SEC Proposes Amendments to Ensure Adequate Financial Incentives for Whistleblowers
As SEC Chair Gary Gensler presaged in August 2021, the SEC has announced proposed substantive amendments to two whistleblower program rules – Rules 21F-3 and 21F-6 – to address concerns that the 2020 amendments to those rules could impact financial incentives for whistleblowers and discourage them from reporting alleged misconduct. According to Gensler, the proposed amendments "would help ensure that whistleblowers are both incentivized and appropriately rewarded for their efforts in reporting potential violations of the law to the Commission," and "would help ensure the whistleblower program's continued success."
The SEC has proposed four alternative options for amending or replacing Rule 21F-3 that relate to the SEC's methodology for making whistleblower awards where multiple agency award programs may apply to a single action. And, with respect to Rule 21F-6, the SEC has proposed limiting its discretionary authority to consider the dollar amount of a potential award. If the amendments are adopted, the SEC intends to apply them prospectively and retroactively to award applications that are pending when the amendments take effect. Proposed Rules at I.B. In this post, we break down the proposed amendments and what they mean for potential whistleblowers and companies.
The "Multiple-Recovery Rule" for Related-Actions: No Reductions Based on Dollar Amount
Rule 21F-3 of the Securities Exchange Act of 1934 addresses enforcement actions where multiple agencies' whistleblower programs may apply. Generally, the Multiple-Recovery Rule authorizes the SEC to pay a whistleblower award on a potentially "related action" covered by another agency's award program if the SEC determines that its program has a more "direct or relevant connection" to the action than the other agency's program. Proposed Rules at II.A. A "related action" is an action brought by another agency that is based on the same "original information"1 the whistleblower provided to the SEC that led to the agency obtaining monetary sanctions exceeding $1 million. Rule 21F-3(b).
Under the current rule, the SEC considers three factors to determine which award program has a more "direct or relevant connection" to a potential related action:
(A) the relative extent to which the misconduct charged in the potential related action implicates the public policy interests underlying federal securities laws (such as investor protection), rather than other law-enforcement or regulatory interests (such as tax collection or fraud against the federal government)
(B) the degree to which the monetary sanctions2 imposed in the potential related action are attributable to conduct that also underlies the federal securities law violations that were the subject of the SEC's covered action
(C) whether the potential related action involves state-law claims and the extent to which any state whistleblower program may apply (17 CFR § 240.21F-3)
As the rule is currently drafted, a whistleblower will be denied an award from the SEC if the agency determines that another award program has the more direct or relevant connection to the action and the whistleblower "is then left to pursue any claim for a whistleblower award with the other award program." Proposed Rules at n.12. Additionally, under the current rule, a whistleblower may not receive an award from the SEC if it has already received an award from another program for the same related action. Id. at II.A.
The SEC is concerned that the current rule could appreciably impact a whistleblower's financial incentive to report wrongdoing where the alternate award program has a significantly lower award range or caps the award amount. Proposed Rule at II.A. Likewise, the SEC is concerned that similarly situated whistleblowers could receive meaningfully different awards for comparably successful SEC and related actions depending on which award program has the more "direct or relevant connection" to the action, thereby creating a risk for disparate treatment of multiagency whistleblowers. Id. To address these concerns, the SEC proposes four alternatives: 1) the "Comparability Approach," which is the principal proposal; 2) the "Whistleblower's Choice Option"; 3) the "Offset Approach"; and 4) the "Topping-Off Approach." Id. The SEC will finalize an approach following the comment period.
First, under the Comparability Approach, if another agency's award program limits the award range or caps the award amount, the SEC would have authority to pay an award for an action brought by another agency even if the other agency's program has a more "direct or relevant connection" to the action. Proposed Rule at I.B.1. Additionally, if the SEC were to determine that two award programs are comparable and that the maximum award under the SEC's program would not exceed $5 million, an action brought by another agency would automatically qualify as a "related action" for which a whistleblower could submit an award application to the SEC. Id.; see also Id. at II.A.1.
Second, the Whistleblower Choice Option would eliminate the SEC's threshold inquiry of which award program has the more "direct and relevant connection" to the "related action," thereby requiring the SEC to process all related-action award applications that also implicate another award program. Proposed Rule at II.A.2. If both the SEC and the other award program grant an award on the same underlying action, the whistleblower would be able to choose the higher offer. Id. But to prevent the possibility of a double recovery, the whistleblower would have to irrevocably waive any and all rights to an award from the other program before the SEC would pay the "related action" award. Id. However, the SEC acknowledges several countervailing considerations related to this proposed option, including: 1) the potential for conflicting factual determinations by the SEC and another agency based on the same underlying action; 2) whistleblowers would have multiple opportunities to demonstrate their entitlement to an award; 3) whistleblowers could sidestep their failure to satisfy eligibility requirements imposed by another award program; and 4) increased workload on SEC staff and slower processing of award claims. Id.
Third, under the Offset Approach, whistleblowers could receive an award under both the SEC's program and another program, but the SEC would offset from its award the dollar amount the whistleblower would receive from the other program. Proposed Rule at II.A.3.
Fourth, under the Topping-Off Approach, if the SEC could also determine that another agency's award for a non-SEC action was inadequate for any reason, it could "top off" any award also involving a SEC action. Id. But the SEC's "top off" ability may be limited by the statutory 30 percent cap on SEC awards or where the monetary sanctions collected in the related action are substantially higher than in the SEC action. Both the Offset Approach and Topping-Off Approach, however, could create significant administrative delay because an award from the SEC would be held up by the other agency's award process. Id.
Gensler stated that the proposed amendment to the Multiple-Recovery Rule "is designed to ensure that a whistleblower is not disadvantaged by another award program that would not give them as high an award as the SEC would offer." Commissioner Hester Peirce, however, disagrees. Given that the SEC's experience and past practice with multiagency whistleblowers was a basis for the 2020 amendments, she claims that no subsequently discovered information warrants further change. Additionally, she points out that the lack of data on any disparate treatment for multiagency whistleblowers since the 2020 amendments took effect makes it difficult to assess the costs and benefits of the current rule versus the proposed amendments.
Limitation on the SEC's Discretion to Consider Dollar Amounts When Determining Awards
The Securities Exchange Act Rule 21F-6 identifies the factors the SEC uses to determine the amount of a whistleblower award. Prior to the 2020 amendments, the SEC could determine awards based on both upward or downward percentage adjustments. Because the then-existing rule did not explicitly address the Commission's discretion to consider dollar amounts when determining awards,3 the 2020 amendments clarified that the agency does have such discretion. Proposed Rules at II.B. The 2022 proposed amendment, however, would limit that discretion. While the SEC would maintain the authority to consider dollar amounts to increase an award, it would lose its discretion to decrease an award on that basis. Id. at I.B.2.
Gensler says the proposed amendment "would give whistleblowers additional comfort knowing that the SEC could consider the dollar amount of the award only in such cases [to increase an award]." But Peirce asserts that the proposed amendment is unnecessary. First, given that the SEC has not lowered an award based on dollar amount since the 2020 amendments were adopted shows that the SEC has not abused its discretion in this regard. Discretion "exists so officials can exercise it when appropriate facts arise; that those facts have not yet arisen is no guarantee that they never will arise." Second, that large awards generate publicity, and publicity could lead to increased whistleblower reporting is, according to Peirce, "an unremarkable truism." She does not believe it justifies limiting the scope of the SEC's statutory discretion and is gratuitous given the record-breaking year that the agency's award program had in FY 2021. Third, it is immaterial that whistleblowers could misconstrue that the SEC lowers awards merely because it has the discretion to do so and thus discourage whistleblowers from reporting. Other ways exist for the SEC to dispel potential misimpressions, such as guidance on when and how the SEC exercises its discretion to consider dollar amounts or explanations in final award determinations on whether it considered the dollar amount in determining the award amount.
The Look Ahead
These amendments, and the SEC's focus on its whistleblower program, lead to some key conclusions, including:
- Given that the SEC has awarded more than $150 million to whistleblowers so far this fiscal year, the agency's award program could see another record-breaking year in FY 2022. As we previously unpacked in a prior whistleblower post, "the unspoken byproduct of the SEC's bounty program is that issuers are paying significant penalties for alleged misconduct originally identified to the agency by whistleblowers, often company insiders." As the SEC continues to look for ways to further incentivize whistleblowers, this creates a clear connection to increased regulatory risks for companies around compliance, internal controls and corporate governance.
- Accordingly, the SEC's focus on whistleblowers should prompt companies to think about how well their internal compliance departments function, how they empower those departments with proper authority and funding, how the company handles internal reporting, how and when the company decides to conduct internal investigations, and whether to self-report.
The public comment period for the 2020 proposed amendments will remain open until at least April 11, 2022. The SECond Opinions Blog will provide updates on the latest developments with these proposals.
2 "Monetary sanctions" means a) an order in an SEC action or related action to pay a penalty, disgorgement or interest, or to pay money as relief for the charged violations, or b) sums deposited into a fund under section 308(b) of the Sarbanes-Oxley Act of 2002, as a result or any settlement of a SEC action or related action. 17 CFR § 240.21F-4(e).
3 The one exception here involves Rule 21F-6(a)(3) regarding law enforcement interest.