Businesses need whistleblowers

Becoming a whistleblower isn’t easy. It’s fraught with challenges and possible repercussions. Those who choose a whistleblower’s path risk retaliation and a potentially abrupt end to their career.

Few choose it lightly. Even fewer choose it solely in hopes of financial gain.

Now, proposed rule changes from the Securities and Exchange Commission (SEC) are set to make the business of whistleblowing even more challenging, setting caps on rewards in large cases where fines exceed $100 million.

The rule change is bracketed with a 2018 Supreme Court decision, which found that only by whistleblowing directly to the SEC, can whistleblowers obtain the whistleblower protections established in the Dodd-Frank Act of 2010. 

The Supreme Court’s recent decision and the SEC’s proposed rule change mark a serious setback. Businesses need whistleblowers — particularly those with knowledge of the largest infractions. 

The SEC’s latest whistleblower proposal will increase the likelihood that the highest-level corporate frauds will slide by unreported, removing the compensating incentive for upper-level corporate executives with knowledge about high-level scams to come forward, just as the Supreme Court has limited Dodd-Frank’s whistleblower protections to only those who blow the whistle externally.

Here’s the thing about frauds committed at the highest levels of management: Research demonstrates that the more senior the fraudsters, the greater the losses — and the less likely they are to be discovered.

To lower-level employees, as well, the SEC’s proposed cap sends a signal — one that suggests limited support for whistleblowers. That’s dangerous.

In most cases when fraud is uncovered it’s because of one of two leading factors. Whistleblowers are one. The other, it’s just luck.

I’ve been on two sides of this issue. As an attorney, I often represent whistleblowers who have been unfairly treated or terminated after revealing wrongdoing, including many who have filed reports with the SEC. 

I’ve also been a whistleblower myself, back in my days at the SEC, when I sounded an alarm about foreign espionage against the stock exchanges and related to misconduct in the Ponzi investigations into Bernard Madoff and R. Allen Stanford. 

Fraud can go undetected for years before being revealed, often in spectacular fashion and at great cost to stakeholders.

I’ve seen cases in which the CEO or other senior official commits a fraud, presumably at a company’s behest, exaggerating earnings or cooking up some other falsehood. They might think investors will punish the company if it falls short of forecasts. 

But the real punishment comes when the market discovers there’s been a fraud. In those cases, the decline in stock value often far exceeds the amount cooked into the books. It’s because the market (and its own employees) lose trust in the company’s management. In other words, it’s fear. 

That fear can destroy the reputation of a company forever. 

Remember Enron? It was a $60 billion business with accounting misstatements that amounted to about $2 billion. But market distrust drove Enron into bankruptcy, with a downward stock spiral that made its bankruptcy seem like an inevitability, leaving everyone scared to do business with it.

Of course, there was no effective whistleblower hotline at Enron when Sherron Watkins sought to draw attention to the frauds that would eventually doom the company. In Watkins’ case, it might not have mattered, because the board of directors’ audit committee was rife with its own conflicts of interest. 

Section 301 of the Sarbanes-Oxley Act of 2002 addressed those conflicts, requiring publicly traded companies to have a whistleblower hotline monitored by company outsiders and an audit committee populated by arguably independent members of the board of directors — not partners, insiders or employees or those with conflicting business relations.

Those audit committees and whistleblower hotlines appear to be having an impact. Studies have shown that people are much more likely to blow the whistle internally than to blow the whistle externally — to Congress, an inspector general or regulatory agency, for example.

David P. Weber, CFE, is academic director of the Fraud Management Programs, executive education fellow at the Office of Executive Education and a lecturer at the Department of Accounting and Information Assurance at the Robert H. Smith School of Business at the University of Maryland.