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The Coming New Age Of Whistleblower Lawsuits

11/05/2010 | Forbes
by David Kovel

The Dodd-Frank Wall Street Reform and Consumer Protection Act is now law.

Those who have charged the Obama administration and Congress with being hostile to free-market enterprise may take heart from a nugget in the bill. Deep within its thousands of pages it encourages whistleblowers to identify securities or commodities fraud by allowing them to share in the recoveries obtained from the information they provide. These provisions modify the Commodities Exchange Act. They don’t create new bases for liability, but they do acknowledge, implicitly, that agencies can’t do all the work and that it’s therefore necessary to encourage civilian participation. Just how do you get such participation? By using the basic capitalist tool of financial reward. Whistleblowers who provide information of a fraud to the Securities and Exchange Commission or the Commodity Futures Trading Commission can receive 10% to 30% of the recovery when there are sanctions of more than $1 million.

The provisions are modeled on the False Claims Act, which allows whistleblowers who report fraud related to government procurement to share in any government recovery. The False Claims Act has delivered billions of dollars to the federal government and hundreds of millions to whistleblowers, a bargain considering how many additional regulators could have been employed without necessarily achieving nearly as much. Dodd-Frank is designed to ferret out financial fraud and crimes regardless of whether government procurements are involved.

In a 2009 False Claims Act settlement between the Justice Department and Pfizer, whistleblowers altogether received more than $80 million. Had the recent case brought by the SEC against Goldman Sachs, which resulted in a $550 million settlement, been initiated by a whistleblower, that whistleblower would have collected between $55 million and $165 million.

Judging from what has happened with the False Claim Act, Dodd-Frank whistleblower suits will likely mainly concern accounting fraud at companies that file with the SEC. My law firm, Kirby McInerney, has already heard from company insiders who claim to have identified potentially material accounting fraud and say they intend to bring it to the SEC’s attention. Whistleblower lawsuits also may happen when market participants--hedge fund operators or commodities traders--learn of fraud in their markets; for example, they may identify accounting fraud when their own rigorous analyses raise questions about a company’s representations. Likewise, commodities traders may identify market manipulations such as the cornering of a futures market. Employees of fraudulent companies may also start the process.

Had the Dodd-Frank whistleblower provision been in place earlier, the fraud perpetrated by Bernard Madoff, the rampant subprime mortgage and securitization mess, and BP’s alleged manipulation of the propane market, to name but a few events, might have been brought to light far sooner, perhaps preventing their worst effects while earning whistleblowers tens of millions of dollars. That's because the free market provides the best protection from abuses of the free market, and the whistleblower provisions effectively acknowledge that.

Potential whistleblowers may want legal counsel for at least two reasons. First, the SEC and CFTC have discretion concerning what percentage of any fine (between 10% and 30%) to award them. The main considerations for that include how much help the whistleblowers and their counsel provide in the investigation of the facts and the framing of issues. Second, whistleblowers can provide information to the SEC or CFTC anonymously through counsel, and that can often provide comfort to those wanting to provide helpful information.

Some have expressed concern that whistleblower provisions may introduce a flood of unmeritorious claims. That concern is valid but exaggerated. Lawyers who will be paid only upon a successful outcome can be counted on to filter out claims that lack merit before they evolve into actual litigation, and the government itself will do so too. In short, therefore, the Dodd-Frank whistle blower provisions give the market an opportunity to do what it does best--operate freely through individuals.

David E. Kovel is a partner at Kirby McInerney LLP who specializes in whistleblower suits. He has traded commodities and has litigated high-profile commodities and securities fraud cases. Kirby McInerney LLP’s clients include hedge funds and other investment funds, as well as state and municipal governments.