GUEST BLOG: All You Need Is A TCR and a Dream by Aegis Frumento Esq

September 27, 2018

All You Need Is A TCR and a Dream

The SEC runs the country's best lottery. You have a 1-in-350 chance to win overall, and a 1-in-40 chance if you make the first cut, which a good lawyer can help you do. Now the SEC is looking to raise the minimum prize to $2 million for as many as 16% of the winners. And every year, a few hit jackpots in the tens of millions of dollars. No state or national lottery gives you better odds.

I'm talking, of course, of the SEC's whistleblower program. 

The Dodd-Frank Act created the SEC whistleblower program after the subprime mortgage mess to encourage the public and employees to report securities law violations. So, the ticket to play this lottery is a tip. But that's not so rare. This is the securities industry after all! It is full of those looking to make a buck off of someone else (by any means able to be gotten away with), and it is micro-regulated to boot! There's no shortage of industry snitches able to say who's zoomin' who. Last year the SEC received over 4,400 formal whistleblower tips on SEC Form TCR. That has been increasing year by year, and there's no reason to think it won't continue to grow. 

Dodd-Frank requires the SEC to make whistleblower awards of from 10% to 30% of the monies (over $1 million) collected by the SEC and other enforcement authorities resulting from whistleblower tips. The 10% to 30% range is mandatory, but the SEC has discretion within that range. Under the existing whistleblower rules a whistleblower award is presumed to be 20%, subject to adjustments upward (to 30%) and downward (to 10%) based on the facts of individual cases. 

In June, the SEC proposed Rule amendments, and the comment period closed last week. Thousands of comments were received, most concerning a new proposal to have the SEC apply a second level of review to awards that under the first review would be less than $2 million or more than $30 million. This second review would, in most cases, raise smaller awards up to $2 million, and reduce higher awards down to $30 million, in both cases subject to the statutory limits of 10% to 30%. The idea is that a higher award on the low end incentivizes more than a lower award on the high end disincentivizes -- a kind of progressive redistribution of bounties. 

Most of the commenters objected to capping $30 million-plus awards at the 10% level. But only three awards have ever exceeded $30 million. Besides that, any whistleblower who receives $30 million and whines about it should just shut up. On the lower end, $2 million is about 30% of a $7.7 million recovery (after the $1 million bogey). Therefore, the SEC proposal amounts to saying that whistleblowers whose tips result in enforcement returns of up to $7.7 million will usually receive a full 30% award, and no less than $2 million on those cases yielding more than $7.7 million. By my count, such a policy might have impacted 9 of the 57 awards to date. Both proposals together only impact a minority of cases.

As you might expect, the U.S. Chamber of Commerce objected to raising the lower-end awards, arguing that it just encourages greedy stool pigeons. But SIFMA, whose members are more directly impacted, approved it. When SIFMA agrees with its members' chief regulator, you need to ask why. The reason is simple: SIFMA knows that it really doesn't matter how much you pay a whistleblower. What makes this a lottery is not the size of the bounty, but the SEC's discretion to bring a case in the first place.

On average, only 150 SEC enforcement actions per year result in recoveries greater than $1 million. Out of those, about a dozen whistleblowers have gotten awards each year. More than 90% all $1 million-plus cases did not involve whistleblowers. And 99.7% of all the 4,400 TCRs filed result in nothing.

On average, 488 examinations, investigations or inquiries are triggered by a whistleblower tip each year. Savvy securities lawyers can help get tips into that pool by pre-selecting the best tips, articulating why they show securities law violations, and advocating for them to the staff. Over 80% of our whistleblower submissions have ended up there. But 12 awards out of 488 is still a 97.5% failure rate. So, we bettered the odds over a hundred-fold for our clients, and as a lawyer, I think that's pretty good. But at those odds, one of our cases will likely score -- after about 100 tries!

Are we really to believe that 99.7%, or even 97.5%, of whistleblower tips are useless? In "That Long Strange Trip From SunTrust To Wells Fargo" ( Blog, Guest Blog by Aegis Frumento Esq / August 2, 2018) wrote about our experience with a whistleblower and SunTrust Mortgage. The SEC told me they closed that case, even though it was "worthwhile," because of "resource allocation decisions." The SEC's budget is only so rich, its staff only so large, its days only so long. All things being equal, will the SEC choose to push a case proffered by a whistleblower over one developed internally? I think the SEC has an institutional incentive to ensure over 90% of its large cases are internally generated. Otherwise, people might start wondering about its effectiveness.

And manpower is not the only resource the SEC needs to allocate. All of the settlements involving the subprime mortgage scam have exceeded $2 billion, so presumably a case involving SunTrust would have as well. A standard 20% whistleblower bounty on $2 billion would have been $400 million. The whistleblower award fund is smaller than that. Would the SEC really have paid out the entire fund on one case? The SEC can only replenish the whistleblower pot out of money the SEC itself receives from sanctions. Most of the money paid on the subprime cases did not go to the SEC, but to the Department of Justice. To pay a whistleblower and keep the whistleblower fund solvent, the SEC would have had to negotiate with DOJ to have enough of the total sanction go to the SEC to be able to pay a whistleblower award on the entire sanction, including what DOJ kept. Just talking about it is too much work. Or, the SEC would have to get more money from Congress, and good luck with that. The lesson is don't expect the SEC to pursue whistleblower cases that might blow out the whistleblower fund.

Given these uncertainties and long odds, why do we even bother representing SEC whistleblowers? My only answer is that we trial lawyers are hopeless romantics. We play the whistleblower lottery for the same reasons we try cases. We believe that our causes are better than most, that we're better lawyers than most, and, most importantly, that we're luckier than most. We all think we can beat the odds. But we're still just gambling.

If Congress really wanted to enlist whistleblowers to help it to enforce the securities laws, it would take away some of the SEC's discretion over which cases to prosecute. Empower the so-called whistleblower bar to bring cases on the SEC's behalf when the agency declines to prosecute, as we can under the False Claims Act. Private lawyers with real skin in the game would select the best cases and pursue them forcefully. Let us loose to pursue our own whistleblower awards and see what happens.

SIFMA wouldn't lie supine about a proposal like that! That's why it will never happen. So, we keep playing the whistleblower lottery . . . because, hey, you never know!


Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters. Mr. Frumento has also represented clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. 

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP. 

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.