Whistle-Blowers Become Investment Option for Hedge Funds
By DAVID KOCIENIEWSKI
Published: May 19, 2010
Hedge funds have found a new market to invest in: whistle-blowers.
Informants who turn in tax cheats have to wait years to get their share of any reward from the I.R.S.’s recently expanded whistle-blower program. So hedge funds, private equity groups and other big investors are offering an alternative. They are essentially agreeing to buy a percentage of those future payouts in exchange for a smaller amount upfront to the whistle-blowers.
The surging size of the potential awards is driving all the interest. Three years ago, the I.R.S. began offering bigger rewards — 15 percent to 30 percent of whatever money the government recovered — in a move that has turbocharged the agency’s whistle-blower program.Where it once handled only a trickle of tips, often involving relatively small amounts of unpaid taxes, I.R.S. offices now receive a torrent of big money claims. Accountants and company employees have taken to trooping in bearing computer records and boxes of documents to back up their claims of underpayment by big companies.
In what is believed to be the first of these structured tax payouts, an I.R.S. informant who reported that an overseas multinational corporation had underpaid its taxes by billions of dollars received $4 million last month from a private equity firm. In exchange, the firm will receive a portion of the award the informant expects to collect eventually.
The whistle-blower’s lawyer, Eric R. Havian, declined to name his client or provide specifics of the deal, such as how much more than $4 million the investor expects to get. But he said the informant needed money to cover living expenses because he had had trouble finding work since filing his claim.
“The investors take a big bite out of the awards because they could get nothing if the I.R.S. decides not to pay,” said Mr. Havian, a partner in Phillips & Cohen, a firm in Washington specializing in whistle-blower cases.
“And for the whistle-blowers, the amount of the potential award is so astronomical — tens of millions, hundreds of millions of dollars — that they have to ask themselves, ‘How many times over do you have to be rich?’ and ‘Would I be better off with the guarantee of some money now?’ ”
Determining the value of a whistle-blower complaint is a risky endeavor for the investors. Confidentiality rules forbid I.R.S. officials from discussing the status of an investigation even with the whistle-blower, so investors are left to gauge the strength, and potential payoff, of any claim by reviewing the documentation provided by the informant and his lawyer.
I.R.S. officials acknowledge that they have discussed such agreements with whistle-blower lawyers, but the agency does not keep track of how many may have been executed.
Among the lawyers, hedge funds and investors who may provide the financing for class-action lawsuits and whistle-blower cases against government contractors, the reinvigorated I.R.S. program has attracted attention.
Even Credit Suisse, the big Swiss bank, which has been criticized by the United States and other governments for allowing tax evaders to use its private accounts to hide assets, has explored the possibility of investing in a whistle-blower’s award, according to lawyers involved in the negotiations. A Credit Suisse spokesman, however, said the bank had not made any deal and was no longer interested in one.
David Desser, whose capital management firm specializes in litigation finance, said the market was likely to expand once the I.R.S. awarded its first whistle-blower a check under the expanded program, which is expected later this year.
“As soon as the I.R.S. begins paying whistle-blowers, more people will realize that this is a whole new class of assets to be monetized,” Mr. Desser said. “It will be limited in size, because only a percentage of whistle-blowers will have incentive to sell. But for investors there is potential here for outsized returns.”
While the market in whistle-blower futures is in its infancy, investors have been requesting as much as 65 percent of any award an informant receives, according to lawyers negotiating possible deals. In the more established field of litigation finance, investors who underwrite the cost of a lawsuit get 5 percent to 50 percent of any legal settlement or jury award.
Correction: May 21, 2010
An article on Thursday about hedge funds’ investing in informants who turn in tax cheats misstated, in some copies, the business of Sullivan & Cromwell, where Donald L. Korb, former chief counsel of the I.R.S., now works. It is a law firm, not an accounting firm.
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