SEC tipsters’ appeal to court gains more weight after Chevron’s demise

SEC tipsters’ appeal to court gains more weight after Chevron’s demise

A federal appeal by two whistleblowers who helped the Securities and Exchange Commission recover $1 billion for defrauded investors, only to be denied what would have been a record-breaking award, is now shaping up as a test of the program’s future at the Supreme Court.

The timing couldn’t be better for accountant John McPherson and investor John Barr to appear before the U.S. Court of Appeals for the Fifth Circuit on Tuesday. Less than two weeks ago, the Supreme Court overturned the Supreme Court’s decision. Chevron doctrine that required judges to defer to an agency’s reasonable interpretation of ambiguous or ill-defined laws.

McPherson and Barr could receive a potential $250 million settlement if they can prove that the SEC fabricated rules to avoid paying them one of the largest bounties in the program’s 13-year history. The men separately informed the agency about a massive fraud by a Texas life trust and spent years helping the SEC build a case. On March 27, 2023, the commission ruled that they deserved a combined award of 25% of all the money recovered.

But they were never repaid. The SEC ruled that because nearly all of the $1 billion had been recovered through bankruptcy proceedings, not directly by the commission, the men were entitled to virtually nothing.

“The Commission’s illogical result here creates no incentive for whistleblowers to identify securities fraud in a company built entirely on fraud (because it will invariably fail),” Brian Leske, McPherson’s attorney, said in court papers.

Enshrined in the Dodd-Frank financial law of 2010, the whistleblower law was created to ensure that reports of financial impropriety were not ignored, as was the case before the dismantling of Bernie Madoff’s $64.8 billion Ponzi scheme. The law does not specify whether bankruptcy recoveries should be factored into whistleblower compensation decisions, making this case a prime case for judicial review, whistleblower lawyers say.

“I think we can all agree that the law doesn’t mention bankruptcy, so yes, it’s ambiguous. The big change after Chevron is that the court will decide how it should be applied, not having to defer to the agency,” said Stephen Kohn, a whistleblower attorney at Kohn, Kohn & Colapinto, who is not involved in the case. “Any regulation that the SEC creates that is inconsistent with the law will be challenged, and I hope it’s successful.”

Fraud between life partners

Stock-selling firm Life Partners filed for bankruptcy in 2015, days after the SEC won a $38 million judgment for fraud. The bankruptcy trustee, aided by Barr and McPherson, recovered about $1 billion for investors who bought shares in life insurance policies for terminally ill people. The SEC and the trustee said Life Partners falsified data to make it appear that policyholders were near death, when many of them still had years to live.

In his response, SEC attorney Stephen Yoder said the bankruptcy prevented the SEC from pursuing its enforcement efforts and that, as a result, the agency failed to recover the money it recovered. Yoder rejected arguments that the SEC investigation and the bankruptcy were part of a “single action” covered by the statute.

“The bankruptcy petition represented a major complication for the Commission’s enforcement efforts,” Yoder wrote. He added: “The Commission had no further substantive involvement in the bankruptcy case after the appointment of the Chapter 11 trustee, except for a discharge issue and the vote to approve the Plan.”

McPherson and Barr’s attorneys filed their appeals in the Fifth Circuit before the Supreme Court’s Loper Bright decision overturning Chevron’s decision, and tailored their arguments to meet a higher burden of proving that the SEC’s actions were arbitrary, capricious and unreasonable. Neither side has filed additional briefs since the June 29 decision.

The case originated in Texas and is being heard in New Orleans in the Fifth Circuit, which has criticized the SEC and its actions in recent months. In June, it struck down an SEC rule that required hedge fund managers to be more transparent with clients about fees. It had previously ruled that the SEC’s use of in-house judges to handle some civil cases was illegal. The Supreme Court upheld that decision.

Investor Kyle Bass also filed a complaint with the Fifth Circuit after the SEC refused to grant him a whistleblower award. The agency relented before the court could rule and awarded Bass $400,000.

Bankruptcy exclusion

Leske, Barr’s attorney, wrote in his court filing that even as it worked out the percentage McPherson and Barr would receive, the SEC improperly created rules excluding bankruptcy recoveries. He noted that during a rulemaking process that ran from 2018 to 2020, several securities fraud experts argued that Congress never intended to exclude whistleblowers whose revelations of fraud forced a company into bankruptcy.

Among those testifying in the trial was Harry Markopolos, a Wall Street analyst who unsuccessfully tried to alert the SEC about Madoff’s fraud for years before the scheme collapsed. He noted that Madoff went bankrupt as soon as he was caught, and that if the SEC ruled out bankruptcy recoveries, many of the most prominent whistleblowers would never be paid.

Barr’s attorney, Daniel Geyser, wrote in a separate brief that his client is entitled to an award under the “plain statutory language” of the Dodd-Frank Act. The law provides that a “whistleblower who voluntarily provides information to the SEC that leads to a successful enforcement action resulting in monetary penalties in excess of $1 million” will be awarded between 10% and 30% of any money collected.

Barr and McPherson provided that information, Geyser wrote, and the agency used it to sue Life Partners. Where the recovery came from is irrelevant because that is not covered by the law, he argued.

“If the SEC had simply interpreted the law as it says it does, it would have reached a different result,” Geyser wrote. He also argued that “the SEC cannot justify its erroneous interpretation of the law by claiming that its interpretation deserves to be respected. It fails on every level,” Geyser wrote.

Lawyers said it was too early to say to what extent or how the Supreme Court decision will impact whistleblowers and the commission’s work going forward. In the years since Dodd-Frank, the program has evolved considerably, with the commission introducing new rules that weren’t part of the law and, by its own admission, sometimes waiving rules or applying them at its own discretion.

These rules include imposing deadlines for whistleblowers to file complaints, limiting the time a person has to file a claim for an award after the SEC takes action against a company, and creating criteria for determining whether information provided by whistleblowers “led” to a successful enforcement action.

Decision of deference

In a 2022 decision, the U.S. Court of Appeals for the Second Circuit noted the broad regulatory framework used by the SEC to administer the program. It referred Chevron and deferred to the SEC’s “expertise” while upholding the agency’s refusal to award a reward to an informant who exposed fraud at drugmaker Novartis.

“Congress also granted the SEC ‘the authority to issue rules and regulations necessary to implement’ the whistleblower program and the discretion to determine ‘whether, to whom, and in what amount to award rewards,'” the court said. “The SEC’s interpretation of its whistleblower rewards program undoubtedly implicates its policy expertise.”

This review was written while Chevron deference was required.

Overturning it would do no good to whistleblowers whose cases have already been closed, the lawyers said.

The most significant of these involved Victor Hong, whose information about wrongdoing at the Royal Bank of Scotland led to a $10 billion enforcement action by the Justice Department.

Hong brought the information to the SEC in 2014, but rather than act on it, the agency turned it over to the FBI and other agencies. The SEC then said it would not pay Hong because she had done nothing with the information except pass it on to others. The appeals court found the agency’s interpretation “reasonable” and merited. Chevron respect.

The case is Barr V. SEC, 5th Cir., 23-60216