Sure, money talks. But will it persuade witnesses to securities fraud to come forward and talk, even at the risk of losing their job and reputation?
Congress hopes the answer is yes. The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama on Wednesday, mandates substantially greater rewards and protections for whistle-blowers. Under the law, the Securities and Exchange Commission will determine rewards for whistle-blowers in all enforcement cases that involve penalties worth more than $1 million. Successful informants will be entitled to collect 10% to 30% of the wrongdoers’ payout to the commission.
That’s a far cry from previous practice. Before, the SEC could reward only whistle-blowers involved in insider-trading cases. And the commission has been stingy: during its 20-year existence, the SEC’s whistle-blower program has paid out only $159,537 to five claimants. No wonder observers of securities fraud have had little incentive to spill the beans. “Basically, [whistle-blowing] ruins your life,” says Luigi Zingales, a professor at the University of Chicago Booth School of Business who has studied the issue of whistle-blowers. “What is worth your life getting ruined? It’s pretty expensive.”
The new law also expands whistle-blowers’ rights, allowing those who think they have been discriminated against or fired in retaliation to bring their case to a federal judge within six years. Under the Sarbanes-Oxley Act, whistle-blowers were restricted to dealing with Department of Labor judges under a 90-day statute of limitations, with most cases getting thrown out or settled.
For employers, the changes could bring on heartburn. Attorneys warn that the hope of a lucrative payday, no matter how farfetched, could encourage employees who suspect fraud is going on at their company to bypass their compliance departments and go straight to the government. As the SEC sets up its new whistle-blower office (it has until April 2011 to do so), companies should reexamine their whistle-blower polices and consider reminding their workforce how to report problems, such as through an anonymous tip line. (Most publicly traded companies have had such hotlines since Sarbox was passed in 2002.)
At the same time, companies should tread carefully to avoid discouraging employees from turning to federal officials, as such actions could give terminated workers fodder in litigation, notes Daniel Westman, a partner at Morrison & Foerster. “It could be used as evidence of retaliatory intent,” he says.
Of course, companies would prefer to handle a problem internally and fix any issues before bringing the matter to the government, if necessary. “As a senior executive, the last thing you want in today’s environment is to first find out about a problem when a government official calls you up about it,” says Laurence Weiss, a partner at law firm Hogan Lovells. Moreover, the SEC has historically viewed companies that are proactive and forthcoming with their investigations more favorably than those whose frauds are uncovered by outside sources. In January the commission issued new guidelines to its staff for granting leniency to corporations and individuals they consider cooperative.
The reform act also gives new protections to whistle-blowers at financial-services firms. Some of the regulations stemming from the law could create new risks for companies when they distribute pink slips, says Westman. “These new rules are going to be a significant administrative burden in terms of letting employees go,” he says.
To be sure, it could be years before the new law bears fruit in the form of an increase in financial-fraud discoveries. Certainly, the prospect of a cash bounty could result in the SEC’s being inundated with tips, valid or not. (Indeed, Congress wants the commission’s inspector general to examine whether the “reward levels are so high as to encourage illegitimate whistle-blower claims.”) The question is whether the SEC will pay heed to the legitimate claims, given its failure to act on early hints of Ponzi schemes run by Bernard Madoff and Robert Allen Stanford.