Effective Corporate Whistle-Blower Hotline - Essay Example

Auditing Table of Contents Table of Contents 2 Introduction 3 Key Criteria for the Operation of an Effective Corporate Whistle-Blower Hotline 4 82) Sarbanes-Oxley Act of 2002, In Preventing and Deterring Financial Reporting Fraud and Other Unethical Actions 8 Conclusion 13 References 14 Introduction Cynthia Cooper was an accounting student pursuing accountancy in her graduation from Mississippi State University at USA. As she grew up in a poor family she had to study in a local school and had to do a part time job as a waitress. Subsequently, after completing her graduation she went to University of Alabama to pursue Masters in Accounting after which she became a renowned chartered accountant. It was observed that she joined WorldCom during the year 1990 that was established as small and closely held company in the year 1980. As the business of WorldCom grew significantly, it became the 25 largest companies in the US. Later in the year 1999, she was promoted to the post of Vice President in the department of internal audit. However, when the telecom market got saturated the profitability of the company began declining. Cynthia in the year 2002 discovered that the company used illegal practices to manipulate its accounts. It was observed that although the company suffered loss, the balance sheet showed that the company was attaining significant profit. Cynthia thus decided to carry out a secretive investigation on the fraud practices exercised by the company which then resulted to the termination of the Chief Financial Officer (CFO) Scott Sullivan. In spite of her effort to unveil the illegal accounting practices exercised by the company, she was considered as a major suspect in the federal investigation. Based on the above presented case scenario, this study intends to describe the key criteria for functioning of an effective whistle blower in the corporate level. It also discusses about the policies framed by the regulatory bodies to prevent the illegal accounting practices. 1) Key Criteria for the Operation of an Effective Corporate Whistle-Blower Hotline The term whistle-blower is allocated to a person within an organisation who is engaged in the disclosure of fraudulent and illegal practices executed by employers within the organisation to other organisations or a person who are eligible to take actions for curbing such malpractice (Beller, n.d.). Concerning with case provided, Cynthia Cooper was the whistle-blower who unveiled the fraudulent practices carried in the WorldCom. Almost all organisations are widely concerned about management and employee related fraud. It is thus very important to establish a corporate whistle-blower hotline which ensures effective operation in organisations. The main objective of this hotline should be to detect wrongful accounting practices and avoid future potential illegal practices in organisations. Thus to ensure that the whistle blower hotline is effective there must be a balance between the employees to report fraud incidents and encouragement among employees to expose fraudulent reports. The investigation carried out by the whistle blower must be completely balanced and unbiased (CIMA, 2008). The investigation must be based on substantial evidence and in good faith. The key criteria for an effective whistle blower hotline are the confidentiality within individuals to carry out the investigation without retaliation. The hotlines of the whistle blower must be trustworthy, but a situation might arise wherein the employees do not trust it (Beller, n.d.). Irrespective of the fact that whether the hotline might be outsourced the management should seriously consider the investigation process and ensure that it is operated by the experts who are in the position to acquire relevant information pertaining to the fraud practices. Effectiveness of a whistle blower hotline directly depends on emphasising on the wrongful activity and getting to the source for the origin of the problem. An effective corporate whistle-blower hotline should ensure that the process of investigation is clear and concise, the main focus of the investigation should be on the fraudulent practices, internal communication within the internal audit department and the human resource department. Furthermore, the process of investigation need to be periodically evaluated in order to ensure its effectiveness and last but not the least the process of investigation should be spontaneous (Waldron, 2012). Potential pitfalls that should be avoided: There are various reasons due to which the system followed during the process of whistle blowing might fail. These reasons include non-existence of anonymity, poor culture, non-existence of policies and awareness. These are the major factors that must be considered by the whistle blower to avoid pitfalls. It has been observed that one of the biggest barriers in the process of investigation for the whistle blowers is the fear of vengeance while reporting the illegal practice being adopted; another pitfall is that the management might act unsupportively while the whistle blower reports misconduct due to which the individual might not reveal the actual situation. Beside the policy set by the company might not support the investigation process of the whistle blower which may be associated with ineffectiveness in revealing the illegal practice and misconduct executed within the company. Thus, in order to avoid pitfall there must be anonymity in the investigation process. Independence must be initiated in the organisation in order to avoid pitfalls in the investigation process, the investigation process carried out by the whistle blower must be based on true evidence and the investigation process must be thoroughly followed up and actions should be taken appropriately. More importantly in order to avoid pitfall in the investigation process, whistle blowers must receive continuous feedback from the employees for deriving reliable information (Mosley, 2014; Chartered Institute of Internal Auditors, 2014). Professional codes: The code of practice in an organisation should clearly state the principle that enables the employees to report any malpractice or fraudulent activities. A professional code must set the necessity for arrangements that covers the issues relating to the concerns of whistle blower and there should be a written statement regarding the concerns of whistle blower. Furthermore, the professional code should identify the requirement for autonomous oversight along with review for arrangements for whistle blowing by the board and the internal audit department. The review for arrangements should encompass a record of the kind of concerns raised along with the investigation outcomes, any complaints of failures regarding the confidentiality maintenance, a report of any fraudulent activities, review of any suspicious incident identified by the employees and review of any litigation. These codes have to be imposed on employees so that they speak up, but it might cause problems as it sometimes encourages over reporting. Therefore it is highly considered that the code of practice or the professional code must not include the duty of whistle blowing (Public Concern at Work, 2013). Legislation: The whistle blowing legislation was announced by Public Interest Disclosure Act (PIDA) in the year 1998. Legislation has not made any reference regarding the public interest to protect the whistle blowers. It is based upon the belief in the public interest that protection must be provided to the employees while disclosing any information of misconduct if in case the situation of damage or dismissal arises. The legislation provides protection to the employees in the breach of employment contract while disclosing the incident of fraudulent practices. According to the legislation the obligation of employees to disclose any information in good faith during the term of employment has been removed. It is believed that disclosures made out of hatred or with the purpose of personal gain results in peculiar outcomes. It has been revealed that as per the policies disclosures that are made in bad faith would lead to penalising actions. This aspect on the other hand has discouraged the employees to make disclosures of malpractice voluntarily. Due to the introduction of personal obligation relating to the detriments of whistle blowing and vicarious responsibility of the employers in relation to the employee actions has led to the emphasis on the Equality Act 2010 which introduces the protection in line along with protection related to discrimination. However, employers might avoid vicarious responsibility by taking certain steps that would prevent the employees to be a subject of unlawful detriment (Martindale, 2013; Bowers QC, & et.al., 2012). Academic literature: According to the research done by Burai (n.d.) whistle blowing is an act of an employee or group of employees who raise certain concerns in order to prevent misconducts and damage to the public. The author provides a clear picture about the term in which he states that it is an action to prevent damage to others, the whistle blower puts effort to rectify the condition within the organisational framework through providing evidence which is completely reliable. It is expected that the whistle blower would act on the suitable moral motives in the process of disclosing information regarding malpractice that might have caused needless damage to others. According to the author there are certain driving forces for an individual due to which an individual develops intent to blow the whistle. These driving forces include cleaning of conscience, motivation towards welfare and the willingness to punish a person for wrongful activities and illegal practices (Burai, n.d.). 2) Sarbanes-Oxley Act of 2002, In Preventing and Deterring Financial Reporting Fraud and Other Unethical Actions In the present day context multiple cases of fraud and illegal practice in financial reporting of various companies can be observed that has risen because of which it has affected capital markets. There is a negative impact on the capital market due to these illegal practices that has resulted in the reduction of investors’ trust. Fraud and illegal practice of financial reporting has also led to a devastating effect on the reputation of the company in the eyes of the public. Thus, there was an introduction of The Sarbanes-Oxley Act (SOX) in the year 2002 which was legislated in response to the scandals in the corporate level. As it has been observed that these scandals resulted in major losses for the financiers therefore there was a reduction in the confidence level of these financiers in the capital market (Levy, n.d.). The main objective of The SOX was to support the public companies to control the system of financial reporting internally through complete removal of fraud and illegal practices. Moreover, this regulator reform also served as a tool to increase the concerns of the top level management, department of internal audit, board of directors, audit committees and the external auditors of the company in relation to the responsibility for publishing financial reports that are more reliable. The SOX as observed has also led to a significant impact on refining the corporate governance and reducing the incidents of illegal accounting practices and fraudulent financial reporting. However, as per the recent analysis and investigation conducted it has been viewed that the management and the investors have continued to increase their concerns regarding the fraud reporting of financial statement. For instance, The Association of Certified Fraud Examiners’ (ACFE) in the year 2010 reported that due to the cases of fraud reporting in financial statement there has been an increase in the cost incurred by the company wherein the company had to bear a cost of 1.7 million US dollars for a single case of fraud financial reporting. With this regard, fraudulent practices have resulted to a negative impact on the company and its reputation because of which Center for Audit Quality Cares (CAQ) took the initiative in the year 2010. This initiative was intended to arrange meetings between the shareholders who were severely affected by the fraudulent practices in the company. These meetings were aimed to share the perception of the shareholders and their experience to successfully mitigate the fraudulent practices along with new ideas for tackling the problem faced by them. These meetings were focused on the subsets of fraud measures being practiced in the financial reporting of the company. However, frauds like misappropriation of assets were not included in the discussion of these meetings. In these meetings individual shareholders or the group of shareholders shared their ideas for long term plans to collaborate among them which would be a potential aspect for obtaining profit. To be precise this plan signified the commencement of a long term effort that was aimed for progress in detection and deterrence of illegal financial reporting. The main objective of this plan was to provide advantage to the investors of the company for investing in the capital market along with diminishing the risk related to illegal financial reporting. The SOX in order to prevent and deter the fraudulent reporting of financial statements and unethical actions has introduced certain policies. These policies provided significant contribution to respond against the corporate scandals and bring reformation in the corporate governance along with mitigation of the risk related to the fraudulent reporting of financial statements. To be specific SOX reinforced the accountability of corporate officers to ensure that the financial statements are completely accurate and not misrepresented. The SOX implicates obligation on the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO) wherein they have to certify their periodic financial report with the Security Exchange Act 1934 requirements so as to ensure that the financial statements are published legitimately. The SOX established illegitimate penalties for the individuals who practiced illegal system of accounting. It provided disgorgement in relation to the bonuses and profits of the corporate executives who were involved in illegal reporting of financial statements. Moreover, the SOX established a requirement for evaluation of the internal control for disclosing the financial statements made by the management of the company. The SOX also requires improvement wherein it considers whether the companies follow certain code of ethics for the disclosures made by the financial officers. The act also improved the function of audit committee that included the necessity of financial expertise along with their accountability to answer on the mistakes made by the external auditors of the company. The SOX developed these policies in order to mitigate the unlawful practices undertaken while reporting the financial statements and function as a deterrent for fraud practices (The Center for Audit Quality, 2010). Effective solution for preventing and deterring fraudulent financial reporting Education system can be influencing in the financial reporting system through providing appropriate skills, knowledge and ethical values that might turn out to be a prospective aspect in relation to prevention, detection and deterrence of illegal practices in reporting the financial statements. According to the Treadway Commission Report, it is recommended to change the accounting and business programmes in the certification exams and professional education system. The Commission recommended that the accounting system should make the students obtain information and understanding regarding the aspects that cause illegal practices in the financial reporting. The Commission also recommended that strategies should be developed which would result in the reduction of the incidents relating to the fraudulent financial system of reporting. In order to enable the students to avoid the risk related to the fraudulent practices in future prospect at the companies it is recommended to introduce an accounting curriculum that would provide a deeper understanding about the significance and function of the internal control relating to the financial reporting system. In context of the actual incidents that occur in the companies in relation to fraudulent financial system of reporting it is very important for business schools to make the faculty develop certain skills and appropriate classroom materials that would help the in teaching ad instructing the students regarding illegal practices in financial reporting (Young, 2003; National Commission on Fraudulent Financial Reporting, 1987). On the other hand, fraudulent financial system of reporting can be effectively mitigated through regulatory measures and legal reformation that initiates the requirement for increased responsibility of corporate governance. It would be worth mentioning that legal reformation is the best way for preventing and deterring fraudulent financial reporting. In the present day era through effective regulation illegal practices in the reporting of financial statements can be mitigated as the policies set by the regulatory bodies provides mandatory obligation for the individuals to follow the rules and regulations and practice the accounting system as per the given standards. Therefore, it can be ascertained that legal reformation and regulatory measures is the best way to prevent or deter actions related to fraud in the financial reporting system. Moreover, the policies made by the regulatory bodies implies on each and every individual irrespective of their position in the company. Furthermore, legal reformation is very effective as it creates a fear in the mind-set of the individuals to get penalised if the financial report is misrepresented (Bowers, 2013). Conclusion WorldCom is a company based in US, under which Cynthia Cooper was functioning as the Vice President in the internal audit department. It was observed that when the company used illegal accounting practices to misrepresent the financial statement, Copper took the initiative for revealing the actual reason of fraud accounting system practiced by the company. She carried out a secretive investigation which provided a clear picture of the fraudulent approach undertaken by the company’s top level management due to which the CFO of the company Scott Sullivan got terminated. In addition, the key criteria that has to be considered to ensure that the process of whistle blower is effective is that it must be capable of detecting fraudulent accounting practices to avoid prospective practices of illegal accounting in the future. Moreover, the investigation process that has been carried out by the whistle blower must be based on true evidence. Sarbanes-Oxley Act was introduced in order to prevent and deter the actions related to the financial reporting fraud and other unethical actions. As it has been viewed that there are numerous fraudulent activities being carried out by the companies while reporting the financial statements. These actions have led to the investors suffering huge loss. Thus in order to protect their investment SOX was introduced. It is considered that enhancing the educational system can directly have a positive impact on the financial system if appropriate skills and knowledge is provided to the students which would result in reduction of the illegal accounting practices. However, it is considered that legal reformation is the best approach to mitigate the problem of fraudulent financial reporting as it provides mandatory obligation to the individuals who have the tendency of using these practices. References Beller, R., No Date. Whistle-blower Protection Legislation of the East and West: Can It Really Reduce Corporate Fraud and Improve Corporate Governance? NYU Journal of Law & Business, Vol. 7, pp. 875-928. Bowers QC, J. & et.al., 2012. Whistleblowing: Law and Practice. Oxford University Press. Bowers, S., 2013. Law to Be Toughened Up to Stop Companies Benefiting From Fraud. The Guardian. [Online] Available at: http://www.theguardian.com/law/2013/sep/02/tougher-laws-stop-companies-benefiting-from-fraud [Accessed March 3, 2014]. Burai, P., No Date. ‘People behind Stories’ – Portrayal of Whistle-blowers by Hungarian Online Media and Its Impact on the Anti-corruption Policy Process. Literature Review: Whistleblowing. [Online] Available at: http://www.transparency.hu/uploads/docs/People_behind_stories.pdf [Accessed March 3, 2014]. CIMA, 2008. Fraud Risk Management. Fraud Prevention. [Online] Available at: http://www.cimaglobal.com/documents/importeddocuments/cid_techguide_fraud_risk_management_feb09.pdf.pdf [Accessed March 3, 2014]. Chartered Institute of Internal Auditors, 2014. Whistleblowing and Corporate Governance. Internal Whistleblowing. [Online] Available at: http://www.iia.org.uk/media/537988/final_0795_iia_whistleblowing_report_30-1-14.pdf [Accessed March 3, 2014]. Levy, E., No Date. Fallout From The Sarbanes-Oxley Act – Are Private Companies And Non-profits Next? Research in Business and Economics Journal, pp. 1-8. Martindale, N., 2013. Changes to Whistleblowing Law: What You Need to Know. Features. [Online] Available at: http://www.hrmagazine.co.uk/hro/features/1077556/changes-whistleblowing-law [Accessed March 3, 2014]. Mosley, H., 2014. Deloitte Whistle-blower Service - The Pitfalls and Keys to Success. Deloitte. [Online] Available at: http://www.deloitte.com/view/en_AU/au/374ac3605cf9d310VgnVCM2000003356f70aRCRD.htm [Accessed March 3, 2014]. National Commission on Fraudulent Financial Reporting, 1987. Report of the National Commission on Fraudulent Financial Reporting. Recommendations for Education. [Online] Available at: http://www.coso.org/publications/ncffr.pdf [Accessed March 3, 2014]. Public Concern at Work, 2013. Report on the Effectiveness of Existing Arrangements for Workplace Whistleblowing in the UK. The Whistleblowing Commission, pp. 1-31. Stigliano, A. L., 2011. Sarbanes-Oxley and Corporate Greed. . Honors Scholar Theses, No. 207, pp. 1-38. The Center for Audit Quality, 2010. Deterring and Detecting Financial Reporting Fraud. Deterring and Detecting Financial Reporting Fraud: A Platform for Action. [Online] Available at: https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=3&cad=rja&ved=0CDwQFjAC&url=http%3A%2F%2Fwww.ey.com%2Fpublication%2Fvwluassetsdld%2Fcaq_selectedpublications_deterringfraud_october2010%2F%24file%2Fcaq_selectedpublications_deterringfraud_october2010.pdf%3FOpenElement&ei=m08VU6evFcuCrgej_4CgBg&usg=AFQjCNF8gS0n0mLEHppCDIoCbxwpw1xyXw&sig2=rXVuzwIe8ag2Tk92WwJghA&bvm=bv.62286460,d.bmk [Accessed March 3, 2014]. Waldron, N., 2012. The Effectiveness of Hotlines in Detecting and Deterring Malpractice in Organisations. 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