SEC Steps Back from Two 2020 Amendments to the Whistleblower Rules

Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum.

The SEC’s whistleblower program provides for awards in amounts between 10% and 30% of the monetary sanctions collected in an SEC action based on the whistleblower’s original information. The program, which has been in place for more than ten years, is widely acknowledged to have been a resounding success. In September 2020, the SEC adopted a number of amendments to the whistleblower rules, some of which were quite controversial. In early August, SEC Chair Gary Gensler issued a statement indicating that he had directed the SEC staff to revisit the whistleblower rules, in particular, two of the amendments that had been adopted in 2020. (See this PubCo post.) Gensler observed that concerns have been raised, including by whistleblowers as well as by Commissioners Allison Herren Lee and Caroline Crenshaw, that those amendments “could discourage whistleblowers from coming forward.” Now, the SEC has issued a policy statement advising how the SEC will proceed in the interim while changes to those rules are under consideration. Commissioners Hester Peirce and Elad Roisman were none too pleased with the SEC’s action here, questioning whether it might be part of a troubling pattern of unwinding actions taken by the last Administration. They made their views known in this statement.

The WSJ has reported that recent litigation brought against the SEC in connection with the two amendments has just been halted in light of the SEC’s agreement to consider changing the rules. One of the amendments precludes the SEC from, in some cases, making an award to a whistleblower that is potentially also covered by an alternative, separate award program that “more appropriately applies” to the related action. The second amendment permits the SEC to take into consideration the dollar amount of a potential award when making an award determination allowing the SEC, as Gensler phrased it, “to lower an award because of the size of the award in absolute terms.” Gensler has directed the staff to draft potential revisions to permit the SEC “to make awards for related actions that might otherwise be covered by an alternative whistleblower program that is not comparable to the SEC’s own program, and to clarify that the Commission will not lower an award based on its dollar amount.”

The SEC’s policy statement indicated that notice and comment was not required under the Administrative Procedure Act because the SEC had determined that the statement related only to “agency procedures,” did “not substantially affect the rights or obligations of non-agency parties,” and, therefore, was not a “rule” under the Congressional Review Act.

Amendment to Exchange Act Rule 21F-3. As described in the new policy statement, the amendment to Rule 21F-3(b)(3)) authorized the SEC “to determine, based on the facts and circumstances of the claims and misconduct at issue in the potential related action (among other factors), whether the Commission’s whistleblower program or the other whistleblower program has the more ‘direct or relevant connection to the [related] action.’ And responsibility for making an award in connection with the potential related action will then rest with whichever award program is determined to have the more direct or relevant connection to the action.”

The new policy statement provides that, during the interim policy review period, the staff must first consider recommending use of the SEC’s exemptive authority to permit an SEC award on a potential related action under specified circumstances, such as if the claimant could be disadvantaged by a cap in the alternative award program. Otherwise, if an alternative whistleblower program has a “more direct or relevant connection” to the action than the SEC’s program, the staff must inform the claimant, who can then request that the related-action award claim be held in abeyance during the interim period.

Amendment to Exchange Act Rule 21F-6. According to the policy statement, this amendment added language to allow the SEC “to consider, in its discretion, the dollar amount of a potential award when making an award determination. Before this amendment, the text of the rule (with one limited exception) did not expressly afford the Commission authority to consider the potential dollar amount of an award when determining awards; rather, the text of the rule generally referred to setting awards as a percentage of the monetary sanctions recovered.” The statement indicates that, at the time of the amendments, the SEC “explained that the amendment in question was a clarification of discretionary authority the Commission already possessed.” However, the statement notes that “the extent to which the amendment was a clarification was a point of disagreement at the time that the Commission adopted the amended rules in 2020.”

Going forward, according to the statement, the SEC expects that it will continue to consider dollar amounts only where the rules explicitly contemplate the use of discretion to raise awards. In the “unlikely event” of a deviation from this practice, the staff will inform the claimant, who can request that the matter be held in abeyance during the interim period.

SideBar

As noted in the SEC’s policy statement, the open meeting to consider adoption of the whistleblower rule amendments was quite contentious. The amendment to Rule 21F-6 was characterized as a “clarification”—a term that, in the view of some of the Commissioners, might be doing a lot of work—of the SEC’s “broad discretion” when applying the award factors set forth in the whistleblower rules, including the discretion to consider the award factors in percentage terms, dollar terms or some combination.

Notably, the SEC did not adopt Rule 21F-6(d)(2) as originally proposed. Essentially, the SEC said, the proposed rule was “misperceived” as a grant of authority to exercise discretion to reduce the size of big awards, when, according to the SEC, it was really intended only as a clarification of the SEC’s existing authority. Instead, the SEC adopted “a provision that clarifies the Commission’s broad discretion when applying the Award Factors and determining the Award Amount, including the discretion to consider and apply the Award Factors in percentage terms, dollar terms or some combination of percentage terms and dollar terms when determining the Award Amount.” Then-SEC Chair Jay Clayton acknowledged that there was “public confusion about the Commission’s discretion” in applying the factors used to determine award amounts. The amendments, he said, “recognize the responsibility that Congress gave us to determine the amount of awards, subject to the statutory minimum and maximum…. Also, to be clear, in determining the award amounts, we apply the factors and only the factors, to determine the amount. There is no separate (post application of the award factors) assessment of whether award amounts are too small or too large or any type of a cap apart from the statutory maximum established by Congress. “

Commissioner Lee dissented principally because of the treatment in the new rules ascribed to SEC use of discretion if the dollar amount of an award were too high. She then explained a potential reason why there was “public confusion about the Commission’s discretion”—because the proposing release indicated that, in the absence of proposed new Rule 21F-6(d)(2), the SEC did not have authority to reduce the amount of the award it considered too high. In particular, she pointed to language in the proposing release surrounding a hypothetical award of $240 million, which stated that

“[c]ritically, under the existing framework of Rule 21F-6—without proposed paragraph (d)—the Commission in setting the appropriate amount of an award would be unable to consider the extraordinarily large dollar amounts that would be associated with any assessments and adjustments made when applying the existing award factors of Rule 21F-6; the Commission would also lack the authority to adjust the award amount downward if it found that amount unnecessarily large for purposes of achieving the whistleblower program’s goals. …What paragraph (d) would do…is to afford the Commission the discretion to determine whether such an extraordinarily large payout is actually necessary to further the whistleblower program’s goals of rewarding whistleblowers and incentivizing future whistleblowers, and if not, proposed paragraph (d) would afford the Commission the ability to adjust the actual payout to an award amount that is closer to the $80 million minimum….”

Where does the final rule land, she asks? “Remarkably,” she says, the adopting release claims that the entire premise of the hypothetical was mistaken and did not reflect the SEC’s prevailing understanding of its discretion or its historical practice. According to the adopting release,

“the statement that the Commission would be unable to consider the dollar amount, and rather only the percentage amount, in the context of the hypothetical was incorrect and did not reflect the Commission’s prevailing understanding of its discretion or its practice in considering and applying the Award Factors and setting Award Amounts. The Commission has had and continues to have broad discretion in applying the Award Factors and setting the Award Amount, including the discretion to consider and apply the Award Factors in percentage terms, dollar terms or some combination thereof.”

In effect, the broad discretion to adjust the dollar amount of awards existed all along, despite the 2018 rule proposal, and, in the 2020 amendments, the SEC is just reclaiming that right. The SEC, she observed, now claims an even broader authority to adjust award amounts up or down for awards of any size. In support, the staff confirmed to her that the implication of the new language in the rule allowing the SEC to consider awards in dollar amounts was that, in two identical scenarios involving the same whistleblower where the only difference was the amount of the monetary sanctions ($10 million v. $500 million), the SEC could award different percentages for the two claims. As a result, in her view, the new rule was actually more problematic than the old proposal (which she wouldn’t have supported either): it allowed for two different outcomes based on the same set of facts, offered no transparency or accountability and no way for a whistleblower to contest the outcome. She also had numerous concerns about other policy choices, including the position regarding awards in related actions. (See this PubCo post.)

In their statement, Commissioners Peirce and Roisman reprimanded the SEC for its “unwise” action in this policy statement. While acknowledging that the SEC was within its rights to amend its rules at any time—with appropriate notice and comment—even if the rules were less than a year old, the two Commissioners contended that the effect of the policy statement was to adopt “new procedures designed to ensure that two rule provisions, which are subject to litigation, are substantively ignored while proposed amendments are formulated and considered. This effectively nullifies standing Commission rules under the guise of changes to ‘agency procedures.’” Referring to an action with a similar effect recently taken by Gensler and Corp Fin with regard to the proxy advisor rules, they expressed concern that this action “continues a troubling and counterproductive precedent: If a rule challenge is pending in court when the presidential administration changes, the Commission believes it may immediately abandon proposed, noticed, and adopted rules at the majority’s will via public statements. Abandonment of duly-adopted rules without notice and request for comment raises the prospect that the rules that the Commission adopts in compliance with the Administrative Procedure Act may be interim at best, and transitory at worst. This reduces the certainty of the law, a consequence that does not bode well for the Commission or those it regulates.”

SideBar

In July 2020, the SEC adopted new amendments to the proxy rules regulating proxy advisory firms—a rulemaking that was even more controversial than the whistleblower rules. (See this PubCo post). In June, Chair Gensler also directed the staff to consider whether to recommend further regulatory action regarding proxy voting advice. In his statement, Gensler highlighted his direction that the staff consider “whether to recommend that the Commission revisit its 2020 codification of the definition of solicitation as encompassing proxy voting advice, the 2019 Interpretation and Guidance regarding that definition, and the conditions on exemptions from the information and filing requirements in the 2020 Rule Amendments, among other matters.” As a result, Corp Fin issued a Statement indicating that “it will not recommend enforcement action to the Commission based on the 2019 Interpretation and Guidance or the 2020 Rule Amendments during the period in which the Commission is considering further regulatory action in this area.” (See this PubCo post.)

In a separate Statement, Commissioner Hester Peirce and Commissioner Elad Roisman questioned this action, indicating that, while they were “open to seeing what, if any, changes to our rules the staff recommends and to working with our colleagues to consider such recommendations,” they were perplexed as to

“what has changed in the roughly ten months since the Commission last considered this issue that would call into question such recently adopted requirements. Indeed, the compliance date for the exemption conditions is still months away, which makes it challenging, if not impossible, for us to know how these requirements will work in practice. How can we evaluate the appropriateness of further changes without considering such new data or experience? We find it even harder to understand how the Commission would justify a departure from its longstanding legal interpretation about proxy solicitation.”

Acknowledging that some groups were displeased with the rules, they nevertheless believe that the SEC’s rulemaking “was beyond reproach. During the years-long rulemaking process, the Commission considered all policy arguments, including those in opposition to the proposed amendments. The rule’s adopting release discusses the Commission’s analysis of these points in the context of the rule’s entire administrative record. The rule we adopted reflected the broad range of input we received on the proposal.” They hoped that any future SEC action “will not deprive users of proxy voting advice of information they need to properly consider such advice or lead them to make decisions based on misinformation.”

(See this PubCo post.)

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