Whistleblowers, Corporate Fraud, and Congress

The evisceration of the Dodd-Frank Act could make things tougher for employees who report financial misconduct in their firms. The Act’s “whistleblowing” provisions weren’t perfect, but they led in the right direction, writes a financial crimes specialist.

Whistleblowing is a highly risky endeavor. Likening it to “career suicide” would not be a reckless exaggeration.

In 2011, Congress went some way towards reducing the risk by enacting the Dodd-Frank Wall Street Reform and Consumer Protection Act, one of whose most notable provisions was a section prohibiting retaliation by employers against individuals who reported on fraud

The so-called ‘Whistleblower” provisions of Section 922 of the Act also provided for financial awards for those whose information led to a “successful enforcement action yielding monetary sanctions of over $1 million.”

The legislation, widely praised at the time, may now be history. In June, Congress passed a bill that would effectively defang Dodd-Frank. The special target of opponents was the Consumer Protection Bureau set up under the Act, which they considered an example of federal regulatory overreach.

Under the new Financial Choice Act, whistleblowers would be much more constrained. Employees would be required to sign a policies and procedures manual that obligates him or her to report any knowledge or suspicion of wrongful financial reporting internally, thus assuring that the reporting entity can control a would-be whistleblower.

The bill would also disqualify, among others, accounting clerks and others who may be aware of dicey accounting and financial reporting, but persist in “obeying orders” —thus contributing to the securities law violation (until their consciences and/or prospective bounty entice them).

Currently 80 percent of whistleblowers, according to the latest SEC report, use internal channels before reporting to the SEC. But the bill would mandate such a practice, assuming the reporting entity is wisely guided by counsel.

This bill would move the SEC whistleblower further away from the current gold standard of the False Claims Act.

So it’s a good time to ask how effective the whistleblower protections under Dodd-Frank have been.

A recent study by Christine Wiedman and Chunmei Zhu of the University of Waterloo found that it had a deterrent impact. Citing a 2016 Securities and Exchange Commission (SEC) report, it noted that more than 18,000 tips, complaints, and referrals (TCRs) had been received during the period covered by its report, and that 34 whistleblowers had received awards since the program was implemented.

Moreover, according to the 2017 SEC report, nearly $1 billion in monetary sanctions have been ordered against wrongdoers.

Dodd-Frank also authorized the establishment of a similar whistleblower protection program by the Commodity Futures Trading Commission (CFTC). According to the 2017 CFTC report, four awards totaling $11 million have been given to CFTC whistleblowers since inception of the program.

Both programs contained two critical missions that are essential for facilitating effective enforcement: Safeguarding whistleblower confidentiality, and enhancing anti-retaliation protection. Dodd-Frank created a private right of action, giving whistleblowers the right to file a retaliation complaint in federal court, the scope of which is under argument before the U.S. Supreme Court.

The risk of wrongful financial reporting may be mitigated by many policies, including the threats of criminal prosecution, civil litigation, and SEC administrative enforcement actions. While there may be a valid argument about the level of public and private benefits provided under the program, there should be no serious debate about its usefulness and necessity.

Law enforcement depends on having adequate information and evidence with which to conduct a preliminary inquiry (inclusive of administrative and noncriminal judicial proceedings) and, if appropriate, a full criminal investigation. The Whistleblower program facilitates these processes through enforcement of protective rules that assure a necessary level of confidentiality and essential protection against retaliation by the reported wrongdoer.

Without these Whistleblower protections, individuals with original information about wrongdoing related to securities law violations, including fraudulent financial reporting, would largely be on their own.

Judging the value of the program—and deciding whether to continue it—rests on one or more of the following premises:

  • The program does not provide adequate public benefits.
  • The program is too costly for the level of public benefits provided.
  • The program benefits are already provided and thus redundant.

How do you measure public benefit? That depends on the yardstick applied. If the value of monetary sanctions approximates the value of the public benefit, then the SEC would seem, on its surface, a $1 billion benefit over six years (FY 2012 through FY 2017).

But reasonably, this should be construed as a lower limit on public benefit.

That’s because the general deterrence value needs to be estimated, as the Wiedman-Zhu study cited above attempted to do—measured against the cost of the program.

The cost may be reasonably inferred by examining the operations of SEC’s Office of the Whistleblower (OWB), which is part of the SEC’s Division of Enforcement. According to the 2017 SEC report, the OWB is staffed with 11 attorneys, four paralegals, and one administrative assistant. Assuming that all of these individuals staffed the OWB from inception (unlikely) the labor costs to operate the OWB would not seem to approach the specific deterrence value of $1 billion over six years.

Granted that there may be marginal indirect costs from consultation with SEC employees outside of the OWB, if not outside of the SEC, the argument based on cost alone is unpersuasive.

If the program benefits are already provided by another agency or office, then the public benefits could be presumed to cannibalize benefits provided under other funded governmental programs. This would not materially add to the public benefit, and it would also presumably increase costs.

Other notable whistleblower programs include the following sources:

  • False Claims Act: Individuals may make claims based on wrongful charges directly against or reimbursable through the federal government. This would seem not to cover most, if not all, securities law violations like the SEC program.
  • IRS Whistleblower Office: Individuals may make claims based on non-compliant taxpayers. This, too, would not seem to cover most securities law violations like the SEC program, though a non-compliant taxpayer would include most entities subject to the SEC program.
  • Department of Labor’s Occupational Safety and Health Administration: Many whistleblower statutes are enforced by OSHA, including those under the Sarbanes-Oxley Act as amended by Dodd-Frank. Though SOX covers securities law violations and includes anti-retaliation protection, it has a comparatively brief filing period (i.e., 180 days, extended from 90 days by Dodd-Frank, compared with six years for the SEC program), and it does not allow for the financial bounty provided under the SEC program (i.e., the percentage of sanctions range from 10 to 30 percent for awards greater than $1 million under the SEC program). Dodd-Frank also added whistleblower protections enforced by OSHA for employees of consumer financial products entities (see Section 1057).

The public benefits provided through Dodd-Frank, specifically the SEC whistleblower program, seem to clearly outweigh any reasonable allocation of costs. They complement and enhance the public benefits provided through pre-existing laws and regulations.

But given that, the Weidman-Zhu study’s effort to show a deterrent effect is valiant but unconvincing. The authors, for instance, do not discuss the effects of then-Attorney General Eric Holder’s decision to reduce the threat of criminal prosecution—which makes me wonder how potential bounty hunter employees could meaningfully deter aggressive financial reporting in the absence of strong enforcement by the public prosecutor.

David Shapiro

David M. Shapiro

The program may as yet become worthwhile. It’s not a game changer, but it was a sound beginning.

David M. Shapiro is an Assistant Professor at the John Jay College of Criminal Justice. A Fraud Risk and Financial Crimes specialist, his background includes work as an FBI (public sector) special agent/assistant legal advisor, assistant (public) prosecutor, and corporate (private sector) investigator. He welcomes comments from readers.

from https://thecrimereport.org