Creating an Effective Whistleblowing Environment
MacGregor, Jason, Robinson, Michael, Stuebs, Martin, Strategic Finance
From Enron to Bernie Madoff, a steady stream of fraud in companies of all sizes and from all industries has marked corporate America in recent years. Beyond the direct costs associated with fraud, these crimes damage public trust and undermine shareholder confidence in the market.
In an effort to strengthen regulatory and corporate governance mechanisms in order to limit the potential losses associated with fraud and restore investor confidence, the U.S. government responded with legislative actions such as the Sarbanes-Oxley Act of 2002 (SOX) and the Dodd-Frank Wall Street Reform and Consumer Protection Act. Whistleblowing is central to these legislative reforms and remains the most common, effective way to detect fraud. Dodd-Frank even mandates that all public companies have whistleblowing programs.
This means companies are no longer faced with the question of whether or not to have a whistleblowing program but with how to best implement and manage an effective whistleblowing program. From the employee perspective, witnessing a wrongful act isn't always enough to turn someone into a whistleblower. Many witnesses choose to keep silent about any wrongdoing they may have seen or encountered evidence of during the course of their job. Companies thus need to understand what they can do to influence an individual's decision to blow the whistle and apply that understanding to develop an effective system of whistleblowing procedures.
Establishing Effective Whistleblowing Procedures
On a fundamental level, the whistleblower is simply an individual making a reporting decision. Figure 1 shows a general reporting environment model involving three parties: the reporter, the reportee, and report users. In the general reporting process, the reporter assesses the performance of the reportee and issues a report. Based on information in that report, the report users analyze the reportee's performance and make decisions. In writing the report, the reporter decides what information is gathered and how it is communicated. Both report users and reportees rely on the reporter to report trustworthy, accurate, and useful information.
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In the whistleblowing environment, the reporter is the whistleblower, the reportee is an individual or group committing an alleged wrongdoing, and the report user is an authority of some kind. Technically, this authority can be someone outside the organization, but we focus on internal reporting as it is more relevant for companies aiming to implement a program. Within an organization, the whistleblower should report the information to an authority such as a supervisor, the internal auditors, and/or the audit committee.
This discussion shows that an effective whistleblowing environment depends not only on the actions of the whistleblower, who observes or detects wrongdoing and issues a report, but also the authority figure who receives the report. Understanding this from an organizational perspective is a critical issue when trying to design, implement, and manage effective whistleblowing procedures.
Whistleblowers typically aren't trained reporting professionals, and they're often novices compelled by circumstances to serve as reporters. Therefore, it's important to have procedures in place that will motivate witnesses of wrongdoing to blow the whistle. Based on James Rest's model of ethical decision making as well as research on internal controls, we believe there are four pillars of a successful whistleblowing environment: (1) hire and develop potential whistleblowers, (2) educate employees, (3) promote reporting of wrongdoing, and (4) analyze and respond appropriately to all reports (see Figure 2). A weakness in any pillar reduces the effectiveness of the entire system.
Pillar 1: Hire and Develop Potential Whistleblowers
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An effective whistleblowing environment must begin with employees who are open to the possibility of reporting what they witness. …