Whistleblowing - Research Paper Example

?Running Head: WHISTLEBLOWING Whistleblowing [School] Whistleblowing The term “whistleblowing” is derived from the English tradition where police used to “blow the whistle” to call the attention of passers-by and other police whenever they spotted an illegal activity. In this discussion, whistleblowing is defined as “the disclosure of information that a current or former organization member reasonably believes is evidence of illegal, immoral or illegitimate practices carried out by other organization members to other people and/or organizations that may be able to effect action (Kleinhempel, 2011).” Using this definition, the paper will look at three famous whistleblower cases – Enron in 2001, WorldCom in 2002 and Madoff’s Ponzi scheme in 2009 – discuss their causes, analyze the importance of whistleblowing and find out the implications that this practice has had on corporate governance globally. At the end of 2001, Enron’s filing for bankruptcy made it the largest corporate bankruptcy in the history of the United States. This fall from being the most innovative company as per Fortunes Most Admired Companies survey was catastrophic. Enron’s misconduct were brought to the fore by Sherron Watkins, a former vice president who had previously warned Enron’s chairman that its current aggressive accounting tactics were nontransparent and would come back and haunt the organization. From her investigations Watkins became increasingly alarmed as it became apparent that Enron was using accounting loopholes, special purpose entities, and poor financial reporting to misrepresent earnings by hiding billions in debt from projects. Enron was a classic case of audit failure which forced the US government to come up with legislation to prevent such scandals from future occurrence. In 2002, WorldCom overtook Enron as the largest corporate bankruptcy in US history – a record that has since been broken by Lehman Brothers in 2008. WorldCom, like Enron, was also involved in use of fraudulent accounting techniques that classified operating costs as capital expenditures and inflated revenues through phony accounting entries to create a facade of financial growth and profitability. Even though the WorldCom board reacted swifter than Enron in dealing with the masterminds of this fraud, it still took the courage of Cynthia Cooper to blow the whistle on WorldCom's unscrupulous financial practices. In reaction to these scandals, the US government enacted the Sarbanes-Oxley Act of 2002 together with several amendments to the U.S. stock exchanges’ regulations. The new rules included different provisions whose purpose was to ensure alignment of incentives of corporate insiders with those of investors, and to reduce the likelihood of corporate misconduct and fraud. For example, the new rules mandated exchange regulations to require a majority of independent directors on corporate boards and independence of the board committees that choose new directors and compensate managers (Chhaochharia & Grinstein, 2007). This act also included provisions that protect whistleblowers by forcing companies to create dedicated mechanisms to record and track information provided by employees both anonymously and confidentially (Eaton & Akers, 2007). The third whistleblower case is somewhat different from the Enron and WorldCom cases with the whistleblower being an individual not operating within the company that committed the fraud. In this instance, Harry Markopolos took it upon himself to conduct an independent financial fraud investigation for close to a decade to uncover evidence that Bernie Madoff's wealth management business was nothing but a grand Ponzi scheme. Markopolos probed Madoff’s operation and kept filing formal complaints at the US Securities & Exchange Commission (SEC) to have Madoff’s hedge fund investigated. The SEC never acted on Markopolos’ tips until 2008. Bernard Madoff Securities firm pitched investors a strategy he called ‘split strike conversion’ that involved investing in a basket of 35-50 stocks from the S&P 100 whereas what he did was to periodically fake statements and send them to investors, and use the same investors' funds to meet the periodic redemption requests of other investors. According to Kleinhempel (2011) it is critical for organizations to rely on their staff to be free to report any misconduct internally before word of the wrongdoing leaks out. This prevents actual damage to the organization by exposing questionable happenings that may undermine its values and/or jeopardize its reputation. For both Enron and WorldCom, Sherron Watkins and Cynthia Cooper, opted to blow the whistle after they had raised their concerns internally and saw a lack of commitment from the leadership. This two cases highlight failure in corporate governance. On the other hand, the case of Bernie Madoff, unlike the former two sticks out as a sore thumb. For starters the entire Madoff outfit was a three-person firm with only one full-time accountant. Secondly, in spite of its constant good returns, none of the major derivatives firms traded with him because they suspected its figures. Yet in spite of this overwhelming evidence that should have raised eyebrows, the US Securities & Exchange Commission (SEC) did not act upon even the tips that they received from Markopolos. In the past Ethics scholars have argued that whistleblowing goes against loyalty to one’s organization. However, from the stakeholder theory point of view, organizations should be thought of as groupings of stakeholders and the purpose of the organization should be to manage their interests, needs and viewpoints. This means that since organizations are dependent on stakeholders to obtain the necessary resources for their survival and for their development, their legitimacy to operate depends on the correspondence of their behavior to rules and values recognized by the society (Friedman & Miles, 2006). Therefore disclosing illegal activities amounts to an act of loyalty to society as a whole (Dasgupta & Kesharwani, 2010). Moreover, many countries have come to not only value whistleblowing but also seek to encourage it through enactment of legislations to safeguard the rights of a whistleblower. In the US one such act is the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2011. This act has a monetary incentive, the whistleblower bounty program, which allows individuals who provide information leading to successful SEC enforcement to receive between 10% and 30% of monetary sanctions over US$ 1 million. To put this into context one has to simply look at the multimillion fines paid by companies in recent years. This is a strong incentive for external whistleblowing considering that whistleblowers may receive substantial monetary rewards. The attitudes towards whistleblowers has also changed over the years with the likes of Sherron Watkins, Cynthia Cooper and Harry Markopolos achieving celebrity status – epitome by two ladies nominations for ‘Time’ magazine’s ‘Person of the Year’. With such strong incentives for external whistleblowing organizations have to either avoid illegal activities altogether or encourage internal whistleblowing. The former is a good goal to pursue, but it is inherently unrealistic. Kleinhempel (2011) states that it is preferable for organizations to anticipate potential misconduct so as to put in place preventive measures as soon as possible. Ariane (2005) encourages companies to promote internal whistleblowing because: (1) it offers the organization the option to deal with the situation on their own terms and in their own time which minimizes public exposure; (2) it can make the company aware of potentially damaging conditions before they become a crisis which minimizes risk; (3) it makes employees feel more valued and thus can express themselves more freely at work which can create competitive advantages for the company, and (4) it minimizes associated costs that come about as a result of external whistleblowing. Ariane (2005) therefore advices companies to develop a plan for handling whistleblowing situations. Research shows that organizations that not only have a plan but also stick to it fare far better in crisis than organizations that do not. In conclusion, organizations need to comprehend that “whistleblowers are not only valued employees, but that they also perform a beneficial function for the company as the first step to creating positive outcomes from disclosures of wrongdoing (Ariane, 2005)”. The courageous acts of Sherron Watkins, Cynthia Cooper and Harry Markopolos have led to the enactment of laws that protect investors from unscrupulous corporate leaders. The world has become increasingly transparent and thus it has become increasingly difficult to conduct illegal activities. Nevertheless, the fairly recent collapse of Lehman Brothers and exposure of Madoff’s Ponzi scheme are reminders that the world still needs external whistleblowers. References Ariane, D. (2005). Whistleblowers: who are they and how management should respond. Graziadio Business Review, 8(4). Retrieved from http://gbr.pepperdine.edu/2010/08/whistleblowers/ Chhaochharia, V., & Grinstein, Y. (2007). Corporate Governance and Firm Value: The Impact of the2002 Governance Rules. Journal of Finance, 62(4), 1789 - 1825. Dasgupta, S., & Kesharwani, A. (2010). Whistleblowing: A Survey of Literature. The IUP Journal of Corporate Governance, IX(4), 57 - 70. Eaton, T. V., & Akers, M. D. (2007, June). Whistleblowing and Good Governance. The CPA Journal Online. Retrieved July 29, 2011, from http://www.nysscpa.org/cpajournal/2007/607/essentials/p58.htm Friedman, A. L., & Miles, S. (2006). Stakeholders: Theory and Practice. Oxford: Oxford University Press. Kleinhempel, M. (2011, March 6). Whistleblowing. IAE en los Medios. Retrieved July 29, 2011, from http://www.iae.edu.ar/iaehoy/prensa/paginas/Item%20de%20prensa.aspx?itemid=1003  Read More