In 2002, Time magazine gave its coveted “Person of the Year” award to three women, including Sherron Watkins, who was formerly the vice-president of corporate development at Enron. Before the company went bankrupt, Ms. Watkins helped to expose the company’s illegal accounting practices that brought down the company. After the company tumbled, investors lost tens of billions of dollars, pension holders lost over $2 billion and thousands lost their jobs.

I saw the damages firsthand when my firm worked as co-lead counsel in a case representing former Enron employees. Following the collapse of the company, the employees lost much of their retirement savings. We were able to secure a $220 million settlement for the employees, but that fell well short of what employees had lost; the bankrupt company simply did not have the resources to repay any more.

I often wonder how things might have turned out differently if someone within Enron has spoken up sooner. Back then, there were very few incentives for insiders to stand up and alert the Securities and Exchange Commission, the government agency that oversees securities fraud.

While one might hope that simple human decency would encourage those with knowledge of criminal activity to come forward, the reality is that the risks are often too great. Choosing to stand up and call out the fraud often means the end of an individual’s employment with the company. It also means one is ostracized not only within their company but often within their field.

What was missing from the system then was a positive incentive to convince whistleblowers to come forward. On May 25 the Securities and Exchange Commission (SEC) approved a new program that does just that.

Under the program, any whistleblower that provides original information leading to an SEC enforcement action with penalties totaling at least $1 million can receive up to 30 percent of the recovery.

Given that these cases often involve tens of millions of dollars, this represents quite an incentive.

Perhaps more importantly, the program includes special protections for whistleblowers that will encourage them to come forward and tell what they know. It is now illegal for an employer to retaliate against a worker who provides information to the SEC.

The program is part of the agency’s response to the financial crisis. Imagine if in 2006, insiders at various hedge funds had told regulators when they saw risky mortgage-backed securities being packaged in with safer investments. At the same time, the investors were mislead about the nature and risk of their investments.

If a credible whistleblower program had existed then, someone might have alerted regulators. Given the size of the fraud being committed, a whistleblower would have been able to make millions and society would have benefited by stemming at least some of the damage that ultimately brought the entire financial system down. Instead, insiders kept quiet, bet against the risky investments and stood idly by while investors on main street lost everything.

Again, while I wish that the fear of prosecution or simple human decency might drive insiders to inform regulators about fraudulent activities, the recent financial crisis demonstrates that these factors are simply not enough.

I think the SEC’s decision is an appropriate response to the financial crisis. First of all, it will help the SEC do its job more efficiently and effectively.
It is no secret that SEC is chronically overburdened and underfunded. The Dodd-Frank Wall Street Reform Bill signed into law by President Obama last July required that the SEC hire an independent consultant to assess the organization’s strengths and weaknesses and make recommendations on how to make the organization stronger. The consultant’s final report, which was released in March, concluded that the SEC needed at least an additional 400 additional employees to handle its current workload.

Instead of increasing funding, however, the U.S. House of Representatives passed a budget resolution in April that would decrease the SEC’s budget by $212 million. SEC Chair Mary Schapiro testified at a Senate hearing that this would mean cutting the SEC’s 3,800-member staff by 1,000.

All of this might sound like a hopeless situation, but the new whistleblower program should help relieve the burden on the SEC, allowing it to act more nimbly. The expected payout will encourage whistleblowers to work with investigators and attorneys in drafting their claim to the SEC.

Those investigators and attorneys will also help save the SEC time by more fully developing the legal case before the whistleblower files a claim. For instance, SEC enforcement official Stephen Cohen disclosed that a whistleblower in a large case recently came forward with enough evidence and direction to save the agency at least six months of time investigating.

The program will also encourage insiders to expose fraud to the light of public scrutiny. In fact, shortly after President Obama signed the Dodd-Frank bill, which authorized the creation of the program, the SEC saw a dramatic uptick in the number of high-quality tips reported. Before the bill passed, the SEC normally received about two dozen high-quality tips per year. Since the bill passed, the SEC has reported receiving one or two per day.

Perhaps most importantly, the program will deter future fraud. The increased risk of being caught will encourage large corporations and financial institutions to steer clear of illegal activities, saving investors and consumers millions in the long run.

There are some pitfalls with the SEC’s approach however, that whistleblowers should be careful to avoid.

The SEC is already overloaded with more cases than it can handle, so it will be looking only to pursue new cases that are thoughtful, well-reasoned and immediately actionable. Thus, whistleblowers will have to make sure to do the appropriate research and investigative leg work to present a clear and actionable claim to the SEC.

Professional investigators and attorneys who have experience in both whistleblower and securities law will play a crucial role in helping whistleblowers develop a claim that gets the SEC’s attention.

At Hagens Berman, we have extensive experience in both areas. We’ve won some of the largest settlements in decisions in securities law, unlike most other whistleblower firms, who have little or no experience in the area.

I’ve seen firsthand the impact that securities fraud can have on investors, employees and others. The SEC’s whistleblower program will help the agency deter malfeasance and prosecute violators, helping us to avoid another financial crisis.