Hotlines helpful for blowing the whistle: required for public companies under the Sarbanes-Oxley Act, corporate hotlines for whistleblowers have become a big weapon against fraud--more effective than internal audits. Yet, research shows that companies may not deem them highly effective.

• Author: Sweeney, Paul
• Position: ETHICS

Question: What is the No. 1 deterrent to corporate fraud? If you guessed "tips"--and if this had been a TV game show--you'd have hit the jackpot.

Most studies consistently show that about a third of the instances of business and workplace fraud that eventually come to light were first disclosed by employees or other key informants blowing the whistle. Most recently, this was confirmed in 2006 by the Association of Certified Fraud Examiners (ACFE) in its biennial, in-depth survey. The fraud-busting group found that 34.2 percent of "occupational fraud"--defined essentially as misusing one's position at an organization for personal economic gain--was first detected by tipsters.

Tips, according to ACFE's survey, work better at detecting white-collar larceny than a whole panoply of formalized legalistic procedures. Disclosure of fraud from informants outpaces internal audits (20.2 percent), internal controls (19.2 percent) and external audits (12 percent).

None of those more orthodox constraints, moreover, qualified for the second-most-common way that rip-offs are uncovered. A quarter of occupational fraud (25.4 percent) was detected "by accident," according to ACFE.

Together, tips and accidental discovery account for nearly 60 percent of all fraud detection, which speaks to the capricious and serendipitous nature of combating thievery that is often elaborate and technologically sophisticated. Unlike an old-fashioned bank embezzler, who stuffs cash into a valise and blows town, modern defalcation schemes typically involve adding or removing accounting entries into a computer or remitting payments to spurious addresses.

In cases where top company executives or owners concocted a scam, ACFE reports, the percentage of frauds first uncovered by tips alone rises still further--up to 48 percent, or nearly half. That is especially significant because, ACFE notes, dollar losses resulting from conniving top executives and owners "tend to be larger than for any other group."

All told, ACFE reports, fraud in 2006 accounted for losses of roughly $652 billion in the U.S., or 5 percent of annual corporate revenues.

The fact that tips are the No. 1 fraud detection method and that whistleblowers played a key role in uncovering the multi-billion-dollar scandals earlier this decade at Enron Corp. and WorldCom Inc. has not been lost on lawmakers. The Sarbanes-Oxley Act, enacted in 2002, requires that publicly traded companies maintain reporting mechanisms, including a toll-free whistleblower hotline, and that oversight is lodged with the audit committee.

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Today, according to the Security Executive Council's 2007 report, some 81 percent of public and private companies have instituted whistle-blower hotlines. Companies employing "best practices," says Ron Durkin, a forensic accountant at KPMG and a former FBI agent, have added "robust" training and education programs that encourage not only employees but vendors and customers to call the hotline if they see...