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The Hypocrisy of the Millionaire Whistle-Blower Program

Under a little noticed provision of the Dodd-Frank Wall Street reform bill, the government will pay bounties that could amount to millions of dollars to whistle-blowers who bring evidence of fraud to the Securities and Exchange Commission.

CNBC

The odd thing is that just a few years ago, similar payoffs in securities fraud cases were regularly occurring—but they were illegal.

Four years ago, a grand jury indicted the Milberg Weiss law firm for making illegal payments to lead plaintiffs in numerous securities class action cases from 1981 to 2001. The firm had been paying a portion of its attorney’s fees to the lead plaintiffs in the cases.

The government alleged that this “kickback” created a conflict of interest between the lead plaintiffs and the rest of the class members, ultimately reducing the payout to the victims in the cases.

The Milberg Weiss partners all pled guilty. Two of the partners went to jail.

The new Dodd-Frank whistle-blower award will allow people who give information to the government to collect rewards that can amount to up to 30 percent of the recovery from the resulting SEC case. This will reduce the amount of money available for distribution to victims of the securities fraud—just as the Milberg Weiss kickbacks allegedly reduced the payouts to the victims in the class-action suits.

One of the strongest justifications for outlawing kickbacks to lead plaintiffs in class actions is that the payments seemed to be part of the class-action extortion racket, in which plaintiff’s lawyers would file class-action suits any time a company’s stock dropped. Having a ready-made set of paid-off lead plaintiffs made this task all too easy.

Don’t be so sure that the SEC’s role in the whistle-blower process is a guarantee against similar abuse. In the first place, the structure of the law allows plaintiff’s lawyers to represent the whistle-blowers—even keeping the identity of the whistle-blower secret from the government. The lawyers will then collect the whistle-blower bounty, skimming a piece for themselves in the process. No doubt lawyers are already figuring out how to alert employees or other “whistle-blowers” at companies with falling stock prices about their potential windfalls.

The SEC itself is far from immune to jumping on the same bandwagons that attract the plaintiffs’ lawyers. Think about the misbegotten cases filed against allegedly fraudulent corporations that were accused of backdating stock options. More controversially, consider the case against Goldman Sachs , which the SEC brought with much fanfare and then dropped after Goldman agreed to pay a record-breaking fine.

That’s exactly the kind of deal that could enrich a whistle-blower and his lawyers—for very little public benefit.

This doesn’t mean the law is a terrible idea. We may decide that we need increased incentives for people to come forward to combat corporate wrongdoing. But, if that’s the case, someone should ask why is it only the government that’s allowed to pay off its witnesses.

Why should only the government be in the business of making incentive payments in securities fraud cases?

It’s too late for the partners of Milberg Weiss to get back the years they spent in jail. But wherever they are now, they must feel some sense of vindication. We’re all Milberg Weissians now.

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