Today, Taxpayers Against Fraud  delivered its commentary on the Securities and Exchange Commission's rule proposal for the whistleblower provision created in section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

TAF Executive Director Cleveland Lawrence, III and Phillips & Cohen partner Erika Kelton did an exemplary job analyzing the proposed rule and its weaknesses. 

While I am a proud member of TAF, the contents of this blog post are my own and should in no way be attributed to TAF or to Erika or to Cleveland.

Section 922 of Dodd-Frank is an attempt to recreate the incredible success of the Federal False Claims Act in the financial world; that is, it creates an incentive for individuals to come forward with information related to securities fraud. 

The Dodd-Frank legislation sets three general requirements for a whistle blower to be entitled to an award, provided that a threshold $1 million is recovered: the whistle blower must (I) submit "original information" that is based on the individual's "independent knowledge" or "independent analysis"; (2) the submission must be made "voluntarily"; and (3) the submission must lead to a successful enforcement action. 

Pursuant to its rule-making authority, the SEC has now proposed rules which will effectively gut section 922 of Dodd-Frank by creating all kinds of unwarranted requirements over and above those described in the statute itself.  The worst part, however, is that it grants broad discretion to the SEC to unilaterally determine whether an individual is entitled to share in the reward.    

Granting total discretion to any single government agency to determine if a whistle blower states a claim or is entitled to a reward would be enough to stop many people from coming forward.   As I have discussed before in this blog, this is a result of human nature.  Many government employees do not want to admit that their agency screwed something up.  So it makes absolutely no sense to put the agency in charge of policing an industry in sole charge of whistle blower claims from that same industry.      

But this is the SEC we are talking about here—the same folks who ignored Harry Markopolos  for years despite the fact that he had crystal-clear proof of Bernie Madoff's fraud.  So you take the human nature factor above and multiply it times ten, or maybe even twenty.  

Yes, the SEC is now under new management, and yes an awful lot of the old management "resigned to spend more time with family," but I think it will take time for the new SEC folks to prove themselves.  

And consider this, target audience for the whistle blower provisions includes financial professionals—and by and large these people not only do not trust the SEC, they think the SEC is something of a joke.  No doubt, putting the SEC in charge of the program with so much authority will kill this idea in its infancy. 

In an academic sense, I also wonder whether the incredibly successful qui tam model of the Federal False Claims Act and the Virginia Fraud Against Taxpayers Act will apply to other contexts like Wall Street.  Just putting money on the table certainly won't make this program successful, because the exact people the government is targeting already make enormous salaries and bonuses.  

Moreover, for better or for worse, money is not the be all and end all of human behavior.  IMHO, the False Claims Act works well for a number of reasons, not the least of which is because the ranks of defense contractors, the health care industry and others have a disproportionate share of patriotic Americans who know right from wrong and are not afraid to speak out about it. 

In other words, the Federal False Claims Act depends on individuals who have a healthy, working, moral compass.  Only time will tell if there are enough individuals in the financial industry with a healthy, working moral compass to make a difference, but some of us have our doubts.....