It seems that we are locked in some kind of cycle. Every few years there is a corporate scandal, followed by some public castigation of the offending parties, some new legislation to make sure that it never happens, and then it all fades from the public eye—until it happens all over again. Around the turn of the millennium, the United States was faced with an unprecedented show of the depths that corporate executives will go to for fortune—the Enron, Tyco, Worldcom and Arthur Anderson scandals shocked the conscience of many Americans. In response, the federal government passed the Sarbanes-Oxley Act to tighten reporting standards for large corporations.
Then, there was a lull until Bernard Madoff was convicted of the largest Ponzi scheme in history. In response, the SEC issued a report and made changes in their investigative procedures to prevent such future incidents.
Now, recently, the true level of corruption which underlay the financial crash of 2008 is coming to the surface. Recently, emails have been leaked that show, or at least strongly imply, that JPMorgan Chase, Washington Mutual and Bear Stearns all knew about the toxicity of the products they were supplying to their clients. This, combined with the sheer greed, which seemed to cause the implosion of financial markets, has goaded the Federal government into action yet again, this time with the Dodd-Frank Act.
The Dodd-Frank Act is a complex bill which attempts to restore investor confidence in the financial markets and stabilize the United States economy. Historically, beginning with the ’33 Act, one key to investor confidence has been transparency and disclosure. In the words of future-Justice Brandeis, “Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.” This idea resonates strongly with the basic assumptions of the efficient capital markets hypothesis—if a wider set of information is available, then people will be able to price goods, commodities, and services more accurately.
The question is how to force this information to come to light. Dodd-Frank attempts to seize on a number of tactics. The first level is merely the fact that the law requires more information to be filed with the SEC, the CFTC, and other agencies. This works well for those honest individuals and companies who want to comply with the law and be open. Unfortunately, though, there are a second group of people whose greed is overpowering and who only respond to more direct sanctions and punishments. It is for these people that the SEC reserves its enforcement division. To aid the SEC in its quest to root out wrongdoers, Congress added a Whistleblower program to Dodd-Frank, which provides, in sections 748, 922 and 923, specific protections for whistleblowers and allows them to recover between 10 and 30% of the total fine collected by the SEC, if their information “lead[s]or significantly contribute[s]to the Commission’s successful enforcement action.”
The program completed its first year this past November and issued its initial report. It stated that they had received 3,001 tips but had only paid out once. Furthermore, it turns out that there are only 14 employees working in the SEC’s Office of the Whistleblower—it is difficult to see how that can result in optimal enforcement. It is still too early to tell if that infinitesimal payout rate, compared to the number of tips, is due to lack of investigative resources, low quality of the tips, or just high standards to qualify for payouts.
Additional criticism has been levied against the program because it is seen as undermining corporate culture by fostering mistrust, and because it discourages whistleblowers from first pursuing suspicions with in-house compliance officers. There is an added concern that disgruntled former employees may make frivolous tips, viewing them as an arbitrage opportunity: either getting a hefty bounty or, at least causing a former employer to be investigated and force them to deal with SEC officers.
From a different perspective, though, the bounty could actually be diluting the SEC’s tip supply. In the past, whistleblowers have come forth to report corruption or incompetence. They have done so out of a feeling of conscience and duty. However, the introduction of a financial reward rebalances the equation and justifies people’s silence when they stand to gain more from the continued unsavory practices at their companies than the SEC’s bounty. Perhaps those who would have otherwise been conscientious reporters will become accomplices, because the price is right. The deeper issue is whether this will also attract an unwanted group of tipsters. While earlier, people would only report with quality tips, because their moral compass required it, now people will tip-off with the prospect of a bounty. So, the question which the overseers of the Whistleblowers Program need to tackle is which program will more effectively further the mission of the SEC: the fewer but higher quality tips offered by conscience-driven employees or the more common, but less reliable, opportunistic tipsters.
It is still too early to evaluate the program as a whole, and only time will tell whether this new innovation will improve confidence in the U.S. markets.
