December 08, 2011
Missing the Mark and Wasting a Crisis: The Dodd-Frank Whistleblower Bounty Provision and a Call for An Affirmative Defense for Corporate Criminal Liability
Posted by Marcia Narine

Like its predecessor Sarbanes-Oxley which is less than a decade old, some have labeled Dodd-Frank the latest in a round of “quack corporate governance”- a term first coined by Yale Law Professor Roberta Romano as “low-quality legislative decision making in the context of a crisis” and popularized again by Professor Stephen Bainbridge. Under this theory, the legislation passed under these circumstances inevitably fails to prevent the next financial crisis.

Congress enacted the so-called “bounty-hunter” whistleblower protection law in part in response to the SEC’s failure to deal appropriately with the whistleblower in the Madoff matter, the largest Ponzi scheme in U.S. history. The SEC in turn promulgated the whistleblower protection provision, Section 922 under 21F of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. 78u-6.  This provision went into effect on August 12, 2011 after a significant comment period and extensive lobbying from the whistleblower and business communities. 

Whistleblowers who provide original information to the SEC related to securities fraud or violations of the Foreign Corrupt Practices Act can receive 10 to 30 percent of the amount of the recovery in any action in which the Commission levies sanctions in excess of $1 million dollars.  The legislation also contains an anti-retaliation clause that expands the reach of Sarbanes-Oxley. At a Congressional hearing regarding the unintended consequences of the provision in May 2011, one House member compared corporations to “the mob” and the whistleblowers to “snitches” in need of protection. See my testimony here.

The whistleblower provision admirably aims “to promote effective enforcement of the federal securities laws by providing incentives for persons with knowledge of misconduct to come forward and share their information with the Commission.” 

So how is it doing so far? In November, the SEC released its mandatory annual report with seven weeks worth of data.  Of the 334 complaints received by the Commission since the August implementation date the top three concerns were related to market manipulation (16.2 percent), corporate disclosures and financial statements (15.3 percent), and fraud related to securities offerings (15.6 percent). Other allegations include matters related to trading and pricing (5.1 percent), insider trading (7.5 percent), the Foreign Corrupt Practices Act (3.9), municipal securities and public pensions (2.7), unregistered offerings (5.4), market events (3.3), and “other” topics (23.7). Reports came in from the UK and China as well although the SEC did not break down the nature of those reports. Many expected the FCPA reports to be higher, but I am sure that number will increase once the first big award is announced. The SEC hasn’t made any payments yet, but it certainly has the money to do so with more than $452 million set aside for the program.

Unfortunately, as with much legislation passed after a bubble has burst, the Dodd-Frank whistleblower legislation is inherently flawed because it responds to the wrong question. The real question should be what incentives or penalties will have a measurable effect on corporate behavior to prevent the next Madoff fraud or mortgage crisis. Theoretically, it’s possible for whistleblowers to have some impact. Last Sunday’s 60 Minutes featured the Citibank and Countrywide’s whistleblowers and highlighted the government’s failure to use SOX for its intended purposes.;contentBody. Would those whistleblowers have gone to the government with the hope of receiving a bounty? Would the SEC now take action? Or is the system so flawed that it may not have mattered? 

According to the former senior vice president in charge of fraud investigations at Countrywide, the Department of Justice has yet to interview her.  Indeed, the DOJ has failed to bring charges against any high-ranking financial executive or firm since the “Great Recession” began. Contrast that to the approximately 1,000 convictions from the Savings and Loans crisis of the 80’s, which did not cause a recession and led to “only” 150 billion in losses, notes former regulator and current University of Missouri-Kansas City professor Bill Black.  

It appears that the DOJ has spent much of its time in recent years focusing on well-publicized insider trading and Foreign Corrupt Practices Act prosecutions, which may be easier to win.

There is no doubt that bad corporate actors exist and that whistleblowers can and do suffer retaliation. Although studies show that whistleblowers are not motivated by money, increasing compensation for whistleblowers who have no viable alternative to complain internally may make sense when there is a criminogenic environment or because the perceived personal costs are too high.

However, barring those circumstances, a monetary incentive may also have the unintended consequence of unleashing a flood of frivolous or uninformed tips internally and externally, spurring investigations, which if made public, could have a significant negative impact on a company’s reputation, harming both internal and external stakeholders.

While the legislation may achieve a narrow goal of encouraging more whistleblowers to bring information directly to the Commission, it will not satisfy the public’s goal of preventing the next financial crisis because it focuses on rewarding information gathering rather than on preventative measures. Congress, in its zeal for “reform,” wasted a crisis and missed an opportunity to take the time to comprehensively focus on existing or new behaviorally responsive legislation to deter illegal or unethical business practices that can harm the investing public.

Unlike many commentators and academics, I don’t argue for the abolition of corporate criminal liability in favor of steep civil penalties. When the company’s top officials condone or willfully ignore malfeasance, the DOJ should and must act swiftly and decisively using frameworks that already exist such as Sarbanes-Oxley and Federal Sentencing Guidelines. Companies and individuals must also pay meaningful fines. Unless the government consistently uses the existing criminal and civil remedies at its disposal to punish corporate and individual wrongdoers, this bounty provision may enrich the whistleblowers and their counsel but will do little to protect investors, employees or consumers in the long run.

The focus of my current research is on the companies that do their best to comply, but still get penalized due to the actions of lower and mid-level corporate rogues. Currently, having an “effective compliance program” allows a judge under the Sentencing Guidelines to impose a lower fine but liability still attaches. The standards are admittedly vague, weak and completely unhelpful to corporations because in recent years the DOJ has focused almost exclusively on coercive deferred and nonprosecution agreements (often for FCPA violations) with few details. Companies observing from the outside have no way of knowing whether their own programs are good enough to pass muster because judges aren’t reviewing them and the DOJ releases little information about the effectiveness of the compliance programs run by the offenders. Even companies with purportedly state of the art programs have paid huge fines and penalties with the DPAs, leading other companies to conduct a cost/benefit analysis regarding the amount of scarce resources and personnel to devote to their own programs.

Using a proactive instead of a reactive model provides more of a basis for preventing corporate criminality than any whistleblower provisions ever could. In my next post, I will argue for an affirmative defense for corporate criminal liability for those companies with an “effective compliance program as I would refine it. 


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