The SEC is expected to approve a proposed rule change that could limit the amount of awards paid to whistleblowers, despite evidence that shows whistleblower rewards work.
In 2018, the US Securities and Exchange Commission proposed new rules to its Dodd-Frank Act whistleblower program that could limit the amount of awards paid to whistleblowers in large cases. After two years of consideration, the SEC is posed to finalize its rule on capping the amount of whistleblower rewards. A final vote on the proposed whistleblower rule has been set for September 2nd.
The SEC’s proposal to place limits on the size of awards sparked a widespread debate. Under the Dodd-Frank Act, the Commission is required to pay qualified whistleblowers between 10-30 percent of any sanction obtained from a fraudster. Thus, the SEC could not approve a “hard” cap setting an upward ceiling on the amount of an award. Instead, the SEC proposed a percentage-based cap. Under this “soft” cap, if the SEC obtained over $300 million in sanctions from a fraudster, the whistleblower whose information triggered the enforcement action would be presumptively limited to the lowest percentage award (i.e., a 10 percent recovery).
Over 100,000 public comments were filed in opposition to any cap. Senator Charles Grassley (R-IA), the most respected expert on whistleblowing in Congress, strongly opposed the rule-change. Quoting from the findings of the SEC’s Inspector General, Senator Grassley explained: “high rewards can motivate potential whistleblowers to come forward because the monetary amount may mitigate the cost of professional and social sanctions that can result.” Numerous whistleblower and investor advocacy groups, along with nationally recognized corporate whistleblowers such as Sherron Watkins (who exposed Enron’s fraudulent accounting practices) and Harry Markopolos (who tried to alert the SEC about Bernie Madoff’s Ponzi scheme) filed comments strongly opposing the cap. The US Chamber of Commerce supported the cap.
In response to the widespread public opposition, SEC chairman Jay Clayton made clear that the SEC could not set a hard-cap on awards or set any strict monetary limitations. He also expressed concern over how any rule limiting the amount of an award “could deter potential whistleblowers from coming forward.”
Moreover, last month, the SEC’s Office of the Whistleblower issued a public statement explaining that the Dodd-Frank Act’s whistleblower law was extremely successful, resulting in over $2.5 billion in collected sanctions from fraudsters, $750 million returned to “harmed investors,” and over $500 million paid in rewards to whistleblowers. Despite these comments, the SEC did not withdraw its proposal to institute a soft percentage-based cap, nor did the SEC indicate how it would resolve the controversy surrounding the proposed rule.
Although the SEC has not yet issued a final rule, mandatory caps have long been supported by organizations that historically opposed whistleblower laws, such as the US Chamber of Commerce. Hard monetary caps are also popular outside the United States, including reward laws enacted in Canada and South Korea.
Weighing the Deterrent Effect When Setting Awards
Larger whistleblower rewards can play very important functions in policing markets and ensuring fair competition. While their ability to incentivize employees to report wrongdoing has long been recognized, the impact that reward-based whistleblowers have on corporate behavior is less well known, but ultimately significantly more far-reaching. Effective reward-based laws have a deterrent effect on criminal activity.
In passing the Dodd-Frank Act, Congress recognized this potential. The Act itself requires the SEC to take “the programmatic interest of the Commission in deterring violations of the securities laws by making awards to whistleblowers who provide information that lead to the successful enforcement of such laws.” [emphasis added]. Congress understood that giving awards to whistleblowers could send a very loud message to the market, far beyond simply rewarding a valuable informant for providing excellent information in a timely manner.
The deterrent effect of paying whistleblower rewards is well-documented. In a 2014 article in the Villanova Law Review, University of California-Davis professor of law and Chairman of the IRS Advisory Council, Dennis J. Ventry, explained this effect:
“Whistleblowers can do more than just uncover and report knowing violations of the law. They can also prevent noncompliance from happening in the first place. An effective whistleblower program . . . would add significant risk to noncompliance by increasing the probability of detection and the likelihood of potential penalties, the two most important variables in traditional tax deterrence models.”
Ventry, citing well-documented examples, explained the importance of paying large rewards to increase to public perception that whistleblowers increase the “odds of capture.” His conclusion on this matter was clear: “[K]eep whistleblower awards sufficiently high,” as “sufficiently high awards” can be used to “induce external reporting of otherwise meritorious claims and provide incentives for whistleblowers to incur the risks and costs associated” with blowing the whistle. Numerous studies fully support Ventry’s conclusions. For example, a paper published by the Stockholm School of Economics again confirmed the deterrent effect of paying whistleblower rewards:
“As for empirical evidence on deterrence, Johannesen and Stolper (2017) found that whistleblowing had deterrence effects in the off-shore banking sector… Wilde (2017) also provides evidence that whistleblowing deters financial misreporting and tax aggressiveness…
…Bigoni et al. (2012) conducted laboratory experiments on leniency policies and rewards as tools to fight cartel formation. They found that rewards financed by the fines imposed on the other cartel participants had a strong effect on average price (returning it to a competitive level). In the model setting, this implies that rewards have a deterring and desisting effect on cartel formation. The authors also take it that the results are significant for real world scenarios. They also found that cartel formation was significantly lower in a reward environment than in a leniency environment alone.”
A study conducted by Philip Berger and Heemin Lee, professors at the University of Chicago Booth School of Business and the Zicklin School of Business at the City University of New York, found that there is “a high direct deterrence value of whistleblower cases.” Like Ventry, Berger and Lee recognized the benefits of paying large rewards, finding that the “opportunity for a large payout creates incentives for a whistleblower to come forward with their private information about fraud or misconduct, which can alleviate personal and professional costs arising from whistleblowing on one’s employer” and “creates a profit motive for rooting out impropriety.”
Jetson Leder-Luis’s careful 2019 study Whistleblowers, The False Claims Act, and the Behavior of Healthcare Providers showed that the deterrent value of whistleblower cases is over six-times as great as the immediate enforcement value. Leder-Luis looked at four major health care enforcement actions filed under the qui tam provisions of the False Claims Act. The cases directly resulted in a total of $1.9 billion in government recoveries. However, the deterrent value of these cases over the next five years was calculated to be $18.9 billion. As reported by Leder-Luis:
“These 4 whistleblower case studies recovered around $1.9 billion for the federal government, but exhibit even greater benefit in deterrence effects, totaling around $18.9 billion. The average deterrence effect for these cases is around 6.7 times the settlement value over 5 years.
Overall, these results indicate that the direct deterrence benefits of whistleblowing cases often exceed the settlement values many times over, and greatly exceed the retrospective damages used to compute those settlement values. This indicates a large savings to the Medicare program as a result of these whistleblowing cases, exceeding both the direct recoveries to the government from the settlement as well as the whistleblower compensation.
In addition to the fiscal effects described in the previous section, whistleblowing under the False Claims Act creates incentives for providers to change the way they conduct health care.”
Ventry looked directly at the impact paying large rewards in the IRS whistleblower program. He looked at the fallout from UBS whistleblower Bradley Birkenfeld’s disclosures after Birkenfeld was paid a historic $104 million reward for revealing the ways in which UBS encouraged American citizens to dodge their taxes:
“[T]hanks to one of ‘the biggest whistleblowers of all time,’ the U.S. government . . . received: $780 million and the names of 250 high-dollar Americans with secret accounts as part of a deferred prosecution agreement (DPA) with UBS; another 4,450 names and accounts of U.S. citizens provided as part of a joint settlement between the U.S. and Swiss governments; more than 120 criminal indictments of U.S. taxpayers and tax advisors . . . more than $5.5 billion collected from the IRS Offshore Voluntary Disclosure Program (OVDP), with untold tens of billions of dollars still payable due to only a quarter of the 39,000 OVDP cases being closed . . . All because one person blew the tax whistle.”
As explained by Ventry, the deterrent effect of Birkenfeld’s massive award achieved unprecedented reforms concerning illegal offshore banking, money laundering, and tax evasion.
Officials within the Swiss banking industry quickly realized the impact that paying a whistleblower a $104 million award would have on other employees working in that industry. Days after the Birkenfeld award was announced, bankers and their consultants held a major industry meeting in Geneva, Switzerland. At this meeting, the attendees “seethed” at Birkenfeld and attacked his “total lack of morality” for blowing the whistle on them.
According to a reporter from Agence France-Presse who attended the meeting, Birkenfeld had “driven the nail into the heart of the once seemingly invincible Swiss bank secrecy” system. A respected banking consultant reportedly declared that their US client offshore banking program was “over.”
The day after the Birkenfeld award was announced, the publication SwissInfo reported on the reaction to the award in the Swiss newspapers, and published the following summaries of multiple Swiss press stories:
“Zurich’s Tages-Anzeiger went further describing it as a “seductive offer for bankers.” “This enormous reward show how the US are raising the stakes in their tax fight with Switzerland . . . in promising such high compensation the IRS are hoping that more incriminating material is handed over.
The French-speaking daily Le Temps agreed that Birkenfeld’s huge reward could encourage other bank employees to follow his example.”
From a cost-benefit analysis, the benefits of paying large rewards overwhelmingly outweigh any alleged costs associated with these payments. Awards are paid only if the whistleblower’s information helps to detect criminal activity, activity that would remain unknown to law enforcement but for the whistleblower.
An effective whistleblower program creates a win-win-win-win scenario: the government wins by being able to police illegality; the whistleblower wins because he or she can obtain compensation; the public wins because a criminal is prosecuted and monies obtained from fines and sanctions are returned to the taxpayers; the markets win because potential bad actors are deterred from committing crimes, permitting fair competition and long-term savings to investors. Paying large rewards, with no caps, is the key to a truly successful whistleblower reward program.
The SEC’s final rule on the cap issue will send a powerful message to the markets. Will it be one of deterrence, or will it signal or will it signal a retreat from a willingness to use one of the most effective regulatory tools to deter corruption in the markets?
Disclosure: Stephen M. Kohn is a whistleblower lawyer and partner in the qui tam law firm of Kohn, Kohn and Colapinto. He is the author of The New Whistleblower’s Handbook and the Chairman of the Board of Directors of the National Whistleblower Center. Mr. Kohn currently represents SEC whistleblowers who could be impacted by the proposed rule changes.