by Stephen Kohn
These studies all came to the same conclusion: The largest source of all fraud detections were “tips” from whistleblowers, usually employees of a company. Figure 3 is a chart of how companies detect fraud. As can be seen, “tips” (i.e., whistleblowers) are the largest source of all fraud detection and constitute 43.5 percent of frauds detected within corporations. “Law enforcement” was able to identify only 1.9 percent of the frauds. Thus, a fraud detection program dependent upon government agents or regulators to uncover fraud is destined to fail. But if whistleblowers can be encouraged to report, the ability to detect fraud will radically increase.
The next study looked at how employees respond when they uncover misconduct at work. The studies, conducted by the Ethics Resource Center (a corporate-sponsored ethics association) are consistent with every other similar study. As reflected in Figure 4, 38 percent of employees told no one about the misconduct they witnessed; 60 percent told their supervisors or someone in the company. That accounts for 98 percent of all observed misconduct. Only 2 percent of employees reported the misconduct to “someone outside the company,” which would include regulators or law enforcement. But “someone outside the company” could also include a friend, or filings with the Labor Board, OSHA, or the Equal Opportunity Employment Commission, all of which receive numerous employee complaints every year. These studies demonstrated that without some program to encourage and incentivize employee reporting, the vast majority of frauds would not be detected, and the vast majority of misconduct that was detected would not be reported to the government.
The most important and comprehensive study on whistleblowing came out of the University of Chicago Booth School of Business. In the wake of the collapse of Enron, leading economists from the University of Chicago and University of Toronto published a groundbreaking article, “Who Blows the Whistle on Corporate Fraud?” Their goal was to “identify the most effective mechanisms for detecting corporate fraud,” and their study was based on an “in-depth” analysis of “all reported fraud cases in large U.S. companies between 1996 and 2004.” Their conclusions, based on impeccable scientific research, laid the basis for the U.S. Congress to enact new whistleblower reward laws:
• “A strong monetary incentive to blow the whistle does motivate people with information to come forward.”
• “[T]here is no evidence that having stronger monetary incentives to blow the whistle leads to more frivolous suits.”
• “Monetary incentives seem to work well, without the negative side effects often attributed to them.”
The researchers also determined that existing corporate culture was antithetical to employee reporting: “[E]mployees clearly have the best access to information, [but whistleblowers were] fired, quit under duress, or had significantly altered responsibilities. In addition, many employee whistleblowers report having to move to another industry and often to another town to escape personal harassment.”
Their conclusion was very simple: whistleblowers were the key to fraud detection, but within existing corporate cultures, whistleblowers were punished: “Not only is the honest behavior not rewarded by the market, but it is penalized. . . . Given these costs, however, the surprising part is not that most employees do not talk; it is that some talk at all.”
Fraud is committed secretly and privately. Without a whistleblower, it is very hard to detect white-collar corporate crimes. As the False Claims Act recoveries demonstrated, once reporting is incentivized with a monetary reward and a safe reporting procedure, high-quality tips soar and the public benefits.
Based on objective empirical evidence, statistics, and studies, it is not surprising that in 2006 Congress looked toward the False Claims Act to model its IRS tax whistleblower program, and in 2010 looked at both the False Claims Act and IRS laws to model a whistleblower reward program covering the publicly traded economy and foreign bribery. On July 21, 2010 the Dodd-Frank Act was signed into law, which included two new reward-based laws covering securities fraud, commodities trading fraud, and foreign bribery. These laws contained enhanced confidentiality provisions (including, for the first time, a procedure permitting whistleblowers to file anonymous complaints to the government) and set the rewards at 10 to 30 percent.
The Changes
Permitting whistleblowers to proceed confidentially, and basing compensation on a reward for high-quality and useful information, shifted the manner in which employees blow the whistle. The shifts:
Confidentiality: Proceeding anonymously and confidentially is a new way to blow the whistle. This marks a change from the high-profile public disclosures that marked the previous five decades of whistleblowing. Confidentiality is the best safeguard against retaliation. You cannot fire, blacklist, or harass a person whose identity you do not know.
The move toward confidentiality started with the False Claims Act. Under that law the initial whistleblower disclosure is filed in federal court under “seal.” This means the complaint remains secret and is neither placed on the public docket nor served on the defendant. Additionally, the complaint and a “disclosure” statement are provided to the U.S. Attorneys Office and the Attorney General. These documents are also kept confidential, and they permit the government to conduct an investigation without the wrongdoer knowing the identity of the whistleblower. These provisions encourage reluctant whistleblowers to step forward, knowing that their bosses will not initially know they filed a charge against the company.
The only problem with the law’s confidentiality provision was that it was not permanent. Once the government decides whether or not to prosecute the company, the whistleblower’s complaint, under most circumstances, is taken out of seal and becomes a matter of public record. A whistleblower could ask the court to continue the confidentiality requirements, but that was not mandated by law. The discretion on whether to continue a seal is left to the federal judge, to be decided on a case-by-case basis. In practice, cases are simply taken out of seal, making the complaint discoverable.
The Dodd-Frank Act’s amendments to the Securities Exchange Act and the Commodity Exchange Act closed this loophole. These laws cover fraud on Wall Street.
Under these laws, any individual can anonymously report securities or commodities violations (or violations of the Foreign Corrupt Practices Act) to the Securities and Exchange Commission or the Commodity Futures Trading Commission and remain anonymous. Under this provision, the government would not be told who the whistleblower was. This way, employees on Wall Street could be assured that their identity would be protected if they lawfully reported corruption.
The procedure for filing anonymous complaints is very logical. It protects the identity of the whistleblower, but also requires that steps be taken to prevent frivolous or abusive filings. A whistleblower who wants to keep his or her identity secret has to hire an attorney. The attorney has to confirm the whistleblower’s identity and make a good-faith effort to ensure that the complaint filed has a sound basis in law and fact. The lawyer has to personally sign the charge filed with the government and affirm under oath that the whistleblower in fact exists and that the information filed with the government was the same information provided by the whistleblower. The lawyer is also required to have a signed statement from the whistleblower, confirming his or her allegations. This statement is kept confidential by the lawyer. If a whistleblower’s allegations result in a successful enforcement action and the payment of a reward, the confidential whistleblower must disclose his or her identity in order to assure the government that they qualified for the payment.
The tax whistleblower program also permits whistleblowers to proceed with their cases confidentially. In a major case, entitled simply Whistleblower 14106 v. Commissioner, the Tax Court upheld the right of anonymous whistle-blowers seeking a monetary reward from the IRS for reporting tax fraud or underpayments to remain anonymous during court proceedings. The Tax Court recognized the “severity” of the “harm” that could befall a whistleblower whose identity was revealed.
Initial reward filings with the IRS Whistleblower Office are required to be signed by the whistleblower, under oath, and thus cannot be anonymous. But the rules governing IRS whistleblower claims require that the IRS keep the whistleblower’s information strictly confidential. As mandated in the Internal Revenue Manual, the IRS must aggressively protect the confidentiality of its whistleblowers. This includes:
• “Personnel are required to treat the identity of the whistleblower and the whistleblower’s information as highly confidential and to exercise the appropriate security precautions.”
• “The identity of the whistleblower must not be disclosed to any other Service officials or employees except on a ‘need to know’ basis in the performance of their official duties.”
• “To maintain maximum security, protect documents and screen displays which identify whistleblower information or the whistleblower. Keep all documents, screen displays, and forms secured. This information must be kept concealed from all employees in a locked file cabinet until it is forwarded to the responsible party.”
• “Transmit the information in a double-sealed envelope. (Use pink or gray envelopes.)”
The IRS treats whistleblower information under the same legal standards they use to handle other taxpayer information. These rules are among the strictest secrecy rules governing any federal agency.
The confidentiality provisions make it far easier for employees to blow the whistle. In 2016 alone, 13,396 whistleblowers reported tax frauds and under-payments under the IRS’s confidential program, and 4,218 whistleblowers filed claims alleging violations of securities laws, almost all of which were confidential. These numbers are staggering, and far greater than the number of employees who expose wrongdoing under the older, more traditional laws that do not provide for a reward and do not facilitate confidential filings.
Compensation: Under employment discrimination laws, whistleblowers are compensated if they suffer retaliation and prevail in a wrongful discharge case. A whistleblower’s damages are based on a “make whole” theory (putting the employee back into the position he or she had before blowing the whistle). Damages generally included reinstatement, back pay, compensatory damages (for pain and suffering), and, in some cases, punitive damages. But if the best you can do if you win a traditional whistleblower case is being put in the position you were in prior to blowing the whistle, ultimately the whistleblower always loses. Their career is always damaged and their reputation within their profession is often completely destroyed. You may get your job back, but good luck ever getting another promotion or being placed in an executive position of trust.
The new reward-based laws permit whistleblowers to obtain compensation unrelated to their employment status. Compensation is not based on how much the whistleblower is harmed, but instead on how good the whistle-blower’s evidence of fraud or corruption is. The premium is on a whistleblower coming forward with good evidence, not on suffering. Compensation is based on a percentage of the fines and penalties paid by the wrongdoer. The better the evidence, the higher the penalties. The higher the penalties, the bigger the reward.
For example, under the False Claims Act, if a whistleblower’s evidence was used to successfully prosecute a case, the government is required to pay the whistleblower 15 to 30 percent of the monies collected in fines and penalties. Thus, if a whistleblower reported a hospital for Medicare billing violations and the government collects a $10 million fine, under the False Claims Act, the whistleblower must be paid between $1.5 million and $3 million in compensation, even if the company never knew who the whistleblower was and the whistleblower kept his or her job. These mandatory minimum and maximum reward percentages are reflected in other modernized whistleblower laws: Tax (15–30 percent); Securities (10–30 percent); Commodities (10–30 percent); Foreign Corrupt Practices (10–30 percent).
In 2016, the IRS paid out $61 million to whistleblowers, while the SEC paid an additional $57 million in claims. But the False Claims Act, which is the oldest and most established law, still results in the largest payments. The Justice Department (with court approval) paid whistleblowers $519 million in fiscal year 2016.
These new laws successfully align the interests of the whistleblower, the prosecutor, and the public. They all want to bring fraudsters to justice. The prosecutor needs the evidence the whistleblower has, and the public needs the prosecutor to bring the fraudsters to justice—a perfect alliance for achieving accountability.
Emphasis on Being Right: The next fundamental change in whistleblowing relates to the core concept of a protected disclosure. The very first whistle-blower cases created a firm rule: Whistleblowers were protected from retaliation even if the issue they disclosed turned out to be harmless or incorrect. A whistleblower’s complaint only needed to be “reasonable” or made in “good faith”; it did not have to be proved true. This rule of law, followed by every court, was based on the fact that employees would be very reluctant to ever report fraud or safety violations if they also had to prove their concerns were correct. Who would raise a concern if they could be fired simply because their concern could not be proven?
Reward laws are based on a completely different premise. The heart of the claim is the validity of the whistleblower’s allegations. In a reward case, if the issue turns out to be harmless or incorrect, the whistleblower gets nothing. Rewards are based on the usefulness of the information. Whistleblowers can obtain compensation if their allegations prove correct and support a government prosecution resulting in collection of a sanction from the wrongdoer.
Instead of a whistleblower risking his or her career to report a minor violation, the reward laws encourage potential whistleblowers to objectively evaluate the violation and consider whether the issue could realistically result in a prosecution. This can prevent an employee from being stigmatized as a whistleblower over allegations that can never be fully proved, or that would never result in an enforcement action. Encouraging employees to use a cost-benefit analysis in determining whether to blow the whistle focuses disclosures on issues for which there is strong evidence and/or implicate major violations.
Crimes v. Jobs: Under the old laws, whistleblower cases often became hotly contested employment disputes. The employee would allege that he or she was fired for making a protected disclosure. The company would argue that the worker was fired for just cause, such as insubordination or poor work performance. Whether or not the underlying whistleblower allegation was proved correct may have been relevant to supporting the whistleblower’s credibility, or explaining why the company had a motive to retaliate, but ultimately it was not a required element of the case. A retaliation case is primarily an employment case. Thus the whistleblower’s interest in righting a wrong gets folded into an employment dispute, where the employee has to fight for his or her professional career or face economic ruin if the case is lost. Once the whistle-blower becomes embroiled in a hotly contested employment dispute, the focus on the company’s wrongdoing fades, and the case centers on whether the whistleblower was an incompetent or disgruntled employee.
The reward laws change this. The focus shifts to whether the whistleblower’s evidence is correct and, if so, what laws were violated and what penalties are owed. The focus is on the company’s misconduct, not the employee’s work record. This change helps the whistleblower. Instead of facing an embarrassing employment dispute, where the employer has an interest in digging up every piece of dirt against the employee, the goal in a rewards case is to provide the government with enough evidence to prosecute the criminals or hold the company accountable for its violations of law.
Qui Tam: All the reward laws are based on a medieval law enforcement method that empowered citizens to enforce the laws. These old laws were known as qui tam, which roughly translates to “in the name of the king.” A traditional qui tam law permits the citizen to actually file a lawsuit “in the name of the king” and prosecute the wrongdoer as a private attorney general. The longest-standing and most e
ffective reward law contains this mechanism. Under the FCA, the whistleblower files a lawsuit in the name of the United States and has the authority to prosecute the case, even if the government drops the ball. This is the ultimate check against government corruption and collusion with special interests. If government officials are improperly influenced to ignore frauds, “the people,” through the whistleblower, are empowered to hold corrupt officials and special interests accountable. Over the past five years (2012– 16) whistleblowers used the qui tam procedure to recover $1.533 billion for the taxpayers in cases for which the government refused to act.
The SEC, IRS, and other recently enacted reward laws do not have this special qui tam provision. In SEC and IRS cases, if the government does not prosecute the alleged fraudster, no reward will be paid. As the reward laws mature, and the importance of qui tam becomes more obvious, these citizen empowerment tools most likely will be added to existing laws. But if your case falls under the FCA, you should be fully familiar with the qui tam provisions and carefully consider whether you want to litigate against the fraudster, even if the government backs off the case.
How Successful Are These New Laws?
What happens when whistleblowers are empowered, protected, and rewarded under the new reward laws?
As of September 2016, under the False Claims Act alone, the United States has collected $53.032 billion from fraudsters since the law was amended in 1986. The Justice Department confirmed that over $37.685 billion of these recoveries directly attributed to the “original information” provided by whistleblowers. These recoveries do not include billions in criminal fines, nor do they consider the benefits to the taxpayer from the debarment of corrupt federal contractors, mandatory compliance agreements regularly entered into between the government and the fraudsters to prevent future misconduct, or the imprisonment of some of the worst offenders.
