As the Securities and Exchange Commission continues to finalize regulations mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the Department of Justice negotiates yet another round of settlements with financial institutions, I pondered the following question: What is the most effective tool for ferreting out fraud and abuse in the financial services industry?
After rereading a couple of books on the financial crisis and scouring the archives of several newspapers, I concluded that whistleblowers are the most useful and consistent means of unearthing fraud and other improprieties in the financial world. No one else comes close.
I imagine that some CEOs, corporate counsels and chief compliance officers will take issue with me because whistleblowers have been known to cause a great deal of turmoil and distress. There’s nothing more unsettling than having a whistleblower running loose inside a corporation. However, it is whistleblowers, and not auditors, regulators, prosecutors, or savvy investors who have been the best means when it comes to unearthing serious improprieties inside our financial institutions. This week I’m going to look at the essential role whistleblowers play in our financial system. Those readers who read the sports pages as well as the business section will see parallels with the academic improprieties unearthed at UNC-Chapel Hill.
At the outset, it’s critical to differentiate between a whistleblower and a leaker. A leaker is simply someone who reveals internal information to an external source. While the internal evidence might include potential illegalities, quite often the leaker’s intention is to embarrass, harass or harm a company. While the whistleblower also leaks information to a media outlet or regulator, the leak is a last resort. Typically, the whistleblower is law-abiding. In fact, it’s the whistleblower’s insistence on following the law that is at the heart of her behavior.
Whistleblowers were the first to unearth the accounting irregularities at Enron and World Com. They were the ones who disclosed improper trading and pricing of mutual funds about 10 years ago, and they revealed the sordid lending practices that brought us the mortgage crisis in 2008. Long before the Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act and the Dodd-Frank act, there were plenty of federal and state laws to guard against financial abuse. However, the existing statutes did little to reveal, let alone prevent, the financial practices that were at the heart of the financial crisis. The new laws added hundreds of pages of disclosure, checklists of compliance procedures, new independent departments staffed with auditors, and penalties for executives who flaunt the law. Have these laws made our financial system more secure? Marginally.
Do the new laws and regulations provide a first line of defense against financial fraud and corporate excesses? No. Despite the efforts of Congress, regulatory agencies and prosecutors, financial irregularities continue to run rampant, and the whistleblowers remain our only reliable way to unearth them. In fact, both Sarbanes-Oxley and Dodd-Frank acknowledge the pivotal role of whistleblowers by attempting to protect them from retaliation and by rewarding them with a portion of any fines or penalties extracted by the Securities and Exchange Commission.
As I mentioned earlier, whistleblowers are law abiding. Whether it’s approving improper subprime mortgage applications, stuffing those defective mortgages into a securitization or improperly foreclosing on homeowners, whistleblowers were the first ones to raise those concerns to their supervisors. If the average employee expressed the same concerns, he would drop the matter when his supervisor rebuffed him. The whistleblower, on the other hand, feels compelled to escalate the matter. She will take her concern to compliance and/or legal staff, and even confront the CEO. Typically, it’s only after going up the chain of command that the whistleblower will seek out the media, regulators and/or prosecutors. In my experience, whistleblowers don’t take this last step lightly. Moreover, she’ll take this action after being pressured and/or threatened, knowing full well that her livelihood and career will be jeopardized.
The corporate response is completely predictable. In case after case, the company disparages the whistleblower and does not address the underlying concern. Inevitably the institution claims that the employee is making the claim because she was passed over for a promotion or reprimanded in the course of an annual review. In some cases, the company’s assertions may contain an element of truth. However, the attacks on the whistleblower’s character or motive are beside the point. The financial institution’s real concerns are centered on the threat posed to the company’s short-term profits, annual bonuses, and most importantly, its reputation. The whistleblower’s allegations will by now have become a central concern of the firm’s counsel and outside law firm, and the lawyers will strongly advise the CEO to vehemently deny the allegation, pending a thorough internal investigation. The internal investigation rarely vindicates the claims of the whistleblower.
In the financial services industry, the corporate strategy of vilification and denial has been all too successful. While the U.S. Department of Justice and the SEC have extracted multibillion settlements from the likes of JP Morgan and Citigroup, they’ve gotten very few admissions of wrongdoing and virtually no criminal convictions of corporate executives. The fines are often covered by insurance and deductible from corporate income taxes, so the bank’s or investment bank’s pain is muted.
Clash of cultures
Meanwhile, most whistleblowers find that they are not only pariahs in the financial services industry, but that they aren’t employable in almost any professional capacity. The protections afforded by Sarbanes-Oxley and the potential rewards offered by Dodd-Frank don’t do much to ameliorate the risk borne by whistleblowers. Thankfully, whistleblowers seem undeterred and continue to unearth manipulation and fraud in currency trading, consumer finance and investment banking. They are our only reliable line of defense.
Why do so many financial companies persist in bending and breaking the rules? Why do whistleblowers seem to always surface to expose the abuse? In my view, there’s a clash of cultures. The culture of Wall Street ensures that financial institutions will continue to break the rules. At the same time, a few employees with strong moral compasses will inevitably find work at these institutions. The clash of cultures will occur when the whistleblower becomes involved in or privy to questionable business practices. In due course, the whistleblower will place her career at risk.
In a speech less than a month ago, the president of the New York Federal Reserve, William C. Dudley, warned bankers that they needed to foster a far more ethical set of values and culture or face a breakup of their institutions. He said it is the leadership of Wall Street, rather than a few bad apples, who are responsible for the repeated transgression by bankers. While I think he’s right about the cultural deficiencies, I’m not sure whether he is actually prepared to take decisive action against the banks. As a result, you and I will have to continue to rely on a handful of employees within major financial institutions who have the strength of character to risk everything by blowing the whistle.
Andrew Silton’s Meditations on Money columns can be found twice a month in The N&O’s Work&Money section. He is a retired money manager living in Chapel Hill. He was CIO for the North Carolina Retirement System from 2002-2005. He writes the blog http://meditationonmoneymanagement.