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Blowing the whistle

August 18, 2010

Washington's new rules to encourage whistleblowers will increase European firms' exposure to US fraud and corruption laws. Informants are being offered millions of dollars in rewards for evidence of wrongdoing.

A red whistle hanging from a lanyard
The US wants corporate insiders to alert regulators to fraud and corruptionImage: Bilderbox

The purpose of the powerful American financial regulator, the Securities and Exchange Commission (SEC) is, put simply, to protect investors. That's why it was so harshly criticized when it was found to have ignored warnings about Bernie Madoff's investment empire, which collapsed at the end of 2008.

Madoff operated what was essentially a massive Ponzi scheme - a fraudulent investment fund that pays returns to investors using their own money or cash paid by subsequent investors, rather than from any actual profit.

In his book "No One Would Listen", Madoff whistleblower Harry Markopolos wrote that he offered his sleuthing skills to regional SEC offices on numerous occasions, only to be turned down.

When the Madoff empire finally collapsed under its own weight, Markopolos told Congress that more should be done to help informants expose corporate wrongdoing.

"I would have assumed a disguise as I was trained to in the army and gone undercover and led that team to a successful result very quickly," Markopolos said.

Bernard Madoff
Madoff defrauded investors of billions of dollarsImage: AP

Commission-based whistleblowing

Now Washington has passed the Dodd-Frank financial reform act, however, there will be little need for cunning disguises.

New whistleblower provisions offer corporate insiders between 10 and 30 percent of fraud-related fines and disgorgement of profits, providing that the two figures add up to at least $1 million (770,000 euros).

"This bill is likely to lead to people coming forward from inside companies - broker dealers and investment advisors who are close to the fraud," said Stephen Cohen from the Securities and Exchange Commission. "That will allow us to bring cases more quickly, closer in time to the fraud occurring. People will come forward while the fraud may be ongoing."

The incentive system has caught the attention of managers not only in the US, but worldwide.

International companies listed on US stock exchanges are exposed to the legislation, as are foreign subsidiaries of US corporations. Broker-dealers and investment advisors could also be investigated, given that the rules cover the manipulation of markets and investment products.

"The key here is to have a chilling effect on fraud," said Stephen Kohn, executive director of the National Whistelblowers Center. "For every person looking around a boardroom who is conspiring to rip people off, to know that one of the people in that room may be a whistleblower, may be turning them in, may be making millions of dollars, while they end up in the clink."

European exposure

In addition to outright fraud, whistleblowers can also expose corruption - such as bribes to foreign officials - and bad accounting under the US Foreign Corrupt Practices Act.

"Some of the penalties in the last few years have been very, very high," said Don Zarin, a partner in the International and Cross Border Transactions practice group at the law firm Holland and Knight.

A businessman tucks a bundle of banknotes into his coat
A number of European firms have been hit with corruption charges in the USImage: Bilderbox

"Siemens, for example, had a combined penalty of $800 million between the SEC and the Department of Justice. Other companies like Technip, a French company, recently paid a combined fine of $338 million."

"So there is a great incentive when you are looking at a potential reward of between 10 and 30 percent of that for employees to start gathering information and gathering documents and perhaps consider the possibility of presenting that to the SEC."

Given the many overlapping interests in Europe and America, the whistleblower provisions will have a major impact on the way Europe does business, according to Luigi Zingales, a professor at the University of Chicago Booth School of Business.

"I think it's a great way to introduce a little bit more transparency in Europe," Zingales said. "We will see who is serious about transparency, and who is not. I suspect a few companies will de-list from the United States to avoid that and that will be a clear signal."

All of this obliges European companies with roots or branches in the United States to carefully consider their compliance obligations and internal controls, or risk having one of their employees do it for them.

Author: Daniel Ryntjes, Washington (sje)
Editor: Rob Turner