Wanted: A Whistleblower Statute for Bank & Securities Fraud

by Kurt Schulzke on January 28, 2008

The case of French bank Société Générale, in which a single trader’s off-the-reservation trades cost the bank €4.9 billion ($7.2 billion), highlights a systemic control weakness in global financial markets. No system of regulation, operated from outside and above individual companies can be expected to corral determined fraudsters on a timely basis.

Friday’s Wall Street Journal quotes Charles Goodhart, program director of regulation and financial stability at the London School of Economics, for the proposition that regulators should “provide incentives for people working with the fraudster to catch the fraud.”
Such incentives already exist in the U.S. for insiders to report fraud perpetrated against the government. What about a banking and securities whistleblower system modeled on the U.S. False Claims Act or IRS Whistleblower Office? Under these programs, whistleblowers who report fraudulent claims or tax fraud can receive up to 30% of the amount the government recovers.

A similar approach could be used to encourage employees and contractors working for banks, brokers and other market players to report fraud that comes to their attention in the course of their work. The reward structure would have to be tailored to the particular environment, but much could be done in this regard to increase the likelihood of catching this kind of wrongdoing before it hurts quite so much.

Some observers may say, “Oh, we already have whistleblower protections under Sarbanes-Oxley.” Mere protection of whistleblowers (and not everyone agrees that SOX effectively protects whistleblowers) — which offers no real incentive to report — isn’t the point. What SOX needs is a real financial incentive to report comparable to incentives now provided under the IRS program and the False Claims Act.