Who Discovers More Corporate Fraud: Whistleblowers, Regulators, or Journalists?

A new study in the Journal of Finance offers a friendly reminder of the key role whistleblowers play in rooting out fraud, waste and abuse, finding that corporate fraud is more likely to be detected by an employee from within a firm, rather than external auditors, government regulators, self-regulatory organizations, or the media.

The study examined a total of 216 cases of alleged corporate fraud. Employees, i.e. whistleblowers, were responsible for revealing the fraud in 17 percent of cases — more than any other type of source — in which the fraud was not first brought to light by a firm's management.

For its part, the Securities and Exchange Commission (SEC) revealed the wrongdoing in only 6.6 percent of such cases.

These findings might not be a huge surprise to those following recent news that the SEC hasn't exactly been on the ball with its investigation and enforcement of suspicious firms, and they certainly won't come as a surprise to those like Harry Markopolos, who read the 2008 report by the Association of Certified Fraud Examiners which found that 54.1 percent of fraud cases against public companies were initiated by a whistleblower tip.

But the Journal's new study offers a separate, timely reminder:

A natural implication of our findings is that the role of monetary incentives should be expanded. We find that the use of monetary rewards provides positive incentives for whistleblowing.

As Michael mentioned earlier this week, Congress is now considering legislation to improve the SEC's program to reward whistleblowers, which in over 20 years of existence has resulted in payments to only five people. Hopefully this report can serve as another coal in the fire to cook up a better system.

-- Bryan Rahija

H/T The Dallas Morning News

Photo by hughelectronic, used under Creative Commons License.

Comments

[Nicole Williams]

I agree with Mr. Smallberg that whistleblowers should have more protection.

It will be nice to see more of these white-collar criminals brought to justice and receive the punishment that they deserve.

[Michael Smallberg]

Despite the crucial role that whistleblowers often play in uncovering corporate wrongdoing, they rarely receive help when they face retaliation from their employers. A study conducted a few years ago found that only 3.6 percent of Sarbanes-Oxley whistleblowers win relief through the initial administrative process, and that only 6.5 percent win on appeals. The study also found that administrative judges have often strictly construed or even misapplied the SOX provisions on whistleblower protections: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=977802

In addition to improving the SEC's whistleblower reward program, Congress should also incorporate provisions from Sen. Dodd's financial regulatory reform bill that would strengthen protections for whistleblowers who assist the SEC with any of its investigations or administrative/judicial actions.