Whistleblowers Get a Raise

In the 21 years since the Securities & Exchange Commission introduced rewards for insider-trading tipsters, the agency has disbursed just $1.16 million to six claimants, including a $1 million payout earlier this month to a woman who blew the whistle on the founder of the hedge fund Pequot Capital Management. With the financial-regulation overhaul signed into law by President Barack Obama on July 21, that stately pace is expected to accelerate dramatically.

Stung by accusations that it ignored reports of Bernard Madoff's misdeeds, the commission asked Congress to increase bounties and expand the SEC's authority to reward tipsters for leads on other types of misconduct, including Ponzi schemes and accounting frauds. Those wishes were answered: The financial overhaul says the agency can make whistleblower awards in any case that triggers a sanction exceeding $1 million. And tipsters are now entitled to as much as 30 percent of all the money the SEC collects, including fines and ill-gotten profits. In the past, claimants were eligible for only a 10 percent share of any fine. "The whistleblower provision will substantially benefit our enforcement program by encouraging those with evidence of fraud to come forward," says SEC spokesman John Nester.

What it won't ensure is that the SEC has the resources or expertise to uncover frauds better than it has in the past, particularly as the regulator braces for a flood of whistleblowers attracted by more lucrative bounties. To prepare, the SEC has hired consultants and is studying successful tipster programs at the IRS and Justice Dept. The agency also is using increased funding from Congress to acquire technology that will make it easier for investigators to sort through reams of information on companies accused of wrongdoing. The SEC says its computer system will be upgraded by the end of the year. "They already get a lot of tips, and the number is going to go up exponentially," says Daniel J. Hurson, a former SEC attorney now in private practice in Washington. "They are going to have to have a good system in place to separate the wheat from the chaff."

The goal is to avoid a repeat of past enforcement failures. In 2005, whistleblower Harry Markopolos gave investigators a 21-page report about Madoff titled "The World's Largest Hedge Fund Is a Fraud." Even with that road map, the SEC fumbled the investigation. The $65 billion Ponzi scheme wasn't exposed until December 2008, when Madoff couldn't meet his investors' withdrawal requests.

Some critics warn that the additional powers granted by Congress may create a new set of problems for the agency. One unintended consequence, says former SEC Commissioner Paul S. Atkins, is that disgruntled corporate employees now have more incentive to lodge complaints, which will lead to higher legal fees for companies that have to respond to investigations. The flood of tips may also divert the SEC's limited resources away from legitimate cases, Atkins says.

The Bottom Line: Larger rewards for whistleblowers could bury the SEC in thousands of additional tips alleging wrongdoing.

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