The Impact of Whistleblowers on Financial Misrepresentation Enforcement Actions

Andrew C. Call

Arizona State University (ASU) – School of Accountancy

Gerald S. Martin

American University – Kogod School of Business

Nathan Y. Sharp

Texas A&M University – Department of Accounting

Jaron H. Wilde

University of Iowa – Henry B. Tippie College of Business

Abstract:

Whistleblowers are ostensibly a valuable resource to regulators investigating securities violations, but whether whistleblowers have any measurable impact on the outcomes of enforcement actions is unclear. Using a dataset of employee whistleblowing allegations obtained from the U.S. government and the universe of enforcement actions for financial misrepresentation, we find whistleblower involvement accounts for between 21.0% and 27.5% of the $79.46 billion in total penalties assessed and more than doubles prison sentences of targeted individuals. However, these benefits are not without a cost, as enforcement actions involving whistleblowers take 10.9% (about 10 months) longer to complete. Our findings are relevant to firms, policymakers, and regulators.

The Impact of Whistleblowers on Financial Misrepresentation Enforcement Actions – Introduction

Policymakers have implemented ambitious whistleblower programs to motivate individuals to come forward and reveal information about potential securities violations or financial misconduct. However, we have a limited understanding of the role whistleblowers play in the enforcement process. We investigate the effect of employee whistleblowers on the consequences of financial misrepresentation enforcement actions by the Securities and Exchange Commission (SEC) and Department of Justice (DOJ). Our intent is not to examine the efficacy of any particular whistleblowing program; instead, our objective is to provide empirical evidence on the effects whistleblowers have on penalties, prison sentences, and the duration of regulatory enforcement actions for financial misrepresentation.

Examining the impact of whistleblowers on securities enforcement is important because policymakers continue to enact legislation attempting to encourage whistleblower involvement and because regulators dedicate significant resources to promoting and rewarding whistleblowing activity [SEC 2014]. For example, Congress recently passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) requiring the Commodity Futures Trading Commission (CFTC) and the SEC to establish whistleblower offices that provide a formal venue where whistleblowers can voice complaints and share evidence with regulators. Rewards for whistleblowers who come forward with original information about corporate misconduct can be large, ranging from 10% to 30% of monetary sanctions over $1 million stemming from investigations facilitated by whistleblowers’ information, documentation, or cooperation [CFTC 2013, SEC 2013b]. Determining the effect of whistleblowers on the outcomes of enforcement actions is important because it informs policymakers and increases our understanding of the enforcement process.

The effect of whistleblower involvement on securities enforcement outcomes is unclear for several reasons. First, regulators have limited resources to address whistleblower complaints [Kedia and Rajgopal 2011], so credible whistleblowers likely slip through the cracks.1 Second, whistleblowing complaints are often frivolous [Miceli and Near 1992, Near and Miceli 1996, Bowen et al. 2010]; thus, even if regulators had the resources to pursue every whistleblower complaint, the benefits of doing so are uncertain, and regulators cannot fully distinguish credible from frivolous whistleblowers ex ante. Finally, regulators have historically conferred relatively few whistleblower awards, raising questions about the usefulness of whistleblowers in their enforcement efforts.2 This study fills an important void in the literature by providing empirical evidence on the association between whistleblower involvement and securities enforcement outcomes.

Using the universe of SEC and DOJ enforcement actions for financial misrepresentation between 1978 and 2012 [Karpoff et al. 2008a, 2008b, 2014], we investigate whether whistleblower involvement is associated with more severe enforcement outcomes. Specifically, we examine the effects of whistleblower involvement on: (1) monetary penalties against targeted firms; (2) monetary penalties against culpable employees; and (3) the length of incarceration (prison sentences) imposed against employee respondents. In addition, we investigate the effect of whistleblowers on the duration of the violation, regulatory proceedings, and total enforcement periods. Notably, we examine the effects of whistleblowers conditional on the existence of a regulatory enforcement action. This distinction is important because our tests exploit variation in consequences to SEC or DOJ enforcement with and without whistleblower involvement; we do not measure the effects of whistleblower allegations for which there are no regulatory enforcement actions.

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Whistleblowers

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