By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in India and other parts of Asia researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as writes occasional travel pieces for The National (http://www.thenational.ae).
The Securities and Exchange Commission (SEC) has absorbed lesson one of the Obama administration: messaging trumps performance. Yesterday, it released a self-congratulatory press release on its pathetic performance under the authority provided in Dodd-Frank’s whistleblower provisions that is a model of the genre.
The SEC’s whistleblower program has proven to be a game changer for the agency in its short time of existence, providing a source of valuable information to the SEC to further its mission of protecting investors while providing whistleblowers with protections and financial rewards,” said Mary Jo White, Chair of the SEC, as quoted in the press release
Let’s unpack this. But first, a little history.
History of Whistleblowing
Incentives for private parties to spill the beans are a hallowed component of the US legal system, dating back to the Civil War-era False Claims Act (FCA) and extended by Congress in 1986. This statute includes “qui tam” provisions permitting individuals to sue on behalf of the government– and to receive a bounty if they prevail. The phrase qui tam is an abbreviation for the Latin “qui tam pro domino rege quam pro se ipso in hac parte sequitur”, which means “[he] who sues in this matter for the king as well as for himself.”
No less than (irony alert) noted anti-business jurist Justice Antonin Scalia, writing in Vermont Agency of Natural Resources v United States ex rel Stevens, recognized that similar provisions date back to 1331 in England. Scalia also observed that numerous informer statutes were in place allowing such suits around the same time as the Constitution was adopted. These statutes authorized recovery of as much as half the fine, goods, or penalty, as appropriate, for failing to file a census return, or for illegal harbouring of runaway seamen, or unlicensed trading with Indian tribes, or for various other criminal, customs, bribery, or conflicts of interest violations (see footnotes 5 and 6 of the opinion linked to above).
So a long and venerable tradition of rewarding whistleblowers was in place before Congress authorized the SEC to create a whistleblower program in the 2010 Dodd-Frank legislation. Six years later, we can assess the success of that program– which suggests, shall we say, that the SEC’s victory lap is somewhat premature.
Some would say that the SEC program was badly designed from the start in that it left it to the SEC alone to decide whether to file a legal claim based on the whistleblower’s report. I would say this was a feature not a bug but will not belabor the point. From the SEC’s website “The Commission is authorized by Congress to provide monetary awards to eligible individuals who come forward with high-quality original information that leads to a Commission enforcement action in which over $1,000,000 in sanctions is ordered.”
This means that the whistleblower cannot file a legal claim himself under this statute against the firm that has allegedly committed fraud or somehow violated securities laws. (Separately, the whistleblower might be able to file an action under other existing federal securities laws, but that discussion is beyond the scope of this piece.) Instead, the whistleblower’s only recourse under the Dodd-Frank statute is to report the violation to the SEC, and the agency prosecutes the case.
Why does this matter? As one of my cronies who practices in the qui tam area observes, he often floats arguments that various federal agencies consider to be unappealing on their face and will not pursue (perhaps for political reasons, e.g. the Air Force does not like suing Lockheed). But clever lawyering that ends up before the right judge can sometimes result in the success of some of these arguments, and eventually yield substantial recoveries– for both the government and the whistleblower– as well as have a deterrent effect.
A very effective cadre of privateer lawyers has evolved to bring qui tam cases, and these privateer lawyers are getting very adept at doing what privateers do. Some of this work is summarised at the website of Taxpayers Against Fraud, a bar association for lawyers who specialize in such cases. And in the process, they are sometimes successful at taking on the bespoke suit brigade. They also expand the resources that can be devoted to such cases. IIRC, the Department of Justice (DoJ) in DC has 60 lawyers who take on FCA cases, as compared to several hundred members of the private bar who bring these cases (and sometimes, both DoJ and private attorneys work in tandem). Private lawyers typically get contingency fees of up to one-third of any amounts that they recover on behalf of their clients; the FCA also allows fee shifting to the whistleblower meaning that if these cases go to trial and the whistleblower wins, the losing side pays the whistleblower’s legal fees.
As with so many other parts of Dodd-Frank that required subsequent SEC action before the statute could be enforced, the agency lagged in setting up its whistleblower program, which was not launched until August 2011. This almost certainly reduced potential recoveries, in that statutes of limitation might have run before the Office of the Whistleblower was up and running and able to receive, assess, and act on whistleblower complaints. The SEC’s track record on setting up this office was actually better than its timetable to complete rulemaking on other key elements of the statute, with some rules taking years before they were effective.
Now, five years after that launch, despite receiving over 14,000 whistleblower tips from individuals in all 50 states and the District of Columbia and 95 foreign countries, the SEC has thus far only made 33 awards, the top ten of which the agency has summarized. These resulted from successful enforcement actions that resulted in recoveries of more than $504 million, including more than $346 million in disgorgement and interest for harmed investors. It is impossible for an outsider to determine how zealously the SEC followed up on whistleblower tips. But given that the financial crisis alone led to economic losses of many multiples of that amount, this level of recovery seems rather low, at least to this observer, and at minimum, doesn’t seem worth crowing about.
Requirement for DoJ Co-Operation
So far, the whistleblower statute doesn’t seem to have sparked any major criminal enforcement actions. To be sure, since the SEC cannot bring criminal actions against defendants– it needs the cooperation of the DoJ to bring such charges– the SEC was hamstrung by the Holder doctrine and the DoJ’s overall approach to enforcement. Recall that under the Holder doctrine the DoJ avoided bringing criminal charges against companies or their senior executives and instead favoured negotiated settlements, on the theory that to take a tough enforcement stance would cause unacceptable collateral damage. But, as many have pointed out, bringing criminal charges at minimum, would provide major leverage in the litigation process. It would also have a huge deterrent effect on the activities of high-level corporate officers and would thereby have inevitable knock-on effects in shaping corporate policies.
Part of the problem in prosecuting firms or executives is the facilitating effect played by white shoe law and other professional firms in delivering opinion letters that nuanced opaque statutes and effectively immunized financial and other firms from effective prosecution.
Despite the obstacle raised by the lack of DoJ co-operation, the SEC could have been much more aggressive itself in bringing civil actions and administrative cases. And I might point out that the burden of proof for prevailing in these types of actions is lower, compared to criminal cases, requiring only demonstrating preponderance of the evidence rather than beyond a reasonable doubt. That lower standard of proof, unfortunately, makes those immunity letters from the law firms even more valuable.
Lack of Creativity
Similarly, the SEC has failed to use whistleblower tips in bringing any cases alleging violations of the Sarbanes Oxley internal controls provisions, which require at a minimum for the CEO and CFO to certify personally the accuracy of financial statements and the adequacy of internal controls. As Yves has written, “Sarbanes Oxley is designed so that the civil and criminal provisions are parallel, so that an investigation could start out as a civil case, but if the government got strong enough evidence in discovery, it could easily flip it to criminal.” Some of the bubble-era activities of financial firms seemed tailor-made for invoking this statue against the relevant executives.
The failure of the SEC’s Office of the Whistleblower to pursue any such claims may of course be due to not receiving any relevant tips. Although the Sarbanes Oxley statute is far from perfect, the private bar has been far more successful in bringing other types of claims under its authority and this is another argument for allowing Dodd-Frank whistleblowers greater control of their claims by allowing them, if they so choose, to engage their own private lawyers.