FINANCIAL REGULATION Bernie Madoff’s Legacy: Whistleblower Inc. A decade after Madoff’s arrest, an industry of bounty-hunting tipsters aims to cash in on the next big fraud By Gregory Zuckerman and Dave Michaels Dec. 8, 2018 12:01 a.m. ET Ten years ago, Bernard Madoff’s multibillion-dollar Ponzi scheme, the biggest fraud in U.S. history, shocked the financial world. It soon emerged that a forensic accountant, Harry Markopolos, had been alerting regulators for years to Mr. Madoff’s fraud, but no one had listened. At Mr. Markopolos’s urging, the Securities and Exchange Commission created a cash-for-tips program, designed to encourage reports of financial wrongdoing and prevent the lapses in oversight that gave Mr. Madoff free rein. Today, an entire industry is devoted to surfacing tips from company insiders and expert analysts who scrutinize corporate filings. Whistleblower Inc. is the most tangible consequence of the Madoff scandal a decade after the money manager’s Dec. 11, 2008 arrest. At the center of this new ecosystem stands the Securities and Exchange Commission’s Office of the Whistleblower, which has paid more than $326 million to 59 whistleblowers in seven years. The potential for sharing in such a huge payday has attracted plaintiffs’ lawyers, forensic accountants and former FBI agents to this government-sanctioned fraud hunt. Critics say the deluge of those seeking rewards is now overwhelming the system. More than 5,200 tips have been filed this year, compared to 3,000 in 2012. Requests from undeserving reward seekers have slowed the pace of payments, potentially discouraging future tipsters. Two individuals filed so many frivolous reward requests—one person has filed 143—that they were banned from making future requests, according to agency records. ‘If they don’t fix the program they’re going to kill it,’ Harry Markopolos says of the SEC’s cash-for-tips program, enacted at his urging. PHOTO: MICHAEL BUCHER/THE WALL STREET JOURNAL Mr. Markopolos is among the concerned. “If they don’t fix the program they’re going to kill it,” he says. About 53% of all reward requests remain undecided, according to a Wall Street Journal analysis of SEC figures and data obtained from a Freedom of Information Act request. It takes the SEC about two yearsto decide if a whistleblower’s tip merits a reward, according to a sample of whistleblower award decisions analyzed by The Wall Street Journal. In some cases, the wait is much longer. Bounty BacklogThe share of whistleblowers waiting to hearwhether they will be paid has risen over thepast four yearsSource: SECNote: 2018 is through July .claimsDecidedPending2011’12’13’14’15’16’17’1802004006008001,000 “As you lengthen the time period between the work the whistleblower does, the risks they take, and the reward, it is very discouraging and stressful,” said Edward Siedle, a forensic investigator whose clients include pension funds and wealthy individuals. Mr. Siedle said he acted as a co-whistleblower for a 2015 case that resulted in a $267 million penalty against JPMorgan Chase & Co. The case centered on whether the bank failed to disclose that it preferred to invest client money in its own mutual funds and hedge funds, as well as other hedge funds that shared fees with the bank. Mr. Siedle said the SEC informed him a year and a half ago that it would recommend that he receive a $48 million award , but he still doesn’t have final confirmation. Mr. Siedle provided the same tip to the CFTC, which also investigated JPMorgan and settled a case with the bank related to its sale of in-house mutual funds and hedge funds. The CFTC, a smaller agency that processes fewer reward requests, awarded him $30 million in July. But the SEC now is considering reining in some of the biggest payouts. Under one proposal, the agency could restrict mega-awards deemed “not reasonably necessary to reward the whistleblower.” Critics, including Mr. Markopolos, worry that the move could discourage tipsters from coming forward. Insiders often risk their careers and reputations exposing fraud and must be convinced that the potential benefits outweigh the likely costs. Whistleblower rewards can range from 10% to 30% of the total sanctions in a case. “Whistleblowers don’t like uncertainty,” said Sean McKessy, the whistleblower program’s chief from 2011 to 2016. “They need some idea of the ground rules before coming forward.” Mr. McKessy now works for the law firm Phillips & Cohen, which specializes in pursuing awards for whistleblowers. Bernard Madoff being led out from Federal court, March 10, 2009. Later that year, he would be sentenced to 150 years in prison for operating a long-running Ponzi scheme.PHOTO: JIN LEE/BLOOMBERG NEWS The SEC’s whistleblower program had its start in the months following the 2008 financial crisis as lawmakers searched for ways to prevent the abuses that led to the downturn. An early pitch for whistleblower payouts came in February 2009 testimony from Mr. Markopolos to the House Financial Services Committee. Mr. Markopolos had spent years warning two offices of the SEC about Mr. Madoff. He told House lawmakers that he would like to see a whistleblower bounty that existed for insider trading cases expanded to all financial fraud. This, he said, would “incentivize the foxes out there in the field to come forward” and “give the government a case on a silver platter like I did.” The next month, then-SEC Chair Mary Schapiro recommended the same proposal to a U.S. Senate committee: “I expect to come to you in the near term with a request for authority to compensate whistleblowers who bring us well-documented evidence of fraudulent activity.” Congress approved the idea in 2010 as part of the Dodd-Frank financial overhaul law and the SEC officially opened its centralized tip system in 2011. Here is how it works: Whistleblowers can go to SEC.gov/whistleblower and click a “Submit a Tip” icon to file a tip electronically. After the SEC settles a case or gets a monetary judgment through litigation—sometimes years after the tip arrived—the whistleblower has to file a reward application. The cases must involve penalties of $1 million or more. The SEC set that threshold because it wanted to encourage “big game hunting,” said Jordan Thomas, a former regulator who helped write the original rules for the SEC’s program. The SEC’s office investigates whether the tip merits a reward and offers a preliminary decision that can be appealed if the whistleblower disagrees with the decision or the magnitude of the reward. The agency then reviews a new submission from the whistleblower and issues a final decision. A number of plaintiffs’ law firms immediately began seeking whistleblowers to help them file tips with the regulator. Mr. Thomas quit the agency and became one of the most prominent attorneys representing whistleblowers before the government. His clients are responsible for more than $1 billion of the $1.7 billion in penalties obtained by the SEC in cases involving whistleblowers, he said. Tips from the program have led to major enforcement actions that have generated whistleblower payouts of over $50 million. The agency doesn’t publicly disclose the names of whistleblowers, but says most are current or former insiders of the companies accused of misconduct. The agency says 67% of the awards stem from tips that generated entirely new investigations or examinations. “The fact that we are getting tips that really put the enforcement staff way down the line of the investigative trail, and get the continued assistance of high-quality whistleblowers, is really the game changer,” says Jane Norberg, the chief of the SEC’s whistleblower office. Mr. Thomas, whose firm employs a former FBI agent, said his clients have recorded incriminating phone conversations to provide to the SEC, and worn wires to provide evidence for criminal authorities. Whistleblower WindfallRewards to tipsters in SEC enforcement casesrose gradually until 2018, when they morethan tripled from the prior yearSEC whistleblower rewardsSource: SEC .millionFY2012’13’14’15’16’17’180255075100125150$175 The value of awards more than tripled in 2018, which Mr. Thomas said is the result of promising tips that poured in four to six years ago, when he launched his practice and fewer people knew they could score windfalls by reporting wrongdoing. “The program has established the equivalent of an auxiliary fire department,” said Mr. Thomas, whose New York-based practice is part of Labaton Sucharow LLP. “Now the SEC has the benefit of information, materials and expert assistance to investigate and prosecute their cases at no additional cost to the commission.” The existence of the program has already changed corporate behavior, says Dick Walker, a former SEC enforcement director now at King & Spalding LLP. Firms have to move faster to probe problems because they know the SEC may soon hear about them from a whistleblower, he added. But abuse of the system has slowed things down. Some filers seek rewards for tips they never provided, or for information not useful to a case. The requests create a backlog that must be vetted, and they slow the SEC’s ability to reward credible tipsters, Ms. Norberg says. Mr. Walker said the program also had an obvious downside for big banks like Deutsche Bank , where he worked as global general counsel for a decade. Some employees who faced tough internal reviews or even termination over their performance could claim to be whistleblowers, he said. “Becoming a whistleblower puts sand in the gears,” said Mr. Walker. There is disagreement about how to fix this. The agency has proposed ways to reject flawed applications more easily, possibly speeding payouts. Those who submit three consecutive bogus claims would be barred from making future claims. Mr. Markopolos says it should be “one and done.” Then there are the proposals to scale back the biggest payouts, in particular those stemming from corporate fines in excess of $100 million. Some officials say scaling back the largest windfalls would mostly hurt those who inform on problems at big banks, where many of the largest rewards originate. The SEC disclosed in June that it would pay $83 million to three individuals who helped reveal a scheme at Bank of America Corp.’s Merrill Lynch unit that involved misusing customer cash and securities in an effort to boost profits. Mr. Thomas represented the tipsters. As for Mr. Markopolos, he says he never expected to receive financial reward for contacting the SEC’s Boston and New York offices to warn about Mr. Madoff, although he later participated in books and films about the Madoff affair that did earn him some money. In the years since Mr. Madoff’s arrest, Mr. Markopolos has pursued other cases of corporate wrongdoing that he hopes will result in an award. In one case, he assembled a team that alerted the government to alleged mistreatment of customers in foreign-currency-trading. The government settled charges with two big banks related to the claims and Mr. Markopolos’s group believes it’s due an award that could amount to as much as $96 million. Their wait is closing in on four years. “I’m so frustrated,” Mr. Markopolos said, citing payment delays to whistleblowers that occur even after cases have been settled, fines paid and victims have received restitution. The SEC’s backlog of payouts, which has been growing, has Mr. Markopolos considering changing how he operates. Now, he’s looking for accounting frauds involving publicly-traded companies, hoping to profit working with hedge funds betting against shares of the companies. Working with short sellers enables Mr. Markopolos to “get paid the same year in which I do the work,” he said. Write to Gregory Zuckerman at gregory.zuckerman@wsj.com and Dave Michaels at dave.michaels@wsj.com Corrections & Amplifications The law practice of attorney Jordan Thomas is based in New York. An earlier version incorrectly stated that it is based in Washington. (Dec. 8, 2018)