Whistleblowers and Outcomes of Financial Misrepresentation Enforcement Actions

• Author: JARON H. WILDE,GERALD S. MARTIN,NATHAN Y. SHARP,ANDREW C. CALL
• Published date: 01 March 2018
• DOI: http://doi.org/10.1111/1475-679X.12177
• Date: 01 March 2018

DOI: 10.1111/1475-679X.12177

Journal of Accounting Research

Vol. 56 No. 1 March 2018

Printed in U.S.A.

Whistleblowers and Outcomes

of Financial Misrepresentation

Enforcement Actions

ANDREW C. CALL,

∗GERALD S. MARTIN,

†

NATHAN Y. SHARP,

‡AND JARON H. WILDE

§

Received 8 December 2014; accepted 11 April 2017

ABSTRACT

Whistleblowers are ostensibly a valuable resource to regulators investigating

securities violations, but whether there is a link between whistleblower in-

volvement and the outcomes of enforcement actions is unclear. Using a data

set of employee whistleblowing allegations obtained from the U.S. govern-

ment and the universe of enforcement actions for financial misrepresenta-

tion, we find that whistleblower involvement is associated with higher mon-

etary penalties for targeted firms and employees and with longer prison

sentences for culpable executives. We also find that regulators more quickly

begin enforcement proceedings when whistleblowers are involved. Our

∗Arizona State University; †American University; ‡Texas A&M University; §University of

Iowa.

Accepted by Christian Leuz. We thank Larry Brown, Dan Collins, Ed deHaan, Re-

becca Files, Cristi Gleason, Max Hewitt, Jared Jennings, Steve Kaplan, Bill Kinney, Jeff

McMullin, Rick Mergenthaler, Tom Omer, Steven Savoy, Susan Scholz, Terry Shevlin, Ed

Swanson, Brady Twedt, workshop participants at Temple University, and participants at

the 2014 Center for Business Ethics, Regulation, and Crime (C-BERC) Conference and

the 2016 Annual Conference on Empirical Legal Studies at Duke University for help-

ful comments and suggestions. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

123

Copyright C, University of Chicago on behalf of the Accounting Research Center,2017

124 A.C.CALL,G.S.MARTIN,N.Y.SHARP,AND J.H.WILDE

findings suggest that whistleblowers are a valuable source of information for

regulators who investigate and prosecute financial misrepresentation.

JEL codes: G38; K22; K42; M40; M41; M48

Keywords: whistleblowers; enforcement actions; fraud; penalties; financial

reporting; Securities and Exchange Commission

1. Introduction

Policy makers have implemented ambitious whistleblower programs to mo-

tivate individuals to come forward and reveal information about potential

securities violations or financial misconduct. However, our understanding

of the role whistleblowers play in the enforcement process is limited. We

investigate the association between employee whistleblowers and the out-

comes of financial misrepresentation enforcement actions by the Securi-

ties and Exchange Commission (SEC) and Department of Justice (DOJ).

Our intent is not to examine the efficacy of any particular whistleblow-

ing program; instead, our objective is to provide empirical evidence on

the links between whistleblowers and (i) penalties, (ii) prison sentences,

and (iii) the duration of regulatory enforcement actions for financial

misrepresentation.

Examining the role of whistleblowers in securities enforcement is im-

portant because policy makers continue to enact legislation attempting

to encourage whistleblower involvement and because regulators dedicate

significant resources to promoting and rewarding whistleblowing activity

(SEC [2014]). For example, the Dodd-Frank Wall Street Reform and Con-

sumer Protection Act of 2010 (Dodd-Frank Act) requires the SEC and

the Commodity Futures Trading Commission (CFTC) to establish whistle-

blower offices that provide a formal venue through which whistleblow-

ers can voice complaints and share evidence with regulators. Rewards for

whistleblowers who come forward with original information about corpo-

rate misconduct can be large, ranging from 10% to 30% of monetary sanc-

tions over $1 million stemming from investigations facilitated by whistle-

blowers’ information, documentation, or cooperation (CFTC [2013], SEC

[2013b]).

Despite this heightened emphasis on whistleblower programs, prior re-

search offers little insight into whether whistleblowers are associated with

meaningful differences in enforcement outcomes. If whistleblowers pro-

vide incriminating information or details, similar to the role a witness

plays in a criminal investigation (Decker [1995]), their involvement in the

enforcement process should be associated with heightened enforcement

outcomes.

However, prior research notes that whistleblower complaints can be

frivolous in some settings (e.g., Near and Miceli [1996], Bowen, Call,

and Rajgopal [2010], and even credible whistleblowers can slip through

WHISTLEBLOWERS AND ENFORCEMENT ACTIONS 125

the cracks.1Further, regulators have historically conferred relatively few

whistleblower awards, raising questions about the usefulness of whistleblow-

ers in enforcement efforts.2Given that regulators have the power to sub-

poena documents and interview employees with or without a whistleblower,

it is unclear whether whistleblower involvement is associated with more se-

vere enforcement outcomes.

Using the universe of SEC and DOJ enforcement actions for finan-

cial misrepresentation since the passage of the Sarbanes-Oxley Act of

2002 (hereafter, SOX) (Karpoff, Lee, and Martin [2008a,b], Karpoff

et al. [2017]), we investigate whether whistleblower involvement is asso-

ciated with more severe enforcement outcomes. Specifically, we examine

the associations between whistleblower involvement and: (i) monetary

penalties against targeted firms; (ii) monetary penalties against culpa-

ble executives; and (iii) the length of prison sentences imposed against

employee respondents.3We also investigate the association between

whistleblower involvement and penalties assessed against third-party re-

spondents (e.g., the firm’s auditor, bankers, suppliers), as well as the du-

ration of the discovery and regulatory proceedings periods. Notably, we

examine the role of whistleblowers conditional on the existence of a regu-

latory enforcement action. This distinction is important because our tests

exploit variation in consequences to SEC and DOJ enforcement with and

without whistleblower involvement; we do not examine whistleblower al-

legations for which there are no corresponding regulatory enforcement

actions.

Toidentify whistleblower involvement in enforcement actions, we use two

distinct data sources. First, we begin with a data set of employee whistleblow-

ing allegations we obtained from the U.S. government using a Freedom of

Information Act (FOIA) request (Bowen, Call, and Rajgopal [2010]), Wilde

[2017]). The Sarbanes-Oxley Act of 2002 tasked the Occupational Safety

and Health Administration (OSHA) with fielding employee complaints of

discrimination for blowing the whistle on alleged financial misconduct.

OSHA is required to communicate these allegations to the SEC (OSHA

[2012]), after which the SEC can choose to investigate the underlying al-

legations or refer the allegations to the DOJ. We obtain 934 allegations of

financial misconduct in complaints filed with OSHA from 2002 to 2010.

1A whistleblower in the Bernie Madoff Ponzi scheme made multiple attempts over a nine-

year period to alert the SEC concerning the fraud. He stated, “In May 2000, I turned over

everything I knew to the SEC. Five times I reported my concerns, and no one would listen

until it was far too late.” (Markopolos [2010], p. 3).

2The U.S. federal government has offered financial rewards to whistleblowers since 1863.

Between the creation of the SEC Whistleblower Office in 2011 and the SEC’s report to

Congress on the Dodd-Frank Whistleblower Program in 2016, only 34 whistleblowers received

bounties under the program (SEC [2016a]). Many, including the Government Accountabil-

ity Office, have criticized agencies for being slow and inefficient in addressing whistleblower

concerns related to the OSHA whistleblower program (Scott [2010]).

3The respondent is the party (either a firm or an individual) targeted by the SEC/DOJ.