The Dodd-Frank Act provides that Securities and Exchange Commission ("SEC") whistleblower awards may not be less than ten percent nor more than thirty percent of the monetary penalties collected in the action to which they relate; SEC Rule 21F-6 contains criteria that the SEC may consider in determining the award percentage within statutory limits. Not all tips will have this effect; on the contrary, some will impose more costs than benefits on the SEC. First, tying awards to the value of any penalties imposed in the covered action, rather than simply to the monetary penalties collected, would better align whistleblowers' incentives to tip with the SEC's deterrence mission.
Second, the SEC should be required to be more transparent about the percentages it awards and why. This requires, among other things, that the whistleblower submit the tip before the SEC requests information from the whistleblower related to the subject of the report and that the whistleblower is not previously legally required to report the information to the SEC. Rose, Better Bounty Hunting: How the SEC's New Whistleblower Program is Changing the Securities Fraud Class Action Debate, 108 Nw.
To receive an award based on a related action, the SEC must determine that the original information the whistleblower provided to the SEC also led to successful enforcement of the related action under the same criteria used to evaluate awards for covered actions . CALCULATION OF PRICES: CURRENT PRACTICES, PROPOSED REFORMS The SEC recently issued a lengthy release proposing several changes to the rules for WP. The Dodd-Frank Act leaves the determination of the size of an award within the ten to thirty percent statutory limits to the discretion of the SEC.46 However, the Act provides that in exercising this discretion, the SEC must take into account:.
53 In deciding whether to increase the amount of a whistleblower award, the rule requires the SEC to consider the three factors enumerated in the Dodd-Frank.
Proposed Revisions to Rule 21F-6
A THEORETICAL APPROACH TO AWARD CALCULATION
Underlying the debate over the desirability of the proposed amendments to Rule 21F-6 is a more fundamental question: Why should the percentage method be the SEC's primary method of pricing whistleblowers anyway, as opposed to some other methodology. Only after we understand the function the percentage method serves can we intelligently evaluate whether the SEC's proposed rule revisions are desirable.
The Purpose of Whistleblower Awards
The risk of an expected price is partly a function of the probability that it will materialize (the tip may not produce a covered action, or the SEC may find the signal ineligible for a price). It is also a function of the certainty of the assumptions underlying the expected price calculation. The SEC's whistleblower program seeks to encourage a greater number of tips by changing individuals' internal cost-benefit calculus, as discussed above.
Rather, it is designed to assist the SEC in its enforcement mission, which this article assumes to be a deterrent to securities law violations. In other words, the cost side of the whistleblower's cost-benefit equation may depend on a factor related to the probability of an award and thus the award's expected value. Private individuals often possess information about securities law violations that would be costly for the SEC to discover on its own; therefore, encouraging whistleblower tips can help the SEC save on investigative costs it would have otherwise incurred.
However, an improvement in the SEC's enforcement regime is not the inevitable consequence of a whistleblower reward program, because the program itself imposes costs. Whistleblower programs such as the SEC's therefore face a challenge: they must encourage whistleblowers with desirable tips to come forward (namely tips that yield more benefits than costs and thus move the SEC closer to its goal of optimal deterrence) without at the same time encourage submission. of unwanted tips (i.e., tips that create a net cost and thus undermine the SEC's deterrence objective).95 Even if the SEC could identify and remove tips at no cost. Weak tips can also embolden potential violators of securities laws by reducing the likelihood of detection, if the SEC were to devote resources that would otherwise be spent on detecting misconduct to sorting out tips.
Tip desirability is a continuum, and where along that continuum tips become more burdensome than useful to the SEC will be, in part, a function of how effectively the SEC can sort through tips and identify which ones are worthy of pursuit. The SEC's covered action requirements serve to create different incentives for individuals to report depending on tip desirability, so understood. To the extent that the SEC is more likely to pursue a case involving more serious wrongdoing, whistleblowers who suspect more serious wrongdoing will view a covered act as more likely than those who suspect less serious wrongdoing; therefore, other things being equal, they will be more likely to come forward because prices will have a higher expected value for them.
The flood of tips would predictably move the SEC further from, and not closer to, its goal of optimal deterrence, by generating more costs than deterrence benefits.9 7 Moreover, even if the SEC could identify and remove at no cost those tips that are not worthwhile are to pursue, it would end up spending a lot. Even if the SEC could sort out the tips at no cost, reward amounts should not be set arbitrarily high, because funds in excess of what are needed to achieve the program's objectives could be diverted to more socially productive purposes. This does not mean that the SEC should strive to set award amounts with complete accuracy so that no additional dollars are spent beyond what is necessary to create appropriate incentives for whistleblowers to come forward.
Evaluating the Percentage Method
IMPLICATIONS FOR REFORM
This would encourage the SEC to focus on the costs of whistleblowing, which are essentially neglected under the current methodology, within a percentage framework that is tied (albeit imperfectly) to the deterrence benefit generated by the tip. Put simply, this equation suggests that the SEC must award an amount equal to twenty-four times the whistleblower's costs. Not only is the SEC incredibly opaque about the weight it assigns to the various factors identified in the rule,113 it rarely discloses the percentage it has assigned.
In the cases resulting in awards to whistleblowers of $1 million or more, the SEC has never disclosed the percentage awarded. To see this, we must consider why the SEC behaves so non-transparently in setting pay rates, despite the negative impact on the whistleblower program. There is no reason why the SEC cannot publish this information while maintaining whistleblower confidentiality.
I believe that most of the individuals at the SEC are dedicated public servants with a high level of moral integrity. Individuals with serious suspicions of wrongdoing are likely to visit the SEC's website and learn about WP there. For example, the SEC may provide summary data about award dollar amounts (for example, "During the past year we awarded over $100 million to seven individuals"), or provide a vague description or range the overall dollar size of the award along with the percentage in specific cases (for example, "Today we ordered a twenty percent award based on factors X, Y, and Z, which will result in a multi-million dollar payout") .
But requiring the SEC to consider the incentive effects of the dollar value of awards in all cases would impose greater administrative costs on the agency, and it would create greater opportunities for distortion if the SEC exercised its adjustment power unwisely. Indeed, the existing Rule 21F-6 criteria are best read to allow the SEC to already consider them. 120 But the rule can and should be revised to require the SEC to do so expressly and in every case.
Not only would it improve the whistleblower program by more closely tying expected awards to the SEC's deterrence objectives, but it would also force the SEC to thoughtfully consider the relative value of the various remedies at its disposal, which perhaps could lead to better enforcement choices. This amount could be adjusted if necessary under the proposed revisions to SEC Rule 21F-6. More broadly, the SEC should be more transparent about the weight it gives to Rule 21F-6 criteria and the actual percentages it assigns to covered actions.
The proposed amendments to Rule 21F-6 would address this shortcoming by allowing the SEC to consider the dollar amount of awards generated by the percentage method, at least in a subset of cases, and to make adjustments for incentive effects. First, the SEC should be more transparent about the percentages it awards and why.
