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Walmart Whistleblower Sees Openings to Invest in Claims Like His

Aug. 19, 2019, 8:49 AM

Charles Middleton may know the perils and potential payoffs of the IRS’s secretive whistleblower program as well as anyone.

For 10 years, he has grappled with the program over claims against two former employers, Walmart Inc. and billionaire Bill Koch’s Oxbow Carbon LLC. That has given unique insight that the former senior tax executive hopes will jump-start his next venture: an investment fund bankrolling claims like his.

The idea isn’t a new one. Some litigation finance and investment firms, such as Burford Capital Ltd., have been investing in a small number of IRS claims for years. Middleton said his Tax Truth Capital will differentiate itself by investing only in IRS claims, offering “more tailored assistance” from one whistleblower to others.

“The biggest difference is I am a tax expert first,” he said. “Other funds are finance guys first and last.”

Even by the standards of litigation finance, IRS whistleblower claims are an all or nothing gamble. Middleton knows that full well, as he hasn’t seen a penny from his claims. The average reward takes more than eight years to be paid out, if a payment is made at all.

But the risks can pay out big. The IRS in fiscal year 2018 made 217 awards to whistleblowers, totaling about $290 million after accounting for certain reductions.

Successful IRS whistleblowers can get anywhere from 15% to 30% of the money the government recovers as a result of their claim. The biggest payout to date went to former UBS Group AG banker Bradley Birkenfeld, who received $104 million for providing insider information on the Swiss bank’s schemes for helping American citizens dodge their taxes using offshore accounts.

The IRS—due in part to restrictions on disclosing taxpayer information and the agency’s culture—is notoriously stingy with the information it shares with whistleblowers, making it difficult to assess the likelihood of an award being paid out. But Middleton sees opportunity in recently enacted legislation that requires the IRS to update claimants on the status of their submissions, something he sought for years in letters to IRS investigators that mostly went unanswered.

Structure Matters

Whistleblower claim investments can work differently depending on the stage at which an investment is made, said Sarah Johnson, co-head of the litigation investing team at D. E. Shaw & Co. For example, in the case of IRS claims, some may involve litigation—making investments similar to more “traditional” litigation finance—while others won’t, she said.

She said her firm considers all types of whistleblower claims, including IRS claims, but rejects most because of strict underwriting standards.

“The ‘black box’ nature of the IRS whistleblower program has often made litigation funders uneasy,” Johnson added.

It can take the IRS years to decide whether to reward a whistleblower for a claim. Once a final determination has been made, claimants have the option to petition the U.S. Tax Court if they disagree. But some firms will make their investment long before litigation has started.

“Buying” a piece of someone’s whistleblower claim, whether it is tied to litigation or not, can raise potential regulatory or legal issues. To avoid these problems, firms will often structure their investments as “working capital” or nonrecourse investments in the eventual proceeds of the claim rather than as a purchase of a portion of the claim itself.

If the money being invested is going to the whistleblower’s lawyer, it will typically go toward covering any operational expenses, such as the costs of communicating with the IRS, preparing potential litigation, or doing research. Money going directly to the whistleblower will generally go toward personal expenses, such as rent, while that person waits for the government to process his or her claim.

Middleton said his fund would focus primarily on funding whistleblowers rather than their attorneys. Investments would be structured so claimants are effectively hired to work on their matter.

“The whistleblower would be paid for the whistleblower’s time and supporting the effort,” he said.

As Middleton says he knows first hand, whistleblowers can face repercussions, such as being blackballed by the industry they work in. That money can help them afford their living expenses while they wait for a potential payment from the government, he said.

Ideal Investment

Even with the lack of transparency, the long gaps between filing and potential payment, and the strong possibility there will be no reward at all, IRS claims can still be an attractive investment—especially very strong claims not involving litigation, said Andrew Cohen, senior vice president at Burford Capital.

The cost of filing Form 211, the form a whistleblower fills out to seek an award, is relatively small compared to the potential return, Cohen said.

“If a tax whistleblower has information that a company has not paid hundreds of millions of dollars in taxes, the cost of filing that information with the IRS is relatively small compared with litigation where if there are hundreds of millions of dollars in dispute, the cost of that litigation is going to be tens and tens of millions of dollars,” he said.

According to Cohen, an ideal IRS claim has aged a bit and received helpful feedback from the agency. Burford Capital also looks at whether the company that has been accused of fraud has put anything in public statements or annual reports suggesting the IRS has begun an audit on the tax years in the claim.

Middleton, similarly, says he will focus initially on mature claims—those that are nine-plus years old. He noted data from the IRS Whistleblower Office’s latest report showing that there are 4,906 claims filed in fiscal year 2010 that are still open.

“If they were meritless after nine years, the IRS should have denied them already,” he said.

Ripe for Growth

Middleton and his competitors are looking to see how much of a boost they get from The Taxpayer First Act (Pub. L. 116-25), signed into law July 1. It requires the Treasury secretary to notify whistleblowers about the status of their cases within 60 days of cases being referred for audit or taxpayers making payments to settle liabilities related to information whistleblowers provided.

It also allows the IRS to exchange information with whistleblowers to the extent disclosure is necessary in obtaining information that isn’t otherwise reasonably available to help the agency determine how much a taxpayer owes.

Cohen said it will probably take time to see how the new law affects investor demand.

“It has the potential to be for sure helpful to investments in tax whistleblower claims,” Cohen said. “It will depend on the level of disclosure that the IRS actually undertakes.”

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Bernie Kohn at bkohn@bloomberglaw.com

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