During this podcast series, I have been interviewing 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 data from NAVEX Global, Inc., the sponsor of this podcast series. This data was from the company’s hotline reporting systems. 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) and there were fewer material lawsuits brought against the company overall and there were lower settlement costs if a lawsuit did occur. Finally, there were fewer external whistleblower reports to regulatory agencies and other authorities. We continue to take a deep dive into the Report and today, we go into the weeds to consider the key findings of the Report.
We began with a distribution of findings in the Report. It is probably not too surprising to relate that the largest number of findings were in the realm of Human Resources (HR) or as Dr. Welch put it, “I would have said the biggest problems show up from humans interacting with other humans and not getting along or having some sort of inappropriate interactions.” The smallest distribution was in financial reporting. But it even specified to a greater level of detail and nuance between industries. He stated, “different industries that have what seems to be more mature compliance are seen as having more robust whistleblower reporting.” He cited to the examples of the energy industry, FinTech, financial services and healthcare in particular as whistleblowing is more active in these industries.
We next considered the determinants of use in a whistleblower reporting system. In addition to the types of industries identified above, Dr. Welch pointed to corporate governance as a key determinant of a robust whistleblower reporting system in an organization. One of the most prominent is corporate governance. He stated, “Governance is one that we see as absolutely impacting whistleblowing.” Here he referred back to the Entrenchment Index(Index) which considers a number of governance metrics for matters in corporate governance. It includes how entrenched managers are at a company. “Things like providing senior management with golden parachutes, poison pills for acquisitions, staggered Boards and staggered Board elections so that if you have a Board election that makes it harder to turn over the entire Board of Directors.” All of these facts go into the Index.
All of this means that that companies with higher quality governance, meaning firms with lower scores on the Index, where Boards are less entrenched and shareholders have more power, actively use whistleblower reporting systems and are more generally “power users”. Conversely, firms with poor governance with higher scores on the Index, typically use whistleblower reporting systems less. Next newer and younger firms use whistleblower reporting system less that firms that are more mature. Further, companies with lower quality earnings tended to use whistleblower reporting system less. “So we factor all these things into our relationships here in and making sure that we’re identifying not just one to one relationships, but how these other factors impact the outcomes of whistleblower reporting systems. All of these determinants of use are control variables to help us identify the outcome that we want to isolate and see the relationship within context.”
All of this leads to the key finding of a reduction in material litigation costs and remember this is not simply civil litigation but all reportable proceedings against a company, including regulatory enforcement actions, criminal sanctions sought by the Department of Justice (DOJ) and all other court proceedings. A material proceeding would have to be 5% of a company’s gross margin, so the amount would be quite high. Companies with robust whistleblower reporting systems also had 4% fewer pending lawsuits the year after increased hotline activity, improving to 6.9% fewer material lawsuits over the next three years. Additionally, overall litigation settlements of non-material matters dropped almost 20% over three years as well.
All of this points to one unmistakable conclusion, a robust whistleblower reporting system facilitates a company’s resolution of problems before they become major problems or legal violations bringing the Securities and Exchange Commission (SEC) or DOJ calling.
In our final episode, we consider what all this means for the compliance professional.
This podcast series is sponsored by NAVEX Global, Inc.