January 3, 2011
Expanded comments of Robert Shattuck on File No. S7-33-10
Proposed Rules for Implementing the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934
(submitted electronically on January 3, 2011)
I. Prior submission on December 28, 2010
I was out of the country from December 8 through December 16. I first learned of the proposed rules on December 26. I desired to make a submission even though it was past the stated deadline of December 17. I quickly drafted and made a submission on December 28, 2010. I have now had time to prepare a longer submission that I wish to make. I request that these expanded comments be received and considered by the SEC even though not submitted on or before December 17th.
II. Background of submitter
I am a retired lawyer with no professional or corporate affiliation.
I have an acute interest in corporate wrongdoing and what society can do to lessen the same. I have had a special interest in whether the work of plaintiffs lawyers aids in the deterrence of corporate wrongdoing. I have concluded that their work undermines business ethics and deterrence. I have urged ethics professionals to evaluate my arguments that plaintiffs lawyers undermine the deterrence objective of the civil law, and, if they agreed, in turn for those ethics professionals to raise the matter with management and/or make advocacy to lawmakers and others regarding how to increase the deterrence efficacy of the civil law.
I have a blog How To Combat Plaintiffs' Lawyers (URL http://robertshattuck.blogspot.com) in which I report my work. I have an article Does the Civil Liability System Undermine Business Ethics? (URL http://robertshattuck.blogspot.com/2007/11/i-thought-this-would-be-effective-email.html) in my blog in which I set forth my argumentation that plaintiffs' lawyers undermine business ethics and deterrence.
III. Expanded comments
A. Basic contention
It is submitted that (i) in dealing with corporate wrongdoing, the law is unacceptably deficient from a deterrence standpoint in the way the law fails to punish officers, employees and other individuals who participate in and are responsible for the design, implementation, and carrying out of corporate acts that comprise corporate wrongdoing, (ii) the law is mistaken in its willingness to assume punishment of a corporation can achieve adequate deterrence, and (iii) the law fosters a mindset and a willingness of some persons to take advantage of the foregoing deficiencies and to benefit from them at the expense of innocent parties, such as shareholders . Until these deficiencies are addressed by lawmakers, regulators, judges and others, there will be similar deficiencies connected with the whistleblower program, the program will fall short in achieving deterrent objectives, and the program will be at risk of being unduly exploited for personal gain and benefit in a fashion similar to that referred to in the preceding sentence.
Accordingly, lawmakers, regulators and others should first correct the foregoing deficiencies in the law before the proposed whistleblower program is put in place.
B. Supporting discussion and argumentation
1. Basic context
It is indisputable that corporate dishonesty is a big problem.
At the same time, whistleblower payments are an extreme tool.
Honest citizen cannot be pleased if corporate dishonesty is such an intractable problem that we need to transplant, into the corporate business world, street crime fighting tactics of paid informants such as entertain us on TV crime shows. Then, life is life, and honest citizens cannot be pleased either to read in their local newspapers that an almost Gestapo like FBI has come into their state or city, armed with the latest, sophisticated surveillance technologies, and have followed or resurrected specific trails of crooked politicians taking bribes from local businessmen in transgressions that local law enforcement does not seem up to the task of policing.
The SECs whistleblower payment rules, mandated by Dodd-Frank, are limited to the SECs jurisdiction over securities law violations. There are other types of corporate wrongdoing in which whistleblower payments could be utilized, and their broader potential use should be kept in mind when thinking about their limited use for SEC purposes.
The proposed rules, published on November 3, have attracted hundreds of comments and have sparked strongly worded opinions on opposing sides. Average citizens, evidencing anger about perceived orgies of corporate wrongdoing, have expressed brief, simple, unqualified support for whistleblower payments. Corporate management, in house counsel, and corporate ethics and compliance officers have submitted numerous comments voicing their concern about undermining internal corporate compliance programs. Media reporting includes The Wall Street Journal, Whistleblower Bounties Pose Challenges, December 14, 2010 The New York Times, For Whistle-blowers, Expanded Incentives, November 14, 2010 CNBC, Sustained Ethical Corporate Culture at Risk From Proposed SEC Whistleblower Rules NACD National Association of Corporate Directors details chilling effect in comment letter to the SEC Internal compliance systems undermined by Dodd-Frank Provision, December 20, 2010.
This public interest in the proposed rules potentially lends itself to a teachable moment about corporate dishonesty, what society does to battle it, whether additional steps can be taken short of the tool of paid informants inside corporations, and, after considering those things, whether whistleblower payments should be employed or not.
2. Current problems of corporate wrongdoing
Commercial wrongdoing is as old as commerce, but it was a simpler problem in simpler earlier times. Now, societal organizational structures are very large and complex, and they are a daunting challenge to police and regulate.
Modern day bigness and complexity introduce or augment significant difficulties in trying to contain corporate dishonesty. The activities of large corporations are designed and carried out through the collective action of numerous corporate officers, employees and other agents, and identifying those persons and determining their respective responsibilities for a wrongdoing can be extremely difficult, time consuming and expensive. Amidst complexity there are more nooks and crannies for employing deceptions and tricks to obtain wrongful gains. Bigness and complexity create more conflicts of interest in which persons can improperly exercise their authority in one position to favor another economic interest they have in a different position. More expansive involvement of the government in the economy increases political corruption, and that can foster an acceptance of dishonesty that infects the business mindset generally. Larger scales of commerce, greater geographical mobility, an increase in transient business and personal relationships, and new means of anonymity, undermine the nurturing of trust and integrity in the commercial world.
Other factors contributing to corporate dishonesty are more constant, such as human selfishness and greed, and propensities of many human beings to use their human intelligence to scheme in their commercial dealings.
3. Some current theories, approaches and techniques
A longstanding multi-faceted effort against wrongdoing is provided by lawmakers, regulatory bodies, state attorneys general, prosecutors, judges, and plaintiffs' lawyers
The wrongdoing of big corporations is a priority concern because of their potential to cause greater amounts of loss, injury and damage to the public. In recognition of this, elaborate internal compliance and ethics programs have been developed by bigger corporations.
Within the business ethics commumity, there has been extensive debate, purportedly backed up by academic research, about how best to achieve deterrence. Illustrative of this is the comment submitted by the Business Roundtable Institute for Corporate Ethics, which cites a notable Harvard Business Review article that the Institute uses as a teaching tool in its ethics seminars. This comment states that the Harvard Business Review article
"provides a useful distinction between organizations that manage ethical behavior either through (1) compliance-based programs, for organizations which focus activity and resources on threats, deterrence, and punishment for legal and ethical breaches, or (2) integrity-based programs, in which companies promote internally-developed values and self-governance to drive ethical decision making and behavior. The article asserts that companies with integrity-based programs are most effective at discouraging misconduct, a conclusion that is also confirmed by further academic research."
The compliance-based programs referred to in the above comment are internal to the corporation. They are an add on to societys previously mentioned external compliance based programs created and carried out by lawmakers (in enacting criminal and civil laws), regulatory bodies (of which the SEC is one), state attorneys general, prosecutors, plaintiffs' lawyers, and judges.
In external compliance based programs, there is debate about whether the corporation should and can be punished to achieve deterrence and whether it is needed to punish individual officers, employees and agents to deter. Also there is debate about whether lengthy, specific, detailed rules work better for regulating behavior or whether general principles are better for guiding conduct.
All in all, there is a muddle in the theories, approaches, techniques, and practices currently employed or advocated as means to regulate corporate conduct. Whistleblower payments are but one item in a confused bigger picture.
The whistleblower payment rules are an expansion of society's external "compliance-based" programs and are a clear sign that there is no serious movement afoot to shift to an exclusive reliance on self-policing by corporations. Advocates, designers and implementers of internal corporate compliance and ethics programs at a minimum need to manage an interfacing of their internal programs with society's external compliance based programs.
The concept of integrity based internal corporate compliance programs touted in the above comment by the Business Roundtable Institute of Corporate Ethics is, notwithstanding its asserted support by academic research, in a particularly tenuous position, given the seeming insistence of society on its "external" compliance-based programs. The extreme tool of whistleblower payments is an especial effront to the sensibilities of those advocating "integrity-based" programs.
Given that the SEC's whistleblower payment rules are a high profile attack on the sufficiency of internal corporate compliance programs, one upshot should hopefully be soul searching by advocates of internal programs about deterrence and what is needed to accomplish deterrence. It should further prompt consideration of whether anything is impeding the efficacy of internal compliance-based programs (and external compliance-based programs) for achieving deterrence.
4. Failure of law to punish corporate officers and employees
There is one central element in the big picture muddle that needs pressing, to wit, getting a better handle on the question of punishing the corporation to achieve deterrence versus punishing responsible officers, employees and other agents who conceive and implement the corporate activities that constitute the wrongdoing.
It is not as though this question does not come up, both frequently and in highly publicized ways. It is relevant not only to deterrence, but raises questions of fairness in punishing innocent shareholders for wrongdoings perpetrated by management. Several years ago this question was front and center in the public eye in connection with the Justice Department's criminal indictment of Arthur Andersen over Enron. More recently federal judges have refused to approve SEC fines levied on Citigroup and Bank of American.
Let us be clear that this is a seriously unresolved question. Without oversimplifying, it is probably reduces to some quantum of belief that it is simply too difficult, time consuming and expensive, or politically impossible, to have legal machinery that will, in a standard way, undertake determinations about, and impose punishments on, responsible officers and employees, and, and in default of having such machinery, the approach shall be to hit the corporation with a big punishment (such as a fine or seeking a criminal conviction of the corporation) and have a hope that, but not think too hard about whether, deterrence objectives are being adequately served in fact..
There is a lot of high level pushing on this question. A Congress that believes the personal incentive of whistleblower payments is needed to encourage whistleblowing is probably hard put not to think that some kind of personal punishment of officers, employees and other individuals will better achieve deterrence than no punishment of them. This is demonstrated by Sarbanes-Oxley and its provisions increasing personal liability of CEOs and CFOs for fraudulent financial statements.
As previously mentioned, there is a consequence of modern day complexity and bigness that makes for diffusion of responsibility among multiple individuals who are officers and employees, making it difficult and expensive to carry out investigations and determininations of responsibilities of officers and employees and punishing them individually. Should skepticism be put aside and should a commited attempt be made to a create the new legal machinery, with its attendant expense.
The views of affected parties need consideration here.
Management might say such machinery will make a corporations officers and employees too cautious and impair the development and carrying out of valuable and useful business activities.
If that argument is accepted, and punishing officers and employees is limited or foregone as a means of improving deterrence because it might deter the devleopment of some desirable business activities, the question would arise of what is the justification for punishing the corporation and innocent stockholders in order to achieve deterrence that is similarly unknown or indeterminate in its consequence.
Of course, management may oppose machinery for identifying and punishing responsible officers and employees because wrongdoing can be profitable, that profitability can justify greater compensation of officers and employees so long as it goes on undetected, and, if it is uncovered, management would want the protection that only the corporation is punished.
Plaintiffs lawyers will oppose the development of machinery for identifying and punishing officers and employees responsible for wrongdoing, because that would undermine their business. Machinery for identifying and punishing officers and employees entails determinations that wrongdoing has taken place. Plaintiffs lawyers work hard at creating a judicial environment in which no determinations of wrongdoing are ever made and in collecting large sums in small amounts from innocent stockholders and others, which is defended as serving a deterrence objective, as well as a compensation objective. If there was working machinery to achieve deterrence by punishing officers and employees, the deterrence purpose of plaintiffs' lawyers lawsuits would be reduced or disappear, and, with deterrence out of the way, more proper attention could be given to serving the compensation objective, including greater sensitivity to situations in which compensation to injured parties will come out of the pockets of other innocent parties, some or all of whom may have received no benefit or gain from the wrongdoing. This would significantly reduce amounts of recovery and reduce plaintiffs' lawyers' compensation.
Further a hard look at the work of plainitffs' lawyers might conclude that there is much waste of economic resources in the lawsuits that plaintiffs lawyers bring, and that these wasted resources could be beneficially used instead as a source of funding for the expense of having machinery that identifies and punishes officers and employees.
I have urged ethics and compliance officers, academics and other ethics professionals to consider whether the law undermines them in achieving their deterrence goals, including that it wastes corporate resources that could be better deployed in support of their ethics and compliance programs. Those business ethics professionals have evidenced little or no interest in considering and evaluationg my contentions. My speculation is that these persons have not wanted to embark on something that corporate managaement might oppose or that would turn out to be a futile battle against plaintiffs' lawyers.
I have stated my basic contention above, which should be considered repeated here.
If my contention is correct, and if corporate management and plaintiffs' lawyers exploit the failure of the law to punish officers and employees and benefit themselves at the expense of innocent parties such as stockholders, the same deficiency carries over with respect to the whistleblower program, to wit. the target of the whistleblower program will remain the corporation and not the responsible officers and employees. In a similar way, the whistleblower program will fall short in its deterrent objectives and would be whistleblowers will tend to adopt the mentality of corporate management and plaintiffs' lawyers to profit at the expense of innocent parties.
To try to establish its correctness or incorrectness, my basic contention needs more consideration and input from affected parties. Corporate management needs to consider and take a position and to put forth a justification for the position it takes. The same goes for plaintiffs' lawyers. Corporate ethics and compliance officers should speak up on the question and not be governed by management opposition. The SEC needs to wrestle more with its own views on the subject before it passes judgment on the deterrence effect of a whistleblower program. Congress needs also to pass judgment.
One final note about an insistence on holding officers and employees accountable in a way that has bite and about not sloughing punishment off in small amounts on large numbers of innocent parties: I think it is a frequent phenomenon in human affairs that there will be more circumspection and reasonableness when significant personal punishment and cost needs to be imposed on identifiable persons whose faces are before one and who will strenuously defend themselves, compared to the ease with which cost or punishment can be imposed in small amounts on a large number of anonymous persons who don't have a sufficient interest at stake to strenuously resist. For example, in plaintiffs' lawsuits there are a large number of anonymous parties who bear the burden of a large liability shared in small amounts, and who don't have enough at stake to strenuously resist, including not insisting on a determination of wrongdoing. Compare that to a small number of officers or employees who are to be held accountable, who potentially face bankruptcy if they have participated in wrongdoing, and who will make strenuous efforts to defend themselves, and insist on determinations that wrongdoing indeed took place.
Translate that to the whistleblower situation. If a whistleblower knows that payment will come from the corporation and be borne by a large number of stockholders in small amounts, the whistleblower may have inadequate restraint in proceeding. Compare that to a whistleblower who knows that, if his whistleblowing claim is to bear fruit, fellow employees will suffer significantly penalties personally. That would potentially promote restraint and lessen abuse of the whistleblower program.
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