The Securities and Exchange Commission's bounty program for rewarding whistleblowers is sorely in need of an overhaul, according to the agency's Inspector General, which issued nine recommendations for improving the program.

An OIG review of the program, which stemmed from an issue identified during its investigation of the SEC Madoff examination and investigations, concluded that the current bounty program "is not fundamentally well designed to be successful."

The main problems with the program, as detailed in the March 29 report, are that no one is aware of it, and that it applies to too narrow a swath of cases to be of much use, according to the report.

Currently, under Section 21A(e) of the ‘34 Exchange Act the SEC is authorized to award a bounty to a person who provides information leading to the recovery of a civil penalty from an insider trader, from a person who tipped information to an insider trader, or from a person who directly or indirectly controlled an insider trader. Bounty determinations, including whether, to whom, or in what amount to make payments are within the SEC's sole discretion, and the total bounty can't exceed 10 percent of the amount recovered from a civil penalty pursuant to a court order.

"The SEC bounty program is limited to insider-trading cases and the stated criteria for judging bounty applications are broad, somewhat vague, and not subject to judicial review," the report states. "Moreover, there is no entitlement to a reward even if the whistleblower's information causes the government to recover money from wrongdoers."

Among other things, the OIG report says improvements are needed to make the application process more user-friendly and help ensure that applications provide detailed information about alleged securities law violations.

Among the issues identified, the OIG said the criteria for judging bounty applications are broad; the SEC hasn't put in place internal policies and procedures to assist staff in assessing whistleblower contributions and making award determinations, and the Commission doesn't routinely provide status reports to whistleblowers regarding their applications, even if the information led to an investigation. While applications are generally acknowledged and forwarded to appropriate staff for further consideration, they aren't tracked to ensure they are timely and adequately reviewed, and files regarding bounty referrals didn't always contain complete documentation, according to the report.

Although the SEC has had a bounty program in-place for more than 20 years, there have been few payments made and few applications received, because the program isn't widely recognized inside or outside the Commission, according to the OIG report.

Since the inception of the program in 1989, the SEC has paid a total of $159,537 to five claimants, all of which were for the 10 percent maximum amount permitted by statute. The SEC formally denied five bounty applications since the program's inception.

According to the report, from Jan. 1, 2005, to Jan. 1, 2010, the SEC received approximately 30 other bounty applications, but didn't formally take action to approve or deny them and didn't notify the applicants. SEC staff said that's because the agency only makes a formal determination and provides notice when the information results in the recovery of an insider-trading civil penalty in accordance with the Exchange Act.

As noted in the report, the SEC is seeking expansion of its authority to permit bounties for any judicial or administrative action brought under the securities laws that results in monetary sanctions exceeding $1 million. Proposed legislation was included in the Investor Protection Act (H.R. 3817) introduced in the House last October and referred to the House Financial Services Committee. Variations of the bill are being considered by the House and Senate.

The SEC is already overhauling its entire system for handling all tips and complaints as part of its sweeping post-Madoff reforms. The SEC hired The MITRE Corp. last year to review its internal procedures for evaluating tips, complaints, and referrals. Last August, it created the Office of Market Intelligence, Enforcement's liaison to the agency's tip, complaint, and referral process and system.

The nine recommendations detailed in the report are:

(1) Develop a communication plan to address outreach to the public and staff about the bounty program, including efforts to make information available on the SEC's intranet, enhance information on the SEC's public Website, and provide training to employees who are most likely to deal with whistleblower complaints.

(2) Develop and post to its Website an application form asking whistleblowers to provide specific information, such as the facts pertinent to the alleged securities law violation and explanation as to why the whistleblower believes the subject(s) violated the securities laws and a list of related supporting documentation.

(3) Establish policies on when to follow-up with whistleblowers to clarify information and obtain available supporting documentation prior to making a decision on whether a complaint should be further investigated.

(4) Develop specific criteria for recommending the award of bounties, including a provision that where a whistleblower relies partially on public information, it won't preclude them from receiving a bounty.

(5) Examine ways to increase communications with whistleblowers by notifying them of the status of their requests without releasing non-public or confidential information during the course of an investigation or examination.

(6) Develop a plan to incorporate controls for tracking tips and complaints from whistleblowers seeking bounties into the development of Enforcement's tips, complaints, and referrals processes and systems for other tips and complaints.

(7) Require a bounty file to be created for each application, containing, at a minimum, the application, any correspondence with the whistleblower, documentation of how the whistleblower's information was utilized, and significant decisions made related to the complaint.

(8) Incorporate Department of Justice and Internal Revenue Service best practices into the program with respect to applications, analysis of information, tracking complaints, recordkeeping practices, and continual assessment of the program.

(9) Establish a timeframe to finalize new policies and procedures for the bounty program that incorporates the best practices from the DoJ and the IRS as well as any legislative changes.

In his response, Enforcement Division Director Robert Khuzami noted that the Division's independent findings and plans for developing a new whistleblower program are consistent with those set forth in the report.

Khuzami noted that the vast majority of insider-trading cases arise from routine surveillance performed by the SEC staff and the Self-Regulatory Organizations, not public tips. For example, 31 of the 37 insider-trading actions brought by the Commission in FY 2009 were the result of surveillance by the SROs or the Division.

"We believe the principal reason that the current bounty program has not yielded more rewards derives more from its relatively narrow scope and the confidential nature of insider-trading violations than from the procedural shortcomings we recognize exist," Khuzami wrote. "... While we concur with the recommendations, it is our hope that pending legislation ... will create a new program wholly replacing the current one."

In that case, he noted, "We believe it would be appropriate to address many of the recommendations ... through enactment of policies and procedures involving the agency's new authority as opposed to embarking upon modifications of the current insider-trading bounty program, which we hope will soon be superseded."

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