The SEC also took the unprecedented step this year of not contesting a motion to seal an appeals court ruling critical of an SEC decision to award $14 million to Carson Block, CEO of short-seller Muddy Waters Capital LLC. SEC staff found Block didn’t qualify as a whistleblower under the agency’s own criteria. And it denied a FOIA request from Bloomberg Law to identify the attorney who represented a client who was awarded $20 million, even after the agency found that “much of the information Claimant provided was already known to the Enforcement staff, and the new, helpful information Claimant provided was fairly limited.”

A 2022 Bloomberg Law investigation found the SEC’s emphasis on secrecy went far beyond its legal mandate to protect whistleblowers’ identities, it often ignored its own rules when making decisions, and law firms employing three former SEC officials had been awarded more than $420 million on behalf of clients.

The SEC follows a two-step process when handling whistleblower tips. First, they are vetted by the enforcement division. If an action is successful, whistleblowers then submit paperwork to the Office of the Whistleblower, which determines whether they should be paid for their efforts, and how much. By law, claimants are entitled to between 10% and 30% of any money recovered.

The process can take several years, and whistleblower attorneys have urged Congress to allocate more money to speed it up.

For now, Kohn and Zuckerman each said other measures are needed. First, Congress needs to make sure whistleblowers who expose large corporate fraud are rewarded if the company at the heart of the scandal goes bankrupt.

In March, the SEC approved awards for two whistleblowers who separately uncovered a $1 billion fraud by a Texas viatical company, Life Partners. John McPherson, an outside analyst and investor, and John Barr, a victim of the fraud, spent years helping the SEC investigate, prosecute, and win multi-million-dollar judgments against the company.

But Life Partners declared bankruptcy soon after the SEC sanctions. Even though a bankruptcy court eventually returned about $1 billion to investors, the SEC said McPherson and Barr aren’t entitled to any of that money.

The men have asked the U.S. Court of Appeals for the Fifth Circuit to overturn that decision, and the case is pending.

“If the fraud is so big that it sends a company into bankruptcy, that is telling you that these whistleblowers did a tremendous public service,” Kohn said. “How can you decide not to pay whistleblowers when you recover hundreds of millions of dollars?”

The point of the whistleblower program, and any changes Congress may make, is not just to protect tipsters but to guard the stability of the U.S. financial markets, Zuckerman said. One easy fix, he said, would be to allow SEC enforcement staff to provide more updates to whistleblowers, who can wait for years without knowing where the investigation stands.

“U.S. capital markets are the envy of the world because there is the assumption that there is rigorous enforcement of U.S. securities laws,” Zuckerman said. “The whistleblower program has been tremendously successful, and I think the most important thing is to make sure it has the resources it needs to reward and protect people who put a lot on the line to come forward.”

This article was provided by Bloomberg News.

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