Blow the whistle and reap a web of rewards

15th September, 2012

‘The Internal Revenue Service has awarded a former UBS banker $104m for revealing a tax evasion scheme that cost the US government billions of dollars in taxes and resulted in criminal charges against Swiss banks and top executives.’

Financial Times, September 12

This is “Tarantula”?

Yes, this is “Tarantula”.

Who calls him “Tarantula”?

Well, a chap called Bradley Birkenfeld phoned the Financial Times five years ago with the opening line, “My name is Tarantula. That is not my real name.”

No kidding. Did he also confirm that his real name was not Muppet, Loony or Blowhard?

You’re just grumpy because he’s sitting on $104m. Not bad for a guy who just got out of prison for helping a billionaire to evade tax. But that’s his reward for handing over information to the US authorities about how his former employer, UBS, helped US citizens avoid tax using Swiss bank accounts.

Very nice – but isn’t it a bit crass to give the guy more than $100m?

That’s a fascinating question. You could break it down into two parts. The first is whether we need whistleblowers. The second is whether whistleblowers need to score the equivalent of a lottery jackpot or three before they will speak up.

Whistleblowing feels antediluvian somehow; shouldn’t we be looking to auditors and regulators to spot wrongdoing?

There’s a study of this by Alexander Dyck, Adair Morse and Luigi Zingales. They looked at more than 200 alleged corporate frauds – stealing money from investors rather than tax evasion – and asked how the allegations initially came to light. It’s the job of auditors and financial regulators to spot this stuff, but they rarely do. And shareholders and bondholders have a big financial incentive to discover fraud, but again this doesn’t happen much. It turns out many frauds are uncovered by employees. That makes sense: regulators and auditors are presented with carefully cooked books, but employees are at the coal face and they see the messy details of what is happening. There is no single way in which frauds are uncovered, but whistleblowers are more important than most.

But do we need to pay them so much cash?

Prof Dyck and his colleagues also looked at this. At the time, by far the largest whistleblowing payments were in the healthcare industry, because that was the industry in which the US government was most likely to be the victim of fraud. Under so-called qui tam rules, whistleblowers are due a fat slice of any government money recovered. Whistleblowers were three times more likely to speak out in the health sector, and since the average payout to whistleblowers in successful qui tam cases was almost $50m, that is not surprising.

Why are such large incentives needed?

Perhaps there are cheaper ways to encourage whistleblowing, but it’s clear that it is a hazardous business. Many people who claim to be whistleblowers have had a rough ride.

Such as?

Mr Birkenfeld claimed his life was in danger and he went to jail. Paul Moore, risk manager at HBOS, was sacked. Cheryl Eckard, who identified manufacturing problems at GlaxoSmithKline, lost her job. Ray Dirks, an analyst who uncovered the Equity Funding fraud in the 1970s, was censured by the Securities and Exchange Commission for spreading inside information. Andrew Siemaszko was an engineer at the Davis-Besse reactor when serious corrosion was discovered. Defenders claim he was trying to blow the whistle on safety problems, but he was convicted of lying to the Nuclear Regulatory Commission.

But there are two sides to these stories, aren’t there? I mean, do whistleblowers lose their jobs because they speak out or do they speak out because they lose their jobs?

It’s true many whistleblowers are ambiguous figures. Some have a grudge, while others are culpable and simply trying to reduce their own punishment. But whatever the merits of individual cases, you can see why a potential whistleblower might ask whether the game is worth playing. The chance of $100m might well tip the balance.

Perhaps we should just rely on public-spiritedness.

Fat chance: thanks to the Dodd-Frank act, it should be much more lucrative to blow the whistle on Wall Street in future. That seems sensible. Whenever we’re dealing with complex, fast-moving systems, it’s vital to have early warning of trouble ahead – and that means rewarding whistleblowers.

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