Do the SEC Whistleblower Provisions of Dodd Frank Deter Aggressive Financial Reporting?

Abstract

The stated goal of the 2011 SEC Whistleblower (WB) Program introduced as part of the Dodd-Frank Act was to strengthen investor protection through greater deterrence of securities law violations and more effective regulatory enforcement. While the SEC has articulated the success of the program for detecting and prosecuting violations, there is no evidence on the effect of the program in deterring violations. In this paper, we consider the deterrent effect by examining the impact of the Program on aggressive financial reporting by U.S. firms. Despite ongoing challenges, including the high number of tips received, efforts by some managers to circumvent the new rules by muzzling whistleblowers, and potential unintended consequences of the incentives provided, we document a significant reduction in abnormal accruals following the introduction of the regulation. We observe reductions for both positive and negative abnormal accruals as well as for extreme abnormal accruals. We also predict that firms with weaker internal compliance and reporting program quality are more likely to change their reporting behavior as employees of these firms are more likely to report irregularities directly to the SEC rather than internally. Using two different proxies for the quality of a firm’s internal compliance and reporting program – ratings of a firm’s program as described in its Code of Ethics, and estimated program quality based on disclosures of ineffective whistleblower program controls under Sarbanes Oxley – we find that reductions in aggressive reporting are greater for firms with weaker internal programs. Collectively, these findings provide important large-sample evidence of significant benefits of the SEC WB Program of Dodd-Frank Act for deterring financial reporting fraud, and of the efficacy of bounty-type whistleblower programs, more generally.

Keywords: Whistleblower, Dodd Frank, Fraud, Financial Reporting

JEL Classification: M41, G18