The New SEC Whistleblower Rules and their Impact on Whistleblower Litigation

Abigail Heeter

Associate Editor

Loyola University of Chicago School of Law, JD 2022

Whistleblowers are crucial to the Securities and Exchange Commission’s (SEC) ability to enforce regulatory standards. Because of their knowledge, they can help the SEC protect investors and capital markets, as well as hold those performing unlawful conduct accountable. Through Section 21F of the Exchange Act the SEC has power to award whistleblowers for the information they provide. Last month, an amendment was added to this section altering the rules of whistleblower award allocations.

Section 21F of the Exchange Act (the Whistleblower Rules)

In July of 2010, the SEC enacted Section 21F of the Exchange Act as part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. This statute created an incentive for whistleblowers to report violations to the SEC in return for a monetary award if the tip results in judicial or administrative action. A whistleblower can receive between 10 percent and 30 percent of the sanctions imposed on the entity that violates the Exchange Act, as long as the sanctions imposed in consequence of the tip are in excess of $1 million. Since the whistleblower program has been enacted the SEC has awarded about $523 million to 97 individuals over the last ten years. These large payouts are evidence of the value of these tips to the SEC and the volume of the sanctions they imposed.

The SEC has broad discretion of how they allocate these awards and are to take into account factors such as the significance of the tip, whether the whistleblower assisted in the investigation after the initial tip and the SEC’s interest in deterring the specific violation. They also take into account what is considered ‘negative factors’, such as, if the whistleblower implicated themselves during the investigation or delayed in reporting the violation. The SEC asserts that the review, and subsequent amendment of Section 21F of the Exchange Act, was in response to various complaints regarding their use of broad discretion when determining these awards.

Recent changes to Section 21F

On September 23rd, 2020 the SEC adopted several amendments to this rule. Most notably, now whistleblowers can receive awards from actions such as deferred prosecution agreements, non-prosecution agreements, and settlement agreements (opposed to only results from judicial or administrative proceedings). There are additional measures to prevent frivolous claims, a clarified definition of the term “related action” in determining what qualifies for an award, and a revised definition of “whistleblower” in light of the Supreme Court’s recent decision in Digital Realty Trust, Inc. v. Somers. In that case, the Court held that for the purposes of Section 21F a whistleblower is one who reported a violation to the SEC, not including reports to any other federal agency, Congress, or internally.

The SEC still has discretion when allocating awards to whistleblowers, but the most controversial change to the rule is the treatment of negative factors when allocating awards. If there are no negative factors to the whistleblower’s report and the sanctions imposed from the tip are $5 million or less the whistleblower will receive the statutory maximum, 30% of the sanctions. However, for tips where the whistleblower does have negative factors and the award is greater than $5 million the SEC has even more discretion than it did before the rule change.

The SEC stated in their report that most whistleblowers do not have any negative factors when their tip is evaluated and are going to be recipients of a percentage of a sanction that is less than $5 million, entitling them to the maximum award. However, not all whistleblowers fall into and has a large impact on the discretion afforded to many, including those who may be entitled to the largest awards.

How do these changes impact whistleblowers?

The most controversial issue is the negative factors that the SEC takes into consideration. Many whistleblowers are likely people that know of violations because they are, in some capacity, involved but still came forward to report. Additionally, the language that the SEC uses of ‘delay in reporting’ creates uncertainty about what would qualify as a delay. If a potential whistleblower knows that they have been aware of a violation for even a short period of time and knows that their award could be penalized for not reporting sooner, they may decide that it’s not worth it to report. It is possible that the SEC amended this rule to create an appearance of a more regulated process for allocating these awards but are limiting them for whistleblowers who are eligible for the biggest awards, i.e. percentages of awards from sanctions greater than $5 million.

The new rules were confirmed by a 3-2 vote. The two commissioners who opposed the changes stated that they were already opposed to the discretion the SEC had before the changes when allocating these awards and that they would have preferred a more standardized process. Some lawyers representing whistleblowers have already expressed concern over the changes and argue that they create more uncertainty about whistleblowers’ possible award amounts. Jason Zuckerman from Zuckerman Law stated that “the amended rules adopt a vague and subjective approach to lowering awards without offering any transparency as to how the SEC would apply that discretion.”

However, others are remaining positive and hoping that these changes have a positive impact on whistleblower litigation. A group from Gibson Dunn issued a statement that they predict a decrease in frivolous tips and an increase in lower-stakes cases that are guaranteed an award. They also warn that companies should be vigilant that with the new definition of “whistleblower”, because those with information may be less likely to report concerns internally and will likely report directly to the SEC.