Second Circuit finds no error in SEC's denial of whistleblower claim

On July 21, 2022, the US Court of Appeals for the Second Circuit rejected a whistleblower claimant’s petition for review of the US Securities and Exchange Commission’s denial of his reward application despite the claimant’s information having resulted in large settlements by agencies other than the SEC.

The Court accepted as reasonable the SEC’s determination that neither enforcement actions brought by agencies other than the SEC, nor settlements secured by those agencies, nor the investigative or information-sharing activities undertaken by the SEC, qualify as judicial or administrative actions brought by the SEC within the meaning of Section 21F of the Securities Exchange Act of 1934, 15 USC § 78u-6; nor are the settlements “related actions” within the meaning of the statute.

The claimant, Victor Hong, was employed by RBS Greenwich Capital Markets, Inc., a subsidiary of Royal Bank of Scotland Group plc, for a short time in late 2007.   According to Hong, he resigned because of the illegal practices he observed there.  In 2014, Hong submitted information about these practices to the SEC, and the SEC communicated the information to both the US Department of Justice and the Federal Housing Finance Agency (since the misconduct was connected with residential mortgage-backed securities).  At the time, these agencies had already initiated investigations of the bank’s residential mortgage backed securities practices, and, following receipt of Hong’s information, the DOJ and FHFA issued a subpoena for relevant documents, and interviewed Hong. 

In 2015 and 2016, Hong submitted applications to the SEC’s whistleblower awards, but the SEC rejected the applications as deficient, in that they did not identify a published “Notice of Covered Action” relevant to Hong’s claims as required by Section 21F.  In 2017 and 2018, the DOJ and FHFA entered into settlements with RBS to resolve the residential mortgage-backed securities investigations, and as a result the bank paid over $10 billion.  The SEC, however, denied Hong’s Section 21F application to the SEC for an award of 10-30 percent of the settlement amount on the grounds that the DOJ and FHFA settlements did not constitute “covered judicial or administrative actions” or “related actions” within the meaning of Section 21F.  In 2019, following the DOJ and FHFA settlements, Hong submitted a third whistleblower award application, listing the DOJ settlement with RBS as the “covered action” on the claim form.  The SEC rejected this claim for the same reason as the earlier applications – that it did not identify a covered action and could not be processed.  Following discovery requests from Hong, and the issuance of both a preliminary determination (recommending denial of Hong’s claim), and a final determination by the SEC, Hong petitioned the Court of Appeals for the Second Circuit to review the denial.

The Court noted that it must apply the “arbitrary, capricious [or] abuse of discretion” standard of review described by Section 706 of the Administrative Procedure Act, and accord deference to the SEC’s interpretation of ambiguities in the Securities and Exchange Act as long as the agency’s interpretation of the statute is reasonable.  Neither the facts – including the agencies’ use of materials provided by Hong – nor the procedure applied by the SEC, were in dispute.  Therefore, pursuant to the two-step framework established in Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984), the question before the Court was whether the SEC’s interpretation of the words “covered judicial or administrative action by the Commission” and “related action” was either inconsistent with congressional intent, or arbitrary and capricious on the part of the agency.

In its Chevron step one analysis, the Court found that the congressional intent underlying the term “judicial or administrative action” was not altogether unambiguous; nevertheless, the context and the plain language of the statute do not mandate the claimant’s expansive interpretation of the term as including evidence-sharing and interagency coordination.  Proceeding to Chevron step two, the Court examined whether the SEC’s interpretation of the statute was reasonable.  Hong argued that it was not, pointing to the SEC’s 2020 amendment of the definition of “administrative action” to include certain non-prosecution, deferred-prosecution and settlement agreements, and to the SEC’s comment during the rulemaking process that “Congress did not intend for meritorious whistleblowers to be denied awards simply because of the procedural vehicle [selected for pursuit of an enforcement matter].”  The Court answered this argument by differentiating between negotiated settlement agreements and the range of actions taken by an agency while conducting an investigation.  And while not disagreeing with Hong’s assertion that Congress’ intent was to encourage rather than to dampen whistleblowers’ claims, the SEC’s interpretation was not unreasonable.  Likewise the Court found reasonable the SEC’s interpretation of the phrase “brought by the Commission” to mean that the SEC must have filed or prosecuted a lawsuit, initiated an administrative proceeding, entered into a settlement, and received a sanction payment.  Furthermore, the SEC’s understanding that an action brought by the SEC is prerequisite to a “related action” within the meaning of the statute is not unreasonable.

Having found no error in the SEC’s interpretation, the Court denied the petition for review.

Opinion 

 

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