Whistleblowers Who Exposed $1 Billion Fraud Denied SEC Windfall

Three whistleblowers who exposed a massive insurance fraud and helped secure a $1 billion bankruptcy court settlement aren’t entitled to any of that money, according to an SEC decision being challenged in two federal lawsuits.

The whistleblowers worked with the Securities and Exchange Commission for years and provided information that “significantly contributed” to the successful sanctioning of a Texas viatical company, the SEC wrote in a March 27 final order. But because the money was recovered through a bankruptcy proceeding, the law as written means the whistleblowers can’t be paid, the commission ruled.

One of the whistleblowers, John Barr, was the SEC’s lead witness in court when it successfully petitioned a federal court judge to install the agency’s own choice to become bankruptcy trustee. That trustee won the settlement with Life Partners Holdings in 2016, weeks after filing a report that concluded “Investor dollars have been lost because of the fraud and rampant self-interest and self-dealing,” of company directors.

Read More: Wall Street Whistleblowers Tip Off SEC — But Hear Nothing Back

The whistleblower program provides for tipsters to receive up to 30% of any money recovered from a successful SEC investigation. The agency has awarded more than $1.5 billion since the program’s inception, including payouts of more than $100 million to individual whistleblowers.

But last month the SEC told Barr and the other, unidentified, whistleblowers that they can’t get any money recovered through bankruptcy. Instead, they are left to split $31,000 – money collected before Life Partners went bankrupt. The company filed for bankruptcy in 2015 after a judge ordered it to pay $46.8 million to the SEC following a civil jury trial.

The SEC didn’t respond to requests for comments on the lawsuits or its decision.

“As we noted in connection with the adoption of several rule amendments, our statutory authority does not extend to paying whistleblower awards for recoveries in bankruptcy proceedings,” the commission wrote in the March order, referencing a finding the agency issued in September, 2021, more than nine years after SEC first charged Life Partners.

Barr and one of the other whistleblowers, identified only as John Doe, filed separate lawsuits in federal appeals courts this week seeking to overturn the SEC’s ruling.

“Mr. Barr respectfully submits that the order is unlawful and defective on multiple grounds, including that it is arbitrary and capricious, an abuse of discretion (and) unsupported by evidence,” Barr’s attorneys, Kevin Edmundson and Daniel Geyser, wrote in their initial petition to the U.S. Court of Appeals for the Fifth Circuit last week. A full pleading is expected within the next few weeks.

Doe brought his suit in the D.C. Circuit.

Written into the Dodd-Frank financial reform law of 2010, the whistleblower law was created to make sure tips about financial wrongdoing aren’t ignored, as they were before Bernie Madoff’s $64.8 billion Ponzi scheme unraveled.

Harry Markopolos, a financial analyst and securities fraud investigator, spent years warning the SEC about Madoff’s fraudulent scheme, only to be ignored by the agency. He inspired lawmakers to create the program and in 2018 urged the commission to address a law he said was “unclear, and seemingly fails to address a critical gap in cases that settle and/or go into federal bankruptcy court instead of receivership.”

“Remember, it is the largest, most widespread frauds that bankrupt companies, and the Commission does not want to be in a position of discouraging whistleblowers from bringing cases that may result in such a proceeding,” Markopolos wrote, pointing to Life Partners and WorldCom, a telecom fraud from two decades earlier.

Madoff’s company went into bankruptcy days after it was exposed, and the approximately $15 billion recovered for investors since then has come through bankruptcy proceedings. That means even Markopolos could not have been paid under the current rules, Washington attorney Jason Zuckerman said.

“The law should be amended to clarify that money recovered from a bankruptcy after a whistleblower’s disclosure should be eligible for an award. That should be considered monetary sanctions that would count toward an award,” Zuckerman said.

A House bill introduced in 2021 that would have expanded the law to include bankruptcy recoveries died without a vote.

The cases are Barr v. SEC, 5th Cir., No. 23-60216, 4/25/23 and Doe v. SEC, D.C. Cir., No. 23-1121, 4/25/23.