The most important question in whistleblowing is a straightforward one: Why does whistleblowing work? Modernized whistleblower award laws, such as the False Claims Act and Dodd-Frank Act, have had immense impacts on the detection and prosecution of white-collar crimes. But why have these laws and the programs they created been such an effective tool in combating fraud and corruption?

The key is to look at whistleblowing as a rational economic activity, as opposed to most discussions of whistleblowing, which focus on its moral or ethical dimensions. By doing so, it becomes clear that a successful anti-corruption program must be based on the assumption that the vast majority of potential whistleblowers are rational economic actors and that laws must be designed that recognize this economic reality.

When looking at the evidence of whistleblower award programs through this lens, only one conclusion can be reached: When the economics of corruption confront the economics of whistleblowing, whistleblowing always wins. Under modern whistleblower laws, participants in corrupt schemes can make more blowing the whistle, plus there exist opportunities for them to escape prosecution or get a reduced settlement.

Whistleblowing works because properly structured whistleblower laws can make blowing the whistle a more rational economic activity than continuing to participate in the crime.

Building on the Economic Theory of Crime

In the 1960s, Professor Gary Becker, the University of Chicago Nobel-Prize–winning economist, put forth the economic theory of crime, explaining that crime was best understood as a rational economic activity. If a business could be more profitable by breaking the law, why not break the rules? Without the risk of being detected (and a sufficiently high penalty if you were caught), breaking the law was a rational business decision, increasing corporate profits and making its owners wealthy.

Becker postulated a straightforward formula for understanding white-collar crime and how to fight it: The risk of detection plus the amount of punishment would equal the rate of crime. Or, as Becker explained in economic terms, “If the aim” was “deterrence,” by raising the “probability of conviction,” corporate executives could be deterred from committing these crimes. Under this formula, once the act of committing white-collar crime is viewed as a rational decision often made by highly educated and well-paid executives, only then can the tactics necessary to combat it be understood. If the risk of detection were high and punishment were severe, the rate of crime would be low. No rational executives would engage in corrupt activities if they thought they would be caught. The greater the risk, the greater the punishment, the lower the rate of criminal activity.

Professor Becker predicted that by increasing the risk of detection and the amount of punishment the rate of white-collar crime would decrease. Empirical data on the impact of the False Claims Act and related qui tam whistleblower-award laws vindicated this theory in the context of combating white-collar crimes. But his economic theory has also worked in a completely different manner. It is not simply that increased detection results in a decrease in crime. An increase in the incentives driving detection results in a radical increase in the number of persons willing to report crime. In short, the whistleblower=award laws demonstrate that whistleblowers are also rational economic actors.

By making whistleblowing a realistic economic alternative to going along with frauds and corrupt practices, the ability to detect and prosecute white-collar crime radically increases, thereby increasing not only the ability to hold fraudsters accountable, but the overall deterrent effect the whistleblower laws have on the rate of crime.

Thus, it is not just an abstract fear of detection that is at play. It is also the fact that as the number of persons willing to report crimes increases due to the economic incentives available under qui tam, the risk of detection skyrockets and considerably adds not only to the deterrent effect, but also to the ameliorative impact of each individual prosecution.

Objectively, rate of crime will also decrease as the number of persons willing to report increases. In other words, two forces work together to drive down the rate of crime. At the front end is a fear of detection, but coming from behind is an actual “army” of detectors, profiting not from engaging in crime, but by exposing it. The profit motive behind white-collar crime is turned on its head. In many cases it can be more profitable to report crime than to commit it. In a sense the qui tam laws have turned the fraudster’s most powerful weapon (greed) against itself. Ultimately, the motivation to report fraud can dominate the motivation to commit the frauds, resulting in a radical increase in compliance and a corresponding decrease in crime.

The evidence supporting this reversal of fortune for white-collar criminals is reflected not only in the successful prosecutions outlined above, but also in the numbers of persons willing to become whistleblowers and the growing acceptance of whistleblowing in the workplace.

Making Whistleblowing a Rational Economic Activity

How does whistleblowing become a rational economic activity? In looking at the successful whistleblower laws three elements have proven critical.

First, there has to be an effective law enforcement agency to report to, and the penalties for the crimes being reported need to be substantial. No rational whistleblower would report to an agency that cannot or will not properly investigate a fraudster if provided solid evidence of these crimes. Furthermore, no rational whistleblower would report potential crimes if the criminals will not be held properly accountable. Why risk your job, career, and safety if nothing will come of it? Some whistleblowers will do so for moral and ethical reasons, but the vast majority of potential whistleblowers will not. Not because they are weak or cowardly, but because making such reports is not a good rational economic choice for either themselves or their families.

Second, the Dodd-Frank Act demonstrated the importance of strict confidentiality and the ability to file claims anonymously. As a Harvard Business School study pointed out, 80 percenr of whistleblowers who are known to their bosses report some form of retaliation. Likewise, another study demonstrated that over 90 percent of retaliation cases are triggered by internal disclosures, where the identity of the whistleblower is known to the bosses. However, if a whistleblower can report his or her allegations confidentially the risk of retaliation drastically decreases. A company cannot fire a whistleblower if they do not know who the whistleblower is. This simple point of logic was explained by the chief judge of the U.S. Court of Appeals for the Fifth Circuit 60 years ago: “[T]he most effective protection from retaliation is the anonymity for the informer… [T]he shield of anonymity is preferable to the sword of punishment.”

The third component of a successful whistleblower-award law is a requirement that the payments be mandatory to all qualified whistleblowers and tied to the quality of the evidence provided. Unquestionably, this is the most important aspect of any whistleblower-award law. Without a clear and enforceable right to obtain payment, award laws have not worked and will not work. If whistleblowers, who are often distrustful of the government to begin with, understand that the government can deny them any compensation whatsoever, for any reason, they have little or no incentive to risk a good job or an excellent career to take the risks whistleblowing always implies. Discretionary award laws have all failed. Artificial limits on the amount of an award sends the wrong message to whistleblowers, and discourages many of the best sources of information on white-collar crime, who often hold high -evel or well-paying jobs. Financial incentives need to motivate persons who have a lot to lose and make the risk of a potential catastrophic outcome worthwhile.

Conclusion

Today, modern whistleblowing has changed the historical dynamic where whistleblowers were always on the losing side of the equation. The new laws create a realistic path forward for fighting corruption, both in the United States and around the world. Modern whistleblower laws make reporting fraud and corruption a rational economic activity.

This post comes to us from Stephen M. Kohn, a partner at the law firm of Kohn, Kohn & Colapinto, LLP. It is based on his recent article, “Why Whistleblowing Works: A New Look at the Economic Theory of Crime,” available here.