Whistleblowers and Financial Innovation

NORTH CAROLINA LAW REVIEW Volume 94 | Number 3 Article 3 3-1-2016 Whistleblowers and Financial Innovation Christina Parajon Skinner Follow this and additional works at: http://scholarship.law.unc.edu/nclr Part of the Law Commons Recommended Citation Christina P. Skinner, Whistleblowers and Financial Innovation, 94 N.C. L. Rev. 861 (2016). Available at: http://scholarship.law.unc.edu/nclr/vol94/iss3/3 This Article is brought to you for free and open access by Carolina Law Scholarship Repository. It has been accepted for inclusion in North Carolina Law Review by an authorized administrator of Carolina Law Scholarship Repository. For more information, please contact . 94 N.C. L. REV. 861 (2016) WHISTLEBLOWERS AND FINANCIAL INNOVATION* CHRISTINA PARAJON SKINNER** This Article critically examines post–financial crisis whistleblower regimes and their impact on contemporary financial markets. In particular, the Dodd-Frank whistleblower program, as implemented by the United States Securities and Exchange Commission, has received significant attention in legal, political, and popular quarters. Some praise the whistleblower program as essential to aiding the government’s efforts in overcoming enforcement challenges, while others remain wary of the program’s unintended effects. This Article advances the debate—in favor of whistleblowers—by offering an updated analysis of the program’s benefits and costs, in light of recent trends in complexity and innovation that have made financial activity much more diffuse. By weighing the program’s utility in the postcrisis financial landscape, together with its benefits and costs, this Article argues that the SEC whistleblower program is, on balance, desirable: not only because whistleblower solutions can be effective at detecting financial misconduct in complex financial spaces, but also because they serve other valuable social and economic goals. Overall, the aim of this Article is to prompt further conversation about whistleblower programs by critically examining the crux of regulators’ need for whistleblowers in the financial services arena, revisiting a conceptual cost-benefit analysis of the program, and suggesting certain aspects of the SEC program that are ripe for revaluation and, potentially, redesign. * © Christina Parajon Skinner. ** Associate in Law, Columbia Law School. Yale Law School, J.D., 2010; Princeton University, A.B., 2006. Thank you to Julian Arato, Pamela Bookman, Charlotte Garden, Stephen Forster, Yehonatan Givati, Roberta Karmel, Henry Monaghan, and William Skinner for helpful conversations and suggestions on various drafts of this Article. Thanks also to the editors of the North Carolina Law Review, and to James O’Neill especially, for their excellent editing and feedback. 94 N.C. L. REV. 861 (2016) 862 NORTH CAROLINA LAW REVIEW [Vol. 94 INTRODUCTION ....................................................................................... 862 I. WHISTLEBLOWERS IN A POSTCRISIS WORLD .......................... 867 A. Regulatory Gaps: A Case Study ........................................... 867 1. Shadow Banking .............................................................. 868 2. Technology ....................................................................... 873 B. Whistleblower Programs ......................................................... 879 1. Incentives .......................................................................... 880 2. Expansion ......................................................................... 882 II. A COST-BENEFIT ANALYSIS OF WHISTLEBLOWERS............... 885 A. Framing the Analysis ............................................................. 885 B. Whistleblowing and Its Benefits ........................................... 889 1. Regulatory Gaps .............................................................. 889 2. Regulatory Efficiency ..................................................... 892 3. Market Discipline ............................................................ 896 4. Public Participation ......................................................... 897 5. Financial Culture ............................................................. 900 C. Whistleblowing and Its Costs ................................................ 903 1. Firm Compliance ............................................................. 903 2. Regulatory Resources ..................................................... 908 3. Antisocial Norms ............................................................. 909 4. Unilateral Extraterritorialism ........................................ 911 III. IMPLICATIONS FOR DESIGN, DISCRETION, AND COORDINATION ........................................................................... 917 A. Reporting Requirements ........................................................ 918 B. Alternative Incentives ............................................................ 919 C. Transnational Coordination ................................................. 922 CONCLUSION ........................................................................................... 925 INTRODUCTION In 2012, a group of traders at JP Morgan Chase lost (at least) $6 billion trading exotic credit derivatives.1 Led by the infamous “London Whale”—dubbed so for taking enormous market positions—the group for years had been engaged in a high-risk, high- 1. JPMorgan Chase Whale Trades: A Case History of Derivatives Risks and Abuses: Hearing Before the Permanent Subcomm. on Investigations of the S. Comm. on Homeland Sec. & Governmental Affairs, 113th Cong. 1, 3–4 (2013) [hereinafter Senate Hearing, Whale Trades]. “ ‘Derivatives’ are contractual instruments that derive their value from the values of underlying instruments or commodities upon which they are based.” JOHN C. COFFEE, JR., HILLARY A. SALE & M. TODD HENDERSON, SECURITIES REGULATION: CASES AND MATERIALS 25 (13th ed. 2015). 94 N.C. L. REV. 861 (2016) 2016] WHISTLEBLOWERS & INNOVATION 863 reward strategy, essentially betting on the price of certain bonds.2 Eventually, when this strategy started to fare poorly, the Whale “doubled-down” on his risky position and grew their portfolio to a “perilous size.”3 Ultimately that strategy collapsed, “shock[ing] the investing public.”4 Investigations later discovered that the London Whale’s traders had hidden growing losses from regulatory scrutiny by manipulating internal risk-valuation models and keeping a separate accounting to downplay their deteriorating position.5 There has been no shortage of serious financial misconduct in global institutions and markets since the global financial crisis of 2008.6 In the same year as the London Whale’s losses, regulators in the United States and abroad discovered that several large, global 2. Eleazar David Melendez, How Did JP Morgan Lose Billions in One Trade? London ‘Whale’ Explained, INT’L BUS. TIMES (May 11, 2012), http://www.ibtimes.com/how-didjpmorgan-lose-b (...truncated)