by James Hyatt

Class action lawsuits and federal agency enforcement proceedings have little to do with uncovering corporate fraud, according to a new academic study.

Instead, the authors found, “in the United States fraud detection relies on a wide range of, often improbably, actors,” ranging from employees and journalists to auditors and short sellers.

The study focused on a broad sample of 216 alleged corporate frauds between 1996 and 2004 at U.S. companies with more than $750 million in assets.

The conclusion: “Incentives for the existing network of whistleblowers are weak. Auditors, analysts, and employees do not seem to gain much and, in the cases of employees, seem to lose from whistle blowing. The two notable exceptions are journalists involved in large cases and employees who have access to a qui tam suit” under which individuals who bring evidence of false claims against the government can receive some of the recovered money.

The findings suggest that “the role of monetary incentives should be expanded,” declare the authors – Alexander Dyck, professor of finance at the University of Toronto, Adair Morse, assistant professor of finance at the University of Chicago, and Luigi Zingales, professor of entrepreneurship and finance at the University of Chicago. Their paper, “Who Blows the Whistle on Corporate Fraud?”, will appear in a forthcoming issue of the Journal of Finance.  They described it in a note posted to the Harvard Law School Forum on Corporate Governance and Financial Regulation.

The professors looked at fraud cases that ended up in federal court, and dug into the lawsuits and related publicity to identify how crucial fraud information came to light, and what incentives might have influenced the revelations.  False claims rewards were hefty; the study said whistleblowers in such cases, often involving heath care, collected on average almost $47 million. And there are other apparent benefits for some.  “Journalists breaking a story about a company’s fraud are more likely to find a better job than a comparable journalist writing for the same newspaper/magazine at the same time.”

But, they noted, there are clearly some disincentives to whistleblowing: auditors that blew the whistle “are more likely to lose accounts, and in cases where a named employee provided the information, 82% alleged they were fired, quit under duress, or had had significantly altered responsibilities as a result of bringing the fraud to light. Many of them are quoted saying, “If I had to do it over again, I wouldn’t”.

Of the 216 cases examined in depth, 64 or about 30% involved detection from “internal governance” while 152 or about 70% came from external sources. Employees, the largest external category, accounted for 17% of the cases; the media, 13%, and industry regulators, 13%.  Other players included analysts, 14%, auditors, 11%, clients or competitors, 5%, equity holders, 3%, a law firm, 3%, the SEC, 7%, and short sellers, 15%.

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