Bigger bonuses for whistle-blowers: Are they ethical?

Under a new law, whistle-blowers can earn up to 30 percent of the funds the government recovers in fraud. For Wall Street whistle-blowers, that can mean big payouts.

Whistle-blowing is about to get more profitable.

Under proposed federal rules, now under review, whistle-blowers could collect as much as 30 percent of what the government recovers from violators. Payouts could be eye-popping: a $1 billion fraud, not unthinkable on Wall Street, could net $300 million for one whistle-blower.

Will fatter bounties for turning in one's co-workers and bosses improve the ethics of corporate America – or undercut them? The answer depends, in part, on whom you ask; in part, on how the new regulations are written; and, in part, on how one balances pragmatism and ethical ideals.

Substantial bounties are necessary to uncover fraud, according to Stephen Kohn, executive director of the National Whistleblowers Center in Washington and author of "The Whistleblower's Handbook" (2011). It's not that whistleblowers are motivated by money, Mr. Kohn says. Rather, they need to know compensation is waiting because they'll probably never work again in their field.

"It moves somebody from a concern to actually taking the risk," Kohn says.

Supporters of the proposed rules, which were mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, have high expectations for the added incentives. As a model, they cite the False Claims Act, which has been compensating whistle-blowers since 1986 for tips leading to recoveries in government-contracting fraud cases. Whistle-blower tips have accounted for 67 percent of recoveries, worth $18.2 billion, under the False Claims Act. An expanded bounty program under the Securities and Exchange Commission might bear as much fruit or more, according to Kohn, who worked with the SEC to draft the proposed rules.

Expanded bounties apply to more than financial institutions and large Wall Street firms. Rewards will go to insiders whose tips lead to $1 million-plus recoveries in any area regulated by the SEC. That includes all publicly traded companies – even those based overseas and traded on US exchanges.

Admittedly, paying someone to inform on their colleagues seems a little sordid, something more appropriate to policing the underworld than the corporate world. Worse, the new SEC rules could undercut corporate programs aimed at heading off corruption and other illegal activities, some critics say.

Beefed up since the wave of corporate accounting scandals in the early 2000s, these programs use anonymous hot lines and other methods to foster corporate cultures where wrongdoing can come to light and be taken seriously. But such programs won't be trusted or utilized, critics of the proposed rules say, unless workers are required to use them before going to the SEC, where big rewards await them.

"As soon as employees stop trusting management, or as soon as management stops trusting that employees are going to come to them when there are problems, you start to see a breakdown of the culture," says Patricia Harned, president of the Ethics Resource Center, a nonprofit research organization in Arlington, Va., funded by corporate foundations. "And you actually see more misconduct happen over time."

Companies, led by the likes of Microsoft and the US Chamber of Commerce, have roundly criticized the proposed rules for failing to require whistle-blowers to report internally before going to the SEC. In commenting to the SEC, an AT&T attorney writes that proposed rules "may actually undermine AT&T's programs and encourage unethical conduct."

For example: Instead of speaking up when there's a potential future violation, an employee could avoid voicing his concerns until a significant violation occurred – all in order to collect a reward, writes Wayne Watts, AT&T senior executive vice president and general counsel. "In a bizarre twist, the whistle-blower may be incented to encourage the violation."

The Securities and Exchange Com­mis­sion is reviewing feedback on proposed rules that would allow whistle-blowers to collect as much as 30 percent of what the government recovers from violators. Payouts could be quite large since Wall Street frauds can reach into the hundreds of millions of dollars or more. Final rules are expected to be announced this month.

While it's true a worker might wait until he or she has enough evidence to bring a case (either internally or to the SEC), history with the False Claims Act suggests most whistle-blowers don't calculate their moves with payoffs in mind, says Terry Dworkin, a whistle-blowing expert and scholar-in-residence at Seattle University in Washington State. "There's not a lot of evidence that people are purposely spying on others in their company just to get a big reward."

For some scholars, the question isn't how best to realize an ethical ideal in corporate America. The ideal, Ms. Dworkin says, would be one in which workers report problems internally and resolve them without going to regulators. But, she notes, workers didn't come forward with information about government contracting fraud to any significant degree before bounties existed under the False Claims Act. Hence, in her view, there needs to be room for something less perfect – a monetary incentive system for those who take big personal risks – if regulators are going to smoke out wrongdoers.

"There may be some companies that would be perfectly well served if employees would come to them first," says Ann Buchholtz, research director at the Institute for Ethical Leadership at Rutgers Business School in Newark, N.J. "But there are other companies where [such a requirement] really does put the whistle-blower at risk.... And if we really want these problems brought to light, we can't put obstacles in the way of whistle-blowers."