Friday, May 05, 2023

Does a bankruptcy foreclose whistleblower recovery? Two claimants say no

By Anne Sherry, J.D.

Two claimants that blew the whistle on a massive fraud at Life Partners Holdings are challenging an SEC order calculating the maximum whistleblower award at $32,000. Life Partners filed for bankruptcy after a federal court ordered the company and two individuals to pay $46 million in penalties and disgorgement to the SEC. According to the SEC in the challenged order, the claimants are entitled to an award based only on what the SEC actually collected prior to the bankruptcy (Barr v. SEC, April 25, 2023).

Fraud and bankruptcy. In December 2014, a jury found that Life Partners Holdings, Inc., its CEO Brian Pardo, and General Counsel Scott Peden defrauded investors in life settlements, or fractional interests of life insurance policies traded on the secondary market. By materially understating the life expectancy estimates the company used to price transactions, the defendants misled shareholders into thinking the company’s revenues and profit margins were sustainable. The district court ordered the company to pay a civil penalty of $23.7 million and disgorgement of $15 million. Pardo and Peden were ordered to pay penalties of $6.2 million and $2 million, respectively.

The next month, in January 2015, Life Partners filed for bankruptcy. The SEC voluntarily subordinated its claim in the bankruptcy proceeding.

SEC whistleblower order. In March 2023, the SEC awarded three claimants some percentage of the approximately $100,000 it had recovered from Life Partners prior to the bankruptcy petition. One of the claimants, who is still anonymous and has petitioned the D.C. Circuit Court of Appeals to review the SEC’s whistleblower order, argued that the SEC’s rule implementing the Dodd-Frank provision bases whistleblower recovery on the amount “the Commission and the other authorities are able to collect,” and the SEC did not in fact collect all that it was “able” because it voluntarily subordinated its bankruptcy claim.

The SEC rejected this argument on three bases. First, the SEC said, the argument assumes the Commission could have collected the full penalty had it not subordinated its interest. But the civil penalties would have been disallowed or subordinated as a matter of law, and as to the disgorgement, the SEC would have been a general unsecured creditor entitled to a de minimis payout.

Furthermore, despite the rule’s reference to what the SEC is “able to collect,” the statutory maximum whistleblower award is based on the amount actually collected. And calculating awards based on a hypothetical amount “able to” be collected “would introduce uncertainty, inconsistency, and could delay the processing of award claims.”

The SEC also disagreed with the claimant’s argument that the award should be based on recoveries from the bankruptcy estate. Bankruptcy proceedings are not brought by the Commission or one of the authorities designated in Dodd-Frank, and payments resulting from bankruptcy proceedings are not imposed in SEC covered actions or in related actions. The SEC also declined to exercise its discretion to set a higher award, as it’s never used this authority to approve an award amount above the statutory limit.

District court challenges. Two of the claimants are challenging the SEC’s whistleblower award. Via a petition for review filed in the Fifth Circuit, John Barr asserts that the SEC’s order “misreads the operative statute and contains multiple prejudicial errors that violate [his] legal rights.”

Claimant #1, filing as John Doe, petitioned the D.C. Circuit for review.

The case is No. 23-60216 (Barr) and No. 23-1121 (Doe).