Whistleblower Angered by SEC's Split of $27 Million Award

(1) Constructive termination of Johnston Group's employment; (2) Violation of California Business and Professions Code Prohibiting 'Unlawful, Unfair or Fraudulent business practices; (3) Fraudulent misrepresentations or omissions; (4) Negligent misrepresentation; (5) Breach of contract and implied covenant of good faith and fair dealing; (8) Intentional Interference with prospective business advantage; (7) Violation of provisions of the California Labor Code by withholding the Johnston Group's wages and benefits; (8) Violation of California Business and Professions Code Section 17200 a second time by withholding benefits, earned and deferred compensation from the Johnston Group; (9) Accounting of all sums due to the Johnston Group; and (10) Indemnification of the Johnston Group by Citigroup per California Labor Code for ell attorneys' fees and expenses arising from the recommendation and sale of MAT and Falcon Strategies. 

[T]he causes of action relate to the Johnston Group's employment with Citigroup, the losses incurred by the Johnston Group's clients as a result of investment in two Cittgroup funds, MAT and Falcon Strategies, and Claimants' departure from Citigroup to seek employment with another broker-dealer firm. 

In 2008, the Johnston Team brought an arbitration proceeding against Citigroup before the Financial Industry Regulatory Authority. The arbitration concerned approximately $3 billion in investments that Johnston managed in Citigroup's so-called "ASTA/MAT" funds and its "Falcon" Strategy funds. These funds collapsed during the 2008 financial crisis. Johnston continued to lead the Team throughout the arbitration. He retained an attorney, Michael Blumenfeld, to represent the Team. 

As Johnston prepared for the arbitration, he claims he discovered, without any input from Mittman or Arnold, that Citigroup made misrepresentations about its "back-tests" -- tests conducted to verify Citi's risk assessment of the ASTA/MAT and Falcon funds using historical investment data. 

In July 2010, after making this discovery, the Johnston Team submitted a 25-page report to the SEC detailing the problem. Mittman and Johnston were both present at a meeting on July 26 and 27 in which the two presented the findings of the Team's independent back-tests. 

The SEC then brought an enforcement action against Citigroup Alternative Investments, LLC and Citigroup Global Markets, Inc., which resulted in a settlement of $189 million. See In the Matter of Citigroup Alternative Invs. LLC & Citigroup Glob. Markets Inc., Securities and Exchange Commission Release No. 4174 (Aug. 17, 2015). Following the settlement order, the SEC invited whistleblowers to file claims for an award by issuing Notice of Covered Action No. 2015- 92. Johnston and Mittman each submitted a timely claim, although Johnston's claim stated he was submitting his on behalf of the Johnston Team as a whole.

In 2020, the SEC's Claims Review Staff issued its Preliminary Order, which recommended that the Commission grant Johnston and Mittman a joint whistleblower award in the amount of $18.9 million - 10 percent of the fine the Commission collected - to be divided equally between the two. The recommendation was supported by the affidavit of a staff attorney, Olivia Zach, who had been the primary SEC point of contact with the Johnston Team. As Johnston notes, her affidavit stated: "While we had significantly more contact with Michael Johnston, we have no insight into how much Michael Mittman had contributed to the materials provided by Johnston." As a result, the SEC viewed the two men as having provided the original information jointly. 

SIDE BAR: In the Matter of Citigroup Alternative Investments LLC and Citigroup Global Markets Inc., Respondents (SEC Order Instituting Proceedings and Imposing Sanctions ("OIP"); '34 Act Rel. No., 75710; Invest. Adv. Act Rel. No. 4174; Admin. Proc. File No. 3-16757 / August 17, 2015)
https://www.sec.gov/litigation/admin/2015/33-9893.pdf As alleged in the "Summary" of the OIP:

These proceedings concern material misstatements and omissions made by Respondents between 2002 and 2007 in the offer and sale of securities in two now-defunct hedge funds-the ASTA and MAT funds ("ASTA/MAT") and the Falcon Strategies funds ("Falcon"). The ASTA/MAT and Falcon funds were recommended and sold by two groups of individuals, the "financial advisers" of Smith Barney and the "private bankers" of Citigroup Private Bank (together, the "financial advisers"), to their advisory clients. The financial advisers were associated with respondent CGMI. Both funds were managed by respondent CAI, which acted through its employees, including an employee who had a primary role in creating the funds and serving as the funds' manager during the relevant time period (the "fund manager"). Respondents raised approximately $2.898 billion from approximately 4,000 investors in ASTA/MAT and Falcon. In 2008, both funds collapsed resulting in billions of dollars in losses. 

From 2002 through 2008 (the "relevant period"), financial advisers and the fund manager misrepresented the funds' risks and performance to advisory clients, who were told that the investments were "safe," "low-risk," "bond substitutes" and suitable for traditional bond investors, despite statements in marketing documents that the funds should not be viewed as a bond substitute. In addition, while the risk of principal loss was disclosed in written materials provided to clients, certain financial advisers and the fund manager orally minimized the significant risk of loss resulting from, among other things, the funds' investment strategy and use of leverage. Investors were also told that the biggest risk facing ASTA/MAT was the adoption of a flat income tax by the federal government. Financial advisers encouraged many of their advisory clients to sell portions of their bond portfolios in order to invest in the funds. In late 2007, financial advisers and the fund manager continued to offer and sell Falcon as a safe, low-risk investment, even though both funds- the Falcon fund was 20 percent invested in the ASTA/MAT fund-began experiencing increased margin calls and liquidity problems in the second half of 2007 that continued until the funds collapsed. 

Moreover, the fund manager was involved in virtually all fund-related communications with the financial advisers and investors. The fund manager and the fund manager's staff were responsible for drafting and reviewing offering materials for the funds, crafting sales pitches to investors, training CAI sales personnel (who, in turn, were responsible for marketing the funds to the financial advisers), drafting quarterly investor reports, disclosing interim fund performance, and managing the funds themselves. Furthermore, throughout the fund offerings and fund operations, the fund manager and the fund manager's staff at CAI met with prospective investors and responded directly to inquiries from the financial advisers concerning the funds without sufficient oversight governing those oral communications. The fund manager and his staff at CAI had significant influence over the dissemination of information relating to the funds without review or oversight, including information relating to the funds' risks and performance. CAI failed to implement a system in which the fund manager's authority was checked adequately or to ensure that the fund manager's communications with investors and financial advisers concerning the ASTA/MAT and Falcon funds were accurate and not misleading. 

[(1)] By ignoring the contract between the two and splitting the award evenly, the SEC overstepped its statutory authority; (2) the SEC should have applied the law of joint ventures to determine whether he and Mittman were acting jointly as whistleblowers; (3) having provided no original information to the Commission, Mittman was not eligible for an award; and (4) because the SEC ignored unrefuted evidence that he and Mittman were not joint whistleblowers, the decision to treat them as such was arbitrary and capricious. 

We see that three of the arguments Johnston raises directly challenge the division of the award, not Mittman's eligibility for an award: (1) The law of joint ventures bars Mittman from receiving an equal award, a component of the first issue Johnston raises, namely, whether the SEC should have applied the law of joint ventures in its decision; (2) the SEC ignored the parties' contract in deciding to split the award evenly between Mittman and himself, the remainder of the first issue Johnston raises; (3) the authority Congress delegated to the SEC to issue a whistleblower award does not include the power to interpret an agreement between parties to split the award, the second issue Johnston raises. Because these arguments challenge the percentage of the award Mittman should receive, rather than his eligibility for an award, we do not have jurisdiction to consider them. On the other hand, Johnston is correct, as the SEC concedes, that the remainder of Johnston's arguments go to Mittman's eligibility. Therefore, we deny in part and grant in part Mittman's motion to dismiss Johnston's petition, and do not consider Johnston's arguments going to the amount of his award relative to Mittman's. 

[A] single attorney, Mr. Blumenfeld, represented both men at their meeting with the Commission staff, and later wrote to the SEC on their behalf recounting that "Michael Johnston and Michael Mittman . . . voluntarily presented to the SEC a portion of the original research and independent analysis developed by the Johnston Team pertaining to the Falcon and [ASTA]/MAT Funds." Indeed, Johnston's own award application says not only "The Johnston Group discovered the . . . results of the MAT backtest," which is irrelevant, but also "the Johnston [G]roup was able to conduct their Independent Analyses and to present them to the SEC in 2010 and 2011." Therefore, we hold the SEC had substantial evidence that Johnston and Mittman acted jointly when providing the information to the Commission.

Johnston next argues that because he and Mittman filed separate award applications, the two cannot be considered joint whistleblowers. As the SEC points out, however, nothing in the statute or its regulations requires the Commission to consider how an individual styles his award application in determining whether he is a joint or solo applicant. 

Finally, in an argument so obtuse as to be insulting, Johnston quotes a portion of the SEC's regulations stating "[a] whistleblower must be an individual," from which he purports to infer a whistleblower cannot be two or more individuals acting jointly. 17 C.F.R. § 240.21F-2(a)(2). In fact, the quoted phrase simply distinguishes an individual from "[a] company or other entity" because those entities are "not eligible to be a whistleblower." Id. Indeed, the immediately preceding portion of the regulation contradicts Johnston's position because it states: "You are a whistleblower for purposes of Section 21F of the Exchange Act (15 U.S.C. 78u-6) as of the time that, alone or jointly with others, you provide the Commission with [qualifying] information." Id. at § 240.21F-2(a)(1).

The SEC whistleblower statute does not ask who developed the original information that led to a successful resolution of a covered action; instead, it asks who provided that information to the Commission. The SEC did not err as to the law, nor did it lack substantial evidence as to the facts, in determining that Johnston and Mittman acted as joint whistleblowers when they provided information to the Commission, making Mittman eligible for an award. Johnston's petition for review is therefore

Dismissed in part and denied in part.

• Whistleblower
• DCCir
• SEC
• Joint Claimants
• FINRA
• Arbitration
• Citigroup Global Markets
• ASTA/Mat
• Falcon Strategy Funds
• CRS
• BrokeAndBroker
• Bill Singer