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    Published: October 28, 2008

    Guest Column By Jason M. Zuckerman

    The Financial Crisis:  Whistleblowers Could Have Helped Avert It

    During the height of the subprime lending spree, a whistleblower retained me to represent him in a retaliation action stemming from his disclosure at a large subprime originator about a sales manager directing employees to increase the company’s subprime lending by forging federally-mandated subprime disclosure forms that inform borrowers of the disadvantages of subprime loans.

    The subprime loans were more lucrative for the lender because they carried higher interest rates and therefore the company strongly encouraged its sales force to originate subprime loans. 

    When my client opposed this unlawful practice (forging federally-mandated disclosure forms), the sales manager withheld sales leads from my client, whose compensation consisted primarily of sales commissions, and engaged in various acts of retaliation designed to ensure that my client would fail.

    I vividly recall that client warning me in 2005 that there was widespread fraud in the mortgage underwriting industry and also recall the company’s reaction to my client’s retaliation claim.  They perceived it as an “affront” and kept pointing out that the company was in business to serve the public interest by making housing more affordable to low income workers.

    Three years later, that company has suffered more than $1 billion in losses from subprime mortgages, and borrowers who would have fared well with non-subprime loans are unable to make the payments on high-interest subprime loans.   As I read the news about an unprecedented credit crisis, mass layoffs, widespread foreclosures, and trillions of dollars of losses in retirement accounts, I wonder if the situation would not be as dire if companies and the government encouraged whistleblowing and took whistleblower disclosures seriously.

    In that vein, this column proposes five tips for companies to encourage early disclosures of misconduct and to appropriately respond to employee concerns.

    Sham Investigations Always Backfire

    Sham investigations designed to suppress a whistleblower’s disclosures, reach a foregone conclusion or discredit the whistleblower always backfire.  Indeed, such investigations can incur liability for the company and provide the whistleblower evidence of retaliatory intent and pretext in a retaliation claim.

    More importantly, a sham investigation deprives an organization of an opportunity to identify misconduct and take appropriate corrective action.  In addition, a sham investigation will chill employees from reporting additional misconduct or wrongdoing.  Accordingly, it is critical to select an investigator who has a proven record of conducting credible investigations and who has the independence to uncover the truth even where the truth might reflect poorly on management.  Where the allegations implicate misconduct by management, it may be necessary for the investigator to report directly to a senior officer or to the Board of Directors.

    Conversely, hiring an aggressive, big firm litigator who views all whistleblowers as miscreants and who is looking to win favor with management by concluding that the whistleblower’s allegations are meritless will result in a sham investigation that is more damaging than failing to conduct any investigation.

    Keep Whistleblowers in the Loop

    In managing concerned employees, companies should bear in mind that whistleblowers feel vulnerable to retaliation and are eager to see their concerns addressed promptly.  If an employee who has blown the whistle internally believes that the company is not taking the employee’s concerns seriously or is failing to take necessary corrective actions, the employee likely will pursue other avenues outside the company to get corrective action.   For example, my clients who have blown the whistle to law enforcement or to regulatory agencies did so only after they concluded that their internal disclosures were not taken seriously.

    Accordingly, a concerned employee should be updated frequently about the status of an investigation and should be provided an opportunity to react to information gathered in the investigation and suggest additional sources of information to corroborate the whistleblower’s allegations.  In addition, the whistleblower should be updated on corrective actions taken in response to the findings of the investigation.

    Don’t Question a Whistleblower’s Motive

    The surest sign that an investigation is a sham is when the investigator is focused on the whistleblower’s motive for disclosing wrongdoing rather than on the whistleblower’s disclosures.  Accordingly, investigators should focus on uncovering the merits of the whistleblower’s allegations and not become distracted by personal attacks on the whistleblower.  This underscores the importance of selecting an independent and objective investigator who will not be controlled or intimidated by a manager whose misconduct has been exposed. 

    Encourage Early Reporting and Provide Alternative Channels for Whistleblowing

    Adopting a company policy encouraging employees to report unlawful acts and other misconduct is just one of many steps a company should take to encourage internal whistleblowing.  To ensure that a company derives the benefit of early reporting, i.e., an opportunity to take corrective action before a minor regulatory violation becomes a criminal act, it is necessary to adopt a comprehensive strategy.  This includes offering employees multiple avenues for reporting, including an option to bypass the chain of command (to ensure that an employee is not confined to reporting misconduct to the person who engaged in the misconduct).  In addition, employees should be reminded periodically that the company encourages early reporting and that whistleblowers will be protected from reprisal.

    Monitor Corporate Culture and Maintain an Open Work Environment

    A common trait of many of the large financial institutions that failed in recent months was a flawed tone at the top.   Those companies shared an obsessive focus on generating short-term revenues to maximize performance-based incentive compensation, which predictably can result in management taking shortcuts and ignoring or condoning unlawful conduct.  Rather than focus solely on achieving a particular earnings target, management should also focus on ensuring that the target is achieved through lawful means.  Accordingly, it is essential to continually foster an open work environment in which employees identify misconduct and feel comfortable reporting it without risking their jobs.  In addition, management should monitor the culture through periodic surveys.

    Hopefully, the current economic crisis will cause companies to understand the importance of maintaining an open work environment and responding appropriately to whistleblower disclosures.

    Jason M. Zuckerman is a Principal at The Employment Law Group (www.employmentlawgroup.net) in Washington, D.C.

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