WHISTLEBLOWERS: IMPLICATIONS FOR CORPORATE GOVERNANCE.

• Author: Demott, Deborah A.

TABLE OF CONTENTS INTRODUCTION I. DEFINITIONS, CONTINGENCY, DUTY, AND MOTIVATION A. Definitions, General Usage, and Contingency B. Duty and Motivation II. THE TEXTURE AND CONTENT OF WHISTLEBLOWING LAW III. REFRAMING WHISTLEBLOWING WITHIN CORPORATE GOVERNANCE A. Evolution in Corporate Law B. Whistleblowers as Governance Actors CONCLUSION INTRODUCTION

Whistleblowers are not among the actors who populate academic accounts of corporate governance. Nor are whistleblowers visible in formal governance frameworks consisting of legal and non-legal elements that enable a firm to operate, all traceable to a corporation's charter and bylaws adopted in compliance with the law of the state of incorporation. (1) Within a corporation, whistleblowers may be lower-rank employees, not directors or officers; they may report their perceptions of wrongdoing to others within the corporation or inform governmental or other actors who are externally situated. Nonetheless, it is striking how often retrospective accounts of corporate scandals involve episodes of whistleblowing associated with governance and compliance failures in one form or another. (2) An influential quantitative study of major financial frauds found that, in the aggregate, actors outside the traditional governance cast of characters and formally-appointed gatekeepers accounted for a substantial share of fraud detection, prompting the authors' observation that it "takes a village" to discern the presence of much fraudulent activity. (3)

Focusing primarily on internal whistleblowing, this article argues that incorporating whistleblowers into formal governance structures could spur more proactive involvement by directors in monitoring compliance with law and regulation. Whistleblowing is significant to internal compliance functions because it reveals private information suggestive of wrongdoing, (4) often furnished by actors within an organization who are not subject to duties to blow the whistle. Credible whistleblowers create friction that abrades the plausibility of officially sanctioned narratives. Their reports (especially when ignored) can furnish valuable documentation in after-the-fact investigations of corporate fraud and other major compliance failures, as can retaliation against whistleblowers. (5) By charging the board with responsibility for adopting and overseeing the implementation of compliance policies with whistleblower components--as one state has done (6)--formal organizational statutes would underscore the importance of proactive engagement by directors and increase the likelihood that whistleblower reports would be used more effectively. To be sure, whistleblowers can be mistaken and may act from a mixture of motives, with the consequence that whistleblowing comes with costs as well as benefits. (7) Thus, how best to structure a whistleblowing policy and handle reports should fall within the board's exercise of good faith business judgment.

The principal value of internal whistleblowing stems from its creation of friction, whether to gain the attention of higher-level executives or internal compliance functions and personnel; internal reports may also be tied to revelations to investigative news media and law-enforcement authorities, which complicates the analysis. To illustrate more concretely, consider one of recent history's best-known whistleblowers, Tyler Schultz, who found his first job after graduating from Stanford at Theranos, Inc., working on the immunoassay team. (8) Commenting later--in the wake of his anonymously-made report to a state regulator, revelations to a board member and the CEO, and extensive conversations with an investigative reporter, culminating in the collapse of Theranos with legal repercussions for its principals--Mr. Schultz divided the company into two realms. (9) These were "the carpeted world," inhabited by senior management, the board, and marketing officials, distinct from "the tiled world," a separate domain of testing laboratories in which lab personnel struggled with malfunctioning equipment manufactured by Theranos. (10) By whistleblowing, denizens of the tiled world can create friction for their colleagues and superiors in the carpeted world. Whistleblowers' reports call into question assumed factual premises or disrupt a preferred narrative, whether of business success, legal compliance, or both. And information revealed by externally-oriented whistleblowing can arc over the hushed environs of the carpeted world to reach audiences explicitly charged with publicly-oriented missions. The friction that whistleblowers create can also help overcome the blind spots of compliance chiefs themselves who, increasingly drawn from the ranks of elite lawyers, may overlook risks inherent in the propensities of others to cheat to meet organizational metrics for performance, having themselves always succeeded (without cheating) when confronted by challenges. (11) To be sure, in more neutral terms whistleblowers furnish private information suggestive of wrongdoing (12) and serve as a mechanism to furnish information that alerts others to suspicions of wrongdoing. (13) But the act of whistleblowing--potentially risky and almost always contrarian in one sense or another, even when required to fulfill a duty--is charged in a fashion that is understated by more neutral terminology, underscoring its propensity to generate friction.

The article opens by examining questions of definition, contingency, duty, and motivation that are associated with whistleblowing. (14) Definition is important within statutory structures and common law doctrines that protect and sometimes reward the revelation of information when requisites of the definition are satisfied. But not all actors referred to as "whistleblowers" fit within these formal definitions. Moreover, the causal connection between a revelation and an outcome--the detection of wrongdoing--can be highly contingent, as the Theranos example illustrates. (15) Many whistleblowers are not subject to duties to report, which situates them outside analytic frameworks in which duty serves as the central structuring point. (16) And what motivates an individual's decision to blow the whistle is often unknowable, in particular the extent to which the decision stems from a calculated weighing of externally-imposed potential costs and benefits, as opposed to an intrinsic motivation to do the right thing. (17) Reward and protection systems for whistleblowing implicitly reflect judgments about motivation but may not optimally account for the likelihood of adverse consequences feared or suffered by many whistleblowers. The next portion of the article briefly surveys the patchwork that comprises whistleblowing law in the United States, stressing that highly salient scandals generally precede the adoption of whistleblowing regimes.

Against this background, the article turns to corporate law and governance in the United States, arguing that both are more dynamic and less static than some academic accounts assume. Nothing inherent to either corporate law or governance bars the formal incorporation of mandated whistleblower protection into organic organizational law. Directors' duties of loyalty under contemporary Delaware law encompass invigorated oversight of legal and regulatory compliance. And although the posture of the compliance function itself--motivated by internal concerns to assure the appropriate use of assets but also by externally imposed governmental pressures--is contested within corporate governance practice and scholarship, its presence and impact are undeniable elements of how contemporary organizations function. Situated within organizational law, the legal regime applicable to whistleblowing would have greater coherence and uniformity across firms incorporated in a particular jurisdiction, complementing the operation of any whistleblowing laws specific to the firm's industry or other circumstances. Embedded in organizational law, whistleblowing would also become freshly visible to lawyers who advise organizations and furnish an additional formal basis on which lawyers could encourage directors to engage with compliance matters more broadly. (18) When handled by in-house legal experts, whistleblower reports can function as red flag indicia of obvious flaws in the company's public disclosures, undergirding allegations of awareness on the part of senior managers. (19) The link between the information revealed by internal whistleblowing and directors' duties of loyalty strengthens the argument for treating whistleblowing as a component of corporate governance that should be formalized via organizational law.

1. DEFINITIONS, CONTINGENCY, DUTY, AND MOTIVATION

   Dimensions of whistleblowing as a phenomenon range beyond the law but nonetheless implicate corporate governance. These include how whistleblowing is defined and how a whistleblower's report may interact with other factors in revealing misconduct. Whistleblowers' motivations, which may be mixed and are often imponderable, also raise fundamental questions.

   1. Definitions, General Usage, and Contingency

      How "whistleblower" is defined matters for legal purposes because the definition is the initial element that triggers the consequences specified by whistleblowing statutes or common law doctrine. For example, under the provision added to federal law in 2010 by the Dodd-Frank Wall Street Reform and Consumer Protection Act, triggering the statute's anti-retaliation protection requires that an individual provide "information relating to a violation of the securities laws" to the SEC. (20) Under the provision earlier enacted via the Sarbanes-Oxley Act of 2002 (SOX), protection against retaliation by an employer is afforded to an individual who provides information or otherwise assists in an investigation of conduct the individual "reasonably believes constitutes a violation" of criminal fraud statutes, any SEC rule or...