Who are you going to call?

Have you (or employees in your organization) found incriminating evidence, but you don’t trust the internal hotline? Here are two ways to report fraud and possibly receive awards for your troubles.

Here are two typical scenarios. Ben Sanderson is a junior accountant at Bacme Corp. — a publicly traded manufacturing company. He recently noted some unusual entries in the company’s books. The entries, which don’t conform to generally accepted accounting principles, caused overstated revenues on the firm’s financial statements. Ben is afraid to use Bacme’s hotline to report his concerns because most employees believe that management’s lackeys oversee the whistleblowing process. So, he’s in a quandary about reporting this fraud.

Janice Milford, a tax accountant for a highly successful consulting partnership, recently came across some documentation showing that the partners had consistently understated their revenues, and so Janice believes the partners significantly misstated their tax returns. Like Ben, Janice faces difficult choices as she decides how to report the serious issues she has uncovered.

GOVERNMENT WHISTLEBLOWER AWARD PROGRAMS

These stories are fictitious, but they represent the dilemmas faced by employees and stakeholders in companies that operate outside accounting rules and tax laws. Blowing the whistle can be risky; it often results in tipsters losing their jobs and reputations and facing limited future career prospects.

Yet, governments around the world rely heavily on whistleblowers’ tips to uncover fraud. U.S. government agencies encourage these tips by offering whistleblower awards programs that pay monetary awards to tipsters if their information leads to successful enforcement and collection of money from a violator.

Fortunately for all the Bens and Janices, the Securities and Exchange Commission (SEC) and the Internal Revenue Service (IRS) operate whistleblower awards programs. The IRS program, which began 140 years ago, authorizes the Department of the Treasury to pay amounts to individuals who provide information that allow the IRS to detect, bring to trial and punish those guilty of violating internal revenue laws. A 2006 amendment created the current IRS whistleblower program, which mandates that the government pay whistleblowers awards based on the size of the taxes collected as a result of their tips.

[The seminal U.S. Federal Claims Act, enacted in 1863, allows whistleblowers a portion of reclaimed money when defendants are found guilty of defrauding the federal government. The Commodities Futures Trading Commission has also recently established a whistleblower program.]

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act established the SEC’s whistleblower awards program. The program seeks to encourage high-quality tips about securities violations with its monetary awards supplemented by protections from retaliation.

OVERVIEW OF THE IRS WHISTLEBLOWER AWARDS PROGRAM

The IRS created the whistleblower awards program, codified in IRC 7623(a), to close the tax gap and fight tax fraud more aggressively. In this original program, the maximum award was 15 percent of collected taxes, penalties and other amounts not to exceed $10 million, but the decision whether to make an award at all was within the IRS’ discretion. When the courts considered attempts to challenge award decisions under this law, they uniformly found that the discretion to make or not make an award is essentially not reviewable. In other words, the courts decided the IRS has the right to make an award or not, and the whistleblower can’t appeal that decision.

The Tax Relief and Health Care Act of 2006, which made major changes to the IRS awards program, mandated that the IRS pay out a substantial award whenever a whistleblower’s information leads to the collection of tax, interest and penalties based on disputes in excess of $2 million. This new section, IRC 7623(b), was intended to create strong incentives to bolster insider reporting of tax violations for claims enacted after Dec. 20, 2006.

The awards are now mandatory rather than discretionary, and they range from 15 percent to 30 percent of monies collected with no cap on the dollar amount of the award. With some exceptions, a whistleblower may collect an award even if convicted of a felony. 

Whistleblowers are eligible for awards based on additions to tax, penalties, interest, and other amounts collected as a result of any administrative or judicial action resulting from the information provided. The 2006 amendment added whistleblower appeal rights to the U.S. Tax Court. To implement the law, the IRS was also required to create a Whistleblower Office that reports to the IRS commissioner.

Submissions that don’t qualify under the new section IRC 7623(b) (usually because the disputes are for less than $2 million) are processed under the original IRC 7623(a). The IRS will continue to consider these cases, but the award is at the discretion of the agency, and there’s no requirement that an award be issued. These whistleblowers have no minimum statutory award percentage and no appeal provision. 

OVERVIEW OF THE SEC WHISTLEBLOWER AWARDS PROGRAM

The Dodd-Frank bill was partly a response to financial debacles such as the Madoff fraud and widespread mortgage frauds. Many criticized the SEC for its inaction to the circumstances that led to the Great Recession, although it definitely wasn’t alone in its failure to uncover and stop massive frauds.

The SEC had an awards program before Dodd-Frank, but it wasn’t particularly effective, and it focused solely on insider trading. This new whistleblower awards program, which is much broader, encourages tips related to all kinds of securities violations from financial statement fraud to alleged Ponzi schemes.

The Dodd-Frank whistleblower program stipulates that as long as collected monetary sanctions exceed $1 million, awards are 10 percent to 30 percent of that amount. Awards are paid to individuals who voluntarily provide original information that leads to successful SEC enforcement. The award percentage is increased or decreased based on several factors including the extent of the whistleblower’s assistance.

Section 924(d) of the Dodd-Frank Act required the SEC to create a separate office within the agency to enforce the new regulation. In May 2011, the SEC adopted the Final Rules, Regulation 21F, which included prohibitions against retaliation, defined terms and established policies for submitting tips, applying for awards and filing appeals on award decisions.

COMPARISON OF THE PROGRAMS

So how would someone like Ben fare under the SEC whistleblower awards program and someone like Janice fare under the IRS program? The following information will help potential whistleblowers understand their options under these programs.

Who is a whistleblower?

In the IRS program, a whistleblower must be a “natural person”— in other words, not a corporation or other business organization. Because the claim form must be signed under penalty of perjury, the whistleblower can’t be anonymous, nor can the claim come from a representative of the whistleblower. Multiple whistleblowers can submit a joint claim, but each must sign under penalty of perjury. Similarly, in the SEC program the whistleblower must be a natural person or persons. However, the SEC whistleblower can be anonymous up to the point that the award is paid out, and he or she can be represented by an attorney or other person.

IRS whistleblowers can’t be taxpayer’s representatives, employees of the Treasury Department, or employees of federal, state or local governments if they learned of the information as part of their job duties. The SEC whistleblower can’t be an auditor who learned of the issue as part of his or her duties during an audit or other engagement. The SEC whistleblower also must provide the information “voluntarily,” which means that the whistleblower can’t provide it in response to a request from regulators or law enforcement.

What type of information must be submitted?

IRS claims must include the tax violator’s name and address, date of birth, Social Security number and the specific nature of the violation. If possible, it should also include the tax year(s), the dollar amounts of unreported income or erroneous deductions and supporting documentation. SEC claims must be original information about possible securities laws violations not already known to the SEC and not derived from publicly available sources. Even though the whistleblower employee might have first reported the information to his or her company’s internal hotline process, the SEC will still consider the information to be “original.” The content of this required information isn’t as clearly specified as in the IRS program, but it must cause the SEC to open (or expand) an investigation and bring a successful enforcement action.

What type of confidentiality and/or protection exists for the whistleblower and the information submitted?

The IRS protects the whistleblower’s identity as far as possible. If the whistleblower is needed as a witness in a court case, the IRS will notify the whistleblower who can then decide whether or not to proceed. The legislation that established the IRS program failed to include any protection for the whistleblower from possible retaliation. However, the alleged tax violator’s information is strictly protected, so that the whistleblower can only be told whether the case is open or closed. If the case is closed, the IRS can reveal to the whistleblower if his or her claim is payable, the amount of a payment or if a payment has been denied.

The SEC can’t disclose information that could reasonably be expected to reveal the identity of a whistleblower except if it needs to comply with law enforcement proceedings or protect investors by notifying another authority. For example, the SEC might need to notify the U.S. Department of Justice or a state attorney general or even foreign law enforcement if a criminal investigation should be opened as a result of the whistleblower’s allegations.

The SEC informant must file through an attorney to remain anonymous during the process. After the SEC presents the award to the whistleblower, it will release the whistleblower’s name. Federal laws state that the whistleblower’s company can’t retaliate against the employee. A whistleblower can bring a private action in federal court against his employer if he feels his employer retaliated against him. If he wins, the whistleblower may be awarded double back pay and litigation costs, and he may be reinstated in his job. Also, the SEC can take legal action against an employer that retaliates.

Problems with whistleblower confidentially

Confidentiality is a whistleblower concern in both programs; recent events showcase instances in which the SEC and IRS whistleblower programs had different levels of success. In the following examples, the SEC failed to keep whistleblower’s identity secret, but the IRS maintained the confidentially of its informant.

Peter Earle was a trader at Pipeline Trading Systems, a stock-trading platform, from 2005 to 2009. He noticed that the company had misguided clients about how it had filled their orders. On April 25, 2012, The Wall Street Journal reported that the company advertised that its software privately matched one customer’s buy order with another customer’s sell order without disclosing the orders to the wider world of Wall Street. (See “Sources’ Cover Blown by SEC,” by Scott Patterson and Jenny Strasburg.) 

When the company started up in 2004 and didn’t have enough customers to ensure quick order execution, its parent company created a trading unit to fill orders. A few months into his job, Earle raised concerns internally about the trading activities and began to document conversations and his observations. He also made other internal complaints about trading. Five years later, the company’s trading affiliate still filled most orders, while they advertised that customer orders were filled by matching them up with those of other customers.

A few days after Earle was fired, allegedly for poor performance and having an affair with another trader’s wife, he notified the SEC of his concerns by email. When the SEC investigated the matter, it showed Earle’s notebook to a Pipeline executive, who recognized Earle’s handwriting. Earle was found ineligible for an award under the Dodd-Frank Act because he contacted the SEC before the law took effect. Pipeline reached a settlement in October 2012 with the SEC, which said that Pipeline had misled investors about how it had filled their orders. The SEC eventually fined Pipeline $1 million and two of its executives $100,000 each, according to the WSJ article.

Another issue of identity disclosure arose when a whistleblower reported an alleged underpayment of tax by his employer to the IRS. The whistleblower’s information didn’t result in the detection of a tax underpayment and therefore the IRS denied any award. The whistleblower appealed to the U.S. Tax Court, requested anonymity and made a motion to seal the record (Whistleblower 14106-10W v. Commissioner, 137 T.C. 183, 2011).

The Tax Court confirmed the IRS decision denying an award. It granted the whistleblower’s request for anonymity and redaction from the record of any identifying information. The Tax Court took into account the whistleblower’s legitimate privacy interests as well as the nature and severity of the specific harm asserted to arise from disclosing the whistleblower’s identity. It denied the motion to seal the record because the anonymity and redaction adequately protected the whistleblower’s privacy interests.

How are the tips processed?

For the IRS, once an informant completes Form 211, the Whistleblower Office assigns a claim number and an analyst to the claim file. The claim is forwarded to the appropriate operating division (possibly including Criminal Investigation) to evaluate and act on it by instituting an audit or investigation or determining that the lead isn’t productive. Once the IRS collects the proceeds, the Whistleblower Office determines the award amount.

For the SEC, the whistleblower submits information by completing Form TCR and submitting it either online, by mail or by fax. The whistleblower then checks the SEC website for a posting of an action exceeding $1 million in sanctions. The whistleblower must complete a form within 90 days of posting to apply for the award.

What factors affect the amount of the award?

The IRS award may be reduced to 10 percent if the action was based principally on information from sources other than the whistleblower. It may also be reduced if the whistleblower planned or initiated the violation. The award will be denied entirely if the whistleblower is convicted criminally based on his or her role in the violation. Other positive and negative factors will move the award between 15 percent and 30 percent.

Positive factors include: violations that would have been especially difficult for the government to detect, documentation that’s detailed and complete to save IRS time and the whistleblower’s identification of taxpayer assets that were unknown to the IRS. Negative factors include: delayed reporting by the whistleblower that impeded the IRS investigation, the whistleblower’s profiting from the tax violation and the whistleblower’s premature disclosure to the taxpayer of the IRS’s planned action.

For the SEC, the percentage is increased if: the information provided by the whistleblower is particularly significant, his or her assistance during the investigation is extensive, or he or she also reported the information internally to the company. The award is decreased if: the whistleblower was culpable in the violation of the securities laws, unreasonably delayed reporting the violation or interfered with the company’s internal reporting systems.

How and when is the award paid?

The IRS pays its awards when the proceeds are collected, and the appeals period for the taxpayer has expired. Many have said that the IRS program process is lengthy and slow. Claimants can generally expect to wait five to seven years to receive an award. While a whistleblower can’t appeal the award amount for IRC 7623(a) through the Tax Court, awards filed under the newer IRC 7623(b) are subject to appeal in the Tax Court.

The SEC will pay after the time has expired for the violator to file an appeal or after any appeals have been concluded. Then it evaluates all claims. The SEC must collect all sanctions from the violator before the SEC pays the award. A whistleblower can’t appeal an award amount but can appeal a denial.

JANICE AND BEN CONSIDER THE WHISTLEBLOWER AWARDS PROGRAMS

For employees like Janice and Ben — assuming that the irregularities they uncovered are large enough to meet the criteria — whistleblower awards programs promise the chance to make potential large amounts of money in return for running the risks that go along with blowing the whistle.

Someone like Janice must be patient with the lengthy IRS process and must understand that her confidentiality isn’t guaranteed. Also, the IRS rules won’t protect her from employer retaliation if the partnership should find out about her claim.

For someone like Ben, the SEC’s whistleblower program appears to be a faster process, but he should be very concerned that his confidentially could be compromised. He should consider first reporting internally to his company because the SEC, in an effort to encourage direct reporting within a company, may then actually increase his ultimate award. The SEC program does include protection for the whistleblower so that Bacme Corp. would be unable to retaliate against Ben if they found out about his claim.

So, if you become aware of financial wrongdoing and want to blow the whistle (which we hope you do), be prepared for a long bumpy ride with the chance — but not the promise — of riches at the end of the line.

Martha A. Howe, Ph.D., CFE, is a senior lecturer in accounting at Bentley University in Waltham, Mass.  

Priscilla A. Burnaby, Ph.D., is a professor of accounting at Bentley University in Waltham, Mass.

Brigitte W. Muehlmann, Ph.D., ACFE Educator Associate, is an associate professor of Taxation in the Sawyer Business School at Suffolk University in Boston, Mass.

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