Study: Sarbox Curbs Fraud Whistleblowing

Despite the 2002 law's whistleblower protection provision, employees have been less likely to come forward with fraud concerns.

Contrary to its intentions, the Sarbanes-Oxley Act has discouraged employees from coming forward and blowing the whistle on corporate fraud, a new study finds.

Despite the 2002 law’s whistleblower protection provision, employees have been less likely to come forward with fraud concerns, according to the National Bureau of Economic Research, a non-profit research organization. From 1996 until Sarbox’s enactment, employees made up 21 percent of fraud detectors. Since then, that number has dropped to 16 percent.

Luigi Zingales, who co-wrote the report, “Who Blows the Whistle on Corporate Fraud?” blames most of this decline on the fact that employees have little incentive to tell others they suspect a fraud has occurred. Indeed, the have considerable disincentives: in 82 percent of cases with named employees, the report found, the whistle-blower “alleged that they were fired, quit under duress, or had significantly altered responsibilities as a result of bringing the fraud to light.” For the report, researchers looked over 230 alleged corporate fraud cases involving companies with at least $750 million in assets.

In another key finding, the report says that audit firms’ involvement as the first detector of fraud has risen sharply since Enron (and later Arthur Andersen) collapsed more than five years ago. Since the fall of Enron, auditors have been held especially accountable for not detecting instances of fraud. Before the energy giant went bankrupt, only 9.6 percent of the fraud cases detected by people outside of companies were found by auditors. But after Enron, auditors were the first detector in 16.9 percent of the cases.

But auditors still make up only a small part of those who notice serious lapses in judgment at U.S. public companies. In fact, Sarbox’s enactment, those mandated to share fraud concerns (the SEC, auditors) aren’t appreciably more likely that those whose job does not have that requirement (journalists, company employees) to be the first one to bring a fraud case to light.

Zingales figured that the press would have been the go-to detector for fraud. The researchers found, however that the media detected just 14 percent of the cases and that corporate fraud’s detection is spread out among many groups.

SEC certainly can’t claim to be the top cop in this area. Indeed, the commission has detected only 6 percent of fraud cases from 1996 to 2004, according to the researchers. Instead, “the United States apparently relies upon a village of fraud detectors, many lacking a governance mandate,” wrote the authors.

During those eight years, the SEC has had to depend on the work of other entities to alert them to fraud. Besides auditors, which detected 14 percent of cases and the media , industry regulators (16 percent), and employees (19 percent) helped out, too. At the same time, the researchers note that stock exchange regulators, commercial banks, and underwriters did not trigger any of the fraud cases they examined.

“There’s no police [when it comes to corporate fraud],” Zingales says. “No one ever says, ‘It’s my responsibility to detect fraud.’”

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