Banking StandardsWritten evidence from the Financial Services Authority

1. This memorandum follows Martin Wheatley’s oral evidence to the Commission on 25 October. We set out below our current approach to whistleblowing, discuss the possibility of providing financial incentives to whistleblowers and set out how we might go about reducing the associated moral hazard.

2. We are already considering a number of steps that may encourage further whistleblowing. These are outlined below. However, on current evidence any potential benefit from providing financial incentives to whistleblowing would be outweighed by the disadvantages. We will however keep the international evidence and our position under review.

The FSA’s Current Approach to Whistleblowing

3. We take all information received from whistleblowers extremely seriously, working to protect the confidentiality of the whistleblower and to ensure the information is followed up appropriately.

4. Our whistleblowing service receives over 3,500 contacts each year regarding the firms we regulate. The information is graded by our Intelligence Interface Team: about one in eight disclosures are judged to provide actionable intelligence1 and are passed to firm supervisors, our Unauthorised Business Department, Markets Division, or others as appropiate. The service has comprehensive procedures in place to ensure its duty of care and confidentiality to whistleblowers is maintained. Most whistleblowers are motivated by a perception they have identified regulatory breaches or conduct that they regard to be criminally or morally wrong. However, approximately one in ten appear motivated by frustration or animosity towards a current or former employer, while a much smaller number seem to have vexatious motives.

5. Our whistleblowing service sits alongside other measures that encourage the reporting of wrong-doing, including our contact centres dealing with the public and the arrangements in place for receiving suspicious transaction reports. We also place wider regulatory obligations on firms to deal with us in an open and cooperative way, and disclose issues of which we would reasonably expect notice.

Protection provided by UK law to whistleblowers

6. Protection under law: The Public Interest Disclosure Act 1998 gives some protection to employees against dismissal or victimisation if they make “Protected Disclosures”, meaning disclosures made in good faith regarding actions and conduct which are criminal, dangerous or damaging. Public interest protections from disclosure also exist in the general law, under the Financial Services and Markets Act 2000 and in the Upper Tribunal. Public interest immunity can be used to protect the identity of whistleblowers if their material is presented to a court or tribunal, although this will be balanced against the potential for injustice to the defendant if the material is not disclosed. If it is consequently possible we may abandon a case rather than be required to disclose a whistleblower’s identity.

7. However, there are practical limits to the protections that may be available. If a whistleblower’s identity becomes public they may reasonably fear damage to their chances of future employment. It is unlikely any law could offer credible protection against this.

Incentives for whistleblowing

8. While we do not provide financial incentives for whistleblowers, there are a number of other mechanisms by which we may seek to encourage whistleblowing reports or fill intelligence gaps. These include:

(a)Support at employment tribunal: we are currently exploring what information we can provide to employment tribunals to support whistleblowers who have lost their position.

(b)Publicity and awareness raising: we have seen an upward trend in the number of whistleblowing reports following increased media attention on the financial sector.

(c)Closing intelligence gaps: we are considering new sources of information to help us identify insider-dealing. This is sensitive for operational reasons.

US Experience of Incentivising Whistleblowers

9. The 2010 Dodd-Frank Act created whistleblower programmes for the US Commodity Futures Trading Commission and for the Securities and Exchange Commission (SEC).2 This scheme invites whistleblowers to report securities law violations, with the whistleblower taking a mandated 10% to 30% of any money collected by prosecutors as a result of the disclosure, provided the whistleblower’s information led to at least $1 million being recovered. Whistleblowers can remain anonymous and are advised to act via a legal representative. The Act also ensures whistleblowers can seek damages from their employer if disclosure leads to their dismissal. There are limitations on payment being made: for example, whistleblowers must not have gained the information through audit or regulatory work, or through breaking the law. About 2.5% of reports the SEC receives come from the UK: the top non-US source of tips.3

10. Since this scheme was introduced, the SEC has reported an increase in the volume of reports. However, to date, it has only made one whistleblower payment, of $50,000 in September 2012. It is therefore too early to draw clear conclusions from the US experience.

Providing Financial Incentives to Whistleblowers in the UK

11. If there are potential whistleblowers who have not been setting out their concerns to us, the extent to which they can be incentivised to come forward will depend on the size and structure of the package available.

12. Size of payments: Larger payments offer a greater incentive, and may destabilise criminal conspiracies from which participants stand to make substantial gains such as insider dealing rings. In such cases the rewards would need to be substantial, perhaps in the millions because, in addition to losing out on the proceeds of the crime, a well-remunerated City high-flyer would reasonably expect their career prospects to be harmed by reporting other insiders and being associated with a criminal act. Handing over such sums would be a substantial shift in UK policy norms.

13. More modest rewards may prompt, for example, bank branch staff concerned about mis-selling to blow the whistle.

14. It is possible an appeal to financial self-interest may prompt reporting that would not otherwise occur, although we will perhaps only learn what kinds of sums are effective through trials.

15. Qualification criteria: A whistleblower motivated by a reward would need to be confident of receiving the money, particularly if making a report put their career in jeopardy. Likewise, we would not want to reward those providing poor information, particularly if it were not provided in good faith; doing so could increase moral hazard. The SEC sought to achieve this balance by placing emphasis on the criteria for receiving rewards being simple and clear; they will not, for example, reward whistleblowers if information prompted an investigation, but did not lead to a prosecution.

Reducing moral hazard

16. Financial incentives could create a number of moral hazards:

(a)Malicious reporting: The introduction of financial incentives may lead to more approaches from opportunists and uninformed parties passing on speculative rumours or public information. We already receive a small number of such reports, and have processes in place to filter out low value information, although, on occasion, investigations prompted by what proved to be wrong information from a whistleblower have taken place. Reputations of innocent parties may be wrongly damaged as a consequence.

(b)Entrapment: It is conceivable that some market participants may seek to “entrap” others into an insider dealing conspiracy in order to then blow the whistle and benefit financially. Not rewarding offenders and only acting when reports are corroborated by further, independently gathered, evidence would obviate this danger.

(c)Conflicts of interest in court: If a whistleblower’s disclosure led to a criminal prosecution (such as in an insider dealing case) the court could call into question the reliability of their evidence because the witness stood to gain financially. Our case would not rest solely on the whistleblower’s testimony, as we would present our own investigatory evidence, however the fact the whistleblower stood to gain financially from their disclosures may undermine the prosecution’s case.

Other considerations

17. There are a number of other factors which should be taken into consideration:

(a)Public Interest Disclosure Act: Whistleblowers’ protections under the Public Interest Disclosure Act depend upon their acting in the public interest. If whistleblowers are motivated by financial gain, the Act may need amendment so that whistleblowers can still benefit from these protections.

(b)Consistency with FSA’s “principles for businesses”: Rewarding whistleblowers for performing what is arguably their regulatory duty may sit uneasily with the principle that firms deal with their regulator in an open and cooperative way and the principle that financial firms should conduct business with integrity.

(c)Public perception: It may be reasonably expected that individuals who have knowledge of any crime or wrongdoing should report it to the relevant authority without incentive. Paying significant sums to high-income individuals for fulfilling a public duty could reinforce some attitudes that the financial sector may appear to be at odds with the rest of society.

(d)Needless rewards: Some rewards are likely to be paid to whistleblowers who would have come forward anyway, and hence not be a productive use of our resources.

(e)Funding: A number of options for funding are available. The FSA’s general budget is raised by fees on regulated firms. Using the general budget to fund whistleblower incentives would require us to make an assessment each year of what we think the costs of whistleblowing will be and levy that fee in advance. We are not convinced that the best use of any rise in general fees would be incentivisation of whistleblowing.

(f)Whistleblowers could be paid from proceeds confiscated after a criminal prosecution, where that occurs: this is chiefly in insider dealing cases.

(g)An alternative approach would be to fund whistleblowers from fines imposed on firms following our Enforcement work. Until recently, such fines were used to reduce the fees of other regulated firms. However the Financial Services Bill currently passing through Parliament contains changes that will mean fines from this year, less some Enforcement costs, are instead paid to the Exchequer. Further changes in legislation would be needed to allow us to use fine revenues to reward whistleblowers.

Conclusion

18. On current evidence, the FSA considers any potential benefit from incentivising to be outweighed by the disadvantages.

19. Although the US model is one the UK can learn from, it is too early to assess whether or not it has been successful. With no long-standing model successfully applied in a regulatory context elsewhere, any UK system will be subject to a degree of trial and error the scale of payment that would be effective at promoting useful disclosures is unknown to us.

20. There are serious moral hazards associated with any change in policy. These can be reduced by only rewarding whistleblowers with clean hands whose information leads to action. Nevertheless, an increase in spurious reporting is also likely.

21. Adequate incentives may need to be sizeable; this would go counter to UK policy norms and could lead to public disquiet, particularly if it was seen to be richly rewarding people on high salaries for what is arguably their regulatory duty under existing legislation. If changes were made, the perception may remain that this is not the most appropriate use of the FSA’s resources.

22. Some legal amendments would be necessary: whistleblowers cannot currently be paid a share of regulatory fines, while the protections offered to whistleblowers who gain personally from a disclosure may need to be clarified. In any event, the courts may have doubts about witnesses who have been paid for their evidence.

23. It is not clear to us our existing whistleblowing measures need to be augmented by a process that would be complex to administer, has risks that are difficult to assess and—as yet—no proven benefits. We will keep this position under review as evidence becomes available from the US. We are also considering other measures to enhance our existing arrangements, which already generate sizeable volumes of intelligence and have frequently prompted supervisory interventions and enforcement action that could not otherwise have taken place.

11 December 2012