by Cydney Posner
An academic study, first reported by the WSJ, concludes that, in regulatory enforcement actions brought by the SEC and DOJ alleging financial misrepresentation, employee whistleblowers have a consequential impact on regulatory outcomes, increasing the size of penalties, length of prison sentences and duration of the actions. In addition, whistleblower complaints were found to significantly increase the likelihood of an enforcement action.
Federal whistleblower programs have a long history, commencing with the False Claims Act, which dates back to 1863 and authorizes claims related to fraud by federal contractors against the government. More recently, SOX and Dodd-Frank have included provisions regarding whistleblowers. Dodd-Frank directed the SEC to pay awards to eligible whistleblowers who voluntarily provide the SEC with original information about a violation of the federal securities laws that leads to a successful enforcement of a covered judicial or administrative action or a related action that results in monetary sanctions exceeding $1 million. The awards can range from 10% to 30% of the total monetary sanctions collected.
The authors of the study looked at all SEC and DOJ enforcement actions associated with financial misrepresentation between 1978 and 2012. The paper indicates that it was not always clear when whistleblowers were involved in an action. As a result, some instances reflected only potential whistleblower involvement, while some actions may not have been included because they did not specifically include references that whistleblowers were involved. The paper reports that, “[o]f the 1,133 firms subject to financial misrepresentation enforcement actions between 1978 and 2012, 145 are associated with at least one whistleblower complaint.”
The paper discusses prior research showing that external stakeholders, such as auditors, analysts and investors, ”often fail to identify financial misconduct with publicly available information.” However, because employees have greater access to inside information, the SEC views employee whistleblower programs as important enforcement tools. Interestingly, however, a footnote in the paper indicates that a “common misconception about whistleblowers is that they play the primary role of discovering and exposing misconduct (i.e., tipsters). However, by design, regulatory whistleblower programs suggest, and [the study’s] evidence indicates, that the benefits of whistleblower involvement often arise after a regulator already suspects wrongdoing (i.e., whistleblowers are facilitators in the enforcement process).”
The study concluded that whistleblower involvement was associated with a significant increase in penalties. “On average,” the study concluded, after controlling for factors the SEC and DOJ indicate are important in determining penalties, “whistleblower involvement is associated with $90.16 to $92.88 million greater firm penalties than if no whistleblower was involved. Furthermore, penalties assessed against executives and other employees [averaged] $50.22 to $56.50 million more than if no whistleblower was involved. Finally, when whistleblowers are associated with an enforcement action, executives and employees at targeted firms are sentenced to prison on average 21.86 to 27.02 months longer than if no whistleblower was involved.” (Amusingly, the study also found that “[p]rison terms decrease as the distance from the regulator to the firm’s headquarters increase….” ) In summary, the study found that “whistleblowers enabled regulators to successfully obtain additional judgments of $20.75 to $21.27 billion more than would have been obtained without their assistance. This increase in penalties accounts for 30% of the total $70.13 billion penalties assessed over the 35 year sample period from 1978 to 2012….These findings indicate whistleblowers are a valuable source of information for regulators in the investigation and prosecution of firms and their managers.”
The study also considered whether whistleblower information expedited case resolution (by providing a facilitating roadmap to the case) or prolonged the case (because of the need to investigate additional information provided by the whistleblower). The study found that cases involving a whistleblower continued for about 10 months (10.7%) longer than actions in which no whistleblower was involved.
In addition to regulatory outcomes, the study also analyzed the impact of a whistleblower complaint on the likelihood of enforcement action. The authors determined that the “increased risk of an enforcement action given a whistleblower complaint is highly significant.” More specifically, the study concluded that the “odds of a firm facing an enforcement action are 5.76 times greater among firms with prior whistleblower complaints.” Notably, however, in the case of approximately 85% of the whistleblower complaints, or 79.5% of firms with whistleblower complaints, there is no subsequent enforcement action. The authors interpret this data as showing that “a rather large portion of whistleblower complaints are either frivolous or not sufficiently informative to result in an enforcement action.”