No bonus? Try whistle-blowing instead
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No bonus? Try whistle-blowing instead

The award of $104 million to UBS tax whistle-blower Bradley Birkenfeld in September showed that there is still good money to be made in banking. It just may come in the future from turning in your former colleagues and bosses to the authorities.

The question of if and when to inform on a current or former employer is evolving more rapidly than many areas of modern finance. In terms of positive motivation, the increasing willingness of regulators to pay a bounty for information about malpractice has raised the stakes for potential whistle-blowers, just as compensation prospects dim for the vast majority of financial sector employees.

This motivation is particularly stark in cases of tax malpractice. Birkenfeld’s award accounted for 26% of the $400 million in tax paid by his former employer, UBS, to the US in a 2009 settlement, which is within a range of 15% to 30% that the Internal Revenue Service has set for potential payouts to whistle-blowers who help to secure substantial tax collections. The Dodd-Frank Act sets a similar range of 10% to 30% for payouts rewarding evidence of securities law breaches in the US, and the SEC made its first award based on the new rules in August. The whistle-blower in that case (which was not detailed by the SEC) received a relatively modest first payment of $50,000, but the regulator said the amount was 30% of a preliminary collection of $150,000 on sanctions that will eventually total over $1 million, which set an encouraging precedent.

The coming deluge of cases involving Libor fixing by banks might create fertile ground for whistle-blowers’ provision of trading details to regulators, as might other sectors where there could have been abuses in the setting of index prices, such as oil dealing. The tax-credit-structuring business, as practised on a highly profitable basis by Barclays and other banks until recently, also seems rife with a potential incentive to peach.

The Libor cases being pursued in multiple jurisdictions could provide a nexus of the twin motivations to cooperate with investigators: a potential payout and the chance to escape or dilute punishment. Cash payouts are not typically on offer outside the US – for now at least – but there are plenty of other incentives to cooperate with investigators.

These incentives differ depending on where you sit in the pyramid structure of the modern investment bank.

The decision by Barclays to pursue an early settlement of the accusations it faced about Libor abuses is now viewed as an unmitigated disaster by senior managers at other banks. Not only did CEO Bob Diamond, chairman Marcus Agius and COO Jerry del Missier lose their jobs, but the entire future of Barclays as a leading investment bank has been cast in doubt, just as the firm was starting to deliver on its goals of increased market share.

The shaming of Diamond is likely to convince senior managers at other banks caught up in the Libor scandal to delay settlement as long as possible and hold out for their ideal solution of an industry-wide accommodation that does not single out individual firms or their top executives.

But employees further down the totem pole have different motivations. For more than two decades Wall Street and the City of London offered an implicit contract that supplied substantial financial incentives in return for playing by some loosely agreed rules, including a commitment to resolve disputes in private.

This implicit contract was the equivalent of Napoleon’s motivational remark that there was a marshal’s baton in every French soldier’s knapsack, but with money rather than glory as the incentive. Potential multi-million dollar payouts were on offer to most investment bank employees. These possible payouts were not limited to the clear winners among firms and they were not predicated on rising to the very top of banks. They were also paid mainly in cash, rather than shares.

Those days are now gone, and banks are creating new elites among their top managers that exclude the bulk of their employees.

The partners at Goldman Sachs form the banking elite that draws the most public attention. The biennial partnership selection process is under way and Goldman has already signalled that it is likely to reduce the number of new partners announced in November by 10% or more compared with 2010, for a total at or just under 100 new members. Goldman partners draw attention because they remain among the highest-paid participants in the industry, but the partnership pool at the firm is also becoming one of the bigger elites among top banks, with its typical total membership of between 350 and 400 individuals.

The recent announcement by Deutsche Bankthat around 150 employees will be subject to the strictest rules on bonus payments under its new compensation regime indicates the size of the new elite at the firm, which has more investment bank employees in total than Goldman.

Members of the emerging elites at banks have an increasingly powerful incentive not to turn on one another, as the timeframes for their ability to cash in bonuses are pushed ever further out. Senior staff at Deutsche will now have to wait five years for their bonuses to vest, for example. Mid-level employees must also wait before they can sell the stock portion of bonuses, but they face lower total compensation and now receive a growing fixed portion in the form of salaries. Once they realize that they have been shut out of the new elites – which should become apparent relatively quickly to any alert staff members – the incentive for the vast majority of investment bank employees to stick to the old implicit contract will become diluted.

That shift might not lead to a sudden increase in whistle-blowing by bank employees. The industry will remain a relatively comfortable one in terms of remuneration, if not in job satisfaction. There will also always be some stigma attached to informing on an employer, at least for staff members who might wish to move to another sell-side role at a big firm. And the P&L of peaching remains relatively untested. Not every would-be informer can turn in a bank that has been enabling billions of dollars of tax evasion, as Bradley Birkenfeld did at UBS. Nor do payouts come quickly.

But whistle-blowing will at least take its place as a potential tool in the kit of the banker who happens to come across evidence of malpractice.

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