Covington & Burling Partner Gerald Hodgkins on the SEC Proposal to Limit the Size of Whistleblower Awards

You work for a large Wall Street bank. You have solid information that the bank you work for is defrauding investors. You approach the Securities and Exchange Commission and report the fraud.

Gerald Hodgkins
Covington & Burling
Washington, D.C.

You are now a whistleblower. And under SEC rules, if because of your report, the SEC recovers $1 billion from the bank, you are entitled to ten to thirty percent of the recovery.

Let’s say you did everything right, according to the SEC and they award you the top amount –   thirty percent. Under current SEC rules, that means you are entitled to $300 million as a bounty.

The securities industry is now pushing to limit the size of SEC whistleblower awards. Under a proposed SEC rule, the SEC can reduce the size of an award merely because it is too large.

Gerald Hodgkins is a partner at Covington & Burling. Before joining the firm earlier this year, he spent twenty years at the SEC’s Enforcement Division. And for the last five of those years, he sat on an SEC claims review panel that reviewed SEC whistleblower awards.

Hodgkins says that the biggest area of activity in the SEC’s whistleblower program is the bounty program.

“Dodd-Frank basically said that individuals that bring original information to the SEC can receive a bounty of ten to thirty percent of the monies recovered by the SEC in what they call a covered action – an action that qualifies for a whistleblower award,” Hodgkins told Corporate Crime Reporter in an interview last week.

“To qualify for a whistleblower award, an action has to be brought by the SEC and have a judgment of over $1 million. There are rules and regulations for properly submitting a claim. And the SEC determines whether the individual properly submitted a claim and provided information that led to an enforcement action. That person’s claim will be reviewed first by the whistleblower office and then the claims review staff and then possibly the SEC itself. And a determination will be made as to whether that person will receive between ten and thirty percent of the money recovered.”

“If you have a $10 million judgment in an SEC action, but only $500,000 was recovered, you would only receive ten to thirty percent of that recovered amount, not the overall judgment.”

How many whistleblower reports have there been to the SEC?

“According to the SEC, in FY 2017, they had 4,484. In 2016, 4,218. In 2015, 3,923. It’s been going up slowly but steadily. There have been over 22,000 tips since the inception of the program.”

How many of those tips have resulted in awards so far?

“As of September 2018, the SEC had awarded more than $326 million to 59 whistleblowers since issuing its first award in 2012.”

More than 22,000 tips and only 59 awards. What does that say about the program?

“It shows that there is a limitation to the SEC capacity. The SEC brings about 500 cases a year from all different sources – not just whistleblowers. There are only 500 cases a year. And some proportion of those are coming from whistleblowers. There are a lot of tips that do not result in investigations. The tips are deemed to be not sufficiently detailed. Or many of them don’t even relate to the federal securities laws. But there are a lot of reasons why certain tips are not deemed to be ones that would be pursued by the SEC.”

Are you convinced that if the SEC had more resources that it could pursue more of these  whistleblower cases?

“Definitely. That’s not to say there are 22,000 cases they could pursue. But it would be incrementally more than they are bringing now. The SEC does have to make choices about what they pursue because of resources. There are probably whistleblower tips that would be pursued. But that’s on the margins. The ones that are very credible that pertain to allegations of serious misconduct that can affect investors – they will always be pursued.”

“The SEC will always dedicate the resources to those kinds of whistleblower tips. Why? The whistleblower tips are often much more specific and credible than the other sources the SEC builds its cases from.”

Are you convinced that but for this program, many of these 59 cases would not have been pursued?

“There are a significant proportion of those cases that would not have been brought. That’s from my experience.”

The SEC is proposing changes to the program. What are the changes?

“The SEC is seeking discretion to take into account the size of the award when the award is particularly large and particularly low.”

Hodgkins says that under current rules, the SEC’s whistleblower office and its claims review staff makes a determination of whether the award will be ten percent or thirty percent or somewhere in between.

“The SEC whistleblower rules lay out the factors that they can consider to increase the size or decrease the size,” Hodgkins said.  “To increase the size, the SEC can consider the significance of the information, the assistance that the whistleblower provided the agency, the law enforcement interest in making the award and the participation by the whistleblower in the internal compliance program. All those factors can increase the size.”

“The SEC can decrease the size. They look at the culpability of the whistleblower. If the whistleblower was involved in the conduct, they might still qualify for an award. But the award can be reduced in size because the whistleblower actually participated in the misconduct the SEC is alleging. They also look at any unreasonable reporting delay by the whistleblower. This is a real issue that the claims review staff has to deal with quite frequently. Sometimes it takes the whistleblower a while to make the submission to the SEC.”

“And finally, they look at any interference with an internal compliance or reporting system by the whistleblower. That can also decrease the award.”

“Nowhere explicitly in those factors does it say – if the award is too big, just reduce it because that’s a waste of taxpayer money. That’s what they are trying to address with the proposed rule change.”

Thousands of people are weighing in on this. Who is weighing in and what are they saying?

“The SEC received over 3,000 comment letters. The comment process closed in September. The overwhelming majority of the comments were mostly form letters supporting the position of the National Whistleblower Center.”

“The National Whistleblower Center opposed what it called a cap on the awards. It’s a proposal to limit the size of an award solely because it was too big. The National Whistleblower Center is opposed. They argue that the cap would deter insiders at large financial institutions who already make a lot of money from coming forward. In other words, you need really big awards to get people inside of financial institutions to come forward.”

“I think that argument is questionable given the size of some SEC awards. There are already pretty substantial awards. I don’t think the cap is going to deter individuals from coming forward.”

What does the securities industry say?

“The Securities Industry and Financial Markets Association (SIFMA) submitted a comment. They supported giving the SEC discretion to reduce large awards. Their position is probably consistent with what I described as my position. The cap is essentially for any case over $100 million where any one individual is receiving $30 million or more in a whistleblower award. In that circumstance, when you get over $30 million award, there is little marginal incentive for whistleblowers to come forward. After $30 million, it’s just a windfall. You don’t need that extra money to incentivize individuals to come in. That’s SIFMA’s position, which I agree with.”

“When the whistleblower comes in, they don’t know what they are going to get. It’s not like they say – if it’s $40 million, I take a tip to the SEC. But if it’s $30 million, no way – I’m not going to do it. That kind of calculus is impossible to do when a whistleblower is making a calculation on whether to come in and make the tip or not.”

What about Congressional proponents of the whistleblower program – like Senator Charles Grassley (R-Iowa). Has he weighed in?

“He has. Senator Grassley submitted a comment letter in opposition to the proposal. His position is that the SEC has failed to point to any compelling reason to veer from award levels that are working and that are comparable to other federal rewards programs. Senator Grassley is essentially saying — if it isn’t broken, why are you trying to fix it? The awards program is working. It’s bringing in cases. It’s incentivizing whistleblowers. Why would you want to mess with it?”

“And Chairman Grassley cited an SEC Inspector General report that found that the SEC awards were appropriately calibrated. However, that IG report came out in 2013. And I can say from my own personal experience that most of the larger awards have come between 2013 and 2018. That report that Chairman Grassley has cited did not really consider the really large awards in the program that came in after the IG report. I’m not sure that IG report is particularly insightful about whether really large awards are effective or not.”

There is a provision in the proposal that allows for SEC whistleblower awards even when there is no SEC settlement but there is a deferred or non prosecution agreement.”

“The program allows for a whistleblower award when original information provided leads to an action to a monetary award of $1 million or more. And the SEC position thus far is that deferred prosecution and non prosecution agreements are not actions. They are not court actions. The SEC is not going into court as a party asserting claims. Deferred and non prosecution agreements are more in the nature of contracts. The question is –  those contracts that are resolution of matters – are they really actions that have been brought as defined under the whistleblower rules? The SEC is proposing that in the future, deferred and non prosecution agreements can be considered actions for the purposes of the rules. They are tools that are used to resolve matters just as enforcement actions are.”

“Right now, you need an SEC action to recover. You can also recover on the amounts recovered under a Department of Justice parallel resolution of an action. If the SEC brought a civil action in court and recovered more than a million dollars and then the Department of Justice brought a criminal action and somebody plead guilty and there was a restitution award for example – that amount could be included in the amount of money recovered for purposes of calculating the whistleblower award. If there is a parallel non prosecution agreement or deferred prosecution agreement, that would not be included.”

“In the context of the Foreign Corrupt Practices Act, a lot of actions are settled with a criminal deferred or non prosecution agreement. That money is excluded at this point. Under the proposal, it would be included.”

The Chamber of Commerce doesn’t agree with SIFMA on this.

“You would think that SIFMA and the Chamber are very much aligned in their approach to these issues. They represent some of the same entities. But they came to different positions.”

“The Chamber essentially said that the SEC is going outside its authority to bring in deferred and non prosecution agreements. They said that statute doesn’t give you that authority. The Chamber says that deferred and non prosecution agreements are contracts, not SEC actions. The SEC doesn’t have the authority to include them without Congressional action.”

“SIFMA took a more results oriented approach. They see the value of deferred and non prosecution agreements. They want to incentivize federal law enforcement agencies and regulators to use deferred and non prosecution agreements as opposed to criminal indictments and federal court actions. I’m interpreting their comment letter. But SIFMA believes that if you have deferred and non prosecution agreements as part of the whistleblower program, it will incentivize those federal law enforcement agencies and regulators to use those tools. That’s my interpretation of their comment letter.”

[For the complete q/a format Interview with Gerald Hodgkins, see 32 Corporate Crime Reporter 43(12), print edition only.]


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