How do a few dozen SEC and CFTC staffers sift through the avalanche of tips submitted under Dodd-Frank whistleblower “bounty” programs to determine which ones to investigate?

The answer: They don’t.

Using new data obtained from both agencies under the Freedom of Information Act, my new working paper demonstrates that the tip-triage function has been outsourced to a group of well-connected, repeat-player, private whistleblower lawyers who are exempt from any meaningful transparency, regulation, or public accountability.

Key findings from the analysis, which includes all successful whistleblowers from the programs’ inception through 2020, include the following:

• Lawyers Dominate – Both the SEC and CFTC made twice as many awards to represented tipsters as to unrepresented ones. In the aggregate, represented tipsters received five times more money from the SEC, and 28 times more from the CFTC, than unrepresented ones. Average awards for represented tipsters also dramatically exceeded those for unrepresented tipsters in both programs.
• Concentration – Both programs are dominated by a small set of well-connected firms. At the CFTC, a single firm accounts for two-thirds of all money paid out. At the SEC, a single firm accounts for one-fifth.
• Repeat Players – Repeat player lawyers dominate both programs. The median and average awards for clients of lawyers who have previously won at least one award are dramatically higher than first-timers.
• Revolving Door – About a quarter of all dollars awarded by the SEC have gone to clients of lawyers who formerly worked for that agency. Assuming a standard contingency fee, the SEC has effectively caused as much as $70 million of public funds to be paid to its own alumni.
• Law Firm Types – Very small firms (five or fewer lawyers) have done well, while traditional plaintiffs’ firms and large defense-side firms are virtually absent.

Private whistleblower attorneys have escaped critical scrutiny for too long. Scholars have either ignored them, minimized their role, or adopted an overly positive account of their influence – for instance, assuming these attorneys improve agency tip-sifting by screening out low quality tips and by ensuring that the highest-quality ones receive the most careful attention.

But the true role of these attorneys is not so benign.

The high fees and expenses (typically 30-40 percent of the bounty plus costs) they charge can significantly reduce the incentive to blow the whistle. A high-quality would-be tipster may rationally decide not to come forward, even when the prospective bounty was very appealing, because she understands that half that bounty will go to lawyers, experts, investigators, and other intermediaries.

I estimate that private attorneys and other intermediaries have extracted as much as $300 million through 2020. That is, nearly a third of the public expenditures in this program are not being used to encourage whistleblowers to come forward. Had these funds instead been appropriated directly to the SEC, it could have roughly quadrupled its tip-sifting staff, while avoiding a significant amount of wasteful duplication involved in the current system.

Whenever agency leaders report on the whistleblower programs’ performance to Congress or the public, they invariably cite, as a key metric of the programs’ success, the impressive dollar amounts paid to whistleblowers. But these statements conspicuously fail to account for the very substantial portion paid to private attorneys and other intermediaries. Congress and the public at large are being fed a grossly exaggerated picture of the program’s accomplishments – and a grossly understated picture of its true costs.

The dominant role of well-connected attorneys in these programs also raises some significant legal and constitutional concerns. Several leading former SEC officials now in private whistleblower practice have publicly acknowledged that they stay in close touch with the SEC enforcement attorneys investigating their clients’ employers and leverage these relationships to get confidential information about ongoing SEC investigations and even direct access to the agency’s investigative files. These lawyers also have stated that they habitually direct their clients to gather evidence using techniques that would be illegal if done by the agency itself. One may wonder whether these tipsters are, in effect, deputized government actors for constitutional purposes.

The dominance of well-connected attorneys may also be distorting the programs in other ways. Last week, Bloomberg reported that the SEC had awarded a $14 million whistleblower bounty to controversial short-seller Carson Block, even though he “didn’t qualify” for one, according to the agency’s own staff. That seems inexplicable . . . until one reads in the Wall Street Journal that Block’s lawyer was the same former SEC official who (I found) has been destroying the competition and dominating the program for a decade.

So far, Congress and the agencies have decided to let whistleblower lawyers operate free from virtually any meaningful public oversight, regulation, transparency, or accountability. This Wild West approach stands in sharp contrast to the extensive legal and regulatory regime governing the private attorneys who enforce the securities laws through class actions. It is also out of step with the more careful regulatory approach to private contingency fee arrangements in numerous other contexts where private parties seek federal payouts, including at least one program administered by the SEC itself.

Ten years and more than a billion dollars in, it is time to reconsider whether this outsourcing without oversight is really serving the public interest or has allowed the program to be captured by a small group of well-connected repeat player attorneys. My paper outlines several reforms that would bring more accountability and transparency to these programs in order to ensure these private actors are adding value to these programs, not merely extracting it.

This post comes to us from Professor Alexander I. Platt at the University of Kansas School of Law. The post is based on his new working paper, “The Whistleblower Industrial Complex,” available here.