Will the SEC undermine America’s most successful corporate whistleblower law?

The U.S. Securities and Exchange Commission (“SEC”) will soon vote on radical proposals that could restructure the Dodd-Frank Act’s highly successful corporate whistleblower law. If implemented as originally proposed, these changes would destroy America’s most successful Wall Street whistleblower law.

It is obvious why Wall Street fraudsters want the whistleblower law gutted. Since it became operational in 2012 the SEC has confirmed that whistleblower tips have resulted in over $2.5 billion in fines and sanctions from fraudster, over $750 million has been returned to defrauded investors, and $500 million was paid in awards. Remarkable achievements for a young program. Even more remarkable because the vast majority of whistleblower cases are still under investigation.

In addition to holding Wall Street accountable, the actual scope of the Dodd-Frank Act’s whistleblower program covers numerous crimes beyond traditional securities frauds. This includes international violations of the Foreign Corrupt Practices Act and numerous prosecutions of frauds committed by individuals and companies illegally profiting from the COVID-19 pandemic.

The commission’s Sept. 2 vote is the cumulation of a two year “rulemaking” proceeding. Initiated in June of 2018 the SEC, by a 3-2 vote (along party lines) proposed radical changes to its whistleblower program. Under the law these changes were subject to “public comment.” Thereafter the Commission would be required to vote on final approval.

Because of the devastating impact the proposed changes would have on corporate whistleblowers there was an outpouring of opposition. A record-setting 100,000 citizens signed petitions opposing the rule change. They were joined by numerous whistleblowers, public interest and investor advocacy groups, along with U.S. Sen. Charles Grassley (R-Iowa), the leading congressional expert on whistleblower laws.

Why this massive opposition? One commission’s proposals would strip thousands of whistleblowers of their right to collect an award, even when their original information resulted in large fines and penalties against corporate fraudsters. A second proposal prohibits the commission from taking enforcement action against corporations that retaliate against internal whistleblowers. A third proposal would authorize the commission to significantly reduce the amount of rewards in large cases. Taken together, these three changes will knee cap the program.

The most radical of these three proposals is a rule that would restrict otherwise fully qualified whistleblowers from eligibility to collect a reward, regardless of the quality of information provided or the hardships they faced after reporting large corporate crimes. Under the proposal in order for a whistleblower to qualify for a reward they must first communicate their allegations of fraud on a specific form available on the website of the SEC’s Office of the Whistleblower. Failure to use the specific form when first reporting a fraud would result in automatic disqualification from the Dodd-Frank Act’s reward program.

In other words, any employee who initially reports securities frauds to any office or employee of the SEC, without first filling out a specific form (known as a Form TCR) located on the commission’s website, automatically loses all of his or her rights to receive the mandatory rewards set forth in the law. For example, take the case of an employee who initially writes a letter to the chairman of the SEC detailing information about a large corporate fraud. The chairman’s office receives the letter, and writes back to the employee urging them to fill out the Form TCR. The employee hires a lawyer and 35 days later files the official TCR form. This triggers a two-year investigation in which the corporation is found guilty of fraud. The whistleblower worked with the enforcement staff over that two-year period, all of his or her information was true and accurate, and the whistleblower’s evidence was critical in finding the company guilty. As a result, the SEC collects $100 million in fines and penalties. However, the whistleblower was subjected to retaliation by the company, and was ultimately fired. The whistleblower was not able to find another job on Wall Street, and filed for bankruptcy.

Under the proposed rule that whistleblower would be automatically and permanently disqualified from ever receiving a reward or any compensation from the commission. The whistle gets nothing. Who would ever blow the whistle if they feared facing this end-result?

The proposed rule would establish a mandatory, highly technical, and extremely narrow method for whistleblowers to “first” provide the commission with “original information” on Wall Street frauds. Any whistleblower who fails to use this method when “first” reporting violations would automatically find themselves outside of the whistleblower program, potentially subject to massive economic retaliation from their bosses, with no ability to obtain the mandatory reward Congress required just to prevent this type of injustice.

A second proposal would strip the SEC of its current jurisdiction to sanction publicly traded companies that retaliate against whistleblowers who report concerns to internal corporate compliance programs. Most whistleblowers initially raise concerns with their management. Current rules permit the SEC to take enforcement action against companies that retaliate against such internal whistleblowers. A second proposed rule eliminates the jurisdiction of the SEC to hold companies that retaliate against internal whistleblowers accountable. The commission would return to pre-Dodd-Frank Act days where it turned a blind eye to thousands of corporate employees who reported frauds to Audit Committees, a “hot lines” or their supervisors and faced retaliation.

Another proposed rule creates a “soft cap” on the amount of awards whistleblower can be paid in large cases. The law requires the SEC to award whistleblowers between 10-30 percent of any sanction obtained based on the whistleblower’s original information. However, the SEC was given discretion to set the percentage range of an award. Under the current rules this percentage range is based on factors explicitly tied to the quality of information provided and the potential deterrent effect of effectively policing these corporate crimes. Under the proposed rule the commission would be authorized to reduce the amount of an award on the sole basis that the whistleblower would get too much money.

Under the proposed rule, if a whistleblower’s original information results in a major enforcement action (i.e. fines and penalties of over $300 million), that whistleblower would be presumptively limited to a 10 percent award – the lowest possible compensation. This rule change would harm the most important whistleblowers, who often hold high corporate positions and risk losing high salaries if they are fired. They have the most to lose by taking the risk of reporting frauds, and thus need the strongest incentives to place their entire careers and reputations at substantial risk. It is this relatively small group of whistleblowers, who have the best information, yet are at the greatest risk of catastrophic economic devastation, who are harmed by this rule.

The pending proposals could undermine one of the most successful whistleblower programs ever created. It creates a hyper-technical rule that will block numerous (if not the majority) of otherwise fully qualified whistleblowers from ever obtaining the award promised by Congress. It strips the SEC with the ability to protect internal whistleblowers who report concerns through their chain of command or their compliance programs. It creates a disincentive of whistleblowers who hold the highest corporate positions (and who have the most to lose) from reporting large-scale frauds on investors. It would undermine the deterrent effect Congress envisioned whistleblower disclosures would trigger in corporate board rooms.

The commission soon will vote on these three proposals. The good news is that the commission engaged in comprehensive rulemaking process. They delayed the initial vote on the rule in order to have time to obtain additional public input, including from the highly respected ENRON whistleblower, Sherron Watkins, who in 2002 was one of Time Magazine’s Persons of the Year in recognition of her courageous whistleblowing. The commission was made aware of the personal hardships that whistleblowers face when they sacrifice their career to report a major fraud. They were alerted to the outrageous impact of the proposed rule regarding communications with the SEC, that would result in whistleblowers being told that they get nothing simply because a they contacted the SEC before filing a highly technical whistleblower disclosure form. The commissioners were fully briefed on their authority to protect internal whistleblowers, and they were provided extensive documentation as to the deterrent effect paying large awards has on stopping future corporate wrongdoing.

Will the commission use the current rulemaking to enhance its program or will they leave thousands of whistleblowers out in the cold?

Stephen M. Kohn is a partner in the whistleblower rights law firm of Kohn, Kohn and Colapinto  and the chairman of the Board of Directors of theNational Whistleblower Center.