Indoors and outdoors whistleblowing

Larry Ribstein —  1 November 2010

Today’s WSJ notes criticism of Dodd-Frank’s bounty provision for whistleblowers on the ground that it undermines the internal reporting provisions of the previous financial law, Sarbanes-Oxley.  The WSJ notes that

plaintiffs lawyers eager to handle complaints on behalf of whistleblowers are getting the word out, issuing press releases and publishing articles about the new law and in some instances, running ads soliciting work. “We’re gearing up, we’re going to be very devoted to this topic,” said Rebecca Katz, a lawyer at Bernstein Liebhard LLP, a plaintiffs firm based in New York.

The article says companies are trying to beef up internal reporting incentives.  Indeed, firms have every incentive to encourage employees to report fraud.  After all, fraud is an agency cost that hurts companies as it helps employees cover up bad deeds or poor performance.  

Indeed, companies arguably can take care of these problems without a strong federal law.  Even if you don’t want to go that far, it’s still puzzling why Congress should want to bypass internal procedures altogether.  

There is another way:  authorizing insider trading about fraud, as I argued last summer:

The beauty of the insider trading approach to uncovering fraud is that it reduces the need for a lot of the Dodd-Frank whistle-blowing apparatus. The market decides through its price movements how important or original the information is and computes the insider’s compensation for disclosing it. While the insider might still worry about protecting his job, rewards from selling the information could make the disclosure worth the risk.

Another advantage of the insider trading approach is that it does not necessarily bypass the corporation as a first line of defense against employee fraud. The selling-induced stock drop could motivate honest executives to look into the cause of the decline and take action. The Dodd-Frank procedure always bypasses the corporation by rewarding only whistleblowers who bring new information to the SEC.

Anyway, it’s amusing to watch these misguided federal laws — SOX and Dodd-Frank — getting in each other’s way, with Dodd-Frank disabling the incentives SOX put in place.  I suppose we’ll need yet another federal law to referee.

Larry Ribstein

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Professor of Law, University of Illinois College of Law