Whistleblowers Important In Uncovering Corporate Fraud
Despite the expansion of regulatory oversight, much corporate fraud is still uncovered by individual whistleblowers and other non-regulatory actors. The Sarbanes Oxley Act was a response to the flurry of corporate fraud cases that gained notoriety at the start of the millennium. The underlying premise was that regulators had failed and that regulatory monitoring must be increased. Yet, in many cases, corporate fraud is uncovered not by regulators, but by a diverse group of individuals, who come across the fraud in the course of their business.
That’s the finding of a recent working paper by authors Alexander Dyck, Adair Morse, and Luigi Zingales, published through the National Bureau of Economic Research.
The authors analyzed data on a comprehensive sample of alleged corporate frauds in the United States involving companies with more than $750 million in assets that took place between 1996 and 2004. After screening for frivolous suits, the authors end up with a sample of 230 cases of alleged corporate fraud, including all of the high profile cases such as Enron, HealthSouth, and WorldCom.
The authors found that information about fraud is so diffuse that it’s costly and largely ineffective to appoint a single regulator to find such “needles in the haystack”.
Fraud tends to be revealed by people who find out about it in their normal course of business and who do not have any strong disincentive (or, even better, some positive incentive) to reveal it.
In recognition of this, the authors suggest that a cost-effective means to address such fraud in the corporate world would be to extend qui tam legislation such as is used in the healthcare industry to reward whistleblowers for uncovering fraud against the government.
The paper is available for a modest fee at the NBER site.
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September 7th, 2007 at 10:18 am
Congress has begun to expand the qui tam (whistleblower) model of enforcement into areas beyond healthcare and other government frauds. Last December Congress passed a law to encourage tax fraud whistleblowers to step forward. Whistleblowers in tax fraud cases may be eligible to receive up to 30 percent of what the IRS recovers as a result of their information. Previously, IRS whistleblowers were entitled to a maximum reward of 10 percent, but usually got nothing. Since the reward for IRS whistleblowers was increased, the IRS has seen a big jump in the number of whistleblowers who have detailed information about major tax fraud or tax underpayments.
The qui tam model also could be highly effective in other areas, such as enforcement of securities laws or corporate or accounting frauds. The Securities and Exchange Commission has a limited and discretionary bounty program in certain types of cases. But the rewards are so small and rarely doled out that the program is ineffective. It needs to be revitalized and expanded, using the False Claims Act’s and IRS Code’s qui tam provisions as a model.
My law firm, Phillips & Cohen, specializes in representing whistleblowers in cases involving fraud against the government, including tax fraud. We’ve successfully applied the False Claims Act in non-traditional ways, such as in a high-profile whistleblower case against big-name investment banks that involved yield-burning in municipal finance transactions. The banks paid more than $200 million to settle the case.
September 7th, 2007 at 5:26 pm
[...] the view that more needs to be done to encourage whistleblowers to report corporate fraud. Another paper featured recently on Research Recap suggests that a cost-effective means to address fraud in the [...]