Sarbanes-Oxley

• Whistleblowers Need Stronger Incentive Than An Inadequate Shield

Global Markets

• The View From Germany: Sarbanes-Oxley Is Too Burdensome

Financial Reporting, Taxation, & Accounting

• Step Transaction Doctrine In Reorganizations Still Alive, Thriving, And Confusing

Corporate Governance & Directors' Duties

• Using Disney To Address Cronyism And A Failure Of Good Faith

• Shining A Light On Phantom Owners Avoids Trouble

Securities Regulation & Disclosure

• Exemptions Under Rule 145 Based More On No-Action Letters Than Policy

• When Issuers Must Disclose Outsourcing

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No pot of gold for whistleblowers. The Sarbanes-Oxley Act gives employees of public companies meager incentive to reveal corporate and securities fraud, even though it has criminalized retaliation, whether by firing, demoting, threatening, or otherwise discriminating against whistleblowers. Law professor Geoffrey Christopher Rapp lists several reasons why whistleblowers rarely find a pot of gold at the end of their journey. Whistleblowers are allowed (after exhausting administrative remedies) to sue in federal court for reinstatement, back pay plus interest, and reimbursement of litigation expenses (e.g., expert-witness fees and, if reasonable, attorney fees), albeit not for punitive damages; but the likelihood of success seems minimal. The Act requires companies to set up channels for addressing employees’ open or anonymous criticisms about suspicious accounting practices, but it does not specify the type (the SEC has pressed for ombudsmen or in-house inspectors general); but companies evade the requirement’s goal by establishing yet failing to operate the communication channel. Another potential incentive for whistleblowers comes from a 1998 statute that gives the SEC discretion to pay a reward of up to 10% of the penalty imposed on anyone guilty of insider trading; but the SEC has seldom done so.

Losing their money and their minds. The incentives for exposing fraud do not outweigh the strong disincentives, the author fears. Despite Sarbanes-Oxley's anti-retaliation provisions, for example, whistleblowers could lose their jobs if their revelations destroy their companies. Even when the company survives, they face on-the-job ostracism, which is as unpleasant as retaliation but probably legal and—even if illegal—very hard to prove. Some experience psychological strain whether from self-doubt over the validity of their suspicions, frustration over dealing with federal officials, or feelings of having abandoned their peer group. Such strain too often estranges the whistleblower from his or her family. Sarbanes-Oxley cannot prevent other employers from blacklisting whistleblowers, most of whom never find new jobs in their fields. Nor can the statute shield whistleblowers from liability for violating confidentiality agreements, which employers increasingly demand, and fiduciary duties of loyalty and obedience under state law.

Share-the-wealth model. In the author's view, the federal False Claims Act offers a roadmap for how to make the advantages of whistleblowing outweigh the disadvantages. Now applicable mostly in the procurement and health-care areas, the Act makes it illegal to knowingly present a false or fraudulent claim for payment to the federal government. A private citizen can sue on the government’s behalf and, if successful, receive a bounty of 15%-30% of the government’s damages caused by the violation. (The government may take over the suit or move to dismiss it.) With the average bounty exceeding $1 million, the False Claims Act provides ample incentive for private whistleblowers to bring suits and talented attorneys to litigate them. There are more suits brought every year under this statute than private securities suits, even though the market capitalization of US companies dwarfs the value of federal government contracts. The False Claims Act also saves the government substantial litigation costs and brings crucial information to light.

Entice plaintiffs with riches. One method of offering bounties to Sarbanes-Oxley whistleblowers, the author suggests, is to use a state's false-claim statute, which almost all the states have. While the majority contain only anti-retaliation protections, many also have bounty provisions, which usually imitate the FCA. Some bounty provisions are limited to health-care fraud, but others are not. When a state agency purchases shares of a public company, the seller—whether the issuer or a shareholder selling in the open market—makes a claim upon the state for the share price. If the seller makes a false statement (or a material omission) constituting a securities-law violation before the sale, that is a false claim upon which a whistleblower might base a suit and seek a bounty under the state law. The author's second method would not increase the SEC's workload: amend an obscure Sarbanes-Oxley provision that now permits the SEC to pay an investor who was harmed by fraud the monetary civil penalties and disgorgement-order proceeds resulting from an enforcement action. A simple amendment would entitle whistleblowers to a percentage of those funds.

Abstracted from Boston University Law Review, published by Boston University School of Law, 765 Commonwealth Avenue, Boston, MA 02215. To subscribe, call (617) 353-3166; or visit www.bu.edu/law/lawreview.