The Review of Securities and Commodities Regulation, Vol. 44 No.3 (February 9, 2011).
"Although turning workers into informants by realigning their loyalties seemed fundamentally wrong to me, both then and now, Congress has recently decided to move in this direction [in Dodd-Frank].
As a result, publicly traded companies can expect higher compliance costs, added enforcement activities, and more follow-on civil litigation.
These new bounty provisions promise to be a "game-changer" for financial fraud enforcement. Not only will whistleblowers now have strong incentives to put their personal interests ahead of loyalties to their employers, but they will have ample opportunities to do"."
The argument that whistleblowers betray their "loyalty" to the corporation when they alert authorities to the actions of officers and employees who are likely to be violating the law and harming the corporation in order to make the CEO wealthy never made sense. CEOs leading control frauds use executive compensation and the power to hire, fire, promote, and bully to create perverse incentives to induce employees to act on their own behalf by harming the corporation. It is true that Dodd-Frank's whistleblower provisions will increase enforcement actions and civil suits, but that would be a very good thing for corporations (and shareholders) if it clawed back fraud proceeds from the controlling officers. In the longer run, more effective deterrence could reduce civil suits and enforcement actions.
It is bizarre that an attorney, who must deal constantly with officers and directors' fiduciary duties and the absolute necessity of complying with the law, would assert that employees who blow the whistle on fraud are "disloyal" to the corporation and morally degenerate "informers" while employees who say nothing and aid frauds by controlling officers are "loyal" to the corporation and morally superior. (The not very hidden truth is that the senior corporate officers decide whether lawyers are hired, fired, and paid, so lawyers are eager to conflate the CEO with the client even when the CEO is looting the client.) Clark's discussion of fiduciary duties makes clear his all too common conception of legal "ethics."
"Both agencies' analyses appear to be markedly incomplete. For one thing, they do not address the duties of care, loyalty, and good faith that such key corporate officials [who are members of the control group], as fiduciaries, owe to an entity as its decision-makers."
I think it is Clark who misses the concept of fiduciary duties. The most likely scenario is that the CFO learns that the CEO is leading a control fraud. The typical situation is that the CEO dominates the board of directors. The CFO cannot stop the fraud. If he aids the fraud he will be committing a felony. If he confronts the CEO he will be fired and the fraud will continue, harming the client to which he owes these fiduciary duties. The only way he can fulfill his fiduciary duties effectively is to blow the whistle to the SEC (which should promptly make a criminal referral). If the CFO blows the whistle to the SEC and continues to operate as CFO and while refusing to aid the fraud he can provide the SEC with constantly updated information and place the CEO in a dilemma about whether to fire him. Conversely, if the CFO were to blow the whistle only within the organization the CEO can learn exactly what the CFO knows -- and doesn't know -- about the fraud schemes and take steps to make it far more difficult for the government to sanction him for his crimes.
Fish and Corporations Rot from the Head
The obvious question, which the opponents of whistleblowers studiously ignored was how common is it that the senior officers lead securities fraud. COSO's (Treadway's) 2010 study gave an answer to that question -- and the question of whether securities frauds helps a corporation or harms it. The passage below is from COSO's May 20, 2010 press release announcing the key findings of their study.
"The COSO study, which examined financial statement fraud allegations investigated by the U.S. Securities and Exchange Commission over a ten-year period, found that news of an alleged fraud resulted in an average 16.7 percent abnormal stock price decline in the two days surrounding the announcement. Companies engaged in fraud often experienced bankruptcy, delisting from a stock exchange, or asset sale, and in nine out of ten cases the SEC named the CEO and/or CFO for alleged involvement."
Securities fraud harms corporations and shareholders. It is overwhelmingly led by the controlling officers. Credible whistleblowers to the SEC, therefore, will overwhelmingly be giving evidence of likely frauds led by the CEO and CFO. It would be insane to assume out of existence "control fraud" in the securities fraud context where such frauds are nearly always control frauds. The opponents of whistleblowing take their orders from the CEOs and CFOs so their opposition to the SEC's proposed rules invariably -- and implicitly -- assume control fraud does not exist and that securities fraud originates in the cubes instead of the C-suites. They never cite the COSO study findings that demonstrate that it originates almost exclusively in the C-suites even though the COSO study was the definitive work that had just been released. Economists emphasize "revealed preferences." Corporate CEOs have revealed their preferences about integrity -- forget their prating endlessly about their principles -- their actions on whistleblowing demonstrate that their true preference is to prevent the disclosure of securities fraud by senior corporate officers.
The SEC rule does not forbid the whistleblower from alerting the corporation about the misconduct he has spotted. An honest CEO who sends a clear message through her acts and deeds that she demands integrity and takes forceful action against corporate misconduct should be successful in encouraging whistleblowers to inform her of such misconduct.
Corporations and Courts Encourage Retaliating v Whistleblowers
But it gets much, much worse. Corporations are going to court and claiming that the Dodd-Frank provisions that protect whistleblowers from retaliation do not apply if the whistleblower only blows the whistle to the corporation, but not the SEC. The real reason why corporations objected to the SEC's proposed whistleblower rule, which provided greater encouragement to whistleblowers to notify the SEC becomes clear. The corporate CEOs hoped to maintain the ability to take reprisals against greater numbers of whistleblowers. The obscene news is that the Fifth Circuit Court of Appeals has ruled that Dodd-Frank's anti-reprisal remedy does not protect whistleblowers who only notify the corporation of the likely crime.
Conclusion and a Plea to Act
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