It has been more than two years since the United States Securities and Exchange Commission (SEC) began operating its whistleblower program, but substantial questions linger over its effectiveness and its transparency. Under the program, whistleblowers are entitled to recover up to 30% of the monetary sanctions collected in SEC and related enforcement actions. For the last two years, the SEC has issued several press releases touting the program and highlighting one award that gave US$14 million to one lucky whistleblower.

But only four whistleblower awards have been made in the program’s history, and the SEC has not disclosed many details about those awards to the public. So, has the SEC’s program been worth it? And if the SEC is going to make a practice of awarding millions of dollars to anonymous individuals without much of a public explanation, is the program already in need of reform?

Background

The whistleblower program began operating in August 2011. In passing the Dodd-Frank Act, Congress mandated that the SEC make monetary awards to eligible individuals who voluntarily provide original information that leads to successful SEC enforcement actions resulting in monetary sanctions over US$1 million. If granted, awards must be paid in the amount equal to 10 to 30% of the monetary sanctions collected by the SEC and by other government agencies such as the Department of Justice.

The Dodd-Frank Act provides whistleblowers with two important protections. First, whistleblowers have a private right of action against any employer who retaliates against them. Second, the statute prohibits the SEC from revealing “any information, including information provided by a whistleblower to the Commission, which could reasonably be expected to reveal the identity of a whistleblower … .” 15 U.S.C. § 78u-6(h)(2).

To administer the program, the SEC established the Office of the Whistleblower (OWB) within its enforcement division. The OWB, which is led by Sean X. McKessy, works with the SEC’s enforcement attorneys to recommend awards, which are then preliminarily approved by senior members of the SEC’s enforcement division. The five SEC commissioners make the final decision on the awards.

Only four whistleblower awards have been made in the program’s existence

If the program is judged only by the number of its payouts, it has not lived up to the hype. Besides the US$14 million award, since August 2011, the whistleblower program has granted three awards in the amounts of US$150,000, US$125,000 (to be shared among three whistleblowers), and nearly US$50,000. Each whistleblower has remained anonymous.

SEC officials have largely based their public praise for the program on the increase of the number and quality of the tips they have received. When the US$14 million award was announced, SEC Chair Mary Jo White stated, “Our whistleblower program already has had a big impact on our investigations by providing us with high quality, meaningful tips.” The OWB reported that the number of whistleblower tips increased to 3,238 for the latest fiscal year. Private attorneys have been aggressive in recruiting whistleblowers from companies, both in the United States and abroad, which has helped contribute to the number of tips being received by the SEC. Last year, the OWB reported that it received the most tips internationally from the United Kingdom, Canada, China, Russia, Ireland, and India.

Despite the modest number of awards, it is a safe bet that we will see a significant increase in the number of whistleblower awards in the coming years. If a whistleblower provides a tip, the payout is mandatory, and if the SEC has seen an increase in the number or quality of tips, one would expect to see many more payments under the whistleblower program in the near future. Through the US$14 million award, the SEC has proven that it is willing to compensate whistleblowers handsomely, and the SEC’s frequent press releases demonstrate its enthusiasm for the program.

Meanwhile, for the whistleblowers, there are only incentives to participate in the program: they keep their anonymity and have the opportunity to obtain a large payout without much effort or exposure. The incentives for both the SEC and the whistleblowers are too well aligned for future payouts not to happen.

Ongoing problems with the lack of transparency

The real concern with the program, however, is the lack of transparency, which has been demonstrated in each of the four awards. The first award was made on 21 August 2012 to an anonymous whistleblower for nearly US$50,000. The SEC reported that this award represented 30% of the money collection in a multimillion-dollar securities fraud that the SEC says was stopped because of the tip. But the SEC did not describe (i) what multimillion-dollar fraud was stopped, (ii) who was charged as a result of the tip, (iii) what information was provided by the whistleblower, or (iv) why the SEC decided to award a 30% payout.

The SEC did a better job in providing information about the second award. That award granted US$125,000 to three anonymous whistleblowers on 12 June 2013. The SEC identified the perpetrators (a sham hedge fund named Locust Offshore Management and its CEO) and the judgment that was entered. The SEC announced that the award represented a total of 15% of the amount expected to be collected by the SEC and Justice Department enforcement actions. The SEC also offered more details about the type of information provided (two of the witnesses gave information that prompted the opening of the investigation and the halting of the scheme, while another whistleblower identified key witnesses and confirmed the information provided by the others). This award demonstrated that the SEC can provide more information to the public without violating the Dodd-Frank Act.

But when the US$14 million award was announced in October 2013, the SEC reversed course and provided virtually no information to the public. The SEC announced only that the US$14 million award was made to one anonymous whistleblower whose information helped the SEC recover investor funds. However, the SEC again did not identify anything about (i) the type of violation that occurred, (ii) the identity of the individual or company responsible for the violation, (iii) the percentage of the award given to the whistleblower, or (iv) any specifics about why the US$14 million was awarded.

The final award followed the same trend of providing only bare-bones information to the public. The SEC announced in October 2013 that it had awarded “more than” US$150,000 to a whistleblower whose tips helped the agency stop a scheme that was defrauding investors. The SEC stated that it was able to obtain emergency relief before any other investors were defrauded and that it gave the maximum 30% award to the whistleblower, but did not give any further details. The award also failed to identify the type of violation that occurred, who committed the violation, what judgment was entered, or any meaningful information as to why the award was granted.

Reforms needed to fix the transparency problem

The public has a strong interest in being able to evaluate the effectiveness of the whistleblower program and the appropriateness of its substantial awards to private citizens, but the public currently has no ability to make any meaningful judgments on those issues. A whistleblower has no incentive to reveal his or her identity, and the first two years of the program suggests that the whistleblower will not do so voluntarily. There is no independent oversight of the program by the judicial branch of government, and the SEC’s reports to Congress and press releases do not disclose any detailed information about the awards.

The SEC’s whistleblower program needs two reforms to fix its transparency problems. First, the SEC should abandon its overly conservative interpretation of the Dodd-Frank Act and provide detailed information in its announcements about whistleblower awards. In every whistleblower award, the SEC should identify the type of violation that occurred, the identity of the individual or company responsible for the violation, the specific judgment that was entered, the percentage of the award given to the whistleblower, and an explanation of the general type of information given by the whistleblower and why the award was granted.

None of this information compromises the identity of the whistleblower in any reasonable way or jeopardizes the soundness of the whistleblower program. But it would provide the public with the necessary information to understand the types of cases that have been brought as a result of whistleblower tips and why it is in the public interest for the whistleblower program to continue.

Second, Congress should consider an amendment to the Dodd-Frank Act and waive the confidentiality protections for individuals receiving an award of US$1 million or more. Otherwise, there is too much potential for abuse, and the SEC should not be expected to make US$14 million payments to private citizens without any scrutiny or assistance from the public as to whether the awards were appropriate. Information about past awards would assist the SEC in making future awards and detecting flaws in the process. Meanwhile, the whistleblower would still be protected by the anti-retaliation provisions of the Dodd-Frank Act, which the whistleblower may not even need after pocketing a million dollars or more.

Whistleblowers should and will play an important role in the SEC’s investigations in the future. However, when they are receiving payouts of US$1 million or more of public money from the U.S. government, the public interest requires that whistleblowers have some accountability, too.

The full and original memo was published by Hogan Lovells LLP on February 13, 2014 and is available here.