Where Were the Whistleblowers?

Mark Gimein points to

"a legal precedent set in the Bayou case that should scare the heck out of anyone who once invested with Madoff but who managed to get out safely in the last few years: Any investors who managed to take out profits from a fund like Bayou before the fraud was revealed had to give the money back."

That means an investor who somehow became aware of the Madoff fraud had an incentive not to snitch, thinks Gimein:

The consequence of this is that any longtime Madoff investors who'd gotten suspicious could very well have seen that publicizing their suspicions and outing Madoff's scam would not have saved their money, but actually exposed them to greater losses.

But I don't think this is the whole story (or even much of it) behind why nobody -- or nobody who could get the SEC's attention -- tried to reveal the fraud. Madoff was under suspicion since at least 1999 while the Bayou decision only came down this year. Where were the disincentives in the pre-Bayou-ruling era to keep investors tight-lipped?

More importantly, the Madoff fraud will hopefully mean that regulators take a serious look at extending Sarbanes-Oxley's whistleblower protections to also cover private companies, or private financial firms at the least. These protections have been found to increase reporting of fraud both in the lab and in the real world.

The biggest problem with a plan like this, though, would be if the smaller average size of private financial firms made it less likely that an employee to would whistleblow. But even a lower propensity is better than no propensity at all.