Fraud hotlines: early warning systems.

Interest in fraud hotlines has surged since passage of the Sarbanes-Oxley Act and its requirement that public company employees be able to confidentially and anonymously report questionable accounting or auditing matters. Private companies, however, may also benefit from establishing similar warning systems. Here are some tips for selecting and operating an effective system.

The Sarbanes-Oxley Act of 2002 (the Act) requires every publicly traded company "to establish procedures for the receipt, retention and treatment of complaints ... regarding internal accounting controls or auditing matters." Section 301 of the Act requires the audit committee to establish a procedure for employees to report--anonymously and confidentially--their concerns about these matters. The Securities and Exchange Commission (SEC) has issued a final rule requiring compliance by the first annual shareholders' meeting after January 15, 2004, but no later than October 31, 2004. Failure to comply results in the company's being delisted by the stock exchange or securities association through which its stock is traded.

This new requirement has revived interest in fraud hotlines, mostly telephone systems and Web-based tools, used to field employee allegations and complaints. Many companies established such hotlines as part of companywide corporate ethics programs in response to the Federal Sentencing Guidelines enacted in 1991 by the U.S. Sentencing Commission. According to the guidelines, the Commission can impose severe financial penalties on an entity convicted of corrupt and unethical business practices. Liability and fines can be significantly reduced, however, if the company has an effective mechanism for reporting wrongdoing, including a system "designed to detect criminal conduct by others within the organization without fear of retribution."

Private company needs

Public companies are not alone in the need to establish complaint procedures as part of an effective internal control structure. Any organization with 50 or more employees is subject to the Federal Sentencing Guidelines. Small businesses can also benefit from establishing a mechanism for the reporting of wrongdoing. The vulnerability of small entities is evident, according to William S. Laufer, Associate Professor of Legal Studies, the Wharton School, in statistics showing that, of all corporations convicted of unethical business practices in federal courts, more than 90% are small businesses and more...