Originally published on the FCPA Compliance Report.
I interviewed Dr. Kyle Welch, Assistant Professor at George Washington University (GWU), on his recently released paper, co-authored with Stephen Stubben, Associate Professor from The University of Utah, entitled “Evidence on the Use and Efficacy of Internal Whistleblowing Systems” (Report). In this paper, Welch and Stubben reviewed some 15 years of anonymized hotline reporting data. Some of the key findings include: companies with a robust whistleblower and reporting system had greater profitability and workforce productivity as measured by Return on Assets (ROA), fewer material lawsuits brought against the company overall, and lower settlement costs if a lawsuit did occur. Finally, there were fewer external whistleblower reports to regulatory agencies and other authorities. My five-part podcast series takes a deep dive into the Report, but today I consider the impact of internal versus external reporting.
Some of the key findings included that companies with a robust whistleblower and reporting system had greater profitability and workforce productivity as measured by Return on Assets (ROA), fewer material lawsuits brought against the company overall, and lower settlement costs if a lawsuit did occur.
Whistleblowing is based upon law in the U.S. that goes back to the Civil War and the creation of qui tam lawsuits to help the U.S. government fight fraud, waste and abuse in procurement and contracting. Readers of my blog will recall that whistleblowing has been used by governments as far back as the Republic of Venice. In the modern era, Sarbanes Oxley (SOX) was seminal in legislation recognizing the role whistleblowers play in uncovering illegal, unethical and harmful conduct in the corporate sector. SOX also brought whistleblower anti-retaliation protection to internal reporters. These concepts were extended in the Dodd-Frank Whistleblower bounty program, although the U.S. Supreme Court cut back on anti-retaliation protection for internal reporters in 2018. Dodd-Frank also instituted a bounty program which has been extraordinarily successful for the Securities and Exchange Commission (SEC).
Internal reporting is when employees use internal whistleblowing hotline systems to report what they observe and that report goes directly to management at the firm.
The change in Dodd-Frank interpretation of anti-retaliation protection by the Supreme Court highlighted the difference between internal and external whistleblowers. Internal reporting is when employees use internal whistleblowing hotline systems to report what they observe, with that report going directly to management at the firm. It allows the organization to deal directly with the problem. Dr. Welch contrasted this with external reporting which is a whistleblower going to a government official or agency, such as the SEC, to report a problem.
Dr. Welch said that most academic research in the past had focused on external whistleblowers because this information is publicly available. This research has demonstrated the negative economic impacts and reputational damage for companies where illegal, unethical or similar conduct is reported to authorities and made public. Conversely, there is a paucity of academic research into internal reporting as such information was not available publicly.
Moreover, even at the SEC there is a clear recognition that most whistleblowers report internally before they report externally to regulators. This reinforces a key point by Dr. Welch: humans are a key component for any company to uncover fraud, waste, illegal or unethical acts. It is the next step which can then lead to greater or lesser economic costs for such companies. Dr. Welch highlights the differences in organizational impact from both external and internal whistleblower reporting. External reporting triggers a series of compounding negative events as information flows outside the organization via media outlets or regulators. Contrast this with scenarios where humans (employees) help identify and solve problems, and you begin to see that information from a company’s employees plays a huge part in identifying and solving problems internally.
And so, as great as big data is, this is a story where humans are needed to uncover and find problems.
All of these issues present numerous lessons to be considered by the compliance professional, regulators and corporate governance experts. Obviously internal reporting is preferable for an organization to stop the illegal or unethical conduct and then remediate the situation as quickly as possible. For regulators, the Report can help regulators make decisions on how and where to incentivize such internal reporters. For boards of directors, it can provide a much clearer and more robust picture of what the employees on the front line are seeing and observing.