Why Are There No Famous Financial Whistleblowers in This Crisis?

November 5th, 2012
in Op Ed

by William K. Black, New Economic Perspectives

This column discusses one of the more subtle issues raised by the Department of Justice’s (DOJ’s) civil fraud action against Bank of America (B of A).  The issue was so subtle that of the three articles about the lawsuit that I choose to review the night after the suit was filed, only the NYT article mentioned one of the most important aspects of the suit – the key role that the whistleblower played in making the action possible.  The AP and the WSJ articles ignored the fact.

Follow up:

The lawsuit threatens to impose steep fines on the bank. The Justice Department filed the case under the False Claims Act, which could provide for triple the damages suffered by Fannie and Freddie, a penalty that could reach more than $3 billion.

The act also provides an avenue for a Countrywide whistle-blower, Edward J. O’Donnell, to cash in. Under the act, the government can piggyback on accusations he filed in a lawsuit that was kept under seal until now.

Mr. O’Donnell, who lives in Pennsylvania, was an executive vice president for Countrywide before leaving the company in 2009. The government’s case in part hinges on the credibility of his claims.

This is the first major action relating to the frauds that caused the crisis that the government has brought that is based principally on a whistle-blowers’s revelations.  This is not simply worth mentioning, it is the most important aspect of the lawsuit.  Indeed, as one can see on the face of the complaint, DOJ is “intervening” in a civil action brought by O’Donnell under the False Claims Act because its investigation has confirmed that his claims are meritorious and DOJ wishes to take the lead in the litigation.

Here are some of the essential discussions that the whistle-blower’s disclosures and DOJ’s continuing refusal to investigate (criminally) and prosecute the elite frauds should prompt.

  1. The fraud “epidemic” that the FBI correctly predicted in September 2004 would cause a financial “crisis” if it were not contained was accounting control fraud.  Accounting control fraud epidemics also drove the Enron-era frauds and the S&L debacle.  In a control fraud the officers who control a seemingly legitimate firm (typically the CEO) use the firm as a “weapon” to defraud.  Accounting is financial control frauds’ “weapon of choice.”
  2. Banks will rarely make criminal referrals against their CEOs.
  3. We have fewer than two FBI white-collar agents per industry, so the FBI agents do not patrol a beat.  They have to wait until they receive a criminal referral to know what they should investigate.
  4. Whistle-blowers can provide those referrals and when they do so the referrals are of immense value because of their insider perspective and because they can provide the FBI with the ability to investigate the frauds before they fail.  This can massively reduce damages and allow far more effective investigative techniques.
  5. There have been a significant number of whistle-blowers during this crisis, but none has become famous.  The Bush and the Obama administrations have failed to praise and make famous as an exemplar anyone who fought within the lenders to stop their endemic frauds.
  6. In the DOJ press release announcing the civil suit, U.S. Attorney Preet Bharara (SDNY) did not even mention O’Donnell’s name, did not note that a whistle-blower had made the suit possible, offered no thanks to O’Donnell, and made no call for others to come forward and alert DOJ to other control frauds.  The press release consists of statements by three federal officials praising – federal officials.
  7. The DOJ press release not only stressed matters that it learned about primarily through O’Donnell, it emphasized an actions that, according to the DOJ complaint, O’Donnell played a major role in that (a) were competent and would have ended the fraud if Countrywide and B of A’s senior management had been honest, (b) were brave, and (c) provided superb evidence of the senior management’s intent to deceive (which is nearly always the most difficult element for prosecutors to prove).  Bharara stated:

Full Spectrum Lending’s senior management was repeatedly warned that eliminating toll gates for quality control and fraud prevention, and expanding the authority of loan processors and compensating them based on volume without regard to quality, would yield disastrous results. For example, in January 2008, a pre-funding quality review showed an overall defect rate of 57%, and a defect rate of nearly 70% for stated income loans. Full Spectrum Lending senior management, however, made no changes to the Hustle, and instead restricted dissemination of the pre-funding review.

Paragraphs 67-71 are the centerpiece of the Complaint.  They show that O’Donnell played the key role in trying to prevent the fraud through these studies and warnings.  Bharara’s failure in the press conference to praise O’Donnell’s actions and ask others to come forward is revealing.

Click for larger, sharper image.
Click for larger, sharper image.

8. The NYT story presented O’Donnell in a dismissive and negative light that would be inappropriate for any straight news story and was bizarre given the strongly positive facts that the reporter would have learned about O’Donnell by reviewing the centerpiece of the Complaint.  Here again are the key passages.

The act also provides an avenue for a Countrywide whistle-blower, Edward J. O’Donnell, to cash in. Under the [False Claims] act, the government can piggyback on accusations he filed in a lawsuit that was kept under seal until now.

Mr. O’Donnell, who lives in Pennsylvania, was an executive vice president for Countrywide before leaving the company in 2009. The government’s case in part hinges on the credibility of his claims.

Not a positive word in the story even though the complaint details repeated positive actions by O’Donnell demonstrating competence, courage, and conscientiousness.  O’Donnell’s action in blowing the whistle may allow the U.S. to recover $3 billion from B of A’s brazen frauds. The NYT routinely uses the word “earned” to describe executive compensation even when the compensation was received for actions that enriched the officer at the expense of the bank.  When discussing an officer, who if the complaint is accurate is vastly more worthy of receiving exceptional compensation, a NYT news article chooses language implying that he was motivated by a desire to “cash in” and a hints that his “credibility” is at issue.  It’s a pretty nasty hatchet job and the only apparent basis for it is that O’Donnell is a whistle-blower.  (Full disclosure:  I’m a serial whistle-blower.)

What makes the immediate sliming of O’Donnell so revealing is that it was clearly instinctive.  The NYT piece had to be written extremely quickly and the author does not indicate that he tried to interview O’Donnell.  The U.S. public probably exhibits less hostility towards whistle-blowers than nearly all nations, but our instinctive reaction is still typically negative.  The finance community’s view of whistle-blowers is that Gitmo would be too good for them.  Financial reporters swim ceaselessly in this cesspool and hear endless complaints from financial elites (who are incapable of introspection and irony) that whistle-blowers are greedy and the scum of the earth.

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