Whistle-blowing mechanisms have long been recognized and used as tools to encourage the revelation of hidden information. The information sought is often evidence of otherwise undetectable fraud. An effective mechanism will be one that best deters such fraud. To do this, the mechanism needs to produce high-quality information that is not otherwise lost in the noise of low-quality information. In this paper, we present a model to explore how the use of a court-centric qui tam mechanism as opposed to an agency-driven mechanism can improve whistle-blowing along these dimensions.
We compare two leading mechanisms that have been implemented in high-profile federal statutes. The first is the court-centric qui tam mechanism embodied in the False Claims Act. The second is the agency-centric system enacted as part of the Dodd Frank Act.
The model demonstrates that the qui tam mechanism--which allows whistleblowers to bring a lawsuit on behalf of the government--produces a separating equilibrium by imposing a private, loss contingent cost commitment on whistleblowers. When whistleblowers possess private information, the cost commitment screens out low-quality information while maintaining the incentives for high-quality information and lawsuits. In turn, enforcement and deterrence are improved. Counterintuitively, then, increasing costs and lowering rewards for whistleblowers can often lead to better enforcement and less fraud.
We conclude by exploring applications of this model and the resulting insights for other areas of private information and third-party enforcement mechanisms.
TABLE OF CONTENTS Introduction. I. Justifying the Competing Mechanisms A. The Different Mechanisms B. Existing Justifications II. Screening the Quality of a Whistleblower's Information A. Screening as a Solution to the Problem of Hidden Information in Whistle-blowing B. The Model of Screening 1. The Decision to Commit Fraud (Firms) 2. The Decision to Blow the Whistle (Informants) 3. The Structure of Whistle-Blowing Laws (Government) a. Financial Reward Schemes b. Reducing the Cost of Blowing the Whistle c. The Screening Benefits of Qui Tam Actions under the FCA III. Broader Applications and Limitations A. Limitation One: Ulterior Motives B. Limitation Two: Asymmetry of Information C. Limitation Three: Public vs. Private Screening Conclusions INTRODUCTION
On February 22, 2013, the Department of Justice joined a False Claims Act lawsuit against Lance Armstrong and his associates. (1) The case had originally been filed by Floyd Landis years earlier. (2) The substantive allegations are straightforward. Armstrong and the other defendants had taken sponsorship money from the United States Postal Service ("USPS") while falsely representing that they were not using performance enhancing drugs or other doping techniques. (3) The facts are equally straightforward. Armstrong famously confessed his sins of doping to Oprah. (4) The contracts between the defendants and the USPS contain representations that no doping was occurring. (5) All that remains is to determine whether that constitutes a false claim and whether and to what extent the USPS was damaged.
Procedurally, matters are not so straightforward. Landis, who has no individual claims in this particular lawsuit, filed the suit as a qui tam action on behalf of the United States. Under the False Claims Act ("FCA"), a qui tam action allows individuals (known as "relators") to file and pursue suits for wrongs committed against the government. (6) Prior to February 22, it was Landis and his lawyers expending the resources and making the decisions in running the case. Pursuant to the statute, and the extensions granted by the judge, the suit remained sealed until the Department of Justice had completed its investigation and made a determination to join the suit. (7) Now the Department of Justice is at the helm. (8) But Landis still stands to receive a substantial percentage of any USPS recovery. (9) And if history is any indicator, recovery is quite likely now that the Department of Justice has taken over. (10)
Meanwhile, in the same district court, the Securities and Exchange Commission has obtained an agreement from JPMorgan Chase to pay over $296 million in fines for misleading investors about the quality of mortgage-backed securities just before the 2008 financial crisis. (11) How are these cases connected? Whistleblowers. The lawsuit leading to the JPMorgan settlement was brought by the SEC. But its allegations may have been derived from information provided to it by one or more unnamed whistleblowers. (12) On February 8, 2013, the SEC invited any individuals claiming to have provided information that led to the settlement to make a claim for their whistleblower reward under the new whistleblower provision in the Dodd-Frank Act ("DFA"). (13)
The financial rewards for whistleblowers under the FCA and the DFA are similar. (14) The procedural mechanisms for the JPMorgan whistleblowers to report and recover under the DFA, however, are different along many important dimensions from those for FCA claimants like Floyd Landis. The FCA whistleblower brings the case directly to the court on behalf of the government and must convince a judge that he has cleared a number of statutory hurdles. DFA whistleblowers, on the other hand, inform directly to the SEC. The procedure is more streamlined but prosecution and recovery is at the discretion of the SEC. (15) At least in the initial inquiry, the court has no say in the DFA award, (16) and the DOJ has no say in the FCA award. (17)
Why the difference? And which is better? We explore those questions in this Article. We present a model demonstrating the value of the FCA qui tarn mechanism in situations where it is difficult to verify the merits of the whistleblower's claim. The qui tarn process screens information and in turn improves enforcement and deterrence. Screening models are, of course, broadly relevant and well developed elsewhere. But the concept has not been addressed in the FCA or the DFA whistleblower context. We suggest that this neglected feature of the qui tam mechanism is perhaps its defining and most valuable characteristic.
The existing literature on whistle-blowing has focused primarily on (1) the incentive effects of whistleblower rewards and protection, (18) and (2) the regulatory capture that may necessitate empowering individuals to bring qui tam cases on behalf of the government. (19) The first strand has been well explored theoretically and a new empirical literature is emerging to test those theories. (20) But these tell us little about the comparative advantage of an FCA court-centric private-plaintiff mechanism and a DFA agency-centric mechanism. (21)
The second strand provides a regulatory-capture and agency-incentive justification for preferring the court-centric private-plaintiff mechanism. (22) This suggests that executive agencies cannot be trusted, because of capture or resource constraints. This reasoning is flawed and under theorized. It is difficult to reconcile with any general theory of agency power. It provides no coherent explanation for why a court-centric private plaintiff mechanism should be utilized in whistleblower cases and not other agency investigations, prosecutions, and regulation. Rather it suggests an unusual and idiosyncratic solution for general agency-incentive problems and suggests no reason to think that a court-centric solution will be more effective than the alternatives. (23)
We suggest a different justification for the FCA mechanism based on information screening. Starting with a rational actor model and assuming risk neutrality, we compare the two mechanisms. (24) We show that the court-centric private-plaintiff mechanism (25) is superior to the agency-centric mechanism (26) when there is asymmetric information (27) because it screens for the most accurate information from whistleblowers. This private cost commitment is not required of the SEC whistleblower under the DFA scheme.
Thus, the qui tarn design should--all else being equal--create a separating equilibrium that enhances the overall quality of information to the enforcers and reduces the costs of effective enforcement. In turn, the design will increase the deterrence effect of whistle-blowing. These screening benefits are particularly important for a whistleblower scheme (with its inherent information asymmetry), (28) and the outcome does not turn on the quality of the enforcing agency or the level of agency-incentive problems. We do not, however, suggest that all else is equal or that the FCA is perfectly designed. Our point is simply that its value in screening information through cost imposition has been under appreciated. To the extent other mechanisms can be modified to achieve this screening, they may be preferable to the FCA design.
Indeed, this analysis provides new, prescriptive guidelines generally for designing whistleblower systems that effectively deter fraud in various contexts. (29) Our analysis suggests that the worries of agency capture and a reduced quantity of information under the DFA are overemphasized. The more vexing concern will be an over-provision of tips relative to a mechanism that imposes some cost on the whistleblowers. This overprovision will swamp the reviewing agency with low-quality information. If the agency is budget constrained and cannot easily distinguish low-quality tips from high-quality tips, this shifts resources toward less effective investigation. Alternatively, it may shift enforcement to other types of cases with less information asymmetry even if those cases are otherwise less important. (30) By reducing effective enforcement, this will in turn result in less deterrence.
Even in the FCA model, an increase in the bounty payment can often lead to under-deterrence. That is, as the reward to the FCA relator is increased, the benefit of the screening of the qui tam mechanism dissipates and the outcome...