WASHINGTON — The new financial-reform law has what some lawyers call a secret weapon against fraud on Wall Street and in corporate America: the promise of a million-dollar jackpot to insiders who reveal an illegal scheme to the government.
Tucked in the massive bill is a provision that for the first time extends a concept long applied to government contracts to the private sector. It gives whistle-blowers a mandatory 10 percent — and as much as 30 percent — of what the government recoups in fines and settlements in financial-fraud cases. These can include illegal insider trading, false earnings reports and classic Ponzi schemes.
To claim a bounty, the whistle-blower must provide the Securities and Exchange Commission with “original information” that reveals the fraud and leads to a successful recovery.
“This is very significant and will have an immediate impact,” said Erika Kelton, a Washington lawyer who has represented whistle-blowers. “It will motivate knowledgeable insiders to step forward and tell the enforcement agencies what they know. It is the secret weapon in this massive bill.”
But some are worried about unintended consequences of the provision.
Some employees may see an incentive not to report a problem internally but instead “to go to the SEC with it,” said Martin Rosenbaum, a Minneapolis lawyer. After the collapse of Enron and the passage of the Sarbanes-Oxley Act, companies tried to keep problems in-house by setting up hotlines and encouraging employees to tell top management if they saw questionable conduct.
“Most people want their company to be strong and do the right thing. This has the potential to be a game- changer” but not necessarily a good one, Rosenbaum said.
Some management experts said they foresee a flood of new claims driven by aggressive law firms that represent whistle-blowers.
“I’m skeptical. This is the trend toward the informant method of law enforcement,” said Walter Olson, a scholar at the libertarian Cato Institute. “Congress sees this as free money, but do we want to live in a society with paid informants everywhere?”
He said the Internal Revenue Service has used similar bonuses to pay those who expose tax cheats.
The idea of bounties for whistle-blowers goes back to the Civil War. Congress in 1863 said private litigants who exposed fraud in military contracts could keep some of what was recovered.
Congress greatly expanded the False Claims Act in 1986 and offered rewards to whistle- blowers who exposed frauds in other government contracts. At first, the targets were mostly Pentagon contracts. More recently, the majority of the claims have involved health care programs.
Thanks to the act, which took effect the following year, the government has recouped $24 billion since 1987. Of that amount, whistle- blowers have received nearly $2.5 billion.
“This is the most successful fraud-recovery program ever,” said Stephen Kohn, executive director of the National Whistleblowers Center in Washington.
