How whistleblowing incentives stop insider trading

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Overview

Insider trading, where shares are bought or sold on information not publicly available, is illegal but has traditionally been very difficult for regulators to prove. The lack of an obvious paper trail has often stymied investigators. Now a study from the Department of Accounting at Monash Business School reveals that an incentive program for whistleblowers can deter insider trading.

In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act introduced a whistleblower bounty program. This program increased rewards for whistleblowers, while also lowering the risks of reporting illegal activity, to encourage more people to come forward.

Since it has been introduced to 2018, the whistleblower program has resulted in 28,000 tips and awarded $326 million to 59 individual whistleblowers.

Previous research showed the new law punishes wrongdoers more effectively and caused firms with allegations against them to reduce their potentially illegal behaviour. However, the impact on insider trading was unknown.

This study shows the whistleblower reduces the likelihood of insider trading occurring. It finds that after the introduction of the incentive program, the number of potentially information driven insider sales in market sensitive periods, such as the pre-earnings announcement window, reduces. Share sales before negatively perceived mergers or acquisition announcements also fell as did trading profits on purchases made by insiders.

“The study shows the usefulness of whistleblowers for detecting crimes that don't generally have other rich evidence sources and have historically been hard to detect and prosecute,” says author Jacob Raleigh.

Takeaways for companies, regulators and corporate governance practitioners

  • Whistleblowers may be helpful in deterring crimes that do not leave an obvious paper trail and are difficult to prove.
  • Incentivising whistleblowers to come forward may be an effective way for regulators to get firsthand knowledge of potential crimes and help decide between coincidences and exploitative behaviour.
  • The findings have implications for corporate governance practitioners who want to improve compliance culture within their company.
  • Australia currently doesn't have a program that pays whistleblowers in exchange for their tips. The study suggest that this approach is suboptimal and more misconduct would be identified and prevented if an incentive program was introduced here.

Implications for research

  • Previous studies have found that rewards can compel whistleblowers to come forward whereas this study reveals the potential benefits of increasing the value of incentives for whistleblowers and how these incentives can act as a deterrent for insider trading.
  • Other research has explored whether the Dodd-Frank whistleblower program was effective at deterring misconduct like accounting fraud, this research explores whether the program is effective at detecting crimes that don't leave a large paper trail behind. In settings without other obvious pieces of evidence, whistleblowers can be especially helpful by providing firsthand experience or direct observation of the crime in question.

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