When the SEC recently announced a $260,000 award to three “harmed investors” for their help in spotting a “well-concealed fraud targeting retail investors,” the SEC no doubt hoped the announcement would encourage other investors to come forward with tips.
As further incentive, the SEC touted the tantalizing figures racked up by the whistleblower bounty program since authorization by Dodd-Frank: “The SEC has awarded approximately $387 million to 70 individuals since issuing its first award in 2012.”
However, encouraging more tips, rather than focusing on ways to improve the quality of the massive number of tips the SEC already receives, may bog down a program that already appears to struggle.
As it happens, the SEC only investigates a small number of the tips it receives, and only an infinitesimal number of the tips actually result in awards.
This suggests that the SEC expends resources responding to tips that ultimately have no merit. Given the high number of “meritless tips,” the bounty program could benefit from reform in 2020.
According to the 2019 Annual Report to Congress about the SEC’s whistleblower program, in fiscal 2019, the SEC “received over 5,200 whistleblower tips” and the Office of the Whistleblower “returned over 2,600 calls to the public.” Over the life of the program, the OWB has returned nearly 24,000 calls and received more than 33,300 whistleblower tips.
The 70 awards given out since 2012 represent approximately 0.2% of 33,000 tips received, and the numbers get worse once the 24,000 returned calls are factored in.
Keep in mind that the SEC may reward only those tipsters “who voluntarily provided original information to the Commission that led to the successful” enforcement actions resulting in monetary sanctions over $1 million.
Putting the success rate another way, 99.8% of tips do not lead to successful enforcement actions resulting in monetary sanctions over $1 million.
Similarly, the number of tips resulting in awards represents a very small fraction of the total number of enforcement actions brought by the SEC. With 70 awards since 2012, the SEC averages 10 awards per year. The Enforcement Division files about 820 enforcement actions every year.
Roughly speaking, then, in any given year a little over 1% of newly filed enforcement actions resulted from an award-worthy tip.
The low quality of the incoming tips becomes even more pronounced when one considers how few of the tips the SEC’s Enforcement Division investigates. Of the roughly 5,000 tips received in any given year, only about 300 (or about 6%) result in an enforcement investigation. Put another way: More than 4,500 tips received by the SEC every year are not ever investigated by the Enforcement Division.
The low quality of the incoming tips should be a cause of great concern for the SEC (not to mention the private parties impacted by meritless tips). Stanford Law Professor David Freeman Engstrom, who has analyzed the SEC’s bounty program along with other similar programs, observed:
A budget-constrained agency that receives additional tips must either ignore some of them, using a triage approach to focus its efforts on a subset of tips, or else allocate fewer investigative resources to examining each tip, thus degrading the agency’s screening accuracy. Paradoxically, a bounty regime with a robust mix of incentives and protections that yields more whistleblower reports may overwhelm the agency.
By reducing the likelihood the agency detects and sanctions misconduct, such a regime may yield less overall deterrence compared to a regime with a less robust mix of incentives and protections.
Unfortunately, SEC efforts to reform the whistleblower program begun in 2018 have recently faltered. The SEC had proposed rules that would have given SEC staff the discretion to reduce certain rewards, but those proposals have met with political resistance.
SEC Chairman Jay Clayton said the SEC would consider final rules in the future, adding that he wanted to encourage more tips.
However, the whistleblower data suggest that the SEC has no shortage of tips. The goal for reforming the whistleblower bounty program should be increasing the quality — rather than the quantity — of tips. Professor Engstrom points out a reform the SEC should consider in order to improve overall tip quality.
Rather than reducing the amount of rewards for tips that have merit, the SEC should have the ability to “fine whistleblowers who submit frivolous tips or even require whistleblowers to post a bond along with their tip.”
Increasing the number of meritless tips ultimately wastes the SEC’s resources and reduces deterrence. Improving the quality of tips by providing a disincentive to those contemplating a making a frivolous tip would be a step in the right direction.