Stock Options as Hush Money to Potential Whistleblowers
Let’s say you’re a rank-and-file employee at a large corporation. Let’s also assume that your employer has recently become much more generous in offering stock options. You certainly are fortunate, aren’t you?
Maybe. But then again, maybe not. Something more sinister could be afoot.
Researchers from three prominent business schools in the U.S. have discovered that over the past 15 years companies have tended to issue more stock options to rank-and-file employees when they’re cooking the books and don’t want to get caught. And these researchers at the Arizona State University, Rutgers, and Columbia Business schools found instances where opening up stock options to the general employee pool who might be involved in (or who weren’t, but might be aware of) financial hanky-panky within the corporation were used as an incentive to keep quiet. And the ploy seems to be working.
The study – Rank and file employees and the discovery of misreporting: The role of stock options – published in The Journal of Accounting and Economics and the Harvard Business Review, surveyed records between 1996 and 2011 from 663 firms which were facing litigation for financial misreporting, and found they collectively issued, on average, 14 percent more stock options during periods when they were accused of falsifying financial results than companies which were not suspected of such malfeasance. Equally interesting was the discovery that rates of option issuance at the dirty firms also decreased 32 percent after their frauds stopped.
The degree to which this pseudo-generosity stifled whistleblowing was also noteworthy. Among the many kinds of financial incentives available to companies to buy their employees’ silence, the ones in the study that were not reported by an insider granted 78 percent more options than those which were unmasked by whistleblowers.
Stock Options Can Buy Employee Silence — and Loyalty
For generations, employees have found themselves in a position to notice, then expose, wrongdoing, within business organizations. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act amplified the mechanism established in 1986 that encouraged employee whistleblowing. Dodd-Frank’s Section 922 pledges to protect whistleblowers from retaliation while it offers monetary awards for disclosure. Those incentives can encompass from 10 to 30 percent of the monetary damages the government collects from the company. Since the Whistleblower Reward Program was established, the Securities and Exchange Commission (SEC) has granted more than $111 million in awards to whistleblowers. The largest – $30 million – was granted in September 2014. The Commodity Futures Trading Commission also has its own parallel reward program.
But companies seem to be focusing on the stock options as an effective countermeasure to any financial rewards that whistleblowers could receive, especially if their silence guarantees strong financial statements which translate into healthy dividends that eventually find their way into the pockets of employees who look the other way. This can be an especially effective deterrent to whistleblowers who consider “spilling the beans” purely for financial gain.
Since the value of stock options is a direct product of a firm’s stock value, and whistleblowing allegations often spur immediate declines in the company’s stock price, potential whistleblowing employees who accept the options would lose financially if they blew the whistle. Another disincentive to whistleblowers is that virtually all employee stock options have vesting terms which require them to wait for up to several years before they can exercise their options. So this tactic has some real staying power for corporations to curb potential whistleblowers over quite a long period of time.
Recent media reports indicate that the SEC is investigating several other “proactive” ways in which firms undercut potential whistleblowers. They include the creation of severance contracts which prevent employees from contacting regulators or benefiting from government investigations they might blow the whistle on and having employees sign even more restrictive confidentiality agreements. In this war of wits between government regulators and companies that break financial reporting laws, both sides keep devising remedies to counter the advantages of the other. And it always impacts the whistleblower conundrum, “Do I tell, or turn a blind eye?”
Qui tam and the Laws That Govern Whistleblowing
The False Claims Act (FCA) [31 U.S.C. § 3729] also called the “Lincoln Law,” imposes liability on persons and companies who defraud governmental programs. The law includes a qui tam provision. The Latin term qui tam dates back to English Common Law and translates into “one who sues in this matter for the king as well as for himself.” It allows those with evidence of fraud against federal programs to sue the offender on behalf of the government.
The Sarbanes-Oxley Act of 2002 incorporated qui tam provisions that offer strong financial incentives to file a lawsuit on behalf of the federal government. And in 2006, Congress amended the Internal Revenue Code to permit whistleblowers to obtain financial rewards for reporting any form of corporate/business tax fraud, which essentially closed the loop on private industry enterprises and brought them under the full measure of the FCA.
The importance of financial incentives when it comes to promoting corporate fraud disclosures was emphasized in a study published in the Boston University Law Journal a few years ago. It examined several possible methods to encourage whistleblowing. The study revealed that the qui tam model creates the most reliable incentive for the whistleblower to bring information to the attention of the government that it was unable to detect on its own. “Qui tam cases bring out important inside information,” the study concluded.
If you believe you have the necessary facts to bring a whistleblower case, seasoned whistleblower attorneys can help you file the appropriate disclosure statement. Under some circumstances, the government will intervene, or join in your lawsuit.
Many whistleblower claims are non-starters — usually because they lack focus or clarity, often because the whistleblower has not properly prepared their complaint or has left out essential information that inspires the government to join in.
But your chances of succeeding are greater if your claim is substantive, clear, and to the point. An experienced whistleblower attorney can increase your chances of winning. And government intervention often increases your prospects of recovering reward money, while you right a wrong and help protect the public.
For a free, confidential evaluation of your case, contact the Louthian Law Firm today by filling out our online contact form.