Zaring Draws Fire for Criticizing the SEC Whistleblower Program


David Zaring

David Zaring

David Zaring, an assistant professor of legal studies at the Wharton School of Business, wrote an article for the New York Times saying he had “second thoughts” about the SEC’s whistleblower program.  Leading qui tam advocates say Zaring misunderstands the program, and is “concerned in the same way that the fox is concerned that the chicken farmer is spending too much time on shotgun shells and electric fencing.”

Zaring’s concerns are similar to those expressed by big corporations.

In the April 29, 2013, article, Zaring questions why securities fraud whistleblowers would need more incentive to report violations to the SEC.  Early in the piece, Zaring describes the SEC whistleblower program as an effort to privatize enforcement.  The program’s provision to pay a percentage of the recovery as a reward to the whistleblower, says Zaring, creates perverse incentives for employees.

Having worked with the SEC whistleblower program since the day Dodd Frank was enacted, I view Zaring’s comments as off base.  There are a few different models of whistleblower bounty programs, and the SEC’s model steers away from true private enforcement.  Closer to the idea of privatizing enforcement is the False Claims Act model, which grants a private right of action for the whistleblower who wants to and is able to litigate the claim without the government’s help.  Even when the whistleblower assumes the burden of litigating the claim on his own, the government is still heavily involved in False Claims actions and has a lot of control over the process.  The SEC program, by contrast, provides no right of action for whistleblowers.  The whistleblower must work entirely through the SEC.  If the SEC doesn’t want to pursue the case, the whistleblower has no recourse.

As to Zaring’s concern that the monetary award provides a perverse incentive, I have to disagree. What’s perverse is the way companies treat people who care enough to raise concerns about violations.  Retaliation against whistleblowers is rampant, costly, and painful.  It’s also human nature.  Whistleblowers need strong incentives to overcome the negative aspects of reporting violations.  Fortunately, the SEC has realized that the way it operated before Dodd Frank didn’t work, and it hit upon something that does work – the qui tam model.

I have my own concerns about the Dodd Frank SEC whistleblower program. It’s designed more like the IRS’s lackluster whistleblower reward program than the very successful False Claims Act.  There is no private right of action for whistleblowers participating in the Dodd Frank version. The same thing is true of the IRS program.  The lack of a private right of action means that the SEC program is not subject to scrutiny from the judicial system in the same way as the False Claims Act.  The IRS whistleblower program faces enormous obstacles and interference from the upper levels of the IRS.  We were fortunate during the initial years of the SEC whistleblower program because Mary Schapiro wanted it to work, and she made it a priority.  The IRS whistleblower program has no such champion at its highest levels; it actually has enemies, and the IRS’s program is only minimally effective.  I don’t like the IRS and SEC models because they live or die in response to agency and staff agendas.  I think we need more robust and better insulated qui tam programs.

As to the concerns about how the SEC whistleblower program could negatively affect corporate loyalty, I have little patience.  SEC whistleblowers are often very worried about the company’s shareholders.  I think it’s wrong to conceptualize a corporation as management and nothing more.  The corporate model dictates that management answers to the shareholders who are the true owners of the company.  If management is violating securities rules, the shareholders should be informed.   The shareholders are the company, and it’s the shareholders we should be concerned about, not upper management.  Whistleblowers protect shareholders from management, and that’s a good thing.

Besides, corporate loyalty, even in the way Zaring uses the phrase, is outdated.  Loyalty is a two way street.  Corporations have burned their bridges by failing to reward employee loyalty. They discard loyal employees as if they were worthless, and they will freely assert that the cheaper inexperienced employee is better for the bottom line.  If a company really wants to inspire employee loyalty, it has to demonstrate loyalty to its employees.  Problems with corporate loyalty are far bigger than the SEC whistleblower program, and they’ve been building for at least twenty years.  Management’s actions will inspire loyalty or discourage it.  The SEC program is a non-factor.

Let’s hope the SEC’s program, already hindered by its insular design, does a better job with whistleblowers than the IRS’s sad attempt.  I doubt the SEC will ever experience the success of the False Claims Act, but the current program is much better than the SEC’s old insider trading program.  Better is always better.  We’ll see what happens.

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