balancing confidentiality and ethics - fraud conference
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Balancing Confidentiality and Ethics:
External Reporting of Internal Information
Anthony Menendez, CFE, CPA
Forensic Litigation Consultant
Monday, June 19th, 2017
Balancing Confidentiality and EthicsExternal Reporting of Internal Information & Sarbanes-Oxley
Anthony J. Menendez CPA, CFE
tony@FinancialFraudExaminer.comFinancial Fraud Examiner LLC
Global Cost of Fraud
✤ The Association of Certified Fraud Examiners (ACFE)
2016 Report to the Nations, estimates the typical
organization loses 5% of annual revenues to fraud.
✤ Of the three major categories of occupational fraud,
financial statement fraud caused by far the greatest
median loss per scheme.
Common Anti-Fraud Controls
✤ External Audits (82%)
✤ Code of Conduct (81%)
Fraud Detection
✤ The Association of Certified Fraud Examiners (ACFE)
2016 Report to the Nations, reports that
whistleblowing “tips” were the primary method of fraud
detection (40%).
✤ External audits account for a very small percentage
of detected frauds (3%)
Ethics Resource Centers 2014
National Business Ethics Survey
✤ (41%) of employees witnessed illegal or unethical
misconduct during the previous year, a significant
percentage (37%) did not report it.
✤ (21%) of those who reported misconduct experienced
some form of retaliation.
✤ (46%) of employees indicated that fear of retaliation as
the reason they did not report the wrongdoing.
The Morality of Whistleblowing
Whistleblowing: “An attempt by a member or a former member of an organization to
disclose wrongdoing in or by the organization” (Valasquez 2006)
Moral Agency
✤ Moral agency is an important aspect of moral behavior
and influences the agent’s behavior. A distinguishing
factor of moral agency is autonomous will or “to act
according to reasons and motives that are taken as
one’s own and not the product of organizational
policies and external forces such as whistleblowing
legislation” (Near and Miceli 1985).
Moral Justification
✤ The “standard theory” on whistleblowing of Davis (1996, p. 147)
holds that whistleblowing is morally required when it is required
at all: people have a moral obligation to prevent serious harm to
others if they can do so with little costs to themselves.
✤ Davis believes that what seems to make whistle-blowing morally
problematic is its organizational context. “The whistleblower
cannot blow the whistle on just any information received as a
member of an organization. Instead, to be a whistleblower is to
reveal information with which one is entrusted” (1996, p. 148).
Moral Permissibility (Extreme View)
✤ Employees are never permitted to externally blow the
whistle, typically based on the notion of loyalty to
one’s firm and/or due to confidentiality agreements.
✤ This position is rejected because it is either morally
repugnant to a free and democratic society, or
because absolute loyalty toward anyone or any
entity does not exist (Duska 2009) or as an ethical
notion is never absolute (Lindblom 2007).
Moral Permissibility (Extreme View)
✤ Employees are always morally permitted to externally
blow the whistle for any reason, typically based on the
notion of free speech.
✤ This position is also always rejected as free speech
has never been considered an absolute moral
principle, or due to the unnecessary harm caused to
the firm by externally blowing the whistle. (Hoffman |
Schwartz 2014)
Morality of External Whistleblowing
Criteria: Richard T. De George
Morally Permissible Criteria
✤ (1) the firm’s actions will do serious and considerable
harm to others;
✤ (2) the whistleblowing act is justifiable once the
employee reports it to her immediate supervisor and
makes her moral concerns known;
✤ (3) absent any action by the supervisor, the employee
should take the matter all the way up to the board, if
necessary;
Morally Obligated Criteria
✤ (4) documented evidence must exist that would
convince a reasonable and impartial observer that
one’s view of the situation is correct and that serious
harm may occur; and
✤ (5) the employee must reasonably believe that going
public will create the necessary change to protect the
public and is worth the risk to oneself. (De George
2010)
Corporate Whistleblower Protections
Before Sarbanes Oxley
✤ No whistleblower protections for corporate employees
✤ In 2001 and 2002 corporate frauds exploded in the U.S.
resulting in large bankruptcies, tens of thousands lost their
jobs and pensions, and investors lost billions in shareholder
value.
✤ Congressional investigations revealed that although many
individuals knew about the wrongdoing they remained silent
and those who came forward were ignored and/or retaliated
against.
Sarbanes Oxley
✤ Whistleblower advocates and scholars alike greeted
SOX with great enthusiasm as it appeared to provide
the strongest encouragement and very broad
protections.
✤ Pioneered jury access
✤ Mandated confidential reporting channels
✤ Created criminal liability for retaliation
Protected Activity (SOX)
✤ 18 U.S.C. Sec. 1514A(a)(1): Information regarding
conduct which the employee reasonably believes
constitutes a violation of law regarding fraud against
shareholders or any rule or regulation of the Securities
& Exchange Commission to ...any person with
supervisory authority over the employee, or any
person who has the authority to investigate, or
terminate the misconduct.”
SOX Failures
✤ SOX simply did not protect whistleblowers who
suffered retaliation. Statistics through 2011:
✤ Employee Wins = 23
✤ Employee Losses = 1,237
✤ For fiscal years 2006 - 2008, Employees lost 488
straight decisions!
SOX Failures
✤ SOX did not protect the investing public from the
financial crisis of 2008 and 2009
✤ Housing prices fell 31.8%
✤ Unemployment exceeded 9% for years
✤ Taxpayer funded $700 billion bailout package
Dodd-Frank
✤ Bounty Provision: Section 922 of Dodd-Frank provides that the SEC
shall pay an award or awards to whistleblowers:
✤ Who voluntarily provide “original information”
✤ That leads to successful SEC enforcement actions, resulting in
collections of $1 million
✤ Not less than 10% or more than 30% of the sanctions collected
Dodd-Frank
✤ Dodd-Frank Act strengthens the whistleblower
protection provisions of the False Claims Act, and
contains one of the strongest confidentiality provisions
for whistleblowers ever enacted.
✤ For the first time, whistleblowers are allowed to
initially report fraud anonymously by filing a claim
through an attorney.
SEC Enforcement: Confidentiality
Provisions
✤ Rule 21-F-17 prohibits companies from taking any
action to impede whistleblowers from reporting possible
securities violations.
✤ “SEC rules prohibit employers from taking measures
through confidentiality, employment, severance, or
other type of agreement that may silence potential
whistleblowers before they can reach out to the SEC.
We will vigorously enforce this provision.” - Director
SEC Division of Enforcement
AICPA Code of Professional Conduct
✤ Permits disclosure of client information under the
following circumstances:
✤ Compliance with subpoena and summons,
✤ Compliance with professional obligations (AICPA,
state society, state board
investigations, or
✤ Compliance with peer review requirements.
Diversity in State Accountancy
Requirements
✤ Today there are statutes for the State Board of Accountancy in each of the 55
jurisdictions. Each jurisdiction sets its own requirements regarding the disclosure of client
information (“CPA whistleblowing”).
✤ Only 3 states out of the 55 jurisdictions explicitly permit CPA whistleblowing. Those 3 states
are:
✤ Colorado permits the disclosure “as part of the process of initiating a complaint with or
responding to an investigative or disciplinary body established by law or formally recognized
by the Board”.
✤ Michigan permits disclosure when the CPA “has knowledge that forms a reasonable basis to
believe that a client has committed a violation of federal or state law or local governmental
ordinance”.
✤ North Carolina permits CPA whistleblowing when the “CPA concludes in good faith based
upon professional judgment that a crime is being or is likely to be committed”.
Implementation of the Whistleblower Provisions of
Section 21F of the Securities Exchange Act of 1934
✤ “Contrary to the suggestion from a number of commenters, we are
not excluding information that is received in breach of state-law
confidentiality requirements, such as those imposed on auditors,
because to do so could inhibit important federal-law enforcement
interests.”
✤ “Several commenters recommended that whistleblowers should have
to use internal reporting processes by either reporting up the chain at
the audit firm or reporting to the audit client. We are declining to adopt
a rule that would require all employees of accounting firms use the
internal processes whether at the audit firm or at the audit client.”
Confidentiality: Empowering
Whistleblowers
✤ The Ethics and Compliance Initiative’s 2013 National
Business Ethics Survey of the U.S. workforce revealed
that 45 percent of individuals surveyed did not report
misconduct because they did not trust their report
would remain confidential.
American Accounting Association’s journal
Behavioral Research in Accounting
✤ The researchers posited that when companies enact
policies that describe “explicit whistleblower
protections” from retaliation, whistleblowers are
actually discouraged by the “salience of retaliatory
threats.” In other words, hearing detailed information
about the various forms of retaliation from which they
were protected, made individuals feel increasingly
afraid of retribution and less likely to report
misconduct.
Survey of US & UK Financial Services
Industry
✤ 28% earning > $500,000 say their company’s confidentiality
policies bar the reporting of potential illegal or unethical acts
to law enforcement or regulatory agencies.
✤ 25% earning > $500,000 have signed or been asked to sign
confidentiality agreement prohibiting reporting to authorities.
✤ 19% of respondents find it likely that their employer would
retaliate if they reported wrongdoing in the workplace.
Survey of US & UK Financial Services
Industry
✤ 47% find it likely that their competitors have engaged
in unethical or illegal activity to gain an edge in the
market.
✤ 34% of those > $500,000 have witnessed or have first
hand knowledge of wrongdoing in the workplace.
✤ 23% believe it is likely that fellow employees have
engaged in illegal or unethical activity.
✤ Percent of Reporters Who (at Some Point) Utilize This Resource:
✤ Supervisor 82%
✤ Higher management 52%
✤ Human resources 32%
✤ Hotline/Helpline 16%
✤ Ethics officer 15%
✤ Someone outside the company, not government or regulatory authority 13%
✤ Legal 11%
✤ Government or regulatory authority 9%
National Business Ethics Survey
NBES: Why Report Externally
✤ 50% Problem was ongoing and I thought someone from outside could help stop it.
✤ 45% I did not trust anyone in my company.
✤ 40% I was retaliated against after I made my first report inside the company.
✤ 40% I was afraid I would lose my job if I did not get outside assistance.
✤ 39% I thought keeping quiet would case possible harm to people or the environment.
✤ 36% My company acted on my report, but I was dissatisfied.
✤ 29% My company did not act on my report.
✤ 29% I thought keeping quiet would get my company into trouble.
✤ 22% I was afraid for my safety.
✤ 14% I had the potential to be given a substantial monetary reward.
Questions?
Anthony J. Menendez CPA, CFE
Financial Fraud Examiner LLC
tony@FinancialFraudExaminer.com
Balancing Confidentiality and Ethics:
External Reporting of Internal Information
Anthony Menendez, CFE, CPA
Forensic Litigation Consultant
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