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In April, the Securities and Exchange Commission issued its final rules concerning the whistleblower requirements of the Sarbanes-Oxley Act. According to the mandate, all 7,000 publicly held U.S. companies must have a method in place for employees and others to anonymously report concerns about accounting matters to the audit committee, or face being delisted by the stock exchanges. Listed issuers have until the date of their first annual shareholders meeting after Jan. 15, 2004 — but no later than Oct. 31, 2004 — to establish these procedures, and foreign private issuers and small businesses have until July 31, 2005, to comply. But there are compelling reasons for companies to act now. An effective whistleblower program helps companies achieve two goals. First, it sends a message to employees and investors that doing things right is important to the company; second, it provides a convenient way for employees to raise any issues, so they can be dealt with and resolved. In addition, there are specific legal, risk, and cost benefits from investing in prevention as opposed to waiting until problems arise. Bottom line: The sooner any public company addresses the new whistleblower requirements, the better positioned and protected that company will be. ENHANCED REPUTATION One of the most critical reasons for companies to act sooner rather than later is the importance of demonstrating a commitment to upright and honest business practices. Companies that implement whistleblower requirements well before the deadline will enhance their reputation with employees, customers, and investors. According to research conducted by KPMG, a company’s commitment to business integrity enhances its ability to attract and retain good employees and customers. And a McKinsey & Company survey of investors suggested they are willing to pay a premium of 12 percent to 14 percent for companies exhibiting high corporate governance standards. Further, research recently published in the Quarterly Journal of Economics indicates that companies that were most responsive to shareholders enjoyed an annual return 8.5 percent higher than the returns of companies run as management dictatorships. Companies should also realize that there is a heightened awareness attached to whistleblowing — recall that Time magazine’s “Persons of the Year” for 2002 were three whistleblowers. Today, more than ever, employees understand their potential role as a whistleblower and have a variety of avenues to raise issues and concerns. A company program that solidifies that role and offers convenient internal avenues is a smart and timely investment. While companies can legally delay implementing the Section 301 requirement for whistleblower procedures, they are already exposed to potential legal liability due to other sections of Sarbanes-Oxley that are currently in force. Sections 806 and 1107 create new penalties for any form of retaliation. In certain circumstances, these penalties can include up to 10 years in jail. Whether or not a company has a whistleblower procedure, employees are still able to raise concerns with management and law enforcement officials. Once they do so, they are protected by the act from retaliation, while the company and its management are exposed to significant risks and penalties if they mishandle the information or the whistleblower. By implementing a comprehensive program now, these risks can be minimized. CUT FRAUD LOSSES Having a whistleblowing program can not only help maintain a good reputation and avoid legal problems, but can also help control fraud. Web- and telephone-based hot lines have been proven to reduce fraud by discouraging unethical behavior and catching it more quickly. According to the National Association of Certified Fraud Examiners, the loss in revenues each year as a result of occupational fraud is substantial. And since the most common method for detecting occupational fraud is by a tip from an employee, customer, vendor or anonymous source, organizations with fraud hot lines cut their losses by approximately 50 percent. A whistleblower program that can reduce fraud can also reduce a company’s insurance costs and claims experience. According to consulting firm Tillinghast-Towers Perrin, “The underwriting of [directors and officers] insurance became more stringent in 2002. While this trend was already well under way, it gained additional momentum from the widespread concerns about high-profile bankruptcies and corporate scandals, and ensuing corporate governance initiatives.” As a result, directors and officers paid nearly 30 percent more for their D&O liability coverage in 2002, on the heels of a similar increase in 2001. Through the use of well-designed whistleblower procedures, companies can expect to reduce fraud, increase financial disclosure accuracy, limit the number and severity of insurance claims, and ultimately lower D&O insurance premiums. IT STARTS AT THE TOP The best whistleblower programs encourage proper conduct while carefully handling reports made by employees. Encouraging ethical conduct begins with company management and the board. If those at the top place a heavy emphasis on values and compliance, the program will be more credible and effective. Company management and lawyers seeking a framework for whistleblowers should consider the needs of the employees, the audit committee (and, by proxy, investors), and management. Here is the framework we propose: • For employees, a whistleblower program has two goals: to promote ethical conduct in the first place and to encourage reporting of any problems that do occur. Ethical conduct is best encouraged by communication, education, and consistent application of company policy. Communication can be centered around the company’s code of business conduct. Education makes sure that employees understand guidelines as appropriate for their job responsibilities. Employees also need convenient ways to raise their concerns and obtain feedback and closure. An anonymous and confidential process, as required by the act, will increase the likelihood that employees will come forward when they see something wrong. • The audit committee needs one thing above all: 100 percent integrity. It needs to make clear that input or submissions will not be edited or filtered in any way. In most cases, the audit committee will rely on management to address issues as they arise, but the committee needs to have complete access to submissions and be able to exercise its oversight role as members see fit. • Lastly, management needs a whistleblower process that facilitates consistency in handling complaints and complies with various document retention rules. To ensure the anonymity of employees and the overall integrity of the system, companies should consider outsourcing key aspects of their program to a trusted third party. A combination of Web and telephone channels provides versatility, convenience, and security, as well as anonymity and two-way communication for easy follow-up. Anonymity and follow-up are harder to guarantee employees with a process based on e-mail and voice-recorded telephone systems. This is a case of the sooner the better. Whether it’s to secure your company’s reputation as a forthright business with integrity, to keep out of hot water legally, to avoid perceived and real retaliation (which can carry criminal penalties for the managers involved), to provide your employees an effective channel for voicing concerns, or to reduce fraud and insurance costs, the benefits of a properly implemented whistleblower program are compelling — and the time is now. While some public companies might wonder whether they should be increasing their compliance costs in 2003, when they can legally delay implementing a whistleblower scheme until 2004, the real question is: Can they afford to delay? Russ Selinger is the CEO and co-founder of Resultor, LLC, which helps companies improve business performance through good business practices. He can be reached at [email protected] or (916) 671-1072.

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