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A decade after Madoff’s arrest, an industry of bounty-hunting tipsters aims to cash in on the next big fraud

Ten years ago, Bernard Madoff’s multibillion-dollar Ponzi scheme, the biggest fraud in U.S. history, shocked the financial world. It soon emerged that a forensic accountant, Harry Markopolos, had been alerting regulators for years to Mr. Madoff’s fraud, but no one had listened. At Mr. Markopolos’s urging, the Securities and Exchange Commission created a cash-for-tips program, designed to encourage reports of financial wrongdoing and prevent the lapses in oversight that gave Mr. Madoff free rein.

Today, an entire industry is devoted to surfacing tips from company insiders and expert analysts who scrutinize corporate filings. Whistleblower Inc. is the most tangible consequence of the Madoff scandal a decade after the money manager’s Dec. 11, 2008 arrest.

At the center of this new ecosystem stands the Securities and Exchange Commission’s Office of the Whistleblower, which has paid more than $326 million to 59 whistleblowers in seven years. The potential for sharing in such a huge payday has attracted plaintiffs’ lawyers, forensic accountants and former FBI agents to this government-sanctioned fraud hunt.

Critics say the deluge of those seeking rewards is now overwhelming the system. More than 5,200 tips have been filed this year, compared to 3,000 in 2012.

Requests from undeserving reward seekers have slowed the pace of payments, potentially discouraging future tipsters. Two individuals filed so many frivolous reward requests—one person has filed 143—that they were banned from making future requests, according to agency records.

Mr. Markopolos is among the concerned. “If they don’t fix the program they’re going to kill it,” he says.

About 53% of all reward requests remain undecided, according to a Wall Street Journal analysis of SEC figures and data obtained from a Freedom of Information Act request. It takes the SEC about two years to decide if a whistleblower’s tip merits a reward, according to a sample of whistleblower award decisions analyzed by The Wall Street Journal. In some cases, the wait is much longer.

“As you lengthen the time period between the work the whistleblower does, the risks they take, and the reward, it is very discouraging and stressful,” said Edward Siedle, a forensic investigator whose clients include pension funds and wealthy individuals.

Mr. Siedle said he acted as a co-whistleblower for a 2015 case that resulted in a $267 million penalty against JPMorgan Chase & Co. The case centered on whether the bank failed to disclose that it preferred to invest client money in its own mutual funds and hedge funds, as well as other hedge funds that shared fees with the bank. Mr. Siedle said the SEC informed him a year and a half ago that it would recommend that he receive a $48 million award , but he still doesn’t have final confirmation.

Mr. Siedle provided the same tip to the CFTC, which also investigated JPMorgan and settled a case with the bank related to its sale of in-house mutual funds and hedge funds. The CFTC, a smaller agency that processes fewer reward requests, awarded him $30 million in July.

But the SEC now is considering reining in some of the biggest payouts. Under one proposal, the agency could restrict mega-awards deemed “not reasonably necessary to reward the whistleblower.”

Critics, including Mr. Markopolos, worry that the move could discourage tipsters from coming forward. Insiders often risk their careers and reputations exposing fraud and must be convinced that the potential benefits outweigh the likely costs. Whistleblower rewards can range from 10% to 30% of the total sanctions in a case.

“Whistleblowers don’t like uncertainty,” said Sean McKessy, the whistleblower program’s chief from 2011 to 2016. “They need some idea of the ground rules before coming forward.” Mr. McKessy now works for the law firm Phillips & Cohen, which specializes in pursuing awards for whistleblowers.

The SEC’s whistleblower program had its start in the months following the 2008 financial crisis as lawmakers searched for ways to prevent the abuses that led to the downturn. An early pitch for whistleblower payouts came in February 2009 testimony from Mr. Markopolos to the House Financial Services Committee.

Mr. Markopolos had spent years warning two offices of the SEC about Mr. Madoff. He told House lawmakers that he would like to see a whistleblower bounty that existed for insider trading cases expanded to all financial fraud. This, he said, would “incentivize the foxes out there in the field to come forward” and “give the government a case on a silver platter like I did.”

The next month, then-SEC Chair Mary Schapiro recommended the same proposal to a U.S. Senate committee: “I expect to come to you in the near term with a request for authority to compensate whistleblowers who bring us well-documented evidence of fraudulent activity.”

Congress approved the idea in 2010 as part of the Dodd-Frank financial overhaul law and the SEC officially opened its centralized tip system in 2011.

Here is how it works: Whistleblowers can go to SEC.gov/whistleblower and click a “Submit a Tip” icon to file a tip electronically. After the SEC settles a case or gets a monetary judgment through litigation—sometimes years after the tip arrived—the whistleblower has to file a reward application.

The cases must involve penalties of $1 million or more. The SEC set that threshold because it wanted to encourage “big game hunting,” said Jordan Thomas, a former regulator who helped write the original rules for the SEC’s program.

The SEC’s office investigates whether the tip merits a reward and offers a preliminary decision that can be appealed if the whistleblower disagrees with the decision or the magnitude of the reward. The agency then reviews a new submission from the whistleblower and issues a final decision.

A number of plaintiffs’ law firms immediately began seeking whistleblowers to help them file tips with the regulator. Mr. Thomas quit the agency and became one of the most prominent attorneys representing whistleblowers before the government. His clients are responsible for more than $1 billion of the $1.7 billion in penalties obtained by the SEC in cases involving whistleblowers, he said.

Tips from the program have led to major enforcement actions that have generated whistleblower payouts of over $50 million. The agency doesn’t publicly disclose the names of whistleblowers, but says most are current or former insiders of the companies accused of misconduct. The agency says 67% of the awards stem from tips that generated entirely new investigations or examinations.

“The fact that we are getting tips that really put the enforcement staff way down the line of the investigative trail, and get the continued assistance of high-quality whistleblowers, is really the game changer,” says Jane Norberg, the chief of the SEC’s whistleblower office.

Mr. Thomas, whose firm employs a former FBI agent, said his clients have recorded incriminating phone conversations to provide to the SEC, and worn wires to provide evidence for criminal authorities.

The value of awards more than tripled in 2018, which Mr. Thomas said is the result of promising tips that poured in four to six years ago, when he launched his practice and fewer people knew they could score windfalls by reporting wrongdoing.

“The program has established the equivalent of an auxiliary fire department,” said Mr. Thomas, whose Washington-based practice is part of Labaton Sucharow LLP. “Now the SEC has the benefit of information, materials and expert assistance to investigate and prosecute their cases at no additional cost to the commission.”

The existence of the program has already changed corporate behavior, says Dick Walker, a former SEC enforcement director now at King & Spalding LLP. Firms have to move faster to probe problems because they know the SEC may soon hear about them from a whistleblower, he added.

But abuse of the system has slowed things down. Some filers seek rewards for tips they never provided, or for information not useful to a case. The requests create a backlog that must be vetted, and they slow the SEC’s ability to reward credible tipsters, Ms. Norberg says.

Mr. Walker said the program also had an obvious downside for big banks like Deutsche Bank , where he worked as global general counsel for a decade. Some employees who faced tough internal reviews or even termination over their performance could claim to be whistleblowers, he said.

“Becoming a whistleblower puts sand in the gears,” said Mr. Walker.

There is disagreement about how to fix this. The agency has proposed ways to reject flawed applications more easily, possibly speeding payouts. Those who submit three consecutive bogus claims would be barred from making future claims. Mr. Markopolos says it should be “one and done.”

Then there are the proposals to scale back the biggest payouts, in particular those stemming from corporate fines in excess of $100 million.

Some officials say scaling back the largest windfalls would mostly hurt those who inform on problems at big banks, where many of the largest rewards originate. The SEC disclosed in June that it would pay $83 million to three individuals who helped reveal a scheme at Bank of America Corp.’s Merrill Lynch unit that involved misusing customer cash and securities in an effort to boost profits. Mr. Thomas represented the tipsters.

As for Mr. Markopolos, he says he never expected to receive financial reward for contacting the SEC’s Boston and New York offices to warn about Mr. Madoff, although he later participated in books and films about the Madoff affair that did earn him some money.

In the years since Mr. Madoff’s arrest, Mr. Markopolos has pursued other cases of corporate wrongdoing that he hopes will result in an award.

In one case, he assembled a team that alerted the government to alleged mistreatment of customers in foreign-currency-trading. The government settled charges with two big banks related to the claims and Mr. Markopolos’s group believes it’s due an award that could amount to as much as $96 million.

Their wait is closing in on four years. “I’m so frustrated,” Mr. Markopolos said, citing payment delays to whistleblowers that occur even after cases have been settled, fines paid and victims have received restitution.

The SEC’s backlog of payouts, which has been growing, has Mr. Markopolos considering changing how he operates. Now, he’s looking for accounting frauds involving publicly-traded companies, hoping to profit working with hedge funds betting against shares of the companies.

Working with short sellers enables Mr. Markopolos to “get paid the same year in which I do the work,” he said.

Human beings are a remarkably altruistic species. So how come there are so many narcissists and psychopaths among us?

A great deal of recent research on evolution focuses on altruism—the tendency of creatures to help others, often at great cost to themselves. This is especially true of human beings, who help one another for a variety of good evolutionary reasons. For instance, people help kin, which is a way of preserving the genes that they share. People help others who are likely to help them back. But the prevalence of altruism also raises an evolutionary paradox: If evolution has selected humans to be nice and kind, how do we explain the high prevalence of jerks?

Research suggests that one fundamental reason people are altruistic is to make themselves attractive to sexual partners. In a large-scale cross-cultural study of qualities found attractive in mates, published in the Journal of Cross-Cultural Psychology in 1990, David Buss and colleagues asked young adults across the globe to rate how important various attributes were in long-term mates. Across a broad range of cultures, they found that kindness placed toward the top of the list. Mate preferences are a very strong evolutionary force, so if people prefer kindness in mates, kindness will become a common attribute in the species. This is one reason why there are so many good people.

So how can it be adaptive from an evolutionary point of view to engage in behavior that other people find objectionable and even hateful? Recent work by researchers including David Schmitt of Brunel University London and Peter Jonason of Western Sydney University has focused on a group of personality traits known as the “dark triad,” which are negatively associated with character and ethics. In a much-cited 2002 paper in the Journal of Research in Personality, Delroy Paulhus and Kevin Williams, both then at the University of British Columbia, defined the dark triad as consisting of narcissism (an excessive focus on oneself), Machiavellianism (manipulating others for one’s own gain), and psychopathy (an overall disregard for others).

People who score high on the dark triad typically engage in behaviors that most people would find obnoxious or immoral. In a 2017 paper in the journal Psychological Topics, Prof. Schmitt and colleagues used data from a global survey of more than 30,000 participants to establish that people who score high on a test for narcissism are also more likely to have short-term sexual relationships, to engage in intimate partner violence and to be more likely to steal other people’s romantic partners. Studies by my own research team have found that people with high scores on the traits that define the dark triad are also particularly likely to cut friends and relatives out of their lives and to plot revenge against others for even minor transgressions.

In the same study, we found that slightly more than 10% of the population may have substantial dark-triad tendencies. What’s more, scores on each of the dimensions of the dark triad were positively correlated with one another: People with a tendency toward narcissism are also more likely to demonstrate Machiavellianism and psychopathy, and vice versa.

This finding raises an evolutionary question: If humans generally find these traits repulsive and prefer not to mate with those who possess them, how did the dark triad manage to become so prevalent? What is the evolutionary benefit of being a bad person?

To understand how some people flourish in life by being nice while others succeed by being jerks, evolutionary psychology turns to the concept of “strategic pluralism.” This is the idea that members of the same species might evolve different and even contradictory strategies for survival, depending on the conditions they face. If an individual grows up in unstable, harsh and unsafe conditions, it makes sense to reproduce early and often, since he or she might not have much time left. On the other hand, if an individual is raised in stable and safe conditions, they will have more time to wait, choose the perfect mate and have only a few children who are given enormous amounts of time and attention. In this way, the same species might develop both “fast” and “slow” life strategies.

We see evidence of strategic pluralism in the natural world all the time. For instance, behavioral scientists who study wood frogs have found that the males employ two distinct strategies in trying to attract a mate. One is to carve out a large territory and issue regular mating calls. Once a female wood frog approaches, the male tries to mount her, while she tries to shake him off. This is a way of selecting for larger mates, since if the male is large enough, it is harder for her to dislodge him.

This preference leaves smaller male wood frogs in a pickle because they can’t stay mounted on the female. So these males have evolved an alternative strategy: They hang out near a large, dominant male as he calls out for females. When a female comes by and releases her eggs—in wood frogs, fertilization takes place outside the body—the satellite male will try to quickly enter the picture and fertilize them with his sperm.

In the wood-frog mating system, then, we see two very different behavioral strategies, each of which can achieve reproductive success. Smaller male frogs face obstacles to mating, forcing them to use an aggressive or “fast” mating strategy, while larger frogs have the luxury of using a safer, “slower” mating strategy.

Something similar may be responsible for the evolution of antisocial personality traits in human beings. In a 2013 paper in the journal Personality and Individual Differences, entitled “The Making of Darth Vader: Parent-Child Care and the Dark Triad,” Dr. Jonason and colleagues found that people who experienced low-quality or irregular parental care were more likely to develop dark-triad traits. They proposed that “stressful, harsh, or unstable child-parent relationships might activate an approach to life, captured by the dark triad, orienting individuals towards seeking immediate returns in mating.” Such challenging circumstances don’t reward “slow” life strategies like patience and cooperation; rather, they would encourage the development of “fast” strategies dependent on aggression and deceit.

And for such strategies, qualities like narcissism and Machiavellianism may be highly adaptive, helping individuals to outwit rivals and achieve success, including reproductive success. Research has consistently found that those who score high on the dark triad tend to be “short-term mating strategists.” In other words, they are more likely to pursue brief sexual encounters, and they have less of a problem than most people with behavior like breaking up other couples, keeping a backup partner in the wings and engaging in infidelity.

Unpacking the elements of the dark triad can give us insights into how these traits are biased toward short-term mating. For instance, someone who is manipulative may not win many points for kindness, which works best in long-term mating contexts, but they may well be effective at manipulating potential mates into brief sexual encounters. This suggests that, as long as human beings are subject to challenging environments during their development—whether social or physical—the dark triad will confer an advantage on some individuals. In other words, unfortunately, jerks may always be with us.

The emerging pipeline of IPOs indicates the potential for 2019 to be a record-breaking year

Uber Technologies Inc. filed paperwork confidentially this week for its initial public offering, according to people familiar with the matter, as it races with smaller rival Lyft Inc. to be the first to market.

The S-1 filing with the Securities and Exchange Commission puts Uber neck-and-neck with Lyft. Both planned IPOs are shaping up to be among the biggest in a spate of offerings aimed for 2019. Lyft said Thursday it had filed its S-1, and people familiar with the matter have said it is aiming to debut in March or April.

Uber’s filing indicates it could go public as soon as the first quarter, as The Wall Street Journal reported in October. That would be sooner than many observers had expected. Uber Chief Executive Dara Khosrowshahi has said he expected to seek a debut in next year’s second half.

Uber has dubbed planning around its IPO “Project Liberty,” according to one of the people familiar with its plans.

That may be a sly reference to the thousands of employees and investors who have waited years to sell their full stake in the company for a profit, one person said. Uber has held recent secondary sales, allowing some investors and workers to sell a portion of their stakes.

Details of Uber’s filing, including exactly when it was submitted, weren’t immediately available. The company’s banking advisers have suggested the ride-hailing firm could go public at a valuation of $120 billion, the Journal has reported. The firm’s most recent private valuation was $76 billion, when it sold a roughly $500 million stake to Toyota.

Based on the pipeline of potential IPOs, which includes data-mining company Palantir Technologies Inc., Slack Technologies Inc. and Airbnb Inc., 2019 could be a record-breaking year for market debuts in terms of dollars raised. It could top the high-water mark reached in 2000, when tech companies raced to cash in on lofty valuations at the height of the dot-com boom.

Uber and Lyft, along with companies outside the U.S. like China’s Didi Chuxing Technology Co. and Singapore’s Grab, have radically changed the way people get around in urban areas and have upended traditional cab businesses. The companies have leveraged their core businesses to expand into other services, like meal delivery and bike sharing.

But Uber, like Lyft, is unprofitable. Its third-quarter loss widened to $1.07 billion amid a sales gain of 38% to $2.95 billion, and it has indicated in recent bond-offering documents it doesn’t expect to get out of the red for at least three years. Lyft had a loss of $254 million on sales of $563 million in the most recent quarter, the Journal has reported.

Lyft has raised $5.1 billion to date, compared with about $20 billion for Uber. Both figures include debt financing. Uber has 20,000 employees world-wide, which is four times more than Lyft has.

For its presentations to potential investors, Uber is likely to emphasize the success of its side projects such as prepared-food-delivery unit UberEats and trucking business Freight, people familiar with the matter have said. It operates in about 70 countries world-wide, while Lyft is just in the U.S. and Canada.

Uber had 69% of the U.S. market, while Lyft had 28% as of October, according to Second Measure, which tracks credit-card spending data.

Mr. Khosrowshahi has put IPO planning at the forefront of his work in recent months. Among recent hires are the company’s first chief financial officer in more than three years, a new chairman and a chief compliance officer.

Uber is also weighing strategic transactions ahead of the IPO, including mergers and acquisitions, that could push out the timeline by several months, people familiar with matter said. Mr. Khosrowshahi and Uber expect that these deals, should they come together, could boost the valuation in the offering, these people said.

Uber last year weathered a series of scandals and setbacks, including claims of workplace sexual harassment, the alleged theft of self-driving-car trade secrets and several federal investigations into its business practices. Investors forced out co-founder Travis Kalanick as CEO, ushering in Mr. Khosrowshahi from Expedia Group Inc. On his first appearance in front of employees in August 2017, Mr. Khosrowshahi addressed his plans to go public, saying it could happen in as little as 18 months. The recent filing suggests the company is on pace with that guidance.

Investors have privately praised Mr. Khosrowshahi for taking a more collaborative approach with regulators, after early wins in London and Brazil where Uber’s business was threatened by new rules.

Uber is still investing heavily in its self-driving-car division, which cost about three-quarters of a billion dollars to operate in 2017. After a fatal accident in March involving one of the robot vehicles, Uber has taken the vehicles off the roads, closed its operations in Arizona and cut staff in other offices, including Pittsburgh. It has a pending application to return the high-tech autos to roads in Pennsylvania.

Although Mr. Khosrowshahi has pledged his support for continued investment in self-driving vehicles, some investors and executives have urged him to further cut spending or dispatch the division.

Are Algorithms Ruling Our Investment Choices?

Trigger-Happy Algos

Humans vs. Machines by Yardeni Research

Dec. 6: It has undoubtedly been a Grinchy 11 weeks since the S&P 500 peaked at a record high on Sept. 20. Uncertainty about trade wars, interest rates, and corporate earnings have combined to cause lots of sideways volatility this year. And yet, with two record highs set this year, the S&P 500 is basically flat for the year at this point.

Both record highs were followed by 10.2% corrections. Given the abundance of negativity baked into stock prices after Tuesday’s rout (on Dec. 4), the holiday spirit has moved us to look for anything that might bring some cheer.

Some market developments suggest that this week’s selloff may be closer to an end than a beginning. For starters, when the S&P 500 fell 90 points on Tuesday, Dec. 4, 10 of its 11 sectors were in the red for the day, with only six industries—including electric utilities, gold, and automotive retail—in the black. When nearly everything wipes out—from the go-go tech names right down to safety sectors—it’s often a sign that selling may be approaching an end.

Such widespread and intense selloffs tend to signal so-called “capitulation bottoms.” Such bottoms don’t always occur in just one day. The bottom of the latest correction in the S&P 500 occurred on Nov. 23. It could be retested and even breached, of course. While Joe Abbott and I are looking for a bottom, others viewing the same chart of the S&P 500 see a major bull market top and are looking for the beginning of a bear market.

However, this year has seen a number of one-day meltdowns like Tuesday’s. We strongly suspect that they were not driven by capitulating humans but engineered, literally, by computer-driven trading algorithms. The “algos” seem to have been triggered to sell by news events suggesting escalating trade wars and flattening yield curves. They tend to be programmed to sell large, liquid exchange-traded funds, which amounts to a “sell everything” trade.

--Ed Yardeni

There’s not much to love about Deutsche Bank . The German banking giant is mired in legal woes, the stock is expensive, and a restructuring will dog its performance for some time. Deutsche Bank shares have the potential to fall 30% on top of already-brutal declines. “We fail to see an improvement in the underlying business,” said a recent Morningstar report. Third-quarter results “were underwhelming,” and while layoffs and a restructuring are “well under way...most of the work still lies ahead.”

Deutsche Bank (ticker: DBK.Germany) shares have taken a beating, shedding more than half of their value over the 12 months through Dec. 6. Contrast that with a 8.1% loss of the Financial Select Sector SPDR exchange-traded fund (XLF), which tracks a basket of bank stocks, over the same period.

Part of the problem is a toxic cloud of scandals. Earlier this week, German authorities settled with the bank over questionable tax deals, and in late November six offices in Frankfurt were raided over allegations of money laundering, a charge that has cost the bank dearly over the past few years. “[R]aids that take place with reasonable frequency in Germany aren’t that well understood outside of Germany,” said the bank’s CFO, James von Moltke, in a TV interview. “Our focus is obviously on cooperating with the prosecutors making sure that we satisfy their requests and hopefully putting the investigation fully behind us.” Deutsche Bank declined to comment further.

Still, that doesn’t make Deutsche Bank stock a buy—and investors should consider dumping it in any forthcoming rallies. Or alternatively, purchase out-of-the-money put options that will pay out if the stock falls.

Deutsche Bank is pricey. Its forward price/earnings ratio is 16.7 versus an average of 13.1 over the past five years, according to Morningstar data. Just across the English Channel, the similarly sized United Kingdom–based Lloyds Banking Group (LLOY.UK) trades at a forward P/E of 7.6, down from 10.5 in 2016. In other words, Deutsche Bank is a lot more expensive than Lloyds, even if you don’t consider performance. Deutsche lost money in the past three calendar years, while Lloyds has been consistently profitable since 2014.

If Deutsche Bank shares traded at the same P/E as Lloyds, then it would be worth $6.24 versus the current $8.89. That price level is slightly higher than that produced with technical analysis. “A 5-handle is not out of the question,” writes J.C. Parets, founder of AllStarCharts and a technical analyst. A 5-handle means that the stock would be worth from $5 to $5.99.

The bank’s prospects look uncertain. “We expect DB’s top line to be negatively impacted by revenue attrition from its decision to downsize the business in recent years,” noted a December report from research firm CFRA. “The European Central Bank’s decision to delay an interest-rate hike into the later part of 2019 will also hurt its interest margin.” In other words, the bank’s profit-making ability is hampered by low borrowing costs.

“If the company can’t make money when there are no setbacks and financial crises, then tell me how it survives the next recession,” says Don Coxe, chairman of Chicago-based financial firm Coxe Advisors.

There are risks of dumping the stock. The scandals may blow over, the restructuring may go better than expected, and the stock may rally. A Bundesbank official recently told Bloomberg: “Experience since the financial crisis has shown that even large institutions are capable of resolutely changing tack. But this takes time.”