Frank-Dodd Financial Reform Act, the SEC and whistleblowers

The Frank-Dodd Financial Reform Act, section 7203

The recently passed Frank-Dodd Financial Reform Act contains a section, 7203, giving the Securities and Exchange Commission what seem to me to be extraordinary powers to compensate whistleblowers.  There are three aspects to this new authority:

1.  what qualifies as whistleblowing

Whistleblowers must

voluntarily furnish

original information

–that results in a successful enforcement action.

2. the amounts paid

The SEC must pay qualifying whistleblowers a minimum of 10% of any settlement of $1 million or more received by the agency.  But the SEC can, if it wants, pay a whistleblower up to 30% of the settlement.

What are the grounds for awarding a big percentage?  Just about anything.  The SEC can pay the highest amount because the information is so crucial, or the case is so important or simply to send a message to other would-be whistleblowers.

The day after the bill was passed by Congress, the SEC announced it was sending $1 million to a whistleblower in the Pequot Capital case.  In case this public relations point was too subtle for some, the agency also told the press that it was eager to hear from high-quality whistleblowers they might not have been able to interest before.  The Pequot whistleblower may be feeling a little put off, though.  Under the new law she could have qualified for up to $8.4 million.

3.  other–BIG–inducements

The whistleblower can approach the SEC anonymously, through his/her lawyer, to negotiate a deal.

The whistleblower need only identify himself/herself to the SEC after the successful enforcement action, just as he/she is collecting a check.  Even then, the SEC can’t reveal his/her identity to anyone, not to the enforcement target nor to other government agencies.

It’s ok that the whistleblower be personally involved in committing the violations being reported.  It’s even fine if the whistleblower is judged guilty in court of an offense–provided it’s a civil offense and not a criminal one.

corporate America isn’t prepared for Frank-Dodd, in my opinion

Although it seems a bit simplistic, my experience of watching companies for thirty years says that managers in a corporation study their superiors very carefully to get cues on how to perform their jobs.  This creates a corporate identity, or fingerprint.

Sometimes this can be comical.  If the boss lives in the suburbs and drives a Mercedes, subordinates will want to live in the same town and drive a Mercedes, too.  If the boss lives in an apartment in the city and takes the subway to work, ditto.  If he (assuming it’s a he) wears blue suits and red ties, so too do the subordinates.  Or they all wear sports jackets and no ties.

Sometimes, it’s not so comical, though. For example, the recently deposed CEO of BP seems to have created a corporate environment where safety rules were ignored.   If the boss has a bad temper and routinely humiliates subordinates in public, lower level managers will feel free to–maybe even compelled to–do so, too.  If he shows his belief that it’s good to stretch the limits of the law in business dealings, subordinates may feel obliged to try to follow him, or even outdo him, in this, as well.

The usual internal venue for complaints about improper work practices–from racial discrimination to violations of securities laws–is the human resources department or the compliance department.  These are the among the least powerful areas of any company.  If you don’t think so, try to name a CEO of a major corporation who used to be the head of either area.

A bad-tempered CEO probably won’t be sympathetic to legitimate complaints of verbal abuse.  One who belongs to an exclusionary social club may not find discrimination in the workplace an important issue.  One who pushes the envelope on compliance with securities laws isn’t likely to be happy if a subordinate says someone in the firm has crossed the line.

The path of least resistance for HR in cases like this is to try to make the whistleblower go away.  As soon as the whistleblower identifies himself by lodging a complaint, he may well have stigmatized himself in the eyes of his colleagues and superiors.  There’s lots of anecdotal evidence to support this conclusion, but I’m not aware of systematic studies.

My point?  Only in the best-run companies is a whistleblower likely to be lauded for his actions.  Of course, such firms are the least likely to allow problems to fester to the point where a formal complaint is necessary.  In poorly run firms, on the other hand, by identifying himself to higher-level management in a formal complaint about work practices, the whistleblower may have effectively ended his career at that firm.  He may also be marked as a “troublemaker” and find it hard to secure employment elsewhere.

Why take that risk in a securities law case if you can go anonymously to the SEC, safeguard yourself from prosecution and collect a huge reward, to boot?

is the SEC ready, though?

The SEC hasn’t exactly covered itself with glory over the past decade.  As I’ve detailed in another post, the story of whistleblower Harry Markopolos’s attempts to alert the SEC to the Bernie Madoff Ponzi scheme has to act as a cautionary tale to any would-be whistleblower.

The picture Mr. Markopolos paints of the SEC is of an institution almost depressingly clueless about the practical functioning of the securities industry.  Much of his time is spent trying to explain basic financial ideas to professional lawyers whom he portrays as having little interest in hearing what he has to say.

Madoff himself has expressed surprise at how easy it was for him to fool the SEC.  The auditors the agency sent to his firm found the fake trading entries in the Madoff books that Mr. Markopolos had pointed them toward.  But they failed to contact the counterparties to check whether the trades were real, instead accepting Mr. Madoff’s word that everything was okay.

If you believe, as I do, that top management sets a tone that quickly permeates through an organization, a change in leadership can address the issue of the SEC’s apparent indifference to actually doing its job.

I think, however, that Frank-Dodd, section 7203, implicitly concedes the point that the SEC doesn’t have enough institutional knowledge of the securities business to uncover fraud without having the help of insiders wanting justice or looking for a big reward.

From the whistleblower’s point of view, this probably means that only easy to understand crimes, like insider trading or misstatements in financial reports, are safe to bring to the agency.  Complex crimes, like Ponzi schemes or dubious derivative trading or after-hours sales of mutual funds, may still be more than the collective cognitive abilities of the SEC management can handle.   The latter group of crimes seem to me to have the most potential for harm.  So if I’m right, the new Frank-Dodd rewards may not be enough to convince whistleblowers to try to bring these crimes to light.

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