After agonizing about the decision, the top financial adviser had finally gone to the Securities and Exchange Commission with proof of wrongdoing at his firm.
He’s blunt about why: the roughly $50 million he stood to make under the agency’s whistleblower program, his calculation based on what kind of settlement he thinks the government could extract. It would be enough to offset any lost earnings in the likely event that his former colleagues figured out he’d turned them in and blacklisted him, even at the salary level he’d attained after a long career in a lucrative business.
“I’m not giving up 10 years worth of income to be a good guy,” the adviser said. “I’ve got to weigh the risk against the reward. And the risk is huge.” (The adviser requested anonymity to avoid disrupting the case, and the SEC never releases the names of people who blow the whistle.)
But last fall, that risk analysis got turned on its head.
Since going live in 2012, the SEC’s whistleblower office has brought in eye-popping settlements from a wide range of financial bad actors, including big names like Merrill Lynch, which paid $415 million in 2016 for trading with cash that was supposed to be in reserve accounts for its customers. By the end of fiscal year 2020, investigations opened thanks to whistleblower tips had resulted in sanctions worth $2.7 billion, out of which $562 million had been paid to 106 individuals.
In a quiet vote on Sept. 23, the Republican-dominated SEC adopted amendments that could allow it to lower payments to whistleblowers. Its argument is that awards should only be as large as necessary to prompt people to come forward, and excessively high payouts might be better spent on other priorities.
Advocates say that may dissuade whistleblowers, insulating the biggest Wall Street banks and investment firms, which are typically subject to the largest fines and whose wrongdoing is often the most difficult to spot without help from highly paid insiders.
The SEC’s shift may exacerbate the effects of the Trump administration’s blitz of deregulation of the financial services industry, advocates fear. With weaker incentives to report fraud, regulators may have fewer allies as they monitor markets for the kind of bad behavior that can follow such loosening of rules.
Now one of America’s top whistleblower attorneys is moving to stop the SEC. Jordan Thomas, who as a former SEC attorney helped write the rules that set up the whistleblower office in 2011, has just filed a lawsuit alleging that the amendments are illegal. The complaint, which he provided to ProPublica exclusively in advance, charges that taking into account the dollar amount of an award contravenes the statute that established the program. Thomas also contends that it improperly sandbags people already in the SEC’s whistleblower pipeline.
“Courageous whistleblowers have put their careers and lives on the line to assist the Commission — including wearing FBI wires and smuggling key documents out of China,” the complaint reads. “Now, in the middle of the proverbial football game, the Commission has moved the goal posts on literally hundreds of SEC whistleblowers.”
Thomas joins a wave of legal challenges to Trump administration actions, from environmental rollbacks to impositions on civil rights, that advocates argue are against the law or were adopted without due process.
The SEC declined to comment. Defenders of the SEC’s action point out that the rule also contained some provisions that are good for whistleblowers, such as the ability to more quickly dismiss frivolous complaints that gum up the system and a new presumption that whistleblowers who help the commission attain settlements worth less than $5 million should get the maximum allowable award. Also, fiscal year 2020 saw the highest payouts in the program’s history and the most claims processed overall.
Thomas acknowledges that his interest in blocking the amendments isn’t altruistic — lawyers who represent whistleblowers operate on a contingency basis, taking usually about a third of their clients’ award. But Thomas argues that the public has a stake as well. When payouts become unpredictable, he said, highly paid executives are more likely to stick with the firms that provide their paychecks and sweep cheating under the rug.
This seemed to affect potential whistleblowers after the rule change was originally proposed in 2018. The following year, the volume of tips coming in to the commission declined for the first time in the history of the program.
“Examiners aren’t that good at catching people. The auditors have a knack for missing it. The whistleblowers are the last line of defense,” Thomas said. “And now they’re disincentivizing their most valuable players from coming forward.”
Over the past two decades, financial industry whistleblowing has gone from being a rogue act of moral rectitude to a formalized industry, incentivizing insiders with the prospect of partaking in the financial penalties that an enforcement action might generate using their information.
There was no clear prospect of a reward for Sherron Watkins, the Enron vice president who warned about accounting irregularities that led to the Texas energy company’s bankruptcy in 2001, or Harry Markopolos, who raised the alarm to the SEC repeatedly about Bernie Madoff’s Ponzi scheme. Those cases, however, helped regulators recognize the value of offering whistleblowers protection and some cash for their trouble.
After the 2008 financial crisis, Congress passed the Dodd-Frank Act and established whistleblower programs at the SEC and the Commodity Futures Trading Commission, which oversees financial instruments known as derivatives. At the SEC, awards were set at between 10% and 30% of the final settlement, with specific factors that determine whether an award gets bigger or smaller. (Whistleblowers get more if they tried to report problems internally; delaying or taking part in the wrongdoing would knock it down.)
The SEC’s office didn’t open for business until 2012, and it had a slow start. But it gained momentum as tips started to result in successful investigations.
From inception, the program faced complaints from the largest Wall Street firms. In 2011, the U.S. Chamber of Commerce complained that the fledgling office would “put trial lawyer profits ahead of effective compliance and corporate governance,” alleging that the rewards would disincentivize people from reporting problems internally. In 2017, the Chamber supported a case before the Supreme Court that stripped the SEC’s whistleblower protections from people who did report internally, agreeing with the argument that Dodd-Frank defined a whistleblower as someone who came to the government with evidence of wrongdoing.
And in 2018, when the SEC proposed an additional review process for awards in cases where the settlements exceeded $100 million, the Securities Industry and Financial Markets Association backed the change.
“It is simply not necessary to pay a whistleblower $45 million (instead of $30 million) to convince that person to come forward in the first place,” the organization wrote in a letter to the commission.
That provision, which some interpreted as a cap on awards, drew intense blowback from whistleblower advocates as well as legislators on both sides of the aisle. Internationally, whistleblower programs under which awards are discretionary see lower participation, they say; one of the SEC program’s virtues is its more formulaic approach. In a comment letter, Sen. Chuck Grassley, R-Iowa, who has been a consistent backer of whistleblower protections, wrote that the change would have gone beyond the bounds of the statute, with no compelling reason to do so.
When the final rule was released in September, that provision was gone, a seeming victory for whistleblower advocates. But they worried about why it had been excised. The new version asserts that the change wasn’t necessary because the SEC already had the authority to raise or lower awards as it saw fit — not just in settlements over $100 million, but any settlement.
The commission weakened the law in other ways, too, making it harder for whistleblowers to get a bounty if they did not have inside information but instead provided analysis that SEC staff members could plausibly have inferred on their own — even if the staff hadn’t done so.
The SEC’s two Democratic commissioners strongly objected to the rule. But they were outvoted by the agency’s three Republican appointees with the support of Chairman Jay Clayton, a former Wall Street lawyer who two months later announced his early departure. For Clayton, the rules capped off an almost four-year term of mostly deregulatory actions friendly to banks and big public companies.
Sean McKessy, who served as the Office of the Whistleblower’s first director and left in 2016, said that he had debated with the agency’s general counsel about whether commissioners could lower awards because they thought the dollar amount was too high. In the end, they decided that the SEC did not have that authority.
“They basically made this up to justify an approach that is not supported by the statute,” said McKessy, who now represents whistleblowers. “And then they said, ‘Despite all that, you should just trust us, that we’re going to do this the right way.’”
Steven Peikin, who served as co-chair of the SEC’s enforcement division before returning to private practice last summer, said whistleblower advocates shouldn’t worry.
“The program is set up and designed to pay whistleblowers,” he said. “People in the Office of the Whistleblower are there because they believe in the program.”
For Thomas, who now heads up the whistleblower practice at the plaintiff-side law firm Labaton Sucharow, the rule changes were personal.
At the SEC, he’d been in charge of writing the section of the Dodd-Frank regulations that dealt with how to reward whistleblowers. After Clayton’s SEC first proposed its changes, he and other whistleblower advocates had multiple meetings with the chairman, commissioners and SEC staff, trying to explain to them that injecting this degree of discretion into the process would put a huge damper on the incentive to report the most complex and damaging cases of misconduct. That’s especially true, he explained, for anybody who might be viewed as undeserving or impure — such as a short seller, or a senior executive who could have reported misconduct purely out of a sense of civic duty, or someone who’s criticized the government in the past.
“Because this ‘too much’ standard has no boundaries, it’s open to abuse,” Thomas said. “The opportunity for politics within the process gets bigger and bigger.”
Thomas thought the SEC understood his argument — so when the final rule came out, he was surprised and disappointed. Thomas decided to challenge the rules in court, filing a 48-page complaint on Wednesday at the U.S. District Court for the District of Columbia, on behalf of himself and the 39 clients he has at various stages of reporting to the SEC. He has a financial interest in the outcome, but he’s also taking a big risk if the courts don’t go his way.
“I worked there, my entire business goes through there. Nobody sues the SEC,” Thomas said. “But because I had a leadership role in developing the program, it really bothers me that they’re breaking faith with whistleblowers who are already in the pipeline, and that they’re giving away a third of the program’s future.”
Now that the SEC will be run by Democrats, it’s possible the push to reduce whistleblower payouts will be reversed or become moot. But any changes could ripple for a long time because prosecutions usually take years to finish and an award determination can take yet more years on top of that.
Erika Kelton, another whistleblower attorney, says she’s already had one client back out explicitly because of the changes to the rules. “The uncertainty was too much. It didn’t make sense for him to come forward,” she said.
The financial adviser who blew the whistle on his firm says the new rules will surely dissuade some insiders at his level from stepping forward.
“If these guys decide they want to lower their awards, they’re going to get $200,000 employees taking a shot, and that’s about it,” he said. “The only people who know stuff are the people who are at the top.”
He understands that Wall Street executives aren’t the most sympathetic characters and that some will bridle at enriching already wealthy people to rat out cheating — but otherwise, it may never come to light. In his case, the adviser had observed one of his fund managers bilking investors to the tune of hundreds of millions of dollars. He says he complained about it to his superiors, who swept it under the rug; their firm was also profiting from the misconduct and would be liable if the authorities found out.
“I appreciate the fact that the average guy on the street can’t comprehend these numbers,” he said. “That it would be offensive to a normal human being making normal money. Lots of people on Wall Street make $100 million every 10 years. They’re not risking that for a million bucks.”
As he waits for the SEC staff to investigate his allegations, his risk-reward calculus has been knocked out of whack.
“I think I made a mistake,” the adviser said. “I trusted the process.”
Is he going to follow through with the case? The adviser took a long pause.
“That discussion is ongoing,” he said.