How Much is Too Much? Whistleblower Bar Challenges the SEC’s Recent Whistleblower Program Amendments

On January 13, 2021, prominent whistleblower attorney and a principal architect of the Dodd-Frank Act whistleblower program, Jordan A. Thomas, filed a complaint against the U.S. Securities and Exchange Commission (“SEC” or “Commission”) seeking a declaratory judgment that certain provisions of the SEC’s recent whistleblower program amendments are invalid and cannot be enforced.  Specifically, the complaint challenges the SEC’s “clarification” of its authority to limit the size and number of certain whistleblower awards.

Under Dodd-Frank, the Commission pays a monetary award to a whistleblower that provides information to the SEC that leads to an enforcement action in an amount equal to but not less than 10% and not more than 30% of the monetary sanctions imposed by the SEC. Under Rule 21-F6, the agency calculates whistleblower awards in that 10-30% range by assigning an award percentage based on an array of positive and negative factors. The SEC then issues an award by multiplying the award percentage by the total monetary sanctions that the SEC collected.

Under the whistleblower program, awards in a single enforcement action as high as $114 million have been paid.  Thomas states that his clients have received some of the largest whistleblower awards in history, with three of his clients’ cases involving monetary sanctions in excess of $100 million.

The SEC voiced concerns in 2018 that excessively large awards could deplete the Investor Protection Fund. As a result, the SEC originally proposed a revised Rule 21F-6 in 2018 that would have expressly provided the Commission with the ability to make downward adjustments in connection with large awards where the monetary sanctions equaled or exceeded $100 million as long as the award payout did not fall below $30 million. However, the SEC ultimately scrapped the proposed rule and instead clarified in the new rules that it has always had the authority and discretion to consider the total dollar payout when applying the award criteria and adjust downward for large awards as reasonably necessary.

In addition, under the prior Rule 21F-3, the SEC would pay awards based on amounts collected in “related actions” and defined “related action” as a “judicial or administrative action that is brought by [specified agencies or self-regulatory organizations], and . . . based on the same original information that the whistleblower voluntarily provided to the Commission.” The SEC’s recent amendments revised Rule 21F-3 to award information provided in a “related action” “only if the Commission finds . . . that its whistleblower program has the more direct or relevant connection to the action.” Further, the Final Rule 21F-3 prevents whistleblowers from receiving an award if they have already been granted an award by another agency or if they have been denied an award by another agency’s whistleblower program.

According to Mr. Thomas’s complaint, the previous rules encouraged whistleblowers to come forward by guaranteeing that those individuals who acted properly would be awarded accordingly and would not have their awards unfairly and arbitrarily diminished.  In his complaint, he argues that this “clarification” to Rule 21F-6 is unlawful under the Administrative Procedure Act (“APA”) for at least five reasons: (1) the Final Rule was not a “logical outgrowth” of the proposed rule; (2) the SEC enacted the rule without acknowledging that it was changing its position; (3) the SEC failed to weigh the costs and benefits of the Final Rule; (4) the SEC adopted the rule without providing a reasoned explanation and despite the harms it will cause the whistleblower program; and (5) the SEC had no statutory authority to enact the rule. Furthermore, the complaint alleges the amendments to Rule 21F-3 are unlawful under the APA because (1) the SEC had no statutory authority to enact the changes and (2) the SEC adopted the rule without providing a reasoned explanation and despite the harms it will cause the whistleblower program.

As the complaint asserts, “[T]he potential for large monetary awards is the primary motivation for individuals to blow the whistle to law enforcement and regulatory authorities” and the challenged rule amendments “turn[] the Commission into a kind of casino that aggressively courts high-rollers with the promise of large jackpots but reserves the right to lower their winnings if those winnings get ‘too large.’” Further, the complaint surmises that would-be whistleblowers may weigh the costs and benefits of the revised whistleblower program and choose not to report possible securities violations to the SEC if they are worried their awards may be adjusted downwards or denied outright under the related action rules, ultimately reducing the number of individuals who report.

Certainly for the whistleblower bar, significant contingent legal fees are at stake.  The complaint notes that Thomas currently has nine whistleblower clients awaiting a final determination of entitlement to an award from the SEC, and that given the monetary sanctions collected, his clients collectively are eligible for awards of more than $300 million.  On each of these potential awards, Thomas’ firm will receive a contingency fee, and Plaintiff Thomas will receive incentive compensation for recovering the award on behalf of his client.

This is the first action attacking the Final Rule and no doubt will be met with a vigorous defense by the SEC.  We will monitor the progress of this action and questions of standing (i.e., whether lawyers that represent whistleblowers have standing to challenge this Final Rule) and whether the Final Rule passes muster under the APA.

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