Concerning the Dodd-Frank Act and Financial Whistleblowing in the US (Part I)

The recent financial crisis caused the U.S. authorities to seriously consider how to prevent a similar type of socio-economic cataclysm. Between 2008 and 2010, the White House and the U.S. Congress actively discussed various bills aimed at improving the financial and banking system. It concluded with the adoption of the law titled the Wall Street Reform and Consumer Protection Act, or more briefly, the Dodd-Frank Act (named after the bill's sponsors). On July 21, 2010, it was signed by President Barack Obama, and it went into effect July 15, 2011. The law is quite comprehensive (around 2,300 pages long), encompassing the most widely varying aspects of financial activity and providing tools designed to prevent the emergence of new financial crises.

Actually, as all analysts unanimously recognize, this is not simply a law, but a program involving the broad reformation of the whole U.S. banking and financial system. President Barack Obama is proud of this law, considering it is one of the main (if not the main) accomplishments of his efforts while in office. I am not going to analyze this vast law and remark on the first results of its practical implementation. I want to examine just one instrument that was established in this law and has nearly escaped the notice of Russian analysts. There is talk of establishing a broad network of informants in the U.S. financial system. This step could have serious consequences for the U.S. and gives us cause to once again consider what American society represents.

America: A Nation of Informants

A short definition: An informant is a person who, voluntarily or for pay, provides other people and organizations with information that they are interested in. The interested parties could be intelligence agents, counterintelligence agents, journalists or representatives of the criminal underworld. As a rule, the interested party is an intermediary between an informant and an interested organization. The interested organization could be intelligence agencies, police bureaus, law enforcement agencies, various government regulatory agencies, the media, banks, corporations, organized criminals, totalitarian sects, political parties and so on. The phenomenon of the informant is as old as the world; I am not going to delve into the history of it.

The informant is a part of American culture, an element of the American way of life. Any American understands well the concept of the word "informant." In 2009, Americans even saw Steven Soderbergh's film "The Informant" on the big screen. The premise of this popular film is fairly simple: The U.S. government decides to charge a large agricultural corporation with colluding with other interested firms to engineer high food prices. The government recruits the vice president of one of the companies, Mark Whitacre, as an informant. He becomes the film's hero and superman.

Valeriy Lebedev, in his essay on the institution of the "informant" in America, "Denunciation or Information?" ("Ogonyok," 2008), examines the fact that "the words “whistleblowing,” “denunciation” and “snitch,” in the negative Russian sense, simply don't exist in America. There are the words “information” and “informer.” In the U.S., it is acceptable for workers to inform their bosses about how their colleagues are working. And this is considered a civic duty, and those who receive the information smile kindly on those who have just informed."

[Translator’s Note: The Russian words Mr. Lebedev cites here ("доносительство," "донос" and "доносчик") are all derived from "доносить," meaning to deliver something to, to report to; his examples do carry a negative connotation. But clearly, we have also long had corresponding words in English to convey a negative meaning for these activities.]

For the sake of fairness, one must say that the Americans' impoverished lexicon has broadened a bit in recent years: Besides the word "informer," the term "whistleblower" has also appeared. It literally means a person who "blows a whistle": that is, who signals a violation. The concept is similar to the Russian word "осведомитель," for "informant." The term "whistleblower" also does not carry any negative connotation in modern America.

The U.S. government is establishing a whole network of informers and informants. This is a very high-density network. Any American goes about his life on the presumption that any other American is an informer, an informant. This leaves a very serious imprint upon Americans' mutual relationships. At least, it seems very striking to a Russian observer. Here is the impression of one of our expatriates about America and informants as an unavoidable part of American life: "Private conversation is snitching. In Russia, it's more complicated. Our snitches are harder to pick out from the group. In America, it's simpler: Everyone is a snitch. There is no need to pick anyone out. As to who points the finger, have a guess. Did animal welfare services come to you asking if you beat your dog? Neighbors. Did the boss deny you a bonus because you ran out to the drugstore for 15 minutes during work hours? Your co-worker. Did the taxman come to seize your property? Your friend, who you treated to your stash of black caviar and Hennessy yesterday. In general, look for those who are closest to you." (1)

It should be said that in the last decade, the government has very actively promoted a culture of snitching in America. It used two basic methods: the media and money. Constantin Simonenko, already quoted above, wrote that: "... snitching is officially encouraged. For example, not long ago I found in my mailbox an official letter from the manager for the building where I live. The text of the letter was roughly this: “If you notice your neighbors grilling on their balcony or in the yard, call us right away. Not only will you avoid the smell of barbecue, you will receive an award from the Fire Department.” And what do you think? They snitched. And I pretty regularly received letters from the FBI, well, if you see suspicious people in the area, immediately call the following telephone numbers. If the person turns out to be a wanted fugitive, a reward is guaranteed."

Snitching can take various forms, independent of the character of the information and its recipient. In the U.S., so-called "criminal" snitching was traditionally practiced; the police and other law enforcement agencies called upon citizens to cooperate in the capture of criminals and investigations of various criminal cases, often promising payment of rewards. After the well-known events of Sept. 11, 2001, so-called "anti-terrorist" informing became actively encouraged in the U.S., and the Department of Homeland Security was specially established to receive this information, along with the police and the FBI.

In general, at the beginning of this century in America, the "foundation" for any form of snitching was well -prepared. On this foundation, "financial" whistleblowing has quickly taken root.

The History of Financial Whistleblowing in the US

"Financial" whistleblowing is a pretty broad term. It means citizens informing various government watchdogs and regulatory agencies about law violations related to the financial sector. These violations are widely varied: tax evasion; money laundering; financial terrorism; corruption; embezzlement; insider trading; falsification of financial accounts and keeping duplicate books; price fixing; various manipulations of the stock market; deception of shareholders, investors, customers or partners; conducting business with banks, companies and organizations that the U.S. has embargoed; and other violations.

Violations might relate to operations both within the U.S. and abroad. Violators might be private citizens (actual people) or companies (legal entities). In a few cases, violators might be not only residents (American persons and legal entities), but also non-residents. For example, it can be the daughter-company or even the granddaughter-company of an American corporation, which might formally be a legal entity of another country.

The rudiments of the financial whistleblower appeared in the U.S. by the 19th century. The most damaging form of financial whistleblowing relates to taxes. The practice of voluntary informant cooperation with U.S. tax authorities was legalized back in 1867. All informants were guaranteed confidentiality, except in cases where it was necessary to appear in court. In cases where the information results in the transfer of unpaid taxes to the Treasury, the informant is paid a reward.

In 2006, there were amendments to U.S. tax law that significantly increased the rewards for tax whistleblowers: 15-30 percent of the sum of unpaid taxes transferred into the Treasury. (Previously, it was 1-15 percent.) Immediately, the activity of tax informants sharply increased. In 2009, the IRS announced that in fiscal year 2008, a total of 476 people "turned in" their acquaintances, clients or employers to the authorities. A year earlier, only 116 such complaints were received — about four times fewer. The voluntary informants in 2008 gave the tax authorities the names of 1,246 people, each of whom allegedly had not paid taxes amounting to at least $2 million. Specific sums were declared in the denunciations of 994 tax evaders. In 228 of the cases, there was talk of non-payments of sums higher than $10 million; in 64 cases, it turned out there was non-payment of sums higher than $100 million.

In the wake of the crisis of the 1930s, the first attempts were made in the U.S. to encourage participants in the financial markets to provide information about violations of American laws to the agencies regulating these markets. Specifically, the Securities Exchange Act of 1934 provided that people informing the U.S. Securities and Exchange Commission about insider trading could count on a reward of 10 percent of the sum of the fine levied against the company.

in 1986, Congress adopted the False Claims Act. This law enables individuals to file court cases in the name of the government if they know of fraud involving budgetary finances (falsification of claims for work performed or services rendered). The plaintiff (sometimes called the whistleblower, which translates as informant) independently collects evidence showing that the contractor is misleading the customer (the federal government). After the plaintiff files in court, the government conducts a detailed investigation of all charges. The Department of Justice analyzes the prospects for the claim. If there is nothing against the claim, then government lawyers are assigned to conduct the case (which removes the plaintiff's burden of paying his own lawyers). In cases where the case has a positive outcome, the defendant is obligated to pay triple the government's losses, as well as a fine of $5,000 to $11,000 per violation. The informant has the right to receive 15 to 25 percent of the sum won with the help of the Justice Department.

D. I. Cherkaev, a member of the Ethics Committee for the Chamber of Commerce and Industry of the Russian Federation, remarked on this law. "Whistleblowing is a very profitable “business” for the U.S. government." (2) According to the U.S. Government Accountability Office, during the period 1987-2008, $22 billion were returned to the U.S. Treasury. (The plaintiffs' payments often were measured in the millions of dollars.) That is, in the course of a year, more than $1 billion was received. One can suppose that the rewards to the whistleblowers were $150-250 million annually.

Corporate Whistleblowing

Even before the appearance of laws on informants for government regulators, the institution of internal (corporate) informants was established in corporate structures at the initiative of shareholders and high-level managers. These informants had to promptly report on any "deviations" in corporate activities to the company's internal control and audit services, and they in turn reported to the company leadership. Such information was encouraged either with bonuses or career advancement. Until recently, there was no U.S. federal law regulating the activities of corporate whistleblowers. Each company defined its own rules on the organization of internal financial control and the role of informants in that control.

At the end of the 1990s and the beginning of the 2000s, a series of major scandals took place in the U.S., connected with the falsification of financial statements, misuse of off-balance accounting and off-market operations (especially relating to derivative financial instruments) and so on. The scandal had a particularly broad resonance in the large energy corporation Enron, which involved many people from the highest echelons of the U.S. government. In reaction to these scandals, the Sarbanes-Oxley Act was passed in 2002. The law strengthened the requirements for internal controls in U.S.-registered companies by requiring, in particular, the implementation of so-called whistleblowing systems. Whistleblowing has become an integral part of American corporate culture. The 2002 law does not define any type of material incentives for whistleblowers, but provides for their protection from retaliation by the company leadership (Articles 806 and 1107).

Today, it turns out that in an American corporation, any employee is a potential informant. Theoretically, the informant could even be the cleaning lady, who "siphons" information from computers, installs listening devices and regularly checks the discarded papers in wastebaskets. In wastebaskets, it is sometimes possible to find very valuable "goods," valued at a sum with a lot of zeroes. Besides potential informants under the company's own roof, there could be real informants persistently, regularly "siphoning" information from outside the company. We are speaking of agents. These could be agents of: a) intelligence services (CIA, FBI, DHS); b) organized criminal groups (for example, drug traffickers or money launderers); c) competing companies. There are known cases where a company employee turns out to be a double or triple corporate agent — that is, having two or three information recipients at the same time.

The Dodd-Frank Act: A New Round of Financial Whistleblowing

The crisis of 2007-2009, which was provoked by fraud in the mortgage-backed securities market, once again brought to mind the experience of using paid informants to stabilize the market in the 1930s. The Dodd-Frank Act provides for rewarding informants not only for information about insider trading, but also about any kind of violations by participants in the financial markets.

It also provides protection for the informant. If necessary, he can act anonymously. Contacts of law enforcement and oversight agencies (the Security and Exchange Commission) with such an anonymous informant are conducted through a lawyer representing the interests of the informant.

Informants may count on a generous reward: It stands at 10 to 30 percent of the amount of the fine for the violation, which is determined by the investigation and set by the oversight agency or the court. Notably, the person providing information about violations has the right to not inform his bosses about the violation, but to act immediately and directly by sending the information to government agencies.

The Dodd-Frank Act encourages the reporting of major violations. If the amount of the fine is less than $1 million, then there is no provision for a reward for the informant. Such a high standard, as a few observers have commented about the law, means that employees will not signal the symptoms and early signs of the "disease." They will await that moment when the violation is massive and they can count on a solid reward.

One can imagine the new "corporate spirit" that the Dodd-Frank Act gave rise to in American banks and companies: The leadership is afraid of its subordinates, the subordinates are afraid of the leadership, no one dares to utter a word, all papers and documents are locked in safes, phone conversations are limited to short phrases, and computers are scrubbed of any questionable information.

Moreover, managers have stopped thinking about their salaries and even bonuses, dreaming of the head-spinning rewards which they could receive for showing "vigilance," i.e., timely information to regulators about violations at the bank (or company). Judge for yourself. In 2010, for example, the SEC opened investigations into the relations of five of the largest Wall Street banks in connection with their questionable activities with mortgage-backed securities. As a result, the Commission fined the Citigroup bank $75 million. At about the same time, another Wall Street bank, Goldman Sachs, received notification to pay a fine of $550 million. In the first case, the informant could receive as much as $25 million; in the second, up to $165 million.

Dodd-Frank Act: First Results

During 2011, according to the Security and Exchange Commission, this agency assessed fines and compensation against stock market participants in the general amount of about $2.8 billion. True, all of the noted violations were identified before the Dodd-Frank Act went into effect.

After the law went into effect, according to lawyers and regulators, the number of reports to the SEC rose significantly: Many of them support charges of fraud in accounting reports and even overseas bribes; others allege cases of market manipulation and insider trading. In just the first week after the Dodd-Frank Act went into effect, a Security and Exchange Commission department head, Sean McKessey, told the paper The Financial Times: "We've received notes, audio recordings of conversations and simple recollections. We've been very pleased with the whistleblower tips either because they're from somebody working at the company they're complaining about or there's a sufficient amount of specificity, or both" According to the Commission, in the first seven weeks after the rules went into effect, they received 334 complaints — about seven per day.

As a rule, whistleblowers are company employees who could be participants in criminal activities, as well as simply observers. Most often, they complained of market manipulation (16.2 percent of the cases) and inadequate disclosure and financial reporting (15.3 percent). Company employees complained of this not only within the U.S., but also in 11 other countries, including China (10 reports) and Great Britain (11 reports). The information submitted by whistleblowers is checked by almost 50 lawyers, as well as FBI colleagues assigned to assist them.

Here is the first major, well-known case of fraud identified by the new rules, which could serve as an effective stimulus for the growth of the number of reports about fraud. Sherry Hunt, an employee in a mortgage securities division of Citigroup, received $31 million for reporting bank fraud relating to mortgage bonds. The bank itself was obliged to pay the authorities almost $160 million in order to close the case. For her vigilance, Ms. Hunt received not only money for a comfortable life, but also the position of vice president of the bank, in charge of quality control. [Translator’s Note: This is not entirely accurate. Ms. Hunt was already the VP of Quality Control at the bank and filed her whistleblower report from that position. Bloomberg reports here.

The most recent of the publicized cases: An employee of Oracle, Paul Frascella, accused his employer of fraud and, at the end of the proceedings, was enriched by $40 million. Another 200 companies paid various sums to the Treasury in the form of refunds and fines. (3)

(1) Constantin Simonenko. Good-For-Nothing Notes on the U.S. // Internet, 2005. [Translator’s Note: The title is a play on words and is written to suggest "Un-Travel Notes on the U.S."]
(2) D.I. Cherkaev. Snitching and Informing: Bad or Good for Russian Companies? // Stock Society №3 (22), 2006.
(3) RBC 14.03.2012.