The Upcoming Test of the Dodd Frank Whistleblower Programs

It’s the 5 year anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law by President Obama on July 21, 2010. An important piece of the Dodd-Frank Act, the whistleblower programs at the Securities & Exchange Commission and the Commodity Futures Trading Commission, is primed for a test as the potential for turmoil in the financial markets is rising.

In the past thirty years, the U.S. Government has relied more on whistleblowers than ever before. They have helped the Department of Justice to recover billions in improper payments to health care providers, mortgage companies and government contractors. Congress has also encouraged whistleblowers to come forward by offering them protection from retaliation, such as when Congress added whistleblower protections in the Sarbanes-Oxley Act to help ward off another accounting debacle like Enron.

Prior to Dodd-Frank, there was economic turmoil both for investors and the public. The SEC was unable to stop the Ponzi scheme promoted by Bernie Madoff despite warnings about problems, including the repeated attempts by Harry Markopolos to draw the Government’s attention to the fraud. And bank excesses led the government and investors to purchase billions of dollars in Commercial Mortgage Backed Securities that weren’t what they expected.

The law aims to stop these sorts of problems. In the Dodd-Frank Act, Congress recognized that an employee considering telling the truth risks career suicide and as a result added rewards for whistleblowers to encourage them to come forward with information about violations of the securities laws. Sean McKessy, head of the SEC’s Office of the Whistleblower, has said that ultimately what the program is all about is getting whistleblowers to provide assistance to stop “potential fraud in its tracks so that no future investors are harmed.” Given that the SEC mission is to protect investors, facilitate capital formation, and maintain fair and efficient markets, it is obvious the potential beneficial role that whistleblowers could play.

Since opening the program, whistleblowers have helped the SEC fine companies more than $100 million for misconduct. With thousands of tips a year flowing into the securities regulator with information about potential violations, it is only a matter of time before there are more success stories. There was one just last week, in which a corporate insider was paid $3 million for assistance stopping fraud against investors.

For the past five years, the SEC and the whistleblower program has been operating in fairly calm waters. The economic problems of the Tech Bubble and the Great Recession seemed behind us. The economy is growing, unemployment is down and the stock market has achieved relatively steady year over year gains. The CFTC was also able to fine banks billions for manipulating LIBOR and the FOREX market.

Yet, there are seeds sprouting that warn about trouble in the world again. China, Greece, Puerto Rico and the bond market are all potential problems that have been at the head of the news this year. Let’s look at each one individually.

Chinese stocks had been tearing it up but these shares are now in free fall. At the start of June, the one year gain for the Shanghai Composite Index was over 100%. However, the market fell by more than 30% from its highs and the media started talking about the Chinese Bear Market. Even if the market has stabilized and is on the mend, the instability that led to the evaporation of $3 trillion in wealth in under a month can’t be good.

During the Great Recession, a bailout saved Greece from defaulting on debts owed to creditors. This summer, Greece was once again in trouble. After battling to avoid leaving the eurozone, it looks like the “Grexit” has been avoided. Nevertheless, the potential problems may have only been pushed farther into the future and the spillover effects on financing by other countries, such as Italy, Spain and Portugal, are still up in the air.

Puerto Rico’s Governor recently announced that the territory was unable to pay its debts and it needed to renegotiate their terms with creditors. Public entities there have more than $72 billion in debt and do not have the ability to file for bankruptcy as a municipality in the United States would have. Puerto Rico has been in a sustained economic recession and nearly half of its population lives below the poverty line. The effect of this debt crisis in the United States, either due to losses in bonds held by mutual funds or a spill over to the $3.7 trillion municipal bond market, is unknown.

The final area of concern right now is bond market liquidity. With the Federal Reserve poised to start reversing historically low interest rates, bond prices will be under pressure. For a large set of reasons, experts including Nouriel Roubini, Robert Schiller, and Bill Gross have warned about potential problems finding bond buyers in a crisis. In the worst case scenario, falling bond prices could spread problems to other areas of the American economy given that the $37 trillion bond market significantly exceeds the size of the US stock market.

None of these problems directly implicate the whistleblower programs of the SEC and the CFTC of course. However, if there is economic turmoil, corporate wrongdoing will be exposed and other individuals will violate federal law in order to attempt to keep the Wall Street gravy train flowing. The former happened following the Tech Bubble, when accounting fraud was discovered at Enron and Worldcom. The latter happened in investment banking during the Great Recession, as banks packaged problematic mortgages for sale and traders manipulated markets to stem losses on financial assets.

The next downturn will be a key test for the whistleblower programs and Dodd-Frank. The fifth anniversary is simply too soon to judge a law that is still being implemented. Will the SEC and CFTC be able to sift through the tips and put a stop to securities fraud before billions of dollars in investments are lost due to misconduct this time around? Let’s hope so. If it does, it will definitely have been worth it.

If you have evidence of corporate wrongdoing in violation of federal securities laws, contact one of our SEC whistleblower attorneys. An attorney can be reached by our contact form or calling 1-800-590-4116.

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