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Financial Sector Oversight Will Be Harmed by New Legislation

Securities and Exchange Commission Building

U.S. Securities and Exchange Commission building in Washington, DC (Photo: Securities and Exchange Commission / Flickr)

Legislation is moving through Congress that would put the Securities and Exchange Commission’s (SEC) invaluable whistleblower program in jeopardy by jettisoning important reforms created by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Passed in 2010 in the wake of the financial crisis, the Dodd-Frank Act created an SEC whistleblower program, which has proven to be of immense value to securities law enforcement and the investing public. The program combines protections against retaliation with substantial incentive awards to encourage individuals to bring forward information vital to the prosecution of securities law violations. Described in 2015 by then-SEC Chair Mary Jo White as a “game changer for the agency,” the whistleblower program has uncovered information leading to the recovery of hundreds of millions of dollars for investors and the US Treasury since becoming operational in 2011.

This powerful law enforcement weapon has been put at risk, however, by amendments in H.R. 10, The Financial CHOICE Act, approved last week by the full House of Representatives on an almost completely party-line vote, 233-186. Representative Walter Jones (R-NC) was the only member to cross the aisle to vote against this bad piece of legislation. The legislation heads to the Senate next.

The legislation’s Section 828 purports to deny “culpable whistleblowers” eligibility for incentive awards. On its face, this a worthwhile aim that has natural appeal. After all, it doesn’t seem right for a wrongdoer to benefit from their wrongdoing. However, what if someone is only tangentially connected to the wrongdoing they expose? The SEC has already thoughtfully addressed these concerns and “adopted a rule that would encourage the reporting of misconduct committed by other persons, but prohibit whistleblowers from profiting from their own misconduct,” according to the National Whistleblower Center. Section 828 would create a gauntlet of technicalities likely to discourage worthy whistleblowers without enhancing the SEC’s already rigorous standards for denying awards to those responsible for illegal conduct.

The proposed new restrictions would disqualify persons who induce or cause another person to commit a violation; aid or abet another person in committing the offense; or having a duty to prevent the violation, fail to make an effort he or she is required to make. These standards import technical legal terms of art that have complex histories in multiple existing statues and that potentially capture employees serving merely as minor functionaries, such as administrative assistants, ordered to perform work that is then put to fraudulent use by another person. It is difficult to believe that a prospective whistleblower could readily determine the scope of the proposed standards and their applicability in his or her case. 

Legal commentators have found that the Choice Act whistleblower amendment “injects significant uncertainty into the entire process,” requiring the SEC “to grapple with and decide on a case-by-case basis issues of intent, involvement, whether or not the whistleblower had a duty to prevent the securities law violation, and what, if any effort the whistleblower should have made to prevent the violation.” These uncertainties “might well deter potential whistleblowers who are concerned, whether justified or not, about the possible implications of their conduct.”

Moreover, the Choice Act provision would harm “securities law whistleblower programs, which may offer rare access to information about difficult to detect fraudulent schemes.”

In short, the Choice Act’s whistleblower constraints would throw sand in the gears of a successful law enforcement program, and it would do so for the purpose of preventing a harm—rewarding culpable whistleblowers—that has already been more effectively addressed by the SEC’s current whistleblower rules. The SEC’s rule is modeled on “the original Federal whistleblower statute—the False Claims Act—[which] was premised on the notion that one effective way to bring about justice is to use a rogue to catch a rogue.” Consequently, the SEC adopted a rule that reflects the “basic law enforcement principle that it is difficult for law enforcement authorities to detect and prosecute sophisticated fraud schemes without insider information and assistance from participants in the scheme or their coconspirators.”

While not an SEC example, perhaps the preeminent poster child for a law enforcement approach that embraces whistleblower tips is Brad Birkenfeld, an American who worked for UBS, a Swiss bank, who disclosed that the bank enabled billions of dollars in tax evasion. On the basis of his whistleblowing, the US Justice Department reached an agreement with UBS where UBS paid a fine of $780 million. Birkenfeld got a healthy cut of that fine: $104 million. Birkenfeld was prosecuted and served time in prison for his own individual role in abetting tax evasion, but this didn’t disqualify him from receiving a whistleblower award through the Internal Revenue Service’s whistleblower program.

In contrast to the Choice Act’s whistleblower provision, the SEC rule defines “culpable” whistleblowers in a clear, practical manner that distinguishes truly culpable whistleblowers—those who directed, planned or initiated, illegal conduct—from those ordered to take actions as part of their employment. The SEC whistleblower rule excludes from incentive awards “any monetary sanctions that the whistleblower is ordered to pay, or that are ordered against any entity whose liability is based substantially on conduct that the whistleblower directed, planned, or initiated.” This standard does not appear to have resulted in any actual, or even alleged, abuses or inappropriate incentive awards. In at least one case, the SEC reduced a whistleblower’s award because the agency determined the whistleblower was somewhat culpable. This shows the rule is working and balances the need to attract insiders who have knowledge of wrongdoing with preventing the primary wrongdoers from benefitting. Rather than providing a corrective to any perceived flaws in the SEC standard, the Choice Act whistleblower amendment appears designed to resurrect approaches previously considered and rejected based on a careful analysis by the SEC in formulating its rules for the program.

In sum, the Choice Act addresses a problem that has already been better handled by existing laws and rules. Moreover, it undermines the effectiveness of the SEC’s whistleblower program. The Choice Act would toss aside the careful balancing act in the SEC’s rule, instead creating barriers that are likely to deter legitimate, worthy whistleblowers from coming forward with high-value information. With the current SEC rule, the SEC’s whistleblower program has a record of providing real and substantial benefits to the public through enhanced securities law enforcement and recovery of investor funds. But that pro-investor, pro-taxpayer track record is likely to end if the current version of the Choice Act becomes law. The Congress should reject the whistleblower provisions of the Choice Act.

By: Susan Ervin
Guest Author, POGO

At the time of publication Ms. Ervin was a guest author at the Project On Government Oversight.

Topics: Financial Sector

Related Content: Financial Oversight, Securities and Exchange Commission

Authors: Susan Ervin

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