Has Time Come to Cap Whistleblower Awards?

Corporate whistleblowers are getting bigger and bigger payouts for reporting fraud, sparking a fresh debate about whether the rewards are justified.

Whistleblowers have collected billions of dollars since the late 1980s by suing government contractors under the False Claims Act and other federal laws. The new Dodd-Frank financial reform law could lead to more payments, something plaintiff attorneys say will provide checks on businesses but companies fear will circumvent their own internal anti-fraud systems.

Awards for reporting fraud hit a record high of $385 million in the 12 months ended Sept 30, 2010, U.S. Justice Department data showed. The total rose nearly 50 percent from the previous year and was the third increase in a row.

The Dodd-Frank law calls on the U.S. Securities and Exchange Commission to pay awards to people who report violations leading to at least $1 million in sanctions.

Workers should have to report problems to internal company monitors as well as to the SEC, some business groups say. Some want the agency to limit payouts if the worker did not try to solve matters internally first.

As proposed SEC Dodd-Frank rules are written, workers would have an incentive to circumvent their companies’ compliance systems in hopes of getting a big cash payout, chemical maker Huntsman Corp. wrote in a comment letter to the SEC.

Employees “have been deputized and promised huge riches to bypass their companies and report to the government” under the new law, said David Baris, head of the American Association of Bank Directors.

[Editor’s Note: the Dodd-Frank provisions on whistleblowers raise insurance concerns for directors and officers, reports Kevin LaCroix.]

But Steven Kohn, executive director of the National Whistleblowers Center in Washington, said internal company programs often fail to fully investigate wrongdoing. He said employees should have a choice where to raise concerns.

Big payouts are the price of getting good information from people who risk their careers to report problems, he said.

“If you want to get the big fish, you have got to pay the big award,” Kohn said.

Kohn has made a career representing people bringing False Claims Act cases. The Civil War-era law was changed in 1986 to give individuals up to 30 percent of recoveries from government contractors. Since then, fraud settlements and court judgments rose to $3 billion in 2010, up from $176 million in 1988.

False Claims cases are “qui tam” lawsuits, a Latin phrase meaning a plaintiff is suing “for the King as well as for himself.” A record 573 new qui tam cases were filed in fiscal 2010, up from 433 the year before.

In October, a former GlaxoSmithKline employee was awarded $96 million, the largest payment ever in such a case. Her reward was part of the $750 million the drugmaker paid to settle a manufacturing fraud case.

False claims cases in state courts also are up. Lawsuits against Bank of New York Mellon contend it overcharged pension funds in Florida and Virginia for foreign exchange services. The cases resemble one pending against State Street Corp in California. Both banks deny wrongdoing.

Various groups have called in the past for caps on these awards, but those arguments have found little traction. For instance, a 2009 proposal by Arizona Republican Sen. Jon Kyl to cap whistleblower awards at $50 million was defeated. Another Republican, Iowa Sen. Charles Grassley, has been a chief defender of the rewards as a way to root out waste.

Critics have gotten an ally, however, in Skadden Arps attorney Michael Loucks, who until 2009 was a top Justice official prosecuting fraud cases. He won settlements from companies including Serono Labs, now part of Merck KGaA , based on whistleblower claims.

In a recent paper in trade journal Health Care Fraud Report, Loucks argued that Congress should cap payments under the False Claims Act to $2 million. That would vastly increase recoveries to taxpayers, he argues.

Of the 14 largest settlements since 2008, whistleblowers received $650 million — $622 million more than if the cap were in place, he wrote.

(Reporting by Ross Kerber, editing by Matthew Lewis)