The Rise of Whistleblower Tips (and Rewards) for Crypto Sleuths

by Arthur · February 17, 2023

Whistleblowers are often viewed as insiders at public companies who report alleged wrongdoing such as insider trading, market manipulation, submission of false or misleading company information or other violations of securities and commodities laws. The rise of the digital asset industry, and the growing number of crypto companies using public blockchains, has changed this paradigm. Now anyone with the time, skill, and inclination can audit every transaction on a public blockchain, and the concept of the “traditional” whistleblower has greatly expanded in this relatively unregulated space.

The Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) have not only embraced this change, but have specifically identified crypto whistleblowers as an important part of their regulatory and enforcement regimes. The effort to round up potential flaws in cryptographics appears to be working, as crypto-related whistleblowing tips reached an all-time high in 2022 and were among the top categories of tips received. This trend is likely to continue in 2023, as members of this largely self-serving ecosystem decide to monetize their investigative prowess amid heightened regulatory focus on crypto.

I. The SEC and CFTC Whistleblower Programs

The SEC and CFTC whistleblower programs were established in 2010 by Congress through the passage of the Dodd-Frank Act. These post-2008 financial crisis programs were intended to encourage people to report possible violations of securities and commodities laws by compensating individuals who provided tips that led to successful enforcement actions. Along with the potential for financial compensation, the SEC and CFTC whistleblowing programs also provide certain privacy, confidentiality and anti-retaliation protections for whistleblowers.

A “whistleblower” is a person (not a company) who voluntarily provides “initial information” about a potential violation of the law that has occurred, is ongoing, or is about to occur. Whistleblowers may qualify for compensation where the information provided is “original,” meaning that the information is: (i) derived from independent knowledge or analysis; (ii) not already known to the Commission; and (iii) not derived solely from another source such as a judicial hearing, government report or from the news media.

Whistleblowers who provide “independent analysis” of publicly available information may also be entitled to compensation. This requires more than just pointing out the obvious – the independent analysis must uncover possible breaches that are not readily apparent from public material. For example, a tip based on an analysis of multiple public sources may qualify as independent analysis where the information cannot be readily identified by a member of the public without specialized knowledge, unusual effort, or significant expense.

To be eligible for compensation under the SEC and CFTC whistleblower programs, the whistleblower’s tip must lead to successful enforcement resulting in the recovery of penalties in excess of $1 million. In these cases, the tipster is entitled to an award of 10-30% of the penalties collected by the SEC/CFTC. The size of the final award is subject to the discretion of the regulators and depends largely on the significance of the information provided, the level of assistance provided, the extent to which the whistleblower was culpable for the violations in question, and the amount recovered. .

A whistleblower may also be entitled to compensation as a result of related actions. That said, potential whistleblowers are not able to “double-dip” by getting out of both the SEC and CFTC whistleblower programs based on the same tip. See 17 CFR § 165.11(b) (CFTC rule provides that no award is permitted “if the claimant has already received an award by the SEC”); 17 CFR § 240.21F-3 (setting forth restrictions on multiple recoveries in related actions).

Finally, the SEC and CFTC provide confidentiality and protection from retaliation for those who submit information to the commissions. Companies that retaliate against whistleblowers may be subject to separate, independent enforcement actions (and fines) as well as lawsuits by whistleblowers who have a private right of action enabling them to recover back pay, damages, legal costs, expert witness fees, reasonable . legal fees and reinstatement of employment.

II. Crypto applicants may be eligible for whistleblower compensation

Whether the SEC or the CFTC will emerge as the lead digital asset regulator is an open question. Along with asserting jurisdiction over misconduct in the digital asset market, both regulators have openly solicited tips from whistleblowers regarding potential crypto wrongdoing. In fact, the SEC and CFTC have stated that crypto-related breaches are exactly the type of misconduct they are interested in learning about.

For example, the SEC specifically includes “Initial Coin Offerings and Cryptocurrencies” in its list of examples of the types of conduct the SEC is interested in receiving tips from whistleblowers. The SEC has also made public calls for continued cooperation and whistleblowing opportunities in connection with the announcement of its latest enforcement actions.

For its part, the CFTC issued a whistleblower alert “Be on the Lookout for Virtual Currency Scams” informing the public of how individuals may be eligible for financial rewards and protections “while helping to stop fraud and manipulation related to virtual currencies.” Importantly, the CFTC’s Alert explains that virtual currencies are commodities under the Commodity Exchange Act (CEA) and when virtual currencies are “used in a derivative contract, or if there is fraud or manipulation involving a virtual currency traded in interstate commerce, CFTC enforcement of CEA comes in.”

These whistleblowing programs make it clear that regulators are looking for leads to initiate their enforcement actions. Whether these tips are based on suspected market manipulation, insider trading, Ponzi schemes, money laundering, or other potential wrongdoing, the SEC and CFTC are interested. From the perspective of the source of whistleblower tips, the digital asset space is different from traditional finance because those with the time, skills and resources can monitor and analyze public blockchain transactions to identify potential fraud. Although transactions on a blockchain may be public, analyzing data to uncover potential wrongdoing will almost certainly constitute compensable “independent analysis” under the SEC and CFTC programs. Although a whistleblower’s information is kept confidential, a number of crypto-related insider trading investigations have been reported to have started with tips from crypto speculators who monitor public blockchain activity. Whether these blockchain tipsters have attempted to monetize their collaboration is unclear.

III. Crypto alert tips are on the rise

As the SEC and CFTC battle for the role of the primary crypto regulator, it is clear that the regulators’ whistleblowers have been extremely effective in generating crypto-related tips. Because the SEC and CFTC keep the identities of whistleblowers confidential, it is not known whether these complaints have resulted in successful enforcement actions, but the data show that these programs do indeed attract tips.

In 2022, the SEC reported receiving its largest number of whistleblower tips – more than 12,300. Complaints regarding initial coin offerings/cryptocurrencies were the third most common category of complaints to the SEC behind manipulation and offering fraud. The 2022 numbers show an increase not only in overall tips, but the percentage of crypto-related tips year over year:

2022: 12,322 total – 1,719 (14%) Crypto or ICO related
2021: 12,210 total – 762 (6.2%) Crypto or ICO related
2020: 6,911 total tips – 345 (5%) Crypto or ICO related

In total, the SEC whistleblower program awarded approximately $229 million in awards in 2022, which was the SEC’s second largest year for awarded dollars. How much of the money was paid out specifically to crypto tipsters is unclear.

The CFTC’s 2022 report revealed a similar trend, with increases in the total number of whistleblower tips and crypto-related tips. In 2022, the CFTC received 1,506 tips, which was a 50% increase over 2021. Notably, the majority of tips the CFTC received in 2022 “involved fraudulent understatement and fraudulent solicitation involving crypto/digital assets (eg, representations of opportunities , or refusal to accommodate withdrawal requests).’

The digital asset industry continues to deal with near-constant industry turmoil, high-profile scandals, and regulators eager to crack down on perceived illegal activity in this space. Accordingly, 2023 is expected to be another record year for crypto whistleblowers, and the SEC and CFTC will certainly be interested in hearing from blockchain scouts and those who can spot potential flaws.

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