by bringing such activity to the authorities speaks to their authenticity and courage, and their ultimate value to the government in building a strong case.

The Threat to the Whistleblower Program of a "Co-conspirator" Award Bar

In drawing the bright line of disqualification for a conviction only, the Dodd-Frank drafters gave a clear signal to whistleblowers: fear not, your involvement, short of a criminal conviction, does not disqualify you. Uncertainty is the key factor here: an individual contemplating coming in with information that may form the basis for an SEC enforcement action wants reasonable assurance that the potential reward is worth the risk. I have had that conversation with nearly all of my clients, and others who have sought my counsel and ultimately decided not to become a whistleblower. The possibility of being identified as a whistleblower is troubling enough without adding to the equation the risk, however remote, that one might end up, after a successful SEC enforcement action based on their information, being denied an award because of their own disclosures, in the government's view, rendered them under the law a "co-conspirator" in the very wrongdoing they sought to expose. I would have to advise such an individual that part of the risk he or she runs in becoming a whistleblower is that it would not be determined until potentially years later whether such disclosures, which could result in a major case for the SEC, would entitle that whistleblower to any award whatsoever.

The risk of blurring the bright red line which now exists by introducing the concept of disqualification for being considered, post facto, a "co-conspirator," introduces a high degree of uncertainly into an already highly uncertain process. If the whistleblower can in any respect be judged later to have been a "co-conspirator" in the conduct, however that troublesome and amorphous term is applied in a given set of facts, and thus denied an award entirely, the odds that person will undertake such a precarious process may decrease dramatically.

The Difficulties in Determining Who May Be a "co-conspirator"

In using the word "co-conspirator" as the key concept in describing the new barrier to becoming a whistleblower, the proposed legislation has focused on one of the most confusing and confounding concepts in the law. Without attempting to get too far into the weeds of conspiracy law, let me pose a simple example of the minefield this requirement would pose for the whistleblower program.

As a former federal prosecutor and defense lawyer, I pay considerable attention to jury instructions. The instructions regarding the elements of conspiracy (these taken from the 9th Circuit U.S. Court of Appeals, other jurisdictions are similar) require (1) an agreement between two or more persons to commit at least one crime as charged in the indictment, (2) the defendant became a member of the conspiracy knowing at least one of its objects and intending to help accomplish it, and (3) one of the members of the conspiracy performed at least one overt act for the purpose of carrying out the conspiracy. But that's not all. As for how one becomes a member of the conspiracy, the instruction says the following: "One becomes a member of a conspiracy by willfully participating in the unlawful plan with the intent to advance or further some object or purpose of the conspiracy, even though the person does not have full knowledge of the details of the conspiracy. Furthermore, one who willfully joins an existing conspiracy is as responsible for it as the originators. On the other hand, one who has no knowledge of a conspiracy, but happens to act in a way which furthers some object or purpose of the conspiracy, does not thereby become a conspirator. Similarly, a person does not become a conspirator merely by associating with one or more persons who are conspirators, nor merely by knowing that a conspiracy exists."

"An overt act does not itself have to be unlawful. A lawful act may be an element of a conspiracy if it was done for the purpose of carrying out the conspiracy. The government is not required to prove that the defendant personally did one of the overt acts."

"Each member of the conspiracy is responsible for the actions of the other conspirators performed during the course and in furtherance of the conspiracy. If one member of the conspiracy commits a crime in furtherance of a conspiracy, the other members have also, under the law, committed that crime." (The Pinkerton charge, derived from the holding in Pinkerton v. United States, 328 U.S. 640 (1946).

These are the instructions a federal jury (laymen, usually not lawyers) receive in every case in which a defendant is charged as a "co-conspirator." Prosecutors, including SEC enforcement lawyers, often charge a conspiracy to violate a given federal law, including securities fraud. Issues surrounding conspiracies and conspirators have bedeviled the courts, the juries, the parties and the legal profession for centuries.4 I can predict that introducing this concept as a critical element in determination of who may qualify as a whistleblower could impact the SEC's program in a myriad of ways. Just a few possible consequences:

  • as noted, it will discourage potential whistleblowers (and their lawyers) from making a submission to the SEC in any scenario in which the whistleblower could be considered, rightly or wrongly, to have any potential exposure on any theory as being a "co-conspirator." Even the most tangential act by the potential whistleblower that might be later construed as furthering the "conspiracy" will have to be considered by the whistleblower and his or her counsel as a potential disqualifier for an award.
  • After the case is brought, it will require the Office of the Whistleblower ("OWB") to spend additional time and effort in investigating the potential of "co-conspirator" status of the whistleblower before making an award recommendation to the Claims Review Staff ("CRS") (as required by Rule 21F-10(b).
  • To resolve a potential "co-conspirator" issue, the OWB might be required to take additional testimony from the SEC staff or the whistleblower himself, or other witnesses to or participants in the scheme, in order to make its recommendation to the CRS. Difficult legal and factual judgments may be required.
  • For example, in considering potential "co-conspirator" situations, the OWB and CRS would confront a myriad of difficult subjective judgments as to when and if a whistleblower had joined a conspiracy, when and if he had committed an "overt act," whether minor actions such as making a single false entry, attending a single meeting at which the fraud was discussed, or failing to formally report the fraud (such as on a SOX sub-certification) constituted knowing and willful participation in the fraud. The SEC's "verdict", which could cost the whistleblower literally millions of dollars, may be one which has historically confounded judges and juries. It will make the award process, now conducted virtually in secret, much more uncertain for the applicants.
  • A preliminary determination by the CRS of denial of an award claim by the whistleblower on the grounds of his being found to be a "co-conspirator" would undoubtedly generate an appeal of the denial by the whistleblower through the process set forth in the rules, further delaying the final award decision. It could also increase the potential for an award denial to be taken to a U.S. Court of Appeals, as provided in the Rules.
  • Even after the CRS decides to recommend an award to the Commission, a single SEC Commissioner can request a review before a Final Order is rendered. Presumably, an award decision which in any respect involves an alleged "co-conspirator" issue could trigger such a review, which could involve the Commission as in essence "judge and jury" of the whistleblower in what could become a mini-trial of the underlying SEC case, many of which cases are quite complex. This could result in another lengthy delay in the award process, and divided Commission votes on whether to make an award.
  • In cases in which there are no individual respondents, just the corporation (which is frequently the case in SEC enforcement actions), the whistleblower who brought the case to the SEC could end up being found to be a "co-conspirator" with other corporate actors who were never charged, and thus denied an award. The whistleblower, who may have "made" the case, would then become effectively the only individual to suffer any penalty in the enforcement action. This absurd result, which might end up being widely reported, could significantly discourage future whistleblowers and thus undermine the entire whistleblower program.

CONCLUSION

The addition of a "co-conspirator" bar to obtaining an SEC whistleblower award opens a Pandora's Box of issues that could seriously impact what has to date been a very successful program. It could materially decrease the heretofore significant assistance courageous whistleblowers have provided the SEC and DOJ in their efforts to enforce the securities laws. Whatever appeal it may have on its face, decades of experience with the difficulties posed by the complex law of conspiracy suggest that its introduction into the whistleblower award process could do significant damage to the SEC whistleblower program. It should be decisively rejected by the Congress.

Footnotes

1 Among the signers of the letter were senior executives of Tyco, Pfizer, JP Morgan Chase, Johnson & Johnson, Citigroup and Alcoa. Over the six years since that letter was sent, these self-proclaimed "high integrity" firms have paid the SEC and DOJ a total of over $2.3 billion in fines and penalties in various SEC and DOJ enforcement actions.

2 I was disheartened to read that the American Bar Association, in its comment letter to the SEC of January 4, 2011, shared these sentiments: "We believe the absence of a more stringent standard may, in fact, create an incentive for persons to promote or engage in unlawful acts solely for the purpose of seeking awards and protections. Persons who have 'crossed the line' and engaged in violations (or possible violations) of the securities laws may in fact have an incentive under the proposed whistleblower rules to maximize the seriousness of the violation in order to increase the potential amount of their awards." (italics supplied). I am still waiting to be contacted by that devious whistleblower, much as I await seeing my first unicorn.

3 SEC Final rule, release No. 34-64545, File No. S-7-33-10. Fed. Register, Vol 78, No. 113, p. 34350, June 13, 2011.

4 "A doctrine so vague in its outlines and uncertain in its fundamental nature as criminal conspiracy lends no strength or glory to the law; it is a veritable quicksand of shifting opinion and ill-considered thought." Sayre, Criminal Conspiracy, 35 Harvard Law Review 393 (1922)(cited in Doyle, Federal Conspiracy Law: A Brief Overview, Congressional Research Service, January 20, 2016).

Daniel J. Hurson is a former Assistant U.S. Attorney and former Assistant Chief Litigation Counsel at the SEC. He now represents SEC whistleblowers on a world-wide basis. His website is http://www.hursonlaw.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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