Madoff-Inspired Whistleblower Program Stiffs Big-Money Tipsters (1)

Nine years have passed since David Danon began helping SEC investigators build a case against Vanguard, uncovering information about a scheme that led the company to return to its investment funds more than $2 billion that had been hidden in a bid to avoid taxes.

The Texas comptroller’s office rewarded Danon for his work, and the Securities and Exchange Commission twice filed legal briefs on his behalf, arguing that whistleblowers must be protected.

But when it came time to get paid, the SEC Office of the Whistleblower stopped returning his calls, according to a July federal court filing.

Danon’s allegations fit a pattern in the agency’s handling of several high-dollar cases involving banks, pharmaceutical companies, and investment houses, a Bloomberg Law review of lawsuits and agency documents shows. The agency has opened investigations and worked with whistleblowers for years, or passed their information on to other agencies that recouped money, then refused to provide details on why it denied their claims.

Despite the SEC’s hype over the occasional huge award, many of the big financial fraud cases the program was built to prevent may slip through the cracks or are passed on to other agencies, attorneys say. The program, set up in the wake of Bernie Madoff’s $64.8 million Ponzi scheme, received about 12,000 tips last year.

A Bloomberg Law analysis found that less than 1% of the more than 54,000 tips in the program’s history have resulted in an award.

The SEC has not responded to Danon’s allegations in court and declined to answer Bloomberg’s written questions about the case, citing the ongoing litigation. The agency also declined to answer questions about funding, resources, or why large cases get passed to other federal agencies.

Tips are always treated with respect and the information provided by informants “has proved to be a powerful weapon in our law enforcement arsenal,” an SEC spokesperson said in a statement released late Wednesday.

“As a result of this information, we have been able to minimize harm to investors, better preserve the integrity of the United States’ capital markets, and more swiftly hold hundreds of corporations and those responsible for unlawful conduct accountable,” the statement read.

The program has awarded more than $1.3 billion to about 280 whistleblowers since 2011 and recouped about $5 billion for investors and victims.

Whistleblowing corporate executives, managers and their attorneys say they are kept in the dark for years. The cases remain hidden behind the agency’s secrecy rules, providing no information about how the commission reached its decisions.

Supporters of the program say SEC enforcement staff are hampered by rules keeping them from talking about investigations, and that Congress hasn’t provided enough funding to hire more staff.

Details about the crime or companies involved only come out when unpaid whistleblowers file lawsuits, as happened with investigations into Vanguard, Teva Pharmaceuticals, Royal Bank of Scotland, and Bank of America.

“The Commission has … utterly refused to tell anyone exactly what it did consider in rendering its decisions,” attorneys for a Bank of America whistleblower argued in a 2020 appeal. Their client, identified only as John Doe, won a settlement in a $50 million False Claim Act case against Bank of America but was denied an award by the SEC.

Darkness then Silence

Danon, a former in-house tax counsel for the Vanguard Group, makes similar claims in his July petition over the SEC’s lengthy delay in his case. He filed a whistleblower complaint in May 2013, around the time Vanguard fired him over what he claims were his internal complaints over an illegal “slush fund” set up to avoid taxes and harm its investors.

Vanguard stopped the fraudulent tax scheme in 2015 in response to the work done by Danon and SEC investigators, returning more than $2 billion to its fund accounts, the lawsuit said.

That’s exactly what Congress had in mind when it created the program, Danon argued in court. He is asking a federal judge to order the SEC to provide an update, and to issue a “Notice of Covered Action,” which starts the whistleblower award process after an investigation brings results. Without that notice, informants can’t file a claim.

“The SEC in nine years has not even issued the basic report it is obligated by law to issue under these circumstances,” Danon’s attorneys wrote in a July 25 federal court filing. “This situation is anathema to the proper application and ultimately the success of the SEC Whistleblower Program. It comes at a time when the Whistleblower Program is already under the glare of Congress, the whistleblower community and commentators for widespread delays and lack of transparency.”

Danon’s cooperation continued for years, according to the July court filing, and involved the highest ranks of the agency.

In 2015 and 2016 he worked with several then-SEC officials, including former Director Sean McKessy, then-Deputy Chief Jane Norberg and Nikkia Wharton, currently senior counsel in the SEC’s Division of Enforcement.

“Danon and his counsel also provided extensive information to these officials over a sustained time period, including without limitation an account of Vanguard’s violations,” according to the petition.

After his complaint to the SEC, Vanguard got rid of its reserve fund, according to Danon’s petition.

That’s when the SEC officials cut off all contact.

Besides asking the D.C. Court of Appeals to order the SEC to issue a Notice of Covered Action, Danon’s filing accuses the agency of being dishonest in its dealings. At one point, he asserts, the agency said it would take three years to fulfill his public records request for his file because it was so voluminous. A few years later, when he made the same request, Danon was told it had no responsive documents.

No Checks on the System

In court documents and interviews, attorneys argue that the agency’s secrecy and inconsistency hurt the program. Maybe some seemingly contradictory denial and award decisions are justified, but because the orders and decisions are all done in secret, there is no way to make sure the awards are impartial, they argue.

When cases are appealed, SEC staff simply file an affidavit saying whether the informant helped build the case, without supporting documents. The D.C. Circuit Court of Appeals has consistently said those declarations are proof enough to uphold the decisions.

“I believe that opacity, combined with a lack of procedural mechanism for meaningful judicial review, means that many attorneys in my position are less inclined to file these cases than the drafters of the law would have hoped,” said Roland W. Riggs of Kreindler & Associates in New York, who participated in the Bank of America appeal.

The Bank of America case lasted for years before the bank agreed on August 21, 2014 to pay $16.6 billion to the U.S. government, including $245 million to the SEC, to settle fraud claims stemming from its sale of residential mortgage backed securities.

More than five years later, the SEC rejected the claims of eight whistleblowers in the case, according to court records and SEC final orders issued on December 5, 2019.

One of them, referred to as John Doe Claimant 5, received an award from the DOJ for his contributions and sought a second one from the SEC, as allowed under the rules. In 2012, he met with SEC investigators, who told him they were part of a task force on the matter led by the DOJ.

The whistleblower spent years working with the task force and was awarded about $12 million for providing information that led to a $50 million False Claims Act settlement between the DOJ and Bank of America. Then he applied for an award with the SEC, assuming his years of work and reams of documents given to the task force would count.

The SEC disagreed, telling his attorneys that it didn’t use his information and that anything he gave to the DOJ first could not be counted as information provided to the SEC. It refused to provide any records supporting his decision, the whistleblower’s attorneys wrote.

“After the Petitioner spent years assisting the Task Force, the SEC failed to provide even a cursory explanation of its Preliminary Determinations,” attorney Clifford Marshall wrote.

Agency attorneys also told the federal appeals court judges that its rules prohibit payments to anyone who gives information exclusively to another federal agency, even if the whistleblower is already working with the SEC. The appeals court ultimately agreed and dismissed John Doe’s complaint.

Marshall said the agency refused to provide documents or any information about his client’s case, making a meaningful appeal impossible.

“There is nothing transparent about the process; it’s a black box where they keep information away from the whistleblower and keep them waiting for years,” said Marshall, a former assistant U.S. attorney who oversaw the FCA program in North Carolina and now represents whistleblowers.

Resources and Resentment

To be sure, some huge awards have gone to whistleblowers.

In September 2021, a client of former SEC senior counsel Rebecca Katz, now at Motley Rice, received $110 million, and another of her clients received $36 million. Clients of former SEC assistant chief litigation counsel Jordan Thomas, who helped create the whistleblower program before going into private practice, were awarded $83 million in a March 2018 case.

Clients of firms employing three former SEC attorneys have received at least $420 million — nearly one-third of all money awarded — according to agency records obtained by Bloomberg Law chronicling payouts between 2011 and 2020, and four months in 2021.

But those cases are rare and distort the reality of what’s facing most whistleblowers, attorneys said.

Aegis Frumento, a partner at Stern Tannenbaum & Bell in New York, points to three reasons that many potentially large whistleblower cases go without a payout: a lack of agency resources to investigate and pay big awards, a resentment of professional enforcement staff toward outsider whistleblowers, and apparent cronyism favoring a small group of former SEC attorneys.

“My experience is you bring them great evidence about shenanigans inside a major company … (it) gets into the hands of actual enforcement staff, they interview your client, then at the end of the day, they say, ‘It was a great case, but we just don’t have the resources to pursue it,’” said Furmento, who praised the line SEC investigators he’s dealt with. “Resources are a real issue for them.”

Congress needs to amend the law to allow private attorneys to bring lawsuits when the agency takes no action, as is allowed under the Justice Department’s False Claims Act, Furmento and other attorneys said. That ensures attorneys and clients only push ahead with the strongest cases, while still guaranteeing whistleblowers 10% to 30% of any money recovered, they said.

“The principal problem with the whistleblower program is the SEC’s discretion to bring cases, because most of the tips wind up in a black hole with no action taken,” Frumento said.

One of the largest U.S bank fraud investigations followed a tip to the SEC by Victor Hong, a managing director at the Royal Bank of Scotland, which led the bank to pay $10 billion to settle U.S. government claims over its handling of mortgage-backed securities and other financial instruments. The SEC passed his information on to the Department of Justice and the Federal Housing Finance Agency, which worked with Hong for years.

But the SEC took no action on its own. In court, agency attorneys argued they could not pay when a whistleblower’s information led to a successful case for another agency. The statute prohibited the SEC from paying Hong and others, it argued. In June, the Second Circuit Court of Appeals agreed that the SEC acted reasonably and in good faith when it denied his claim, while sympathizing with his situation.

Hong’s attorney, Richard Corenthal, called on Congress to pierce the secrecy surrounding the agency’s award process.

“Congress needs to conduct an oversight hearing to redress these arbitrary actions in violation of Dodd-Frank and Congressional intent,” Corenthal said.

New York attorney Oliver Budde, whose client Peter Sivere has a pending tip against Barclays Bank, said the agency’s treatment of its most high-profile tipsters damages the entire program.

“It’s so dispiriting when you have reputable people like Victor Hong, David (Danon) where their information is clearly valid and being used, not getting paid for all their work,” Budde said. “In these bigger cases, people are putting well-paying jobs and careers on the line because they are trying to do the right thing, and they should be protected and rewarded. If this program is going to do what it’s supposed to do, we need to see more big cases being brought.”