See Eric Dixon's analysis and criticisms in his comment letters to the Securities and Exchange Commission.
Proposed Rule 21F-7 would require identifying whistleblowers (pursuant to proposed Rule 21F-10) before the Securities and Exchange Commission (the “Commission”) would pay any award. Proposed Rule 21F-12 provides that awardees may not appeal the amount of an award if it is within a certain range, and that the record for any appeal shall not include “internal deliberative process materials” used to determine the claim.
The provision of monetary awards for whistleblowers is made to encourage people with knowledge or suspicion of corporate wrongdoing to provide such information. The awards support an inference that they are necessary to induce people to come forward with information about suspected corporate wrongdoing. On the other hand, they may create improper motivations for putative whistleblowers and induce false or reckless allegations that potentially may harm their subjects.
Whatever the motivations for whistleblowers, it is important to recognize that whistleblowers assume tremendous risk just by reporting an allegation of wrongdoing. The identification of whistleblowers exposes them to serious risk, including physical harm to them and their families, professional or career reprisals and community ostracization. Whistleblowers may also face retaliation from alleged wrongdoers or their associates, including civil suits. In an era which has seen revelations of huge, shocking financial frauds perpetuated by some of the pillars of the financial community (e.g., Bernard Madoff, Allen Stanford) and legal community (e.g., Marc Dreier, Scott Rothstein) that went undetected by government regulators, prosecutors, auditing firms and banking institutions for years, prospective whistleblowers can hardly be assured that government investigators will “get it right” with future investigations.
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Whistleblowers fearing employment reprisals, retaliation or physical harm to themselves or their families will likely refrain from reporting wrongdoing if their anonymity to the public – and by extension, their safety -- cannot be assured.
Given the Commission’s recent performance, many prospective whistleblowers – however motivated – will take cold comfort in the proposed Rule’s confidentiality provisions which will induce almost all informants to make anonymous submissions through counsel in order to protect themselves.
Proposed Rule 21F-7 reflects the confidentiality requirements set forth in Section 21F(h)(2) of the Exchange Act (15 U.S.C. 78u-6(h)(2)) with respect to information that could reasonably be expected to reveal the identity of a whistleblower. The Commission asserts that it treats all information obtained during its investigations as confidential and nonpublic. However, the proposed rule provides for the Commission to have wide latitude for deciding when to reveal an informant’s identity. Paragraph (a)(2) would authorize disclosure of a whistleblower’s identity not only to domestic authorities, but also to foreign securities and law enforcement authorities when the Commission believes such disclosure is necessary to achieve the purposes of the Exchange Act and to protect investors. Disclosure of a United States person-whistleblower’s identity to foreign authorities from which the whistleblower cannot seek or obtain relief, can hardly be in the interest of American whistleblowers – or investors -- who are being asked to trust their country’s regulators. The Commission’s wide latitude belies its claim of a standard policy of keeping confidential its investigative sources, and as a practical matter, gives prospective whistleblowers absolutely no assurance of confidentiality. A prospective whistleblower concerned about adverse consequences or reprisals cannot reasonably be asked to trust the Commission not to share his identity with foreign regulators. Only the naïve would expect foreign authorities to respect the wishes of a United States informant.
The Commission apparently expects many whistleblowers to provide information anonymously. Paragraph (b) of proposed Rule 21F-7 allows for anonymous submissions under certain conditions. Paragraph (b)(1) would require that anonymous whistleblowers be represented by an attorney and that the attorney’s contact information be provided to the Commission at the time of the whistleblower’s initial submission. However, a careful reading of the Commission’s discussion accompanying the text of the proposed Rule supports the inference that the Commission intends to hold anonymous whistleblowers’ lawyers responsible for any “fraudulent submissions.”
The discussion accompanying Rule 21F-7 provides that the “purpose of this requirement is to prevent fraudulent submissions and to facilitate communication and assistance between the whistleblower and the Commission’s staff.” This statement implies that the retention of an attorney, and the attorney’s performance, is designed to prevent fraudulent submissions. In essence, the attorney is the one charged with the responsibility to prevent fraud. Implicit in a delegation or mandate of responsibility (however unwarranted) is a further consequence for the failure to so prevent that fraud. Further troubling is the flexibility and potential for unbridled Commission discretion in defining “fraudulent submission” beyond its plain English meaning and potentially as broad as encompassing any reported wrongdoing which does not eventually yield a financially successful Commission action – with the anonymous whistleblower’s lawyer facing uncertain civil and even criminal liability under broad statutes like Section 1001 of Title 18 of the United States Code.
It is doubtful that Congress intended either such a draconian shifting of responsibility or a major chilling effect on lawyers (which in turn would inhibit and deter whistleblowers under any circumstances). Moreover, a whistleblower intending a fraudulent submission must (in almost all cases) successfully conceal the nature of that fraud from his or her lawyer. Rule 21F-7 should be amended to narrowly define “fraudulent submission” and to further clarify that lawyers will not be held liable for their clients’ fraudulent submissions the nature of which they were unaware. Such revision would protect lawyers from their clients who are inclined to make fraudulent submissions and to conceal such fraud from their lawyer.
Proposed Rule 21F-12, governing procedures for appeals, also raises concerns. Paragraph (a) of the proposed Rule provides that “the determination of whether or to whom to make an award” is appealable. However, the amount of any award, if within a range of between 10 and 30 percent of the collected sanctions, is not appealable. In addition, paragraph (b) specifying the items constituting the record on appeal deliberately excludes “internal deliberative process materials that are prepared exclusively to assist the Commission in deciding the claim.”
These two exclusions strongly suggest a desire to shield the award process from judicial scrutiny. Even casual observers of corporate fraud cases know that secrecy is often equated with “having something to hide.” Perhaps the Commission wishes to avoid criticism from judges like the Honorable Jed Rakoff, sitting in the Southern District of New York and who famously rejected the Commission’s initial $33 million settlement with Bank of America in 2009. Unfortunately, the exclusions suggest a process that is not open, transparent or likely to protect the capital markets. Such a process can hardly be optimal for encouraging whistleblowers – already facing significant deterrents – to come forward to report suspected wrongdoing. I recommend that both exclusions be deleted or amended in a manner consistent with encouraging legitimate reports of suspected wrongdoing.
Eric Dixon is a New York lawyer who is knowledgeable about the securities laws. Mr. Dixon has been practicing since his 1994 graduation from Yale Law School. Mr. Dixon has substantial securities, business transactions, compliance, regulatory and investigative experience. Mr. Dixon is available for comment or consultation at 917-696-2442 or via e-mail at edixon@NYBusinessCounsel.com.