When President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) on July 21, 2010, it was one of the most sweeping changes to financial regulation in the United States since the Great Depression.
Among other things, the act created the Financial Stability Oversight Council, whose role is to identify and respond to emerging risks that may pose a threat to the U.S. financial system. Members of the council will include the secretary of the Treasury, the Federal Reserve Board and SEC administrators.
Dodd-Frank applies to all public, non-bank financial companies, as well as larger public bank holding companies. However, the act’s implications can and should be used as best practices in other types of organizations. For example, private companies can benefit by implementing risk management processes in the same vein as those discussed in the act. Dodd-Frank also affects all federal financial regulatory agencies and almost every aspect of the nation’s financial services industry.
On May 25, 2011, the SEC adopted final rules implementing whistleblower provisions of Dodd-Frank. While politicians and practitioners have touted the Dodd-Frank provisions as an advancement in corporate governance, these provisions may provide less incentive for whistleblowers to come forward in tax-related matters than the existing rules on which they are based, the Internal Revenue Code, says James P. Martin, CMA, CIA, CFE, managing director of Cendrowski Corporate Advisors LLC.
“More specifically, whistleblowers may elect to report unlawful actions to the IRS as opposed to the SEC due to greater perceived anonymity and monetary rewards, a lower materiality threshold for tax assessments than financial statements and the administrative structure of the IRS and SEC whistleblower programs,” says Martin.
Smart Business spoke with Martin about Dodd-Frank and how it affects whistleblowers.
What types of pressures do whistleblowers face?
Whistleblowers often face significant pressure to remain quiet rather than report unlawful actions. Recent studies indicate that between 82 and 90 percent of whistleblowers are fired, quit under duress, or are demoted. Competitive employers have blacklisted more than 60 percent of whistleblowers.
For individuals working in a geographical area with few employers, or in an industry with little competition, the effects of whistleblowing can be substantial. Whistleblowers may find themselves ostracized by local, regional and national businesses for their actions. They may also face adverse social consequences.
How are these pressures mitigated by legislation?
Many whistleblower laws have anti-retaliation provisions. For example, whistleblower provisions of Dodd-Frank provide for anti-retaliation protection and state that the SEC will protect the identity of the whistleblower to the largest extent possible. However, a whistleblower must satisfy numerous conditions to receive these benefits — arguably more conditions than the Internal Revenue Code on which Dodd-Frank is based.
Many whistleblowers may not come forward because they might assume they will eventually be exposed. Whistleblower laws also incentivize individuals to come forward by offering them a bounty reward in the event that a governmental body successfully recovers monies.
How does Dodd-Frank compare to existing IRS whistleblower laws?
With respect to Dodd-Frank, the SEC must pay an award of between 10 and 30 percent to eligible whistleblowers. Section 7623 of the Internal Revenue Code, however, mandates a whistleblower award of between 15 and 30 percent of the amount recovered by the IRS. Thus, the IRS is required to minimally pay a 50 percent larger award than the SEC for information resulting in successful enforcement of unlawful actions.
Existing IRS whistleblower laws are also more favorable than Dodd-Frank due to the concept of materiality. In enforcing securities laws (including the Sarbanes-Oxley Act of 2002), the SEC is largely concerned with matters that are material to financial statements. The concept of materiality thus constrains the SEC’s actions. If the SEC feels an item is immaterial, it may forego investigation of the issue, and the whistleblower will not receive a monetary reward. The concept of materiality, however, largely does not apply to tax assessments.
As such, a whistleblower with knowledge of tax issues is incentivized to report the issue to the IRS as he or she is unconstrained by the concept of the materiality; the IRS may elect to investigate an issue that the SEC would otherwise not investigate.
How do the SEC and IRS differ in their administration of whistleblower claims?
Currently, the SEC lacks an independent whistleblower office to handle tips, whereas the IRS has a separate, independent whistleblower office, which serves as the central repository for all whistleblower claims. The director of this independent office reports to the IRS commissioner, decreasing the possibility that a claim remains uninvestigated by lower-level IRS managers. The IRS’s organizational structure, with its separate whistleblower office, may incentivize potential whistleblowers to report their concerns to the IRS as opposed to the SEC.
JAMES P. MARTIN, CMA, CIA, CFE, is managing director for Cendrowski Corporate Advisors LLC. Reach him at (866) 717-1607 or firstname.lastname@example.org.