Bass, Block Cases Add to Questions on SEC Whistleblower Rules

The SEC conceded in court that its denial of a whistleblower award to hedge fund manager Kyle Bass may be flawed after his lawyers claimed the agency invoked a non-existent rule, failed to follow its own precedent and wrongly ruled that Bass didn’t personally file the tip.

The Fifth Circuit Court of Appeals agreed to stay Bass’s appeal and send the denial back to the Securities and Exchange Commission for a highly unusual second look after it had already issued a final order. Combined with an appeals court ruling unsealed last week that questioned whether activist investor Carson Block deserved a $14 million award, the action adds to the increasing court scrutiny over how the SEC administers its whistleblower program.

The SEC declined to comment in both cases.

Bass filed an appeal with the Fifth Circuit in December after the SEC rejected his claim to a $2.5 million award. He uncovered a Ponzi scheme by United Development Funding years earlier, leading to criminal convictions of four executives and SEC sanctions while netting himself a $30 million profit selling UDF stock short.

But the SEC rejected his whistleblower claim for a number of reasons, including that he acted on behalf of his company, Hayman Capital Management, rather than filing personally. Bass’ attorneys provided emails and evidence in its court filings that it said proved the SEC had mischaracterized events.

The attorneys also said the agency unfairly denied waivers it has “routinely” made in other cases.

“That result is as unfair as it sounds, but the SEC’s reasoning somehow made it worse,” Bass’ attorney, Andrew Guthrie, wrote in a March 21 filing. The SEC “rejected Bass’s whistleblower claim by enforcing a regulatory filing deadline that it did not enact until roughly four years after Bass initially blew the whistle. …. What could be more arbitrary and capricious than enforcing a deadline that didn’t exist at the relevant time?”

In April, less than three weeks after the filing, the SEC asked the Fifth Circuit to stay the case so it could issue a new final order. But Bass still might not get the $2.5 million award. The motion to remand, which was granted, left open the option for the SEC to reject Bass’ claim on different grounds.

“The Commission acknowledges that, although ambiguous, the general counsel’s statement in the email quoted in Bass’s opening brief could be read to suggest that the general counsel represented Bass in his individual capacity,” SEC attorneys wrote. “The Commission therefore requests that this Court remand the order on review so that the Commission may …. reconsider the award determination.”

Carson Block, chief investment officer of Muddy Waters Capital.

Photographer: Victor J. Blue/Bloomberg

In Block’s case, judges recently called out apparent contradictions in the agency’s decision-making.

The SEC awarded the activist shortseller $14 million in 2022 but rejected a claim by his associate, Kevin Barnes, for half of the money.

The pair worked on a 2011 report that outlined fraud and mismanagement at Focus Media, a Chinese advertising and marketing services company. The report led to an SEC investigation and Focus later paid a $55.6 million fine, which ultimately led to the whistleblower payout.

Last week the Third Circuit unsealed its opinion upholding the SEC’s denial of Barnes’ claim while pointing out discrepancies between its award to Block and agency denials in a previous case.

“We acknowledge that the SEC’s proffered justification …. leaves something to be desired,” the court wrote. The court asserted that although Block emailed his report on a fraudulent company to SEC staff, the “email had no ostensible impact on the investigation; SEC investigators found the Report on their own.”

The ruling does not affect the SEC’s 2022 award to Block, but likely ends Barnes’ chance of being paid by the agency. A separate lawsuit he filed against Block for half of the money remains active.

Bass and Block took different paths to their awards, although both identified corporate fraud that led to SEC sanctions. Block posted his 2011 report about the media company online before sending a copy to the SEC. He filed a whistleblower claim years later.

Bass brought his concerns about UDF, a Texas real estate firm, directly to the FBI and SEC before attacking UDF in a series of anonymous posts online. Those posts tanked UDF’s value and led to a string of allegations and lawsuits.

Bass claimed vindication when four UDF executives were convicted of securities fraud and other crimes and sentenced to federal prison for a total of 20 years.

The case is Bass v. SEC, 5th Cir., No. 22-60674, 12/29/22.