Whistle-Blowing And The D&O Liability Risk

As a result, D&O insurers should be enthusiastically supporting and advocating the implementation of effective whistle-blowing programs.

This article will offer a framework for assessing the potential effectiveness of a corporate whistle-blowing program. The article will also consider some of the risks that may actually be created by a poorly conceived program.

The analysis of corporate whistle-blowing programs should begin with recognition that not all misconduct is the same. A useful dichotomy can be drawn between "personal impact misconduct" and "corporate impact misconduct."

The former involves conduct that impacts a specific individual or a group of similarly situated employees. Personal impact misconduct would include harassment, discrimination and working condition issues.

Corporate impact behavior is behavior that adversely affects the corporation as a whole. Examples of this category fill the business news and include accounting fraud, antitrust violations and criminal activity.

The interest of D&O insurers, shareholders and corporations is to have a whistle-blowing program that will be effective and act as a deterrent with respect to this type of misconduct.

Employees, however, have limited personal motivation to report this category of misconduct. To understand this whistle-blowing paradox, its important to realize that whistle-blowing is inherently risky to the reporting employee. Retaliation is common.

With respect to personal impact misconduct, the direct, personal nature of the affront provides the motivation for the employee to assume the risk and report the conduct. Many companies have successful programs for encouraging and handling complaints regarding personal impact misconduct.

With corporate impact misconduct, the personal motivation to report is lacking, or at least very significantly diminished. In addition, the real and perceived risks of reporting are increased.

This level of misconduct may involve senior people, and taking on the executive suite is certainly high risk. The matters are likely to be complex, increasing the risk of having "wrong."

Criminal activity may be involved, creating a complicity concern.

Thus, for the category of misconduct where the company and the D&O insurer have the greatest interest in having employees report, the employee has limited personal motivation and increased personal risk. An effective whistle-blowing program must recognize that there are different categories of misconduct and that different reporting programs are required in order to address differences in personal motivation and risk.

Successful programs also need to erase the feeling that the whistle-blower is going it alone.

Any employee contemplating reporting a corporate impact issue is going to have serious matter- and time-specific questions. Questions weighing heavily on the mind of the employee will include:

What protections will there be from retaliation? If I report anonymously and people figure out who I am, what protection do I have from retaliation?

How can my identity be protected? Do I have any criminal liability exposure?

Will the report be accurately represented and get to the right people? Am I properly interpreting the events that I am observing?

Merely offering employees the convenience of a 24/7 hotline does not address serious concerns and will not encourage whistle-blowing. The ability to report anonymously may be helpful, but it may also be harmful to the employee.

How does the employee understand the pros and cons of anonymous reporting in a very specific, real context? The same is true with protections against retaliation. How does the employee understand and analyze these?

It is unrealistic to assume that employees will step forward and assume the risk of whistle-blowing on a corporate impact issue without some counsel and advice on their questions and concerns.

No member of the board of directors or senior management would consider assuming a risk comparable to that undertaken by a whistle-blower without a legion of advisors. If a corporate program is to be effective in encouraging whistle-blowing on corporate impact misconduct, the program will have to provide a means for offering a base level of advice, support and counsel to the employee.

In short, an effective program for corporate impact issues will need to provide counsel to the potential whistle-blowers to advise them on their concerns and legal issues.

Next, to be effective, the whistle-blowing program must be actively and continuously promoted throughout the organization.

Merely having a corporate whistle-blowing program is not enough. Many of the companies that have reported significant misconduct had corporate codes of ethics. The adage, "out of sight, out of mind" is apt.

Much of the positive deterrent effect from the whistle-blowing program will come from its being regularly promoted. This activity will deliver a strong zero tolerance message and create the desired concern in the mind of a potential wrongdoer that fellow employees will actually use it.

Finally, the nature of the whistle-blowing program instituted by a company may be a significant indicator of the moral hazard represented by senior management. Management with a true zero tolerance policy and nothing to hide will readily implement strong whistle-blowing programs.

Companies that downplay the importance of a strong whistle-blowing program, perhaps claiming "it is not necessary here," offer a different moral hazard profile that needs to be considered by D&O insurance underwriters.

For the D&O insured, an effective whistle-blowing program can prevent many millions of dollars of loss by either the deterring or the early reporting of misconduct that can harm the entire company.

With D&O insurance costing $35,000 to $45,000 per million of coverage in some instances, the comparative cost of instituting an effective corporate whistle-blowing program will be very modest. Companies that implement a demonstrably strong whistle-blowing program should be in a position to strongly lobby their D&O carrier for an offsetting premium reduction.

The requirement that companies have whistle-blowing programs brings with it new risks. A poorly designed program can increase these risks, while a well-designed program can reduce them. For example, the audit committee must have a program that supports "anonymous" reporting of certain accounting matters. Lawyers experienced in investigations will confirm that protecting anonymity is very difficult.

What liability will directors have when the identity of an anonymous whistle-blower is discovered and the employee learns that he or she has also lost protection from retaliation? The whistle-blowing program should acknowledge and address this need.

If a company funnels all reporting solely to a hotline, what liability is created when an employee loses Fifth Amendment protections in making the report? Alternatively, does the employee either not report or go to the prosecuting authorities first. Neither of these alternatives is good for the company.

If serious misconduct surfaces in the future, as it surely will, the question will be why no employee stepped forward and blew the whistle. If employees with knowledge of the events testify that they remained silent because of unanswered questions and concerns about rights and protections, a steep price will be paid by officers, directors and the company.

In short, having an effective employee whistle-blowing program can provide major benefits. Conversely, now that there is a clear mandate to have such programs, having a weak one may increase the exposure of officers, directors and the corporation.

The nature of a corporate whistle-blowing program is important to the risk faced by D&O carriers. In assessing corporate programs, insurers should consider:

Does the company acknowledge that there are different types of misconduct and that different reporting protocols are necessary?

With respect to corporate impact issues, does the program encourage reporting by providing support and counsel to the employee?

Is the whistle-blowing program actively promoted on an ongoing basis?

If these questions can be answered affirmatively, the D&O risk is being reduced. Negative answers may mean more than simply maintenance of the status quo in terms of risk.

Donald V. Jernberg manages Jernberg Law Group in Chicago, Ill. The firm helps companies design, implement and operate effective corporate whistle-blowing programs. Mr. Jernberg can be reached at djernberg@jernberglaw.com.

Reproduced from National Underwriter Edition, May 19, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.