CLS Blue Sky Blog

Financial Enforcement Actions and the Role of Whistleblowers

In our recent paper, we investigate the association between employee whistleblowers and outcomes of financial misrepresentation enforcement actions by the Securities and Exchange Commission (SEC) and Department of Justice (DOJ).  We examine SEC and DOJ enforcement actions for financial misrepresentation since the passage of the Sarbanes-Oxley Act of 2002 and study whether whistleblower involvement in regulatory enforcement is related to more severe (1) financial penalties levied against misrepresentation firms, (2) monetary penalties assessed against executives associated with the misconduct, or (3) prison sentences of employee respondents. We also explore the relation between whistleblowers and penalties imposed on third‐party respondents (e.g., the firm’s auditor, bankers) and examine the length of the discovery period and the regulatory proceedings period.

We use two distinct data sources. The first is a data set of employee whistleblowing allegations obtained from the U.S. government using a Freedom of Information Act (FOIA) request. The Sarbanes‐Oxley Act of 2002 gave OSHA the responsibility to field employee complaints of discrimination for blowing the whistle on alleged financial misconduct, and OSHA is required to communicate these allegations to the SEC. Because we cannot directly observe whether regulators actually used the information, we note that these whistleblower allegations reflect only potential whistleblower involvement in an enforcement action. We supplement the data with information from enforcement‐related documents containing direct evidence of whistleblower involvement. When a whistleblower’s involvement is specifically referenced in the administrative and legal proceedings associated with financial misrepresentation, we identify this enforcement action as having whistleblower involvement.

Of the 658 enforcement actions since the passage of SOX, 148 (22 percent) are associated with at least one whistleblower complaint made after the beginning of the violation period and before the end of the regulatory proceedings period. Using guidelines published by the SEC and DOJ, we identify a broad set of controls for other factors related to the magnitude of penalties and sanctions. Specifically, when examining the association between whistleblower involvement and outcomes of enforcement actions, we control for the breadth, depth, scope, and egregiousness of the violation. We use proxies such as abnormal stock returns on the date the financial misrepresentation became public, the length of the violation period, the number and type of violations involved, the number of C‐level executive respondents named in the enforcement action, and variables identifying whether the firm was involved in foreign bribery, whether the firm misled the auditor, and whether the firm was credited with cooperating with regulators when penalties were determined. We also control for firm characteristics potentially associated with both the existence of a whistleblower and with enforcement outcomes.

After controlling for various factors that affect the amount of penalties assessed in an enforcement action, we find that whistleblower involvement is associated with larger financial penalties for the targeted firms and longer prison sentences for targeted employees. Whistleblower involvement in the enforcement process is associated with an 8.58 percent increased likelihood that the SEC imposes monetary sanctions on the firm and a 6.64 percent increased likelihood of criminal sanctions against the targeted employees. We also find some evidence that whistleblower involvement is associated with larger monetary penalties against targeted employees. However, this result is not always statistically significant when we employ alternative design choices. In addition, we also find that whistleblower involvement is positively associated with monetary penalties imposed on third‐party defendants, such as the company’s auditor. Taken together, these findings suggest that whistleblowers are a valuable source of information for regulators during the investigation and prosecution of financial misrepresentation.

A common misconception about whistleblowers is that their primary role is to help discover and expose misconduct. However, whistleblower statutes suggest whistleblowers often assist after a regulator has already begun an investigation. Therefore, we also investigate the association between whistleblowing and outcomes of enforcement actions conditional on the timing of the whistleblower’s complaint. We find that whistleblowers who allege misconduct before the end of the violation period or before regulators begin their investigation (i.e., “tipster” whistleblowers) as well as whistleblowers who emerge after the SEC has already begun an investigation (i.e., “non-tipster” whistleblowers) are associated with more severe enforcement outcomes.

We also examine whether whistleblower involvement is associated with the amount of time it takes regulators to begin regulatory enforcement (the “discovery” period) and with the duration of enforcement actions. If whistleblowers provide a road map that facilitates the SEC’s or DOJ’s case, their involvement could expedite the discovery and resolution of enforcement actions. Alternatively, because whistleblowers provide regulators with additional information to investigate, their involvement could also prolong the enforcement process. After controlling for factors associated with the outcomes of investigation and enforcement, we find that the discovery period is shorter when whistleblowers are involved (particularly tipster whistleblowers). We find no significant difference in the length of the regulatory proceedings when whistleblowers are involved.

Our findings are relevant and timely in light of the U.S. federal government’s extensive investments in whistleblowing programs. Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act offers significant monetary incentives (10 percent to 30 percent of monetary sanctions collected via criminal or civil proceedings) to prospective whistleblowers, and also established the SEC Investor Protection Fund to provide funding for this program. As of the end of 2017, the balance in this fund was $321 million, and the government had paid out a total of $160 million to 46 different whistleblowers since the passage of Dodd-Frank. In addition, while the U.S. generally offers the most aggressive whistleblowing rewards, other countries are following suit. For example, in 2016, the Ontario Securities Commission adopted a whistleblowing program and began offering financial incentives to prospective whistleblowers in Canada. As such, large scale evidence on the usefulness of whistleblowers in the enforcement process (at least in terms of enforcement outcomes) is relevant to regulators and legislators who continue to promote whistleblowing programs and reward those who assist in enforcement actions.

This post comes to use from Professor Andrew C. Call at Arizona State University, Professor Gerald S. Martin at American University, Professor Nathan Y. Sharp at Texas A&M University, and Professor Jaron H. Wilde at the University of Iowa. It is based on their recent paper, “Whistleblowers and Outcomes of Financial Misrepresentation Enforcement Actions,” available here.

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