Employees most likely to blow the whistle

Jul 04 2007 by Nic Paton Print This Article

Despite having the most to lose, employees are far more likely to blow the whistle on corporate wrongdoing than external watchdogs – especially if there is some sort of monetary reward for doing so.

Researchers at Chicago Graduate School of Business and the universities of Toronto and Michigan have drawn up a "top ten" of the most active fraud detectors.

The study of 230 analysed cases of alleged corporate fraud in U.S companies between 1996 and 2004.

Topping the list of fraud detectors were employees, followed by the media, then non-financial market regulators, analysts, auditors, strategic players, the Securities and Exchange Commission (at least in the U.S), shareholders, professional service firms and, lastly, short sellers.

The fact that employees emerge as being the most likely to blow the whistle is something of a paradox, the report suggests, since they risk ostracism, job loss and even physical harassment for their trouble.

In contrast, those with the strongest incentive to report wrong-doing - such as stock exchange regulators, commercial banks and underwriters - are so inactive that they don't even register in the top ten.

However this is at odds with European research earlier this year by accountancy firm Ernst & Young which found that employees are still fearful of the consequences of blowing the whistle.

But while Hollywood tended to focus on the Erin Brockovichs of this world, the reality is that whistle-blowing is most often the result of a complex web of disclosures from many different sources rather than a solo saviour.

For instance, in Enron's case, an article in the Texas edition of the Wall Street Journal caught the attention of a hedge fund manager who then tipped off Bethany McLean at Fortune, who subsequently published a piece entitled "Is Enron Overpriced?". Then another short seller tipped off Peter Eavis of The Street.com, who then wrote about shady "related entities".

Yet despite the raft of reforms introduced in the wake of the Enron and other scandals, there has been little impact on fraud detection, the research added.

"Fraud is so diffuse that it is extremely costly (and so ineffective) to appoint an official investigator: it is like looking for a needle in the proverbial haystack," it argues.

Thus the "mandated" approach to detection, where firms rely on people officially tasked with fraud detection (such as SEC, external auditors and industry regulators) is often ineffective.

In contrast, a "market" approach which rewards those who bring fraud to light is likely to be far more effective.

"Fraud tends to be revealed by people who find out about it in their normal course of business and who do not have any strong disincentive (or even better have some positive incentive) to reveal it," the authors concluded.