Dodd-Frank & SEC Whistleblowers: What’s in it for you?

by Kurt Schulzke

Thinking of blowing the whistle on securities or commodities fraud?  It may make sense to do so, thanks to H.R. 4173, the Dodd-Frank Wall Street Reform and Consumer Protection Act (signed into law in July 2010) and related SEC and CFTC regulations.

The SEC’s whistleblower statute — found in H.R. 4173, Section 922 (also known as 15 USC § 78u-6 or Section 21F of the Securities Exchange Act of 1934) — is in most respects a significant upgrade over the anti-retaliation provisions of Sarbanes-Oxley § 806 administered by the U.S. Department of Labor.

Another similar whistleblower protection statute is the False Claims Act or “FCA”.  How do the two statutes compare? In some respects, they are almost identical because borrowed heavily from the FCA in writing Section 21F.  In other respects, the FCA and Section 21F differ significantly.

Both statutes offer whistleblowers potentially lucrative financial rewards for bringing forward “original information” about fraud.  Under the FCA, the awards generally range between 15 and 30 percent of what the government collects as a result of the whistleblower’s disclosures.  Under Section 21F, the whistleblower receives 10-30 percent. The FCA’s primary objective is to protect tax funds from unscrupulous contractors.  In contrast, Section 21F attempts to shield the market from SEC violations like insider trading, misleading disclosures or bad accounting.  Other major points of comparison and divergence follow.

Size Matters

Section 21F makes awards only in cases where the “monetary sanctions” collected from the defendant exceed $1,000,000.  By contrast, there is no statutory floor on FCA claims. However, practically speaking, size is a major factor in the DOJ’s decision to take on (“intervene in”) an FCA case.  Each U.S. attorney’s office has its own FCA-case threshold because there are just too many cases and too few assistant U.S. attorneys (“AUSAs”).  Some won’t consider a case alleging less than $1,000,000 in “single damages”.  Others will jump at a $500K case.

Section 21F excludes more whistleblowers

Oddly enough, if you gain the case information through the performance of an audit of financial statements required under the securities laws and, for you in your position, submission of the information to the SEC would be contrary to the requirements of section 10A of the Securities Exchange Act of 1934 (15 U.S.C. 78j-1), forget about it.  You can’t be an SEC whistleblower.  You’re not alone.  The same exclusion applies to to “any whistleblower who is, or was at the time the whistleblower acquired the original information submitted to the Commission, a member, officer, or employee of (i) an appropriate regulatory agency; (ii) the Department of Justice; (iii) a self-regulatory organization; (iv) the Public Company Accounting Oversight Board; or (v) a law enforcement organization.

Section 21F offers no private cause of action

Unlike the FCA which authorizes plaintiffs called “relators” to sue even if the government decides not to, under Section 21F only the government can pursue a securities fraud claim in court.  Your report.  They decide.  If the SEC chooses not to pursue a whistleblower case, the whistleblower is pretty much out of options.  To place this in practical context, not even Harry Markopolos — with all of his data and analysis — could force the case into court if the SEC doesn’t want to go.

Section 21F’s “original information” is broader than the FCA’s

While the term “original information” is not used in the FCA, the FCA also makes awards only for the provision of new information.  That said, Section 21F’s formulation of “original information” appears to be more expansive than that of the FCA.

Unlike the FCA, Section 21F includes within its domain of “original information” not only bare “knowledge” but also “analysis” provided by a whistleblower.  This should be seen as significantly expanding the “original information” perimeter to include private analysis of publicly available data like that which enabled Harry Markopolos to detect the Madoff fraud long before the SEC did.  While it is possible that an FCA whistleblower may have won a settlement on the basis of such analysis alone, I am not currently aware of any such case.

On the flip side, Section 21F excludes from permissible “original information” information “exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report (as opposed to federal government, in the FCA), hearing, audit, or investigation, or from the news media, unless the whistleblower is a source of the information.  The phrases “exclusively derived” and “a source” are exclusive to Section 21F — they do not appear in the FCA.

Arguably, the net impact of “government,” “exclusively derived,” and “a source” — together with the addition of the word “analysis” — is to expand the pool of “original information” for SEC whistleblowers beyond that available to FCA relators.

Section 21F will be administered by a dedicated SEC office

FCA relators should be so lucky.  FCA claims are typically administered and enforced by Main Justice DOJ Civil Division attorneys or by local Assistant US Attorneys who have lots of responsibilities in addition to FCA cases.  The focus offered by a special SEC whistleblower office should give SEC whistleblowers a leg up assuming that it is properly staffed and managed.

SEC determines Section 21F awards

Unlike the FCA where the district courts have authority to approve FCA settlements and associated whistleblower awards, Section 21F grants the SEC complete discretion to identify award recipients and set largely unappealable award amounts.

Section 21F(c)(1)(B) directs the SEC to “take into consideration” a specific list of four factors in making awards.*  However, the House-Senate Conference Committee’s softening of the Senate version language of § 21F(c)(1)(B) from “shall account for” to “shall take in consideration” signal that the SEC can weight and apply these factors almost at will.  Act § 21F(f) deprives district courts of any supervisory role, sending award appeals directly to the circuit courts which must review SEC decisions in accordance with Section 706 of the federal Administrative Procedure Act.

Readers may judge for themselves what awards whistleblowers should expect in light of the fact that awards will be paid out of the same SEC Investor Protection Fund from which the SEC’s OIG will fund its activities.

Bottom line: Dodd-Frank offers pros and cons for SEC whistleblowers.  While it isn’t nearly as robust as the FCA, Dodd-Frank is a major improvement over Sarbanes-Oxley.

Update: On May 25, 2011, the SEC issued its final regulations, designated SEC Rule 21F, governing the implementation and operation of the Section 21F Whistleblower Program.  The CFTC issued its whistleblower regulations (Whistleblower Incentives and Protection, 17 CFR Part 165) on August 25, 2011.  The regulations provide a wealth of detail for whistleblowers and the targets of whistleblower claims.

# # #

The § 21F(c)(1)(B) award-amount factors are as follows:

1. the significance of the information provided by the whistleblower to the success of the action;

2. the degree of assistance provided by the whistleblower and any legal representative of the whistleblower in a covered judicial or adrninistrative action;

3. the SEC’s programmatic interest in deterring violations of the securities law by making awards to WBs; and

4. such additional relevant factors as the Commission may establish by rule or regulation.

*Cross-posted at The Schulzke Brief.

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