The U.S. Supreme Court's decision not to take up a whistleblower award calculation appeal has highlighted a long-running concern that whistleblowers could be left out in the cold if the company they expose falls into bankruptcy before they get awards to which they would otherwise be entitled.

Earlier this month, the high court declined to take up John Barr and John McPherson's request to review the U.S. Securities and Exchange Commission's calculation of their whistleblower awards under the Dodd-Frank Act. The pair received a combined $26,000 for assisting the SEC's investigation into Life Partners Holdings Inc., which was ordered to pay $38.7 million in disgorgement and civil penalties for defrauding life settlement investors.

But Barr and McPherson argue they were entitled to much more. The SEC's whistleblower program promises to pay between 10% and 30% of monetary sanctions collected in actions brought by the agency and related actions brought by other regulatory authorities. The SEC argued it was only able to obtain a small portion of the judgment against Life Partners because the company declared bankruptcy shortly after the judgment was handed down, and the Fifth Circuit agreed last year.

While some attorneys told Law360 the Fifth Circuit's decision likely won't have a wide-ranging impact on whistleblowers because of the unique circumstances of the case, Katz Whistleblower Law LLC head Rebecca Katz said the case exemplifies a tactic corporations can use to voluntarily carry out "an end-run around paying an SEC judgment and paying a whistleblower."

"Limiting awards to deserving whistleblowers because defendants voluntarily go into bankruptcy really is harmful to informants and has a deterrent effect on whistleblowers," Katz said. "It doesn't happen all the time, but it happens enough to be a real problem."

A Chilling Effect?

McPherson and Barr had argued that the SEC violated its own whistleblower rules under the Dodd-Frank Act by denying them a higher recovery than Barr's 5% and McPherson's 20%, especially given that the agency led the way on appointing a bankruptcy trustee who eventually recovered $1 billion for investors.

After the Supreme Court declined to take up his case, McPherson said the decision effectively killed the SEC's whistleblower program, noting attorneys will not want to spend several years pursuing major fraud cases when the prospect of a bankruptcy filing could eliminate any award payment.

Katz noted the SEC has long held the position that whistleblowers can't collect awards from bankruptcies, calling it a problem that has existed since 2020. During that year, the SEC amended its whistleblower rules to replace the standard for whistleblower recoveries. Whistleblowers were previously entitled to a percentage of the amount the commission would be "able to recover," but the amendments narrowed that standard to a percentage of the money the commission and other entities actually "collected."

Barr and McPherson argued in their petition to the Supreme Court that the SEC "could have collected on its judgment, but chose instead the expedient of routing the collection for investors to a bankruptcy trustee."

Speaking to Law360, Katz said, "This issue with companies going into bankruptcy and whistleblowers not getting paid — it's just not new. It hasn't happened to me, but I've heard colleagues of mine complaining about it for years."

Katz also said an appellate court has never overturned an SEC whistleblower award decision. But the Barr case marks the first time the matter has come through the Fifth Circuit and been denied by the high court, she said.

She said that while paying whistleblowers is important to the agency, the SEC's main goal is getting injured investors their money back. In Barr and McPherson's case, the SEC subordinated a claim in bankruptcy to allow victims to recover funds first, reducing the pool of funds the agency could use to pay out whistleblower awards.

The case exposes a large flaw in the SEC's whistleblower rules, she said.

"I think it's a real problem, and I do think that it will deter people from reporting," Katz said, adding that while it's been happening for years, it's becoming more publicized. That attention will lead to more companies weighing voluntary bankruptcy when they are hit with large fines and penalties, she predicted.

She said the SEC should clarify its rules to allow for whistleblowers to receive awards based on funds recovered in bankruptcy, calling it an unfair result otherwise. Congress could also change the relevant statute, but neither Congress nor the SEC is likely to prioritize this issue anytime soon, she added.

Barr told Law360 he believes the SEC's 2020 amendments "provided bad actors with a roadmap to silence whistleblowers in SEC enforcement actions that could ultimately end up in bankruptcy."

He said firms could use the potential of bankruptcy to steer whistleblowers away from reporting and into a settlement that keeps them quiet. He also thinks bankruptcy is a tactic companies use to get out of paying whistleblowers and that these scenarios will have a deterrent effect on whistleblowers.

In response to a request for comment on this story, an SEC spokesperson said the agency's public affairs office "is not able to respond to many inquiries from the press" due to the government shutdown.

Stephen M. Kohn, founding partner of whistleblower firm Kohn Kohn & Colapinto and chairman of the National Whistleblower Center, said he completely disagrees with the SEC's position that money paid out in bankruptcy does not qualify for whistleblower awards. Those funds should instead be "Dodd-Frank eligible" as collected proceeds, he said.

Kohn said the Dodd-Frank Act defines the kinds of proceedings through which whistleblowers can receive awards, including through a "judicial action." While the SEC doesn't think bankruptcy is a covered proceeding, whistleblowers have argued those proceedings should fall under judicial actions.

"If a whistleblower had revealed the [Bernie] Madoff scandal under Dodd-Frank and did everything they were supposed to do, it would be outrageous to think that they would not get an award," Kohn said, referencing the disgraced Wall Street titan who masterminded the largest Ponzi scheme in history. "It's very detrimental to what I would call some of the worst types of frauds that you want to encourage whistleblowers to come forward on."

He added that Congress passed Dodd-Frank "in large part because of the Madoff scandal," noting also that convicted fraudster Madoff's investment firm went bankrupt.

"You now mean to tell me that Congress somehow intended that that case would have been excluded from the whistleblower law?" Kohn said. "It's kind of a contradiction there."

Kohn also said he anticipates fewer whistleblowers will want to come forward in the future. It's common for large fraud cases to involve criminal charges and bankruptcy, he said, adding fraudsters who file for bankruptcy can protect certain assets.

"If you hate the whistleblower, you're definitely incentivized to go bankrupt," he said. "You may be going to jail, but you'll make damn sure the whistleblower doesn't get a penny."

Kohn said that type of "vengeance" exists in every whistleblower case, adding "the targets of the whistleblower hate the whistleblower."

"If going bankrupt is a way to make sure the whistleblower never collects a penny, they'll be lining up to do it," he continued.

Kohn said the issue is "not an open-and-shut case," predicting the SEC's position will be challenged in the future. But those will be tough cases, he added, and they won't be "big profitable ones."

A Limited Impact

Some attorneys had a different upshot of letting the Fifth Circuit's opinion stand. Jane Norberg, a partner at Arnold & Porter Kaye Scholer LLP and former chief of the SEC's whistleblower office, said she wasn't surprised the high court declined to take up this case, noting the whistleblowers did receive payments, albeit not as much as they had wanted.

She explained that the SEC can pay whistleblower awards on amounts collected on its own enforcement actions, as well as other judicial, administrative and covered actions, such as matters brought by the U.S. Department of Justice.

"The SEC argued, and the Fifth Circuit ultimately agreed, that the bankruptcy case did not qualify as an action brought by one of the enumerated entities for which the SEC could pay an award," Norberg said.

But she said she doesn't think the case will have a long-term chilling impact on the SEC's whistleblower program.

"I don't know how often there's a bankruptcy proceeding where this very specific set of facts and circumstances would apply, where the trustee collects the money and returns it to the investors," Norberg said. "This is very unique."

Erika A. Kelton, a partner at the whistleblower firm Phillips & Cohen LLP, also predicted the impact of the case won't be far-ranging. That's because of the case's unique set of circumstances that hasn't arisen in previous cases, as far as she knows.

"I wish that the result was different. I wish that the SEC had exercised some discretionary power that they have to provide an award, because those whistleblowers, I think, deserved it," Kelton said. "But it was just this unfortunate set of facts and unfortunate timing, and I do hope that it's fixed so that doesn't happen again in the future."