Will Paying Whistle-Blowers for Tips Lead to More SEC Crackdowns?

The feds know that money talks, but they may get more than they bargained for. According to the Financial Times(subscription required), the new Dodd-Frank financial reform act includes a provision to offer lucrative rewards to people who alert authorities to securities and other types of financial fraud. People who are able to provide information that leads to a successful SEC enforcement action will be entitled to 10% to 30% of any penalties collected over the $1 million mark, the newspaper said.

The possibility of a seven-figure reward "reflects the high quality of whistleblower we hope to get -- people within a company, broker or other regulated firm that we might not have heard from before," the Securities and Exchange Commission's Stephen Cohen told the FT.

Cohen says the SEC expects "a tremendous response" from Wall Street insiders. But at least one long-term observer of the system is skeptical.

Gaming the System?

"It's good to have people reporting some type of malfeasance, either corporate or government wrongdoing. You want to encourage people to report," says Dr. Stephen Martin, a clinical professor with the department of business ethics and legal studies at the University of Denver's Daniels College of Business.

But for Martin, who has also worked as a corporate compliance officer and federal prosecutor, providing incentives for such tip-offs can encourage frivolous or unjustified claims.

"The system might be played by people as well as lawyers who are working with whistle-blowers," he says, "to encourage them to go after some type of report, to try and get some kind of big settlement out of it. The real key is not the quantity of reporting [of fraud]. You want quality reporting so the government can use their resources in the best way possible, to really uncover what are the major crimes, frauds, issues -- not chasing down every possible lead, because they don't have the resources to do it."

And while it's "perfectly legitimate" for the Obama Administration to go after such fraud, Martin doubts if it will have any long-term effect on Wall Street's notoriously flexible ethics.

"I think it's something the government [must do] to show it's serious," he says. "I don't know that it really changes behavior on Wall Street. People make decisions based on short-term benefit and greed, financial incentive. They don't worry really about the downside, long-term impact. If they did, you wouldn't see these [financial collapses] happening, and you wouldn't see them repeat. I don't think most people who make these decisions in Wall Street are really worried about whether a whistleblower is going to get 10% or not. For them it doesn't really enter the calculus of when they're making those kinds of decisions. Of course, they'll tell you they weren't doing anything wrong to start with."