WASHINGTON — When insider-trading scandals plagued the financial markets in the late 1980s, lawmakers created a bounty program for whistle-blowers, allowing regulators to reward tipsters who uncovered evidence of manipulation.
The effort largely failed, in part because the issue of whether to make a reward payment was left to the discretion of regulators. In 20 years, the program paid out a total of less than $160,000 to a handful of whistle-blowers.
Now, Congress and financial-market regulators are revamping a reward system for whistle-blowers, offering big payouts for tips about a host of securities and commodity law violations, to be doled out from a new $451 million fund.
The potential rewards are huge. Had the law been in effect, anyone who tipped off the Securities and Exchange Commission to the activities in its recent case against Goldman Sachs, for example, could have raked in $55 million to $165 million.
Already, business executives and trade groups are arguing that those lottery-size windfalls, authorized under the sweeping law that overhauled the nation’s financial regulatory system, will make it harder for companies to police themselves and will pit employees in search of a big payday against a company’s effort to make sure it is obeying the law.
“The new law contains the seeds for undermining corporate governance and internal compliance systems,” said Harvey L. Pitt, a former chairman of the S.E.C. who is now chief executive of Kalorama Partners, a corporate advisory firm. “Compliance departments will now be competing with the S.E.C. for who gets the tip first.”
Whistle-blower advocates disagree, saying that the new law finally provides some balance that encourages people to come forward, “particularly in the financial services industry, where people are well compensated and there is more of a culture of silence,” said Erika A. Kelton, a lawyer at Phillips & Cohen, a firm that specializes in representing whistle-blowers.
The new whistle-blower law requires a payment when penalties exceeding $1 million are collected. But the proposed S.E.C. rules, which are now open for public comment and scheduled to be completed in the spring, also exclude a large raft of people from receiving potential awards.
Under the proposal, almost anyone whose job is to ferret out corporate wrongdoing, and people who are themselves involved in a securities-law violation, are exempt.
And while the rewards can be big in the most spectacular cases, supporters of the new law say that experience with other bounty programs shows that most whistle-blowers receive relatively small awards and that their lives are often made miserable as part of the experience. Other government agencies also have ramped up their whistle-blower bounties in recent years. The Internal Revenue Service whistle-blower program, revised as part of the 2006 Tax Relief Act, awards 15 percent to 30 percent of the proceeds it collects in enforcement actions worth more than $2 million, or in the case of individual taxpayers, $200,000 in gross income.
The False Claims Act, a century-old law updated last year that rewards people who uncover fraud against the government, also can produce blockbuster awards. A former quality-control manager who blew the whistle on GlaxoSmithKline was awarded $96 million last month for helping to uncover the company’s sale of adulterated products.
Part of the incentive for the new financial whistle-blower program was the failure of the S.E.C. to catch some of the most egregious wrongdoing that surfaced after the financial crisis of 2007 and 2008.
After Bernard L. Madoff was arrested in late 2008 and charged with running a multibillion-dollar Ponzi scheme, the public learned that the commission’s staff had received numerous early warnings and detailed complaints about Mr. Madoff but had not performed a thorough investigation.
Linda Chatman Thomsen, who was the director of the S.E.C.’s enforcement division at the time that Mr. Madoff’s scheme collapsed and who is now a partner at the law firm Davis Polk, said the new whistle-blower rules might not meet all of the S.E.C.’s expectations.
“Nobody argues with the notion that the S.E.C. should get higher-quality tips sooner, or with the idea that legitimate whistle-blowers should get protection,” Ms. Thomsen said.
But, she added, “the underlying premise of the statute is that if you pay people a lot of money you are going to get more high-quality tips.” If tested, she said, “I think you would find it to be unfounded.”
S.E.C. officials say that since the passage of the Dodd-Frank financial regulatory overhaul, they have noticed an uptick, but not a flood, of new complaints.
The new programs, administered by both the S.E.C. and the Commodity Futures Trading Commission, require the payment of 10 to 30 percent of the penalty or amount recovered when a whistle-blower’s tips provide the basis for a case involving violations of securities or commodities laws.
In drawing up its rules, the S.E.C. said it wanted to encourage employees to go first to their corporate compliance departments, offering potentially higher rewards for whistle-blowers who did so. The rules also would give employees a 90-day grace period after reporting a misdeed to their company in which to bring the case to the S.E.C. — so that they could preserve their place in the S.E.C.’s whistle-blower priority line.
There is no mandate for a company to let an employee know within 90 days whether it has investigated or resolved a complaint, which could undermine any potential incentive for a tipster to turn first to an employer.
Employees who turned to corporate compliance officers have not always been warmly welcomed, and have often been fired. The Dodd-Frank Act contains protections against retaliation toward whistle-blowers. But Stephen M. Kohn, executive director of the National Whistleblowers Center, said, “many of the companies that are complaining now about these rules have for years argued that going to an internal corporate compliance department is not a legally protected activity.”
The new system has unnerved companies that set up extensive and costly compliance programs in the wake of the Sarbanes-Oxley Act, the legislative response to the accounting scandals of the late 1990s.
“What this does,” said Alice Joe, a senior director of the Center for Capital Markets Competitiveness at the United States Chamber of Commerce, “is circumvent the time and resources that companies put into building up those systems.”
By: Edward Wyatt
The New York Times
November 14, 2010