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IRS Whistleblower Rewards to Convicted UBS Whistleblower Birkenfeld? The Rule of Law Will Sort It Out.

November 28, 2009
Michael Sullivan

In “Protecting Whistleblowers from Criminal Prosecution,” we expressed our amazement at how UBS “whistleblower” Brad Birkenfeld got himself prosecuted for a federal felony while attempting to set himself up for rewards through the new IRS Whistleblower Program. Birkenfeld’s case is highlighted in recent articles by Lynnley Browning in Friday’s New York Times and by Martha Brannigan in Saturday’s Miami Herald.

To attorneys with prosecution experience who represent whistleblowers, it is shocking that Birkenfeld apparently missed a clear opportunity to avoid prosecution altogether by simply “coming clean” and telling the whole truth about his own actions at the outset.

We have a much different take on Birkenfeld’s case than those who suggest it should scare away potential IRS whistleblowers. Whistleblowers who are willing to tell the truth from the start can easily avoid Birkenfeld’s fate, so long as they follow the law and counsel’s advice to disclose all. At the same time, we take issue with critics who say Birkenfeld should not even be considered for an IRS Whistleblower reward, since the “rule of law” should determine the answer to that question.

First, Birkenfeld’s case should make other potential IRS whistleblowers careful about pursuing IRS whistleblower claims, but not fearful. Most IRS whistleblowers face no realistic chance of prosecution, especially since the government often must depend on whistleblower information to make cases.

Even those relatively few whistleblowers with possible exposure such as Birkenfeld (who admitted to engaging in a tax fraud scheme) can often negotiate protection from prosecution, but only if they tell the whole truth from the start, and follow the rules for obtaining protection. This was a topic in the “IRS Whistleblower Boot Camp” panel discussion that I led this past March, with panelists including IRS Whistleblower Office Director Steve Whitlock–how to protect the whistleblower who has potential exposure.

Why Birkenfeld apparently thought he could get away with withholding information from the government about his own wrongdoing–a foolish move to us–remains a mystery, even after we reviewed his sentencing transcript. That horrendous judgment call distinguishes Birkenfeld’s case from all other whistleblower cases we have seen.

At Birkenfeld’s sentencing, prosecutor Kevin Downing explained that Birkenfeld’s information was extremely valuable to the IRS, and that Birkenfeld probably would not have been prosecuted had he simply been forthcoming by disclosing his own misconduct in assisting tax evasion:

“BUT FOR MR. BIRKENFELD FAILING TO DISCLOSE HIS INVOLVEMENT WITH THE FRAUD AND THE U.S. CLIENTS THAT HE AIDED AND ASSISTED IN TAX EVASION, I BELIEVE WE WELL WOULD HAVE NONPROSECUTED MR. BIRKENFELD. BUT GIVEN THE FACT THAT HE REFUSED TO PROVIDE THAT INFORMATION AND LED US DOWN A COURSE WHERE WE HAD TO START [TO] INVESTIGATE MR. BIRKENFELD AND HIS ACTIVITIES, THAT IS WHY WE ARE HERE TODAY, THAT IS WHY HE WAS INDICTED, AND THAT’S WHY HE PLED.” (Birkenfeld Sentencing Tr. 12-13)(emphasis supplied).
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IRS “Voluntary Disclosure” Program Inundated by More Than 14,000 Taxpayers

November 17, 2009
Michael Sullivan

We have followed with great interest the IRS Voluntary Disclosure Program, especially after the UBS settlement created fear of discovery in many U.S. taxpayers with offshore accounts.

IRS Commissioner Doug Shulman announced that the IRS Voluntary Disclosure Program was flooded with submissions by more than 14,000 taxpayers, according to the Wall Street Journal.

IRS Whistleblower cases have been impacted–and in some cases probably pre-empted–by the submissions of recalcitrant taxpayers to the IRS Voluntary Disclosure Program. The IRS Criminal Investigative Division in certain areas
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New SEC Whistleblower Rewards and Whistleblower Protections Approved by House Committee–But Improvements Are Needed

November 9, 2009
Michael Sullivan

Since the Madoff and Stanford schemes proved ruinous to so many investors, many have asked why the SEC has no meaningful “whistleblower” program to expose wrongdoing, a topic we have written about previously.

Perhaps Harry Markopolis’ voice is finally being heard, albeit faintly. Last week, the House Financial Services Committee approved legislation that would expand both whistleblower rewards and whistleblower protections, among other things.

Still, past experience with the False Claims Act and the IRS Whistleblower statute shows that the proposed rewards need to be beefed up to be effective.

The “Investor Protection Act of 2009” (excerpted below) also would increase the SEC’s budget and make other changes designed to strengthen enforcement.

The new rewards to whistleblowers would be up to 30% of monetary sanctions of more than $1 million:

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New ‘‘Health Care Fraud Enforcement Act of 2009’’ Includes Health Care Whistleblower Provisions Aimed at Kickbacks

October 30, 2009
Michael Sullivan

The battle against those who steal taxpayer dollars through Medicare fraud and other health care fraud took a step forward this week. The Senate is now considering the “Health Care Fraud Enforcement Act,” which will enhance the government’s tools used to investigate and remedy Medicare and Medicaid fraud.

After a Senate Judiciary Committee hearing Wednesday on “Effective Strategies for Preventing Health Care Fraud,” Senators Leahy, Kaufman, Specter, Kohl, Schumer, and Klobuchar sponsored the new anti-fraud measure.

Excerpts of the Senate announcement follow:

The bill makes straightforward but critical improvements to the federal sentencing guidelines, to health care fraud statutes, and to forfeiture, money laundering, and obstruction statutes, all of which would strengthen prosecutors’ ability to combat this particularly destructive form of fraud. These improvements include:

o Sentencing increases: The bill directs the Sentencing Commission to increase the guidelines range for health care fraud offenses and clarifies that the full potential scope of the fraud should be considered at sentencing.

o Redefining “health care fraud offense”: The bill includes all health care crimes within the definition of “health care fraud offense,” regardless of where they are codified. (ERISA, drug marketing, and kickback crimes are currently not included) This change will make available to law enforcement the full range of antifraud tools, including criminal forfeiture and obstruction penalties, to combat these offenses.

o Improving whistleblower claims: Kickbacks lead to unnecessary and risky medical care and pervert the doctor-patient relationship. This bill clarifies that all payments made pursuant to illegal kickbacks are false for purposes of the False Claims Act.

o Creating a common-sense mental state requirement for health care fraud offenses: Some courts have held that defendants must be aware that their conduct violates a specific provision of criminal law in order to be held accountable. This bill restores the original intent of Congress that a person is guilty of a health care offense if he knowingly does what the law forbids.

o Increasing funding: Money spent on health care fraud prevention and enforcement is returned manifold through costs savings and civil and criminal recoveries. This bill authorizes a modest, yet significant, increase in federal antifraud spending of $20,000,000 per year through 2016.

The new bill would add to legislation earlier this year to strengthen law enforcement statutes aimed at fraud, the Fraud Enforcement and Recovery Act.

Of particular importance to qui tam whistleblower cases under the False Claims Act, the nation’s major whistleblower law, the new bill removes any ambiguity that “kickbacks” violate the False Claims Act. The official summary discusses kickbacks in section 2(c):

Section 2(c). Kickbacks
All too often, health care providers secure business by paying illegal kickbacks, which needlessly increase health care risks and costs. When a doctor’s independent judgment is compromised by a kickback, the patient faces the risk that the doctor is making decisions that are not in the patient’s best interest. In addition, excessive payments to doctors increase health care costs, may result in unfair competition, and may compromise medical research independence and the standards of scientific integrity.

The Department of Justice has had success both prosecuting illegal kickbacks and pursuing False Claims Act (FCA) matters predicated on underlying violations of the Anti-Kickback Statute (AKS). Nevertheless, defendants in such FCA cases continue to mount legal challenges. A court recently held that, even though a device company may have paid a kickback to a doctor to use a particular medical device, the bill for the procedure to implant the device was not false because the claim was submitted by the innocent hospital, and not by the doctor. United States ex rel. Thomas v. Bailey, 2008 WL 4853630 (E.D. Ark.) (Nov. 6, 2008). In other words, a claim that results from a kickback and that is false when submitted by a wrongdoer is laundered into a “clean” claim when an innocent third party finally submits the claim to the government for payment. This has the effect of insulating both the payor and the recipient of the kickback from FCA liability. This obstacle to a successful FCA action particularly limits Department’s ability to recover from pharmaceutical and device manufacturers, because in such instances the claims arising from the illegal kickbacks typically are not submitted by the physicians that received the kickbacks, but by pharmacies and hospitals that had no knowledge of the underlying unlawful conduct.

This section remedies the problem by amending the AKS to ensure that all claims resulting from illegal kickbacks are false, even when the claims are not submitted directly by the wrongdoers themselves. (Notably, in such circumstances, neither AKS nor FCA liability will lie against an innocent third party that submitted the claim but lacked the requisite intent required under those statutes.)

The full text of the bill is below:
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Health Care Fraud Strike Force Targets Medicare and Medicaid Fraud

October 25, 2009
Michael Sullivan

With the nation’s health care costs growing, a DOJ and HHS initiative to combat health care fraud continues to show progress.

Building on past enforcement efforts, in May 2009 the government announced its Health Care Fraud Prevention and Enforcement Action Team (HEAT), as part of what is now a Cabinet-level battle against Medicare fraud. To date in FY 2009, the Department of Justice has recovered close to one billion dollars in health care fraud cases, and has obtained 300 convictions.

Last week, the government announced
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New False Claims Act Amendments Strengthen Enforcement of Health Care Fraud and Procurement Fraud Laws

October 25, 2009
Michael Sullivan

Defrauding the government of taxpayer dollars has gotten tougher over the past five months.

Important changes to the nation’s primary anti-fraud statute, the False Claims Act, took effect on May 20, 2009, when the Fraud Enforcement and Recovery Act of 2009 became law.

Among the most significant changes, Congress clarified and corrected the False Claims Act by legislatively overruling certain court decisions that sought to limit the scope of the Act, including Allison Engine Co. v. United States ex rel. Sanders, 128 S. Ct. 2123 (2008); United States ex rel. Totten v. Bombardier Corp., 380 F.3d 488 (D.C. Cir. 2004), cert. denied, 544 U.S. 1032 (2005); and United States ex rel. DRC, Inc. v. Custer Battles, LLC, 376 F. Supp. 2d 617 (E.D. Va. 2005), rev’d, 562 F.3d 295 (4th Cir. 2009).

These important 2009 changes to the False Claims Act include the following:

1. The amendments expand the definition of “claim,” and fraud directed against government contractors, grantees and other recipients is now plainly covered by the law.

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Part 2: IRS Whistleblower Program Report by Treasury Inspector General for Tax Administration (TIGTA)

October 8, 2009
Michael Sullivan

We wrote yesterday about the just-released report on the new IRS Whistleblower Program by the Treasury Inspector General for Tax Administration (TIGTA). The “rest of the story” should be told.

Some history is essential to evaluate how far the handling of whistleblower (or “informant”) claims has progressed since the newly created IRS Whistleblower Office was formed in early 2007, and what is still needed.

Although information provided by whistleblowers is extremely effective in exposing fraud, before 2006 Congress had not authorized an effective IRS whistleblower rewards program–and some in Congress affirmatively opposed one.

Some of this history is described in a 2006 report by TIGTA, which helped prompt Congress to create the new IRS Whistleblower Rewards Program. That 2006 report described the value of informant claims–and also the absence of any centralized process within the IRS for coordinating those claims. It described what the new IRS Whistleblower Office Director and still-to-be-hired staff would inherit in February 2007.

First, the 2006 IG Report leaves no doubt about how valuable “informant” information has been to the IRS–even when there was no coordination of informant claims:

The Informants’ Rewards Program has significantly contributed to the IRS’ efforts to enforce tax laws, but additional management focus could enhance the effectiveness of the Program as an enforcement tool and make the process more accommodating to informants. Our analysis of IRS data indicated that examinations initiated based on informant information were often more effective and efficient than returns initiated using the IRS’ primary method for selecting returns for examination.

Nonetheless, perhaps based in part on the past hostility toward the IRS’s making effective use of whistleblowers before 2006, the old “informant” program was no program at all. This was the “mess” that the new Whistleblower Office Director and tiny staff of four inherited and had to start revamping in 2007, as described by TIGTA’s 2006 report:
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IRS Whistleblower Program: Inspector General Urges Whistleblower Protection from Retaliation and Administrative Changes

October 7, 2009
Michael Sullivan

Today the Treasury Inspector General for Tax Administration (“TIGTA”) released a Report on the IRS Whistleblower Program that urges Congress to protect IRS whistleblowers from retaliation by employers, and recommends various administrative changes to the Program.

The Report’s title, “Deficiencies Exist in the Control and Timely Resolution of Whistleblower Claims,” is misleading to this writer, who has followed the progress of the new Program since its inception. Before Congress created the new IRS Whistleblower program in December 2006, the Inspector General had observed
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IRS Whistleblower Office Issues Latest Annual Report to Congress

September 28, 2009
Michael Sullivan

The IRS Whistleblower Office has released its Annual Report to Congress, for the fiscal year ended September 30, 2008. Some highlights are below:

First, the IRS Whistleblower Program has experienced explosive growth since Congress authorized these new IRS Whistleblower rewards in December 2006.

According to this Report, “the initial results suggest that whistleblowers with significant knowledge are coming forward as a result of the changes to the award program. We received claims that appear to meet the section 7623(b) criteria on 46
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Health Care Fraud Lawyers to Analyze Recent Amendments to False Claims Act

September 26, 2009
Michael Sullivan

At the “Advanced Health Law” seminar on October 9, attorneys prosecuting and defending cases of alleged health care fraud will discuss the important new amendments to the False Claims Act. I am honored to be the panelist who will discuss these important new provisions from the perspective of representing whistleblowers (known as “relators”) who bring qui tam whistleblower cases under the False Claims Act.

These significant changes to the False Claims Act took effect on May 20, 2009, when the Fraud Enforcement and
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Health Care Industry and 2009-2010 Changes to False Claims Act

June 6, 2010
Michael Sullivan

The health care industry is adjusting to major changes to the nation’s major “whistleblower” law, the False Claims Act.

Both in 2009 and 2010, Congress has removed obstacles to whistleblowers’ use of this anti-fraud statute to address Medicare and Medicaid fraud, as well as fraud affecting every other federal program. As we have written about previously, the Fraud Enforcement and Recovery Act of 2009 (“FERA”) overruled key judicial decisions that had undermined the the False Claims Act’s effectiveness.

This year, the landmark health
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Offshore Tax Evasion Scheme to Defraud IRS Alleged in Indictment of Miami Beach Developers

May 27, 2010
Michael Sullivan

A high priority for IRS Whistleblower cases is the abuse of offshore “tax havens” or offshore financial centers to conceal income from the IRS that is subject to U.S. taxation. Over drinks in Miami Beach recently with IRS agents who worked the massive UBS matter, I discussed some of the recent announced cases the IRS has made involving offshore abuses.

Using shell corporations and “nominee” entities established in the Cayman Islands, Switzerland, or a host of other countries that market “secrecy,” those looking to conceal income from the IRS, or assets from potential creditors, have made offshore tax havens a booming business.

An interesting example of allegations of offshore tax violations was described in the Justice Department’s announcement yesterday of the indictment of two Miami Beach hotel developers. Mauricio Cohen Assor and his son, Leon Cohen-Levy. They were charged with conspiring to defraud the United States and filing false tax returns. The government alleged as follows:

According to court documents, the two men and their co-conspirators used nominees and shell companies formed in tax haven jurisdictions, including the Bahamas, the British Virgin Islands, Panama, Liechtenstein and Switzerland to conceal their assets and income from the IRS. In order to further conceal their assets and income from the IRS, court documents state the men also provided false and forged documents to banks, opened bank accounts in the name of nominees, titled their personal residences and luxury vehicles in the name of shell companies, filed false and fraudulent tax returns, failed to file other tax returns, suborned perjury in a civil matter pending before the New York Supreme Court by directing individuals to testify falsely under oath, and induced other individuals to make false statements to federal law enforcement agents.

Both defendants are permanent resident aliens who, in 2000, received approximately $33 million from the sale of the New York Flatotel, according to the government. They transferred the proceeds using various Swiss bank accounts in the names of foreign nominee entities, including at least one “bearer share” corporation.

When bearer shares are used, the corporation’s records do not list its owners, as the owners are whoever has physical possession of the stock certificates. As IRS Special Agent Scott Johnson testified by affidavit, “[b]earer share corporations are often used to hide the true ownership of assets because ownership records are not maintained and nominee officers and directors are often used to control the affairs of the corporation.’

Later, the defendants allegedly transferred the funds to accounts of nominee companies at that bank’s New York location, and later to the escrow account of a Florida attorney. The government also alleged that defendants used the money to “fund a luxury lifestyle for themselves and for their family members.”

Offshore tax abuse remains a great priority of the IRS, and thus is a major focus of many IRS Whistleblower claims. The new IRS Whistleblower Program recognizes that whistleblowers have an enforceable right to 15-30% of what the IRS recovers based on information whistleblowers provide.

The government’s full press release is below:
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More Details of UBS Whistleblower Birkenfeld’s Prosecution Explained in Washington Post

May 15, 2010
Michael Sullivan

The Sunday, May 15, 2010 Washington Post will include more details on a perplexing question we have written about: how did UBS whistleblower Bradley Birkenfeld get himself prosecuted for a felony, and earn a prison sentence, while he sought to become an IRS whistleblower?

The story by David S. Hilzenrath explains more of the “dance” between Birkenfeld and prosecutors as he apparently partially told the government what he knew about wrongdoing at UBS.

Birkenfeld blew an opportunity to avoid prosecution for his
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Should SEC Whistleblowers Have Right to Share in Recoveries That They Cause?

May 4, 2010
Michael Sullivan

Congress is at a crossroads in deciding whether there will be a meaningful SEC Whistleblower Program–for the first time.

At this morning’s Offshore Alert conference in Miami, we heard from the SEC Chair’s Senior Advisor Stephen Cohen on this subject, as well as insight from IRS Whistleblower Office Director Steve Whitlock on how the IRS Whistleblower Program is now designed to encourage whistleblower claims.

As we have observed previously about the bills that would create an SEC Whistleblower program, past experience shows that an enforceable right to a meaningful reward is essential to cause whistleblowers to come forward.

The SEC apparently resists guaranteeing whistleblowers a minimum percentage of dollars recovered, as evidenced by the House version of the bill that lacks this feature. The SEC’s Steve Cohen explained that the SEC does not wish to commit funds that might otherwise go to harmed investors. He nonetheless contended that the SEC’s proposal may be better for whistleblowers because it pays from a special fund designated for this purpose, based on sanctions imposed, not collected.

Compare the experiences of the Justice Department and the IRS, however. When each had whistleblower statutes that provided no meaningful right to a reward, whistleblower claims were small and few. We have written extensively about the dramatic successes of the False Claims Act since its rewards increased to meaningful levels in 1986.

Likewise, IRS Whistleblower Office Director Steve Whitlock described again today how large whistleblower claims have exploded since December 2006, when Congress doubled rewards to whistleblowers to 15-30%, and created an enforceable right to those rewards.

History proves that most whistleblowers simply will remain silent, without a right to meaningful rewards. The SEC will be dividing a small pie unless Congress again embraces this principle.

To protect investors, those with information about fraud must have every incentive to speak up–as early as possible–and to be heard. The Madoff debacle proved that point.

In our experience in representing whistleblowers in the financial industry, the Senate’s version of the SEC whistleblower changes is highly preferable. It creates a right to awards of 10-30%.

There are still glaring deficiencies, such as the provisions excluding auditors who have tried unsuccessfully to call attention to fraud within the organizations and auditing firms involved. It will be an interesting next few weeks as Congress debates the final result.
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State False Claims Acts Must Be Updated to Include New False Claims Act Changes, Grassley Warns

April 30, 2010
Michael Sullivan

Senator Chuck Grassley is making sure that the States take advantage of important, recent improvements to the federal False Claims Act–with the help of financial incentives. In doing so, Grassley highlighted a defect in Oklahoma’s False Claims Act that should disqualify any state with a similar defect from these financial incentives.

As we have discussed at length, in the Deficit Reduction Act of 2005, Congress recognized how effective the False Claims has been in recovering money for fraud against the government, by creating financial incentives for states that enact equally effective versions of the federal False Claims Act.

“Weaker” state versions of the False Claims Act do not qualify for the incentives, however. The Inspector General for the Department of Health and Human Services must approve a state’s False Claims Act before the incentives are available. So far, the IG has approved fourteen state FCAs, while disapproving six other state acts.

Since then, Congress has closed loopholes in the False Claims Act exploited by those who steal taxpayer funds. The 2009 Fraud Enforcement Recovery Act made significant improvements to strengthen the nation’s major whistleblower law, as we have summarized before. In March 2010, Congress modified the False Claims Act’s “public disclosure” and “original source” provisions as part of the major health care overhaul, the Patient Protection and Affordable Care Act.

This week, Grassley asked the Inspector General and Attorney General to review existing state False Claims Acts to ensure that they comply with these recent improvements to the federal False Claims Act.

“Updated information will help states fine tune existing state laws and state-level proposals, in order to be eligible for the federal incentive and beef up fraud-fighting efforts,” Grassley said. “This kind of effort at the state and federal level is more important than ever as Medicaid programs are expanded and face new burdens and growing fiscal challenges. Every dollar lost to fraud is one less dollar for those who depend on the program and harms the sustainability of the Medicaid program.”
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IRS Whistleblower Office Announces Important Changes, New Procedures for IRS Whistleblower Program

April 28, 2010
Michael Sullivan

IRS Whistleblower Office Director Steve Whitlock announced important, long-awaited developments in the new IRS Whistleblower Program yesterday at the Second Annual “IRS Whistleblower Boot Camp” in Washington.

First, Director Whitlock finally announced how the IRS will share information that will allow whistleblowers to understand the Whistleblower Office’s decisions about what awards are made to whistleblowers.

A year ago in my interview with the IRS Whistleblower Office Director, Mr. Whitlock discussed the need to solve the vexing question of how the IRS can share this information with whistleblowers and their attorneys, while also complying with legal requirements for confidentiality of taxpayer information under section 6103 of the Internal Revenue Code.

The new procedures described yesterday for what will happen with IRS Whistleblower claims–once the IRS has recovered money as a result of a whistleblower claim– are as follows:

1. After the Whistleblower Office receives a report from the IRS Operating Division that handled the matter, the Whistleblower Office Analyst will review the files and recommend an award to the whistleblower.

2. That recommendation then will go to the Whistleblower Office Director for review and approval.

3. A summary of the award recommendation then will be provided to the whistleblower and the whistleblower’s attorney for comment. That summary will identify:

(a) the amount of money collected by the IRS based on information provided by the whistleblower;

(b) the recommended award percentage to the whistleblower (15-30% of the funds recovered, unless an exception under the statute applies to lower the percentage);

(d) the recommended award amount; and

(e) the whistleblower’s options upon learning of this recommendation.

In welcome news to whistleblower attorneys, the IRS Whistleblower office also will make available a “detailed” award recommendation to whistleblowers and their attorneys who sign a confidentiality agreement. The whistleblower and counsel then may review in person (but not copy) the documents in the IRS administrative file that are the basis of the award recommendation, and comment to the Director about the award. Violation of the confidentiality agreement will lead to reduction of the award.

The new procedures are to be published in the Internal Revenue Manual in June 2010, and later will be included in regulations, with an opportunity for notice and comment.
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New IRS Whistleblower Program Developments Discussed This Week at “IRS Whistleblower Boot Camp”

April 25, 2010
Michael Sullivan

On Tuesday, April 27, 2010, the Second Annual “IRS Whistleblower Boot Camp” will convene in Washington, D.C., sponsored by Taxpayers Against Fraud.

Representatives of the IRS Whistleblower Office will discuss the latest developments in the IRS Whistleblower Program, though which tax whistleblowers can receive up to 30% of recoveries by the IRS. Other IRS and DOJ representatives will take part as well, as they analyze what lawyers representing IRS whistleblowers should know in pursuing these claims.

Like last year’s program, this one is a sell-out. I am looking forwarding once again to moderating a panel discussion, this time on “Protecting IRS Whistleblowers from Criminal and Civil Liability.”

Among the important new developments to be discussed is the “clarification” issued in February 2010, on what contacts the IRS may have with whistleblowers (or “informants”) who are current employees of taxpayers who are the subject of whistleblower claims. (The full notice is reprinted below.)

We expect there may be other major new developments to report at this year’s IRS Whistleblower Boot Camp. We will update you upon returning from D.C. this week.
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SEC Charges Goldman Sachs With Fraud in Synthetic CDO Tied to Subprime Mortgages

April 16, 2010
Michael Sullivan

As Congress finally works to establish a more meaningful SEC whistleblower program, the SEC has just announced that it has charged Goldman Sachs and one of its vice presidents with fraud, in connection with a “financial product tied to subprime mortgages, as the U.S. housing market was beginning to falter.”

Often maligned for failing to protect investors before the recent financial crisis, the SEC now charges that Goldman structured and marketed a “synthetic collateralized debt obligation” (CDO) like those that “contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market,” and then violated the federal securities laws in connection with that product.

The SEC’s Complaint alleges a “securities fraud action against Goldman, Sachs & Co. (“GS&Co”) and a GS&Co employee, Fabrice Tourre (‘Tourre’), for making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (“CDO”) GS&Co structured and marketed to investors. This synthetic CDO, ABACUS 2007AC1, was tied to the performance of subprime residential mortgage-backed securities (“RMBS”) and was structured and marketed by GS&Co in early 2007 when the United States housing market and related securities were beginning to show signs of distress.”

The Complaint further charges:

Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. (“Paulson”), with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO, played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (“CDS”) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future. GS&Co did not disclose Paulson’s adverse economic interests or its role in the portfolio selection process in the term sheet, flip book, offering memorandum or other marketing materials provided to investors.

In sum, GS&Co arranged a transaction at Paulson’s request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson’s role in the portfolio selection process or its adverse economic interests.

The full SEC anouncement is reprinted below.
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SEC Whistleblower Program–The SEC Inspector General’s Report

April 5, 2010
Michael Sullivan

Post-Madoff, we have followed the legislative efforts to help establish an effective SEC whistleblower program. We know that the Senate Banking Committee in particular has worked hard in attempting to devise the best overall arrangement to encourage and reward whistleblowers who report fraud within the SEC’s jurisdiction.

Shortly before Congress authorized the first meaningful IRS Whistleblower Program in December 2006, the Treasury Inspector General for Tax Administration issued its report on many of the changes needed for the IRS to use whistleblowers effectively.

Now, the SEC’s Inspector General David Kotz has issued his report, “Assessment of the SEC Bounty Program.” No one is surprised that it concludes that the SEC has not effectively encouraged, used, or rewarded whistleblowers over the past decades. Perhaps this report will pave the way for something meaningful–like the TIGTA report that preceded the now-promising IRS Whistleblower Program, which rewards whistleblowers with 15-30% of the government’s tax recoveries.

The SEC report recommends adopting the “best practices obtained from DOJ and the IRS into the SEC bounty program.” The SEC Inspector General’s report states as follows:

Although the SEC has had a bounty program in-place for more than 20 years for rewarding whistleblowers for insider trading tips and complaints, our review found that there have been very few payments made under this program.
Likewise, the Commission has not received a large number of applications from individuals seeking a bounty over this 20-year period. We also found that the program is not widely recognized inside or outside the Commission. Additionally,
while the Commission recently asked for expanded authority from Congress to reward whistleblowers who bring forward substantial evidence about other significant federal securities law violations, we found that the current SEC bounty program is not fundamentally well-designed to be successful.
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Well Worth a Read: SEC Whistleblower Harry Markopolos’ “No One Would Listen: A True Financial Thriller”

April 5, 2010
Michael Sullivan

After meeting with the Department of Justice in Washington recently to discuss another whistleblower case, I picked up Harry Markopolos’ recent book, “No One Would Listen: A True Financial Thriller.” It is a fun and engrossing read, with humor that I did not expect to find in this subject.

We have written previously to applaud Harry Markopolos’ work in figuring out Bernie Madoff’s Ponzi scheme, and then in trying to get the SEC’s attention for years. In an era when fraud is being exposed in so many industries through the courage of whistleblowers, his book shows just how paper-thin our government’s resources can be in recognizing and stopping the next huge fraud scheme.

Neither I nor my law firm has any financial interest in recommending this book, and no one has asked me to mention it, but I do believe that any thinking person will enjoy it.
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