Tell the SEC What to Do With Whistleblowers

Do you have strong feelings about how the Security and Exchange Commission defines "Major Security-Based Swap Participant"?

Do you want to tell the Commodity Futures Trading Commission how to treat "Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy"?

No? Well how would you like to read the opinions, informed and otherwise, of people who do (or think they do)?

Regulatory agencies have been posting rules at an impressive clip as they give detailed form to the vaguer provisions of the Dodd-Frank financial regulatory reform bill. Thanks to a newfound commitment to transparency, the websites of the SEC, CFTC, Federal Reserve and the Federal Deposit Insurance Corporation feature both public comments on those rules and (long) lists of lobbyists' meeting with regulators. (Not surprisingly, as of two weeks ago, 90% of those offering their wisdom were in or deeply connected to the financial industry.)

Take, for example, the SEC's new provisions to protect whistleblowers, which offer new protections and rewards for those who report financial wrongdoing. Here's an excerpt from the comments of William Wilson of Americans for Limited Government (PDF):

As put by Jacob Frenkel, a former Commission enforcement lawyer, the proposed whistleblower program, "reverse[s] a decade of effort promoting integrity, self­ remediation, and corporate self-reporting." What Commissioner Frenkel is referring to used to be called, "The American Way."

Other commenters take a different view of the decade that began with Enron and ended with the Great Recession; Some 848 individuals wrote in with the following objection to the prospect of forcing employees to go to their employers before snitching to regulators:

"More whistleblowing about corporate malfeasance could have made the foreclosure crisis and economic meltdown less severe. Whistleblowers should never be forced or encouraged to take their concerns to their potentially corrupt bosses first: Those who go directly to the government deserve the strongest rewards and protections allowed by law."

You can leave comments of your own, but hurry! Today, Friday, December 17 is the last day for this rule. (The SEC will consider these comments as they write the final version in the coming months)

And if all this talk of whistleblowing still seems like hot air, never fear: Economy 4.0 special correspondent David Brancaccio breaks down the Dodd-Frank provisions, and what the SEC's version means for financial reform, on today's episode of Marketplace.

About the author

Stan Alcorn is a multimedia journalist in New York City. He has reported for NPR and WNYC, where he has focused on business and the New York tech scene.
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A Vision of Shared Responsibility in Financial Reform
John Brian Kosecoff
December 17, 2010

Failure of the investment industry has now been laid at the feet of every participant: from the Federal Reserve, to the S.E.C., FDIC, FINRA, Congress, Wall Street, and even Main Street. Care should be taken so that reform is implemented in a manner that does not cripple free markets, cause significant market distortions, or add undue cost to transacting in the markets.

As a thirty-year veteran of the financial services industry, I still have faith in a market economy and believe that reform will be most ideal if it is implemented in a market-centric manner. That is, rather than trusting corporate management, their captive boards, industry lobbyists, or self-serving plaintiff litigators (e.g., such as William Lerach), I think that the public should have a direct seat at the table and that restitution of abuses to the public trust be made in a manner than most directly benefits the common good.

One might suppose that this is the purpose of government. I might favor that view except that the government has shown itself to be anything but neutral in allocating market resources. By way of example, well-intended legislation in the early 1990s to reform excessive cash compensation for entrenched corporate management resulted in excessively allocating stock option incentives to executive management throughout an extended bull market. The result of this was an increase in management ownership of the S&P 500 from 2% at the beginning of the 1990s to more than 7% by the decade’s end. This wealth transfer was disproportionate to the contribution and permanence of corporate management, and came at a cost of depriving retirees, foundations and endowments of their stake in America’s capital.

In an ideal construct, the remediation of corporate abuses would be the restitution of capital to the public from which it had been raised. Accordingly, if whistle blowing were pre-emptive, then a percentage of the lost averted should accrue to the agent (the whistle blower) that prevented such a loss in market value. If the going rate for raising capital is the investment banker’s 7%, then the whistle blower should be rewarded a proportionate 7% for the capital saved. In this construct, the incentive is to be anticipatory and proactive.

For example, if a bank’s trust department were liable for breaching its fiduciary trust by, say, taking undue risk or by applying a blanket investment policy to all accounts, or loading trust portfolios with inferior proprietary in-house mutual funds, the cost to compensate clients for loses might be $2 billion and the cost to rectify the operational cause of the problem might be an additional $100 million. I would favor setting aside 7% of the $2 billion to fund a consumer or fiduciary advocacy agency, and an amount equal to 7% of the $100 million paid to those individuals who brought the abusive practices to light and aided in its correction.

This model, I think allocates capital back to serve the class of society who are most vulnerable to corporate malfeasance: fixed income retirees. If over time, the pooled funds of such restitution exceeds the amount necessary to effectively administer improved corporate governance, then the excess amount should fund direct ownership in companies – reallocated by publicly trusted portfolio managers to those companies that demonstrate prudent financial controls and profitable allocation of capital resources.

A fair arbiter might judge that a 7% reward based on the cost of correction constitutes a substantial windfall. The fairness of this amount, however is supported by three factors:

1) Like the investment banking underwriter’s 7% fee, this is risk capital, since the whistle blower’s career is fully at risk.
2) The amount represents taxable income.
3) Recognition of the whistle blower’s claim must be supported by corroboration, documentation and evidence, and by the following of clear and timely procedures for intervention.

To truly institute a culture of corporate responsibility, publicly traded companies should be incentivized to make their employees financially literate about the economy, the corporate business model, the operating unit fundamentals, and the individual employees’ contribution to the enterprise. More modest rewards should be encouraged and facilitated so that even relatively modest suggestions are articulated with an awareness of the magnitude of impact.

It might be anachronistic to think in terms of long-term loyalty to an employer, a reciprocal social contract, and pride in owning one’s work. However, a culture of mutual interest in producing globally competitive products and services must be developed at all levels of all enterprises, with the implicit value that America’s well-being is built by entrepreneurial initiative – and that American companies can more sustainably thrive by embracing a participatory workforce: what I might coin as “intrepreneurship”.

I wish to include a final note about public interest in a more just allocation of national wealth. There is more than just recognition that there have been abuses, that concentration of wealth is unhealthy to the fabric of America, and an implicit view that “New Deal” remedies to economic distress much be enacted by Federally imposed socialistic reallocation of wealth. America, by its nature, is a diverse society that is dynamic in its constant change, its uncommon mobility, and the underlying aspiration that work and measured risk can result in improved life.

Based on these principles, corrective consideration should be given to holding executive stock incentives until the sustainability of financial results is proven over a normal business cycle (i.e., seven years). Stock options should be accorded to executives whose contribution can be gauged by more than just the relative performance of a stock price versus a peer group in a time when all stocks are rising. Rather, risk adjustments need to be incorporated to measure the quality of accounting, the avoidance of contingent liabilities (i.e., environmental impact, retraining of displaced labor), the creation of domestic employment opportunities, and the rejuvenation of tired and decaying systems of transportation, housing, education, health, and local enterprise. To complement that end, the workforce, corporate leadership, and global capital markets must be convinced and trust that America is worthy of investment for long-term stable returns and mutual benefit.

I disagree with your 7% reward for whistleblowers. While you acknowledge "the whistle blower’s career is fully at risk", 7% is hardly appropriate for someone who may never be able to work in that industry again. Further, I believe you have a misinterpretation of the rule: the 30% reward for whistleblowers is 30% of the penalties collected by DOJ. Given we are constantly seeing consent decrees and settlements that represent mere fractions of the actual fraud committed (look at Goldman's recent $500 million settlement with the SEC over nearly $5 billion in ABACUS-type CDOs they created and conned their customers into buying), a 7% reward is a paltry sum, and is not likely to encourage someone to come forward and expose these kinds of financial shenanigans.

I fully acknowledge that there is some fear that this reward will somehow discourage risk-taking or will somehow result in gaming of the system by whistleblowers, but given that the whistleblowers put everything on the line when they come forward, and given their entire careers will hang on the SEC and DOJ's ability to prosecute, I suspect that whistleblowers will ONLY come forward when they really have found something despicable.

The impartial, detailed, and thorough investigation of Whistle Blower information in a timely fashion is essential to returning any modicum of confidence in Wall Street, Bankers and Corporate America.

The 30% reward for information that leads to conviction is also correct. Once identified as a Whistle Blower where will that person ever get another job? What about all the law suites that will be filed against them....each one has to be answered.

Self examination and self correction does not work. It just warns them to do a better job of hiding. Financial crime is no different than any other crime and the Justice Department would laugh heartily at the suggestion that crooks be told they have been turned in and have X amount of time to make corrections before any investigation occurs.

I am one of the masses of people who would like to see televised perp walks and water boarding for those who got us into this mess. After a Military Tribunal found them guilty, public execution would 'allow closure' better than them sending post cards from warm and sunny places far from our jurisdiction.

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