Why are there no famous financial whistleblowers in this crisis?

By William K. Black

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.

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.

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.

Financial CEOs led the unholy war against adoption of the whistle-blower provisions of the Dodd-Frank Act.  Once the Act became law their principal goal became perverting the SEC rules implementing the provision to deny any financial reward to whistle-blowers unless they alert the firm before they alert the SEC to the senior officers’ fraud.  That prior warning would allow fraudulent senior officers to coerce the whistle-blower to try to prevent him from alerting the SEC, allow the officers to cover up the evidence of the fraud, and alert the officers so that they would not make any admissions that might be overheard by the whistle-blower or through electronic surveillance.  Both Republican SEC Commissioners voted against the rule because it rejected the industry’s demand for a rule requiring the whistle-blower to first alert the senior officers that he had discovered their frauds.  That effort to pervert the Dodd-Frank whistle-blower provision into a rule that would aid elite frauds will succeed if the Governor Romney wins the election.

The fact that the business community fought ferociously against doing anything to encourage whistle-blowers is an example of what we call “revealed preferences” in economics.  Honest CEOs should encourage whistle-blowers.   CEOs often say that they encourage whistle-blowers.  Their SEC filings reveal their true beliefs.

We have far too few whistle-blowers and because of the worst epidemic of accounting control fraud in history and the death of criminal referrals by the banking regulatory agencies our need for whistle-blowers has never been greater.  Indeed, our federal prosecutors are the people who most desperately need to encourage whistle-blowers to come forward who worked at the financial control frauds.

Given that desperate need how would a rational administration respond?  The President and the Attorney General would hold a press conference with a group of whistle-blowers.  He would praise their performance, give a few specifics of how valuable the information they provided was to the nation, urge the tens of thousands of Americans who have information about other frauds to come forward, provide a web site for future whistle-blowers to use, and help arrange a publicity tour in which the select group of whistle-blowers appeared on a series of major television and radio programs where their efforts could be extolled and they could ask others to follow their lead.

The DOJ web site would extoll whistle-blowing and give examples of how their actions helped the nation.  It would showcase video interviews with whistle-blowers that could be picked up by You Tube.

The DOJ would hold rallies outside buildings that had (or do) house the worst frauds featuring the whistle-blowers who had come forward and asking others to follow their lead.  The President would host a White House dinner for the whistle-blowers and bestow a medal on some of the most praiseworthy.  That is what an administration devoted to holding the elite frauds accountable would do.

Instead, Presidents Bush and Obama and their Attorney Generals have ignored the whistle-blowers.  They have never urged Americans to come forward with information on the elite frauds who became wealthy by driving the crisis.  Bharara, in a PR piece he knew would be read by hundreds of reporters, did not thank O’Donnell and did not call upon Americans to come forward with information about the elite frauds.

The federal fraud task force, which has failed to indict any of the elite Wall Street frauds that drove the crisis, does have a web site where citizens could report elite frauds.  Here are the instructions and choices provided on the site:


Fraudulent activities should always be reported to your local law enforcement office. The following is additional information on how specific types of fraud complaints or cases of suspected fraud can be submitted to federal agencies.

I Want To Report:

The Department of Justice once had as a major priority the prosecution of Financial Institution Fraud.  Financial Institution Fraud (FIF) is an official DOJ category. Here is a chart showing the prosecutorial record over time for FIF prepared by Syracuse University.

Conservative economists (and “law and economics” scholars) have long embraced Gary Becker’s claim that the key to dealing with crime is deterrence through increasing the likelihood and severity of criminal sanctions.  They should cite this chart.  If one dramatically reduces the risk of prosecution of the most elite financial frauds the result is likely to be an enormous increase in elite financial institution fraud and a catastrophic financial crisis.

We were told by Obama and Holder that they created the Task Force to reverse the disaster displayed in Figure 1.  So we can doubtless turn to the list on the Task Force’s web site where the public can report frauds for the category “Financial Institution Fraud.”  Except that there is no category.  Perhaps they feared that “Financial Institution Fraud” was too complex a term and might confuse potential whistle-blowers.  “Bank Fraud” would probably be their choice if the designers of the web site were worried about confusing the public – it is a short and clear phrase.  Except that there is no such category.  There is also no general category labeled “other.”  Whistle-blowers that wish to report fraudulent financial institutions need not bother to use the Task Force’s “report fraud” feature.  It’s almost as if FIF prosecutions were not a priority of the Obama administration.  A Great Recession and at least $12 trillion in losses apparently do not outweigh the lure of lobbying lucre.

The sad fact is that the toothless Task Force is an improvement over the Bush administration.  Attorney General Mukasey famously refused to create a task force to investigate the elite frauds that were driving the U.S. into the Great Recession, saying that mortgage fraud was the equivalent of “white-collar street crime.”

It is useless to report financial control frauds “to your local law enforcement office.”  Try this thought experiment:  you invent a time machine and travel back to Houston, Texas in 2000.  You call the Houston Police Department to warn them that something terrible is happening at Enron and beg them to treat it as an emergency and send in a team of detectives to tear apart their books.  You begin to tell the officer about Enron’s Special Purpose Vehicles (SPVs).  If you are lucky, they will refer you to the FBI.  The far more likely result is that they will decide you are crazy and hang up on you.  What they will not do is investigate Enron’s fraudulent accounting.

6 responses to “Why are there no famous financial whistleblowers in this crisis?

  1. This is a keeper.

  2. Thank you once again for a thoughtful analysis of why whistleblowers are not given their due respect.

  3. “Catch-22 says they can do anything we can’t stop them from doing.”

  4. Dr. Bill, of all persons, are you surprised? This administration has indicted more whistle-blowers than ALL previous administrations going back to Washington himself. There is no safe harbour for the breed to be found, even their private correspondence is not safe from governmental spying. The corruption of the system is endemic and beyond correction. The constituting document is no more than an illusion useful to control the uneducated and unaware in their mythological beliefs. Many problems issue from innumeracy in a public benighted with illiteracy. And the judicial function has been thoroughly corrupted. Ask yourself, why the ABA (Am. Bar Assoc.) recommendation for professional competence is disregarded and the privately funded Heritage Foundation has the ultimate word on acceptability to fill judicial positions, a proposition bought by both Republicans and DLC/DNC Democrats; when exactly was this publicly discussed and agreed? Expect naught from political slime.

  5. «The corruption of the system is endemic and beyond correction. The constituting document is no more than an illusion useful to control the uneducated and unaware in their mythological beliefs.»

    This is just silly populism: it is not the system and its beneficiaries who are corrupt, it is *voters* and many ordinary citizens who are corrupt.

    Why are whistleblowerrs persecuted or ignored? Because they are party poopers, spoilsports, they are very unpopular. There were or are very many Contrywide, Lehman, Bear Stearns, City, AIG, Enron shareholders, people who badly want their meager 401k to go up and up and up and up, completely tax free, so they can have a luxurious retirement in the style they deserve as lords of the manor, and f*ck everybody else.

    All these people only want for saboteurs who care about pointless formalities like accounting accuracy to go away. CEOs have the vast measses of financial asset speculators as supporters and accomplices. As Norquist put it very well:

    «Now if you say we’re going to smash the big corporations, 60-plus percent of voters say “That’s my retirement you’re messing with. I don’t appreciate that”. And the Democrats have spent 50 years explaining that Republicans will pollute the earth and kill baby seals to get market caps higher. And in 2002, voters said, “We’re sorry about the seals and everything but we really got to get the stock market up.”»

    Gingrich also noted:

    «If you have a society where almost every middle class person routinely fudges the law, that’s telling us something. We have laws that matter – murder, rape, and we have laws that don’t matter. [ … ] The first thing that every good American says each morning is “What’s the angle?” “How can I get around it?” “What does my lawyer think?” “There must be a loophole!” Then he proceeds to work the angle, and the bureaucracy spends its time chasing that and writing new regs to stop him. America is the most incentive-driven society on the planet.»

    In the marvelous “The Great Crash 1929” J. K. Galbraith discusses (very diplomatically) how to have rules to prevent bubbles, and the chances of effective regulation, and while he seems to think that they can help, he concludes that when fradfuluent speculation is very popular it has irresistible political force and jimini crickets like William Black are not welcome, as this is waht happened after J. K. Galbraith expressed some skepticism about stack market valuations during a hearing in Congress:

    «A few wanted to know if I was likely to say anything hat would affect the market in the near future. I promised them silence. The rest merely wished to denounce me for destroying their dream.

    The telephone calls were supplemented, beginning the morning after the testimony, by a mountain of mail. All was unfavourable. Some was denunciatory; more were belligerent; much was prayerful. The belligerent threatened various forms of physical violence. My wife professed particular concern over five communications from a man in Florida announcing that he was on his way north to kill me. Her alarm subsided when I pointed out (having thoughtfully checked the point myself) that all were postmarked Palm Beach. The prayerful all said they were beseeching their God to have me meet with a bad accident — some were asking that I be deprived of life, some of limb, and the minimum request was that I lose all ability to open my mouth.»

    «Yet, in some respects, the chances for a recurrence of a speculative orgy are rather good. No one can doubt that the American people remain susceptible to the speculative mood — to the conviction that enterprise can be attended by unlimited rewards, which they, individually, were meant to share. A rising market can still bring the reality of riches. This, in turn, can draw more and more people to participate. The government preventatives and controls are ready. In the hands of a determined government their efficacy cannot be doubted. There are, however, a hundred reasons why a government will determine not to use them. In our democracy an election is in the offing even on the day after an election. The avoidance of depression and prevention of unemployment have become for politicians the most critical of all questions of public policy. Action to break up a boom must always be weighted against the chance that it will cause unemployment at a politically inopportune moment. Booms, it must be noted, are not stopped, until after they have started. And after they have started the action will always look, as it did to the frightened men in the Federal Reserve Board in February 1929, like a decision in favour of immediate as against ultimate death. As we have seen, the immediate death not only had the the disadvantage of being immediate but of identifying the executioner.»

    «Long-run salvation by men of business has never been highly regarded if it means disturbance of orderly life and convenience in the present. So inaction will be advocated in the present even though it means deep trouble in the future. Here, at least equally with communism, lies the threat to capitalism. It is what causes men who know that things are going quite wrong to say that things are fundamentally sound.»

  6. An Industry Insider

    I worked for Mr. O’Donnell almost 20 years ago, and we developed a friendship that has lasted to this day. He taught me the ethics that I have followed throughout my career, and I consider him to be one of the few “good guys” left in the mortgage industry. I am proud to have learned from such an upstanding person the key values that I have brought to every position I have held in this filthy business since. Unfortunately, those of us who exhibit such behavior are rarely rewarded for doing the right thing. In fact, we are often treated rather poorly by those who hold authority over us. I have news for you people…it’s 2013 and nothing has changed. This has all been smoke and mirrors to put big banks in charge of all mortgage lending while wiping out mortgage brokers, who collectively originated over 60% market share of new loans in the years immediately preceding the meltdown. Brokers were vilified in the press as the cause, and the legislation that followed the media hype made it impossible for them to keep their doors open. Mortgage brokers could not just make up their own loan products or they’d have no entity to sell those loans to in order to replenish their funds to make new loans with. In actuality, brokers were only following the rules & guidelines created by the big banks who kept adding riskier & riskier loan products for brokers to originate loans with. Brokers had much more of a reason to be concerned about loan and appraisal fraud because if they wound up stuck with just one loan they couldn’t sell, they’d be out of business overnight. This has all been a calculated attack on small businesses and homeownership in America, funded by the taxpayers (most of whom were also victims of this attack), and perpetrated by the same 4 big banks that now control the entire mortgage (and real estate) market.
    I read recently that Lew Raneiri, credited with inventing the mortgage-backed securities that proved to be at the heart of the financial crisis, is now buying up non-performing loans from HUD at 35 cents on the dollar. His company had previously been buying up foreclosures as long-term investments to keep and rent out. Now he’s just buying the mortgages at a huge discount and foreclosing to obtain these investment properties. If HUD is willing to write off 65% of the mortgage balance owed, why aren’t they giving that deal the homeowner directly? I wish I didn’t know what I know. I wish I had another career to fall back on. Everywhere I turn, I see this scam perpetuating to unbelievable proportions right under everyone’s noses, and no one sees it but me.
    Good luck, Ed. I hope you walk away rich because you may never find work in this cesspool again. What a blessing that would be!