The rise of the whistleblower

April 2, 2013

In today’s economic climate whistleblowers are seen as an effective tool to help uncover tax evasion and fill the tax gap.

By Jonathan Berr

The path of the whistleblower can be a lonely one. Just ask Michael Lissack, who helped uncover billions worth of fraud in the municipal bond market in the mid-1990s.

The experience cost him his job, his marriage and many friendships with former colleagues, not to mention having to endure a costly and draining legal battle with his former employer.

If someone asks him whether it’s worth the trouble to report wrongdoing to the authorities, Lissack inquires if they have a family. “If I had kids, I never would have done it,” he says.

Whistleblowing can be a stressful experience but it can also be a lucrative one, at least in the United States, following changes to the law regarding the level of payments that plaintiffs can receive. Prior to 2006, the US Internal Revenue Service (IRS) capped awards for whistleblowers at US$10m.

But, since 2006, when the IRS overhauled its policy toward whistleblowers as part of the Tax Relief and Health Care Act, the administration is now able to pay as much as 30% of the collected proceeds as a reward.

Perhaps the most high-profile award of recent times is the US$104m that the IRS paid to the UBS banker turned whistleblower Bradley Birkenfield for his role in helping the Government to uncover a tax evasion scheme set up by the bank. Birkenfield also paid a heavy personal price for his whistleblowing, spending 40 months in jail for his part in the tax evasion conducted at UBS.

Nevertheless, Erika Kelton, a partner at Phillips & Cohen, who has represented whistleblowers for more than two decades, thinks that the scale of the award sends a powerful message that the IRS Whistleblower Office is open for business. “What you are seeing is more cases and higher value cases as people get more comfortable with the program,” she says.

Senator Charles Grassley (R-IA), who led the push for the Tax Relief and Health Care Act of 2006, says that ongoing scrutiny is essential to ensure continued progress.

“It’s preferable to have more whistleblowers than fewer whistleblowers,” he says. “The cases that resulted in payouts so far have resulted in the collection of taxes that the IRS otherwise would not have known to pursue.”

For those companies that have not already established clear guidance on ethics and codes of conduct, the emergence of greater rewards for whistleblowers is just another sharp driver to establish these, along with supporting mechanisms, such as hotlines. One important step is to establish their own hotlines to enable whistleblowers to escalate concerns internally so that they can be identified and remedied more quickly.

A company that has mechanisms in place to report wrongdoing will be able to address issues more quickly, as well as being looked on more favorably by regulators. “It is in the best interest of companies to be proactive in this respect,” says Cornelius Grossmann, Ernst & Young’s EMEA Law Leader.

Daniel Westman, a litigation partner with Morrison & Foerster, who represents management in whistleblower cases, says that companies need to “win the hearts and minds of employees” by creating an environment that shows that their concerns are being taken seriously. “Companies are in control to the extent that employees perceive their concerns are being addressed,” he says.

But even with the right mechanisms in place, the scale of the rewards on offer from the IRS program could encourage people to contact authorities first rather than trying to bring their concerns to management.

“If a disgruntled employee tries to damage a company’s reputation by disclosing confidential information that is not based on merit, there is very little a company can do against such behavior,” says Grossmann. “The best approach is to keep publicity out of any such incident to the extent possible. The handling will be delicate and can be advised only on a case-by-case basis.”

For its part, the IRS Whistleblower Office is likely to find itself with a heavy workload of highly complex cases. In 2007, the IRS received 2,751 cases but, four years later, that number had mushroomed to 7,411. The staff handling this workload has grown but remains small.

As of the end of fiscal year 2011, the Whistleblower Office had a staff of 18, including 10 analysts, according to a report submitted to US Congress. That staff has since doubled to about 36. The IRS Office of Chief Counsel has also appointed a senior attorney to serve as Special Counsel to Steve Whitlock, the veteran IRS official who is director of the Whistleblower Office.

Developing the cases that are brought to the Whistleblower Office can take considerable time and effort. According to a 2011 report from the US Government Accountability Office, about 66% of the claims submitted in the first two years of the program were still in process.

The first payments under the 2006 law were made in fiscal year 2011. The agency paid awards on 97 claims, although it adds that they were covered under provisions that pre-dated the whistleblower law.

Only four of those cases involved awards that exceeded the whistleblower law’s US$2m threshold. By 2011, it had cases involving 732 taxpayers that reached that limit, according to data the agency provided to Congress last year in a report.

Attorneys who represent whistleblowers paint a sympathetic picture of the IRS office, which is headed by Steve Whitlock, a veteran IRS official. The department must sift through mountains of complaints that fail to pass legal muster for one reason or another.

Some may come from a whistleblower with a personal vendetta against a taxpayer, such as a former business partner or spouse. Neither can the IRS pay any awards until all the taxpayers have exhausted their legal appeals. Understandably, the process can be frustrating for everyone involved.

Mark Matthews, a former IRS enforcement head who is now a partner in private practice at Caplan & Drysdale, says that many whistleblowers think the IRS is concealing information from them, even though they may be trying to help as best they can. “IRS agents were generally advocates of paying the award as soon as possible because they want the program to work,” he says.

The situation at the IRS is undoubtedly improving. One reason is that Acting Commissioner Steven M. Miller has made the performance of the Whistleblower Office, which has been criticized in government audits, to be a priority.

In June, Miller wrote a memo that spelled out procedures to ensure the timely review of whistleblower complaints, including having initial reviews conducted within 90 days. “Timely and comprehensive evaluation of information provided by whistleblowers is essential to the success of this program,” he wrote

In today’s economic climate, where cash-strapped governments are looking for every last nickel of revenue, whistleblowers are seen as an effective tool to help uncover tax evasion and fill the tax gap. And with rewards on offer of the scale awarded to Bradley Birkenfield, there will be no shortage of plaintiffs willing to come forward.

The challenge for the IRS, and other tax administrations that adopt a similar approach, will be to separate genuine cases from invalid ones, and to ensure that they keep pace with a growing backlog.

For the whistleblowers themselves, the decision will always be a complex one. Financial rewards undoubtedly offer some compensation, but potential personal costs should never be ignored.

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