Finance executives that “cook the books” not only have to worry about being exposed by a whistleblower, they and their companies also are more likely to be hit with financial penalties — and likely to pay far higher ones — when a whistleblower is involved in a government enforcement process.
A new study examined data on 658 federal investigations of financial misrepresentation — 22.5% of which involved whistleblowers — from 1978 through 2012. It determined that whistleblower involvement is associated with an 8.5% increased likelihood of the Securities and Exchange Commission or Department of Justice imposing monetary sanctions on a company.
Whistleblower involvement is also associated with a 6.6% increased likelihood of criminal sanctions against employees targeted in the investigation, according to the study.
The study offered some results that were even more eye-popping, although the authors said they should be viewed “with caution”:
- When enforcement does result in financial sanctions for a company, the average predicted amount of such sanctions increases from $8.7 million without a whistleblower to $30.7 million with one.
- Total predicted monetary penalties for employees involved in financial misrepresentation rise from $22.8 million without a whistleblower to $69.4 million with one.
- Most sobering of all, when a prison sentence results from an investigation, a culpable individual will on average receive a sentence of 41.9 months if a whistleblower is involved, compared with 22.5 months otherwise.
The authors recommended caution regarding those findings because of “severe skewness in distribution of both the outcome variables (firm penalties, employee penalties, prison sentences) and several of the control variables associated with outcomes of enforcement actions (e.g., bribery, organized crime).”
The researchers were careful to note that “whistleblower involvement” does not always equate to whistleblowers bringing alleged wrongdoing to light. “A common misconception about whistleblowers is that their primary role is to help discover and expose misconduct. However, the benefits of whistleblower involvement often arise after a regulator has already begun an investigation,” they wrote.
But non-tipster whistleblowers, who may help the investigation but do not cause regulators to initiate an investigation, were also found to be associated with heightened enforcement outcomes.
The time to discovery for enforcement actions associated with a tipster whistleblower tends to be shorter, while the regulatory proceedings period of enforcement actions associated with non-tipster whistleblowers tends to be longer than with other actions.
The study did not attempt to discern the reasons for the differences in outcomes when whistleblowers are involved in enforcement actions.
It did point out that whistleblowers may be more likely to approach regulators when they have knowledge of egregious violations that are more likely to result in large penalties and sanctions. Therefore, the researchers controlled for factors that the SEC and DOJ say they take into account when recommending penalties and sanctions.
After controlling for these factors, the reported association between whistleblower involvement and the outcome of enforcement actions was incremental to the impact of those other factors.
Such factors include:
- The presence or absence of a direct benefit to the company as a result of the violation
- The degree to which the penalty will recompense or further harm insured shareholders
- The extent of injury to innocent parties
- The need to deter the particular type of offense
- Whether complicity in the violation was widespread throughout the company
- The level of intent on the part of the perpetrators
- The degree of difficulty in detecting the particular type of offense
- The presence or lack of remedial steps by the company
- The extent of cooperation with the SEC and other law enforcement
- The effectiveness of compliance programs
- The company’s prior enforcement history
The researchers also controlled for company attributes like market capitalization, market-to-book ratio, leverage ratio, and industry.
The industries most frequently subject to enforcement actions are: business equipment (24.9% of all actions); financial services (12.0%); wholesale and retail (11.7%); health care, medical equipment, and drugs (8.4%); and manufacturing (8.2%).
The study will be published in a forthcoming issue of the Journal of Accounting Research. It was performed by four professors: Andrew Call of Arizona State University, Gerald Martin of American University, Nathan Sharp of Texas A&M University, and Jaron Wilde of the University of Iowa.