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On April 13, news broke of a class action lawsuit against the richest man in the world. The lawsuit alleges that Elon Musk waited ten days to inform the Securities and Exchange Commission that he had enough shares to impact the value of Twitter’s stock unfairly. This delay resulted in losses to investors, who sold shares of Twitter without knowing that Musk held a massive number of shares. It also resulted in major gains for Musk, who announced his large ownership only after approaching nearly twice the ownership stake, he was required to report. Musk finally announced his ownership of Twitter when it reached almost 10%. Within days the price of Twitter stock increased by nearly 30% – an unprecedented and unforeseeable leap. The lawsuit alleges that this was a violation of SEC rules, and the first thing that came to my mind was whether the plaintiff filed a Tips, Complaints, and Referrals form or “TCR.”
What is a Tips, Complaints, and Referrals form, or “TCR”? It is the little known vehicle by which the SEC would prefer whistleblowers use to file complaints. And this plaintiff, Marc Bain Rasella, is a whistleblower. What makes Mr. Rasella a whistleblower? He is bringing attention to the public about a difficult to detect violation of the Securities law. But the SEC might argue that he cannot qualify for a reward – because he brought this information to the Southern District of New York and not to the Commission. Suppose Mr. Rasella’s lawsuit and its ensuing media coverage result in a successful sanction against Musk. Will Mr. Rasella be eligible for a reward? Based on the SEC’s rules, most likely not.
SEC Rules vs. Mr. Rasella’s Actions:
There are three issues to consider: (1) Is Mr. Rasella a qualified whistleblower? (2) Is it good practice to initiate a lawsuit when you suspect SEC violations? (3) Can Mr. Rasella be disqualified because the media published his allegations, and perhaps the media is how the SEC uncovered the issue.
Let’s start with #1: Is Mr. Rasella a qualified whistleblower? This question is up for debate. First, does he identify himself as a whistleblower? Nothing in his filing indicates that Mr. Rasella himself considers his activity whistleblowing. But, if we consider the criteria for whistleblowing, Mr. Rasella might have qualified had he filed a TCR as an analyst. The SEC rules for being a whistleblower require that one be a voluntary original source of information to the SEC. Based on the news, Mr. Rasella did not provide any information to the SEC. But let’s say that he had. Suppose Mr. Rasella had filed a TCR outlining his concerns about Musk’s conduct, he may have qualified under the analyst provisions. Under the Dodd-Frank Act, a person who used their expertise to identify a violation using publicly available information and then provided information outlining the violation to the Commission would qualify as an analyst – and therefore, an original source. Strike one. Mr. Rasella did not take these steps and therefore would not qualify as an analyst.
Let’s look at #2: Is it good practice to initiate a lawsuit when you suspect SEC violations? This one is sticky as well. It was well known that class action lawsuits by investors were regularly used prior to Dodd-Frank. These private strategies were and are controversial because of opportunism. In other words, Mr. Rasella’s action could be seen as a simple means of recovery driven by personal interest and capitalized on by greedy attorneys with their eyes on a massive target with deep pockets – the richest man in the world. Congress has, in fact, passed laws trying to limit them due to abuses. Congress did not include such lawsuits in the definition of “original information.” So, by bringing a lawsuit, Mr. Rasella automatically would not satisfy one of the requirements for being an official SEC whistleblower. One major issue with this strategy is that it is risky and expensive. Hiring an expensive litigator to battle with the richest man in the world can be costly and attract negative attention. But, going to the SEC with allegations about alleged violations of securities laws can be done anonymously. With quality information, the whistleblower would be entitled to a mandatory 10-30% reward. Much better than taking a gamble in court. Strike 2.
And finally, on to #3: Can Mr. Rasella be disqualified because the media published his allegations, and perhaps the media is how the SEC uncovered the issue? In February, National Whistleblower Center, Whistleblower Network News, and Kohn, Kohn and Colapinto, LLP asked the SEC to grapple with this question. We filed a petition requesting formal guidance on the issue. The petition requests that the Commission ensure media whistleblowers are rewarded when the stories they break in the media lead to sanctions.
Our reasoning is partly due to the reality that many people associate the media with whistleblowing. They pursue contact with a journalist they trust – sometimes without knowing that their story implicates securities violations. We also reasoned it is unfair to reward some whistleblowers who do not file TCRs with the SEC. Those who, for example, report to a Public Company Accounting Oversight Board, a self-regulatory organization, Congress, any other authority of the Federal government, or a state Attorney General or securities regulatory authority. And then not reward those who instead go to the media.
Other elements taken aside. Separate from the fact that Mr. Rasella would not qualify as an analyst or an original source. Let’s say the question is whether Mr. Rasella would qualify if the SEC learned of his allegations from the media, as I did?
Would he qualify if he just went to the media?
The Securities and Exchange Commission has long recognized the value of news media as a source of information for their investigations. In 2006 the Commission issued a policy statement where it explained that “Freedom of the press is of vital importance to the mission of the Securities and Exchange Commission. Effective journalism complements the Commission’s efforts to ensure that investors receive the full and fair disclosure that the law requires, and that they deserve. Diligent reporting is an essential means of bringing securities law violations to light and ultimately helps to deter illegal conduct.”
In the Commission’s view, getting tips from the media is an “essential means of bringing securities law violations to light.” Mr. Rasella’s lawsuit and subsequent media coverage are prime examples of this. Without Mr. Rasella’s lawsuit and subsequent media coverage, we might not know about Musk’s possible securities violations, which potentially defrauded thousands of shareholders, and gave Musk an unfair advantage. For Mr. Rasella, unless he submitted a TCR alongside his lawsuit, failing to get to the SEC before major outlets told the story could be his Strike 3.
Balancing Costs and Benefits?
In this instance, we have a person who knows that the conduct he seeks to report is a securities violation. Yet, he chose to file a lawsuit that received immediate media coverage—essentially doing everything wrong. What could have motivated this highly sophisticated whistleblower to go to court rather than the SEC? If he believed he could win in court, wouldn’t he think the SEC could successfully sanction Musk? Could it have been a lack of information? Maybe Mr. Rasella does not see himself as a whistleblower? Maybe Mr. Rasella does not trust the SEC’s ability to enforce against a man who has mocked the Commission? Perhaps, Mr. Rasella just wanted to let the public know? Or he just cared about getting a big payout. We may never know. But we do know for certain that unless he filed a TCR, Mr. Rasella disadvantaged himself by choosing the route of private litigation over formal whistleblowing.
NWC’s petition has received several comments of support. Rewarding whistleblowers who go to the media helps the story get out and the Commission to know about violations. The Securities and Exchange Commission ensures market stability and controls practices we all agree should be prohibited. We do not have to take matters into our own hands.
Formal whistleblowing is the safer and more reliable road for reporting securities violations. When whistleblowers do not otherwise know where to go, tell their story to the media, they should be protected. It is hard to know which way Mr. Rasella’s suit may go. But, under current regulatory conditions it never hurts to file a TCR. The Commission may be best equipped to use insights like Mr. Rasella’s to meaningfully challenge securities violators. Still, whistleblowers should never be penalized for coming forward with useful information – even if the SEC gets it through the media.