Can Whistleblowers Seeking Big-Dollar Rewards from the SEC Be Kept Inside?

By Peter Goldmann, CFE



The debate about the new Securities and Exchange Commission's rules on paying generous monetary rewards to whistleblowers, as mandated by the Dodd-Frank Act, will come to no conclusion at least until enough time has passed to indicate whether the presumed objective of the provision -- enhanced frequency and volume of whistleblower complaints by employees -- is realized.


The notion of paying employee whistleblowers a bounty for coming forward with information that leads to detection of a fraud has been widely unpopular for a long time. The reasons are numerous and sometimes imprecise. "It just doesn't seem right to pay employees to do what should be part of their jobs," one seasoned fraud investigator told me.


Beyond that, educated speculation would lead one to assume that this distaste for financial incentives might in part be due to fear of inundation with complaints that are "half-baked" or altogether frivolous.

Changing Opinions?
But in the wake of completion of the SEC's final rules on the Dodd-Frank bill's whistleblower provision allowing the SEC to award whistleblowers up to 30 percent of recovered funds above $1 million, thinking at the executive level may be shifting.


For example, Mohammed Ahmed, CPA, CFF, CCEP, Senior Manager of Deloitte Forensic & Dispute Services, told a group at the recent ACFE Annual Conference in San Diego that "rewarding whistleblowers may be necessary to compete effectively with the U.S. government's rewards for tips relating to securities violations.


"Some rewards might be widely published internally; others may be much more sensitive. Fairness and generosity of rewards may help to attract employee support and generate more reports."


Moreover, a 2007 study by three university researchers entitled "Who Blows the Whistle?" found that "...monetary incentives or detection in frauds against the government influence detection without increasing frivolous suits, suggesting gains from extending such incentives to corporate fraud more generally."


Whether this approach will be shared by other anti-fraud experts and advisors remains to be seen. Management's distaste for doling out cash for tips is so ingrained in corporate culture that it may take some time for the incentive approach to catch on. In particular, doing so will require a drastic shift away from the prevailing status quo of firing or forcing the departure of employees who blow the whistle to an attitude of protecting and encouraging internal whistleblowers.


With Dodd-Frank having raised the specter of employees running to the SEC to give up the "dirt" on their employers, however, management would presumably be more likely to both reinforce its whistleblower non-retaliation rules, and give serious consideration to instituting an internal bounty policy -- to "compete" with the SEC, as Deloitte's Ahmed suggests.


This won't happen anytime soon, if management's strenuous objection to the SEC bounty program is any indicator. But if fear of employee reporting to the SEC is genuine, management's implementation of an internal reward system would seem like the obvious countermeasure.


For those with doubts about the effectiveness of financial incentives for whistleblowers, consider this: under the federal False Claims Act (FCA), the U.S. Department of Justice is authorized to pay whistleblowers 15 percent to 25 percent of funds collected from a party that has defrauded the government. And now, under Dodd-Frank, the same concept has become available to the SEC. So, if monetary rewards are good for the goverment, why wouldn't they be good for businesses?


The fact is that they are. As the findings of a recent study point out: "...employees respond to incentives and a reward to whistleblowing leads to a higher rate of detection. This higher rate of detection does not appear to come at the cost of more frivolous suits."


In effect, then, a private sector incentive program would only be substituting taxpayer dollars with shareholder dollars in the effort to maintain a fraud-free operation.


The recent testimony by Professor Geoffrey Rapp, before the U.S. House of Representatives Committee on Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises, summarizes the situation well: "...Sarbanes-Oxley failed to offer any sort of financial incentive for whistleblowers who bring fraud to light. Sarbanes-Oxley 'screamed out' for a whistleblower bounty scheme. If the aim of a policy is to encourage whistleblowing, bounty programs work. In industries subject to the federal False Claims Act, for instance, employee tips are responsible for 41 percent of fraud detection, as opposed to just 14 percent in other industries."

One Problem: Size Matters
One obstacle that exists in the business world that may be less at play in government is the dollar amount involved in alleged fraud cases. Often, federal government cases involve wrongdoing related to multimillion dollar contracts. As such, FCA rewards to whistleblower can easily top $1 million.


In one example, United Technologies Corp. billed the government for work on helicopters at its Sikorsky division -- which was work that the company hadn't done yet. Former executive vice president Douglas Keeth blew the whistle on this activity by beginning a lawsuit in the United States District Court. The Federal Government settled for $150 million. Mr. Keeth, the whistleblower, received $22,500,000.


In the business world, it is hard to imagine an employee receiving a $22 million reward from his or her employer for reporting a fraud -- even a multi-million dollar fraud to management. For one thing, the most costly frauds are financial reporting frauds. The losses due to these crimes are not always easily calculated and, more importantly, because they do not involve actual theft of funds, financial recovery is not part of the solution.


On the other hand, an employee who reports an accounting fraud which resulted in a 20 percent boost in revenue could be offered, for example, 5 percent to 15 percent of the amount of that false revenue increase up to a set maximum dollar amount.


Beyond that, frauds common to businesses, such as embezzlement, billing schemes, payroll fraud, skimming and larceny are often very easy to quantify. As such, rewards to employees whose decision to report the fraud resulted in its detection may be easier to calculate.


If a portion of misappropriated funds is recovered, the whistleblower could receive up to 25 percent -- just like government cases. If the stolen funds are not recoverable, and the company has chosen not to prosecute the alleged offender in order to seek restitution, it would still behoove management to provide a monetary reward of, say, 10 percent of the loss -- as a signal to the rest of the workforce that blowing the whistle is not only the right thing to do, but it also pays -- literally.


As Prof. Rapp points out, the chances of an employee getting a reward from the SEC are so small that they would be far more likely to submit a tip internally if even a small reward -- such as $10,000 -- were available for coming forward with legitimate information about an ongoing fraud.



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© 2011 White-Collar Crime 101 LLC, All Rights Reserved.


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Peter Goldmann

Peter Goldmann is the author of Fraud in the Markets: Why It Happens and How to Fight It, published by John Wiley & Sons, available at the ACFE Bookstore. He is also the Editor and Publisher of the monthly newsletter, White-Collar Crime Fighter, http://www.wccfighter.com.