Does Compliance with Laws and Regulations create an Ethical Culture: Lessons from Sarbanes-Oxley and Dodd-Frank

Whistle-Blower Provisions of Dodd-Frank and Financial Statement Restatements

I recently read a report by Audit Analytics that indicates the proportion of corporate financial restatements that had no impact on the bottom line was 59% in 2014. That brought the increase over the past four years to 22 percentage points, which suggests that the Sarbanes-Oxley corporate-governance law has succeeded in bolstering companies’ internal controls over financial reporting.

Can we attribute this remarkable turnaround from the early 2000s to an increase in ethical behavior? I doubt it because creating an ethical culture is much more complicated than compliance with regulations like Sarbanes-Oxley. I do see some hopeful signs, but that is attributable to the Dodd-Frank Law more than compliance with the internal control requirements under section 404 of Sarbanes-Oxley.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was adopted by Congress on January 5, 2010 in response to numerous instances of financial fraud by some of the largest companies in the U.S. It changed the regulatory landscape for internal accountants and internal auditors, and external auditors and auditing firms by protecting whistleblowers who voluntarily provide the SEC with original information about a violation of federal securities laws that leads to a successful enforcement action.

Dodd-Frank provides a reward for whistleblowers of not less than 10 percent and not more than 30 percent, in total, of what has been collected of the monetary sanctions imposed by the courts as a result of the enforcement action taken by the SEC. The settlement must result in monetary sanctions of more than $1 million.  

Internal compliance officers are eligible to become Dodd-Frank whistleblowers in three situations: (1) disclosure to the SEC is needed to prevent “substantial injury” to the financial interest of an entity or its investors; (2) the whistleblower “reasonably believes” the entity is impeding investigation of the misconduct (e.g., destroying documents or improperly influencing witnesses); or (3) the whistleblower has first reported the violation internally and at least 120 days have passed with no action. Now, even external auditors can blow the whistle on their firms after reporting client wrongdoing that hasn’t been resolved at the client level when the firm fails to act as well.

Since the launch of its whistleblower award program in 2011, the SEC has paid more than $50 million to 16 whistleblowers who provided "unique and useful information that contributed to a successful enforcement action." That may not sound like much but hundreds of other cases have not been resolved as yet in part because of the limited resources available to the SEC. The funding by Congress hasn’t caught up to the increase in whistle-blower reports.

The reason I believe Dodd-Frank holds more promise than Sarbanes-Oxley to create an ethical culture in corporations is the whistle-blowing provisions and award seem to have led to the desired effect whereas similar provisions in Sarbanes-Oxley did not. Perhaps the award feature is creating an increased ethical awareness? The act of whistle-blowing itself is an ethical choice.

Notwithstanding the existence of an award, those who consider blowing the whistle do so after weighing the likely consequences not only to the whistle-blower but the company itself. This means an ethical analysis occurs by evaluating the harms and benefits of one’s actions. On the one hand, doing the right thing is a powerful motivational force while, on the other hand, so is the possibility of retaliation and offending coworkers and managers who might view the act of whistleblowing as disloyal.

The fact is by creating a whistle-blower law with specific guidelines as to when an individual can blow the whistle and be eligible for an award, Dodd-Frank has led to an enhanced ethical awareness in corporations, many of which now have dedicated compliance officers, an ethics hot line, and their own whistle-blower guidelines.

The old expression is “good ethics is good business.” Up until now I’ve been skeptical about equating ethical behavior with some kind of monetary award. However, in the case of the act of whistle-blowing, the awards are intrinsic and add value to what the corporation stands for. The result may be stronger results but, at least in part, it occurs because of enhanced trust borne from ethical behavior motivated, perhaps, by Dodd-Frank.

It’s shame that Republicans in Congress see the law as a burden not worth sustaining – the costs of compliance is too high according to the naysayers. Well, I say we cannot afford to not meet that cost.

Blog posted by Dr. Steven Mintz, aka Ethics Sage, on May 13, 2015. Professor Mintz is on the faculty of the Orfalea College of Business at Cal Poly San Luis Obispo. He also blogs at: www.ethicssage.com.