This week I am running a five-part podcast series for which I interviewed Dr. Kyle Welch on his recent 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., from the company’s hotline reporting systems. Today, I want to detail some of the key findings and what it means for the compliance professionals.
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 Indexwhich 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 SEC or DOJ calling.
Implications For Compliance Practitioners
Clearly the Report demonstrates the power of a robust whistleblower reporting system. Once again this is not simply having a hotline but an entire internal reporting system with engagement throughout an organization. This means someone is there to answer the phone; pass the message along and triage the issue. Someone is there to do an investigation, remediate if appropriate, but also communicate with the internal reporter. Most importantly, all in a very fair process manner that the employee or internal reporter will trust.
Dr. Welch added, “The interesting thing is there are two parts to it I do not believe they can be separated. The first is the raw number of reports and then the second thing is engagement with the report.” This is why it is called a whistleblower reporting system and it means you should consider the aspect of engagement with the system by management and how much they value these reports. He stated, “it turns out the relationship is a very strong relationship between the two. And so what that translates into is that usually organizations that have figured this out are hitting on this on multiple levels. There are organizations where employees feel like they can come forward and make an internal report, because they feel safe in doing so and they plan on staying at the organization.”
Obviously CCOs can use this type of information to demonstrate the efficacy of an internal whistleblower reporting system going forward. It also provides the CCO actionable information to prevent, detect and remediate issues before they become full blown legal violations. Conversely, the lack of information can lead to compliance related inquiries.
Dr. Welch then turned to the Board of Directors. He sees two big impacts from this study, directly applicable to the Board of Directors. First, “a more active engagement and more reporting is a good thing for the signal its sends to senior management about corporate culture. The second thing is the direct, unfiltered information that it can provide to Boards of Directors. One of the key corporate governance failures over a wide casting of recent corporate scandals has been the withholding of information to Boards by senior management. Just think about how this could have changed the calculus at Wells Fargo if its Board of Directors had been made aware of the whistleblower reports of fraudulently created accounts up to five years before the scandal broke publicly and the Board finally got the full picture. Remember the Volkswagen Board who found about the emissions-testing scandal when reading about the company’s admissions in the newspaper. Now the Board can have an internal report, with direct information.”
Finally, a robust whistleblower reporting system speaks to a functioning and ethical corporate culture. Employees who can report issues, in a fair manner, without fear of retaliation are more empowered to make the company run more efficiently and more profitably. As Dr. Welch said earlier in this series, one of the reasons employees report internally is they want to stay at the company. Such a culture also attracts more employees, not an inconsequential consideration in this age of the Gig Economy.
Lastly, and from his accounting perspective, Dr. Welch added another reason, that being accruals in financial statements. The more accruals there are going forward, the greater chance there is for financial statement manipulation or fraud. One of his key findings was that companies that did not have at least average whistleblower reporting systems were more likely to have such issues. It may be due to the firms maturity or simply a commitment to do things the right way but if a company does not have a robust whistleblower reporting system, there is such a correlation.
The bottom line of the Report is that it is most welcome news for every compliance practitioner out there. You should study the Report and see if your organization qualifies as a “power user” as defined by Dr. Welch and if it does not, how can you move it towards doing so. Finally, the next time anyone on your Executive Leadership Team (ELT), senior management or Board of Directors asks you about costs, point to this Report as evidence of cost savings through compliance.
This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at firstname.lastname@example.org.
© Thomas R. Fox, 2018