Special Report on Whistleblowers with the Wake Forest Center for the Study of Capitalism with Sherron Watkins, formerly of Enron; Bill McGovern of Kobre & Kim; and John Kostyack of the National Whistleblower Center with hosts Richard Levick and Christina Elson of Wake Forest University Center for the Study of Capitalism. Listen here
Speaker 1: Welcome to the Corporate Counsel Business Journal’s daily podcast, In House Warrior with host Richard Levick, chairman of LEVICK, a global crisis and litigation communications firm.
Richard Levick: Good day, and welcome to In House Warrior, the daily podcast of the Corporate Counsel Business Journal. I’m Richard Levick, and today we are hosting a special report by the Wake Forest Center for the Study of Capitalism, where the executive director, Christina Elson on the subject of whistle-blowing.
Christina Elson: Good afternoon, welcome, and thanks for joining us today. My name is Christina Elson. I’m the Executive Director of the Center for the Study of Capitalism at Wake Forest University. We’re continuing our livestream events on the future of capitalism. Today, we’ll be talking about the role of whistleblowers in capitalism and in rule of law. I’m pleased to be joined by Richard Levick, CEO and chairman of LEVICK, and executive affiliate of the center. Richard, it’s great to see you.
Levick: Christina, it’s great to see you, and it’s always so nice to have you going to that pregnant pause just before introducing me. I can’t imagine what someone whispered in your ear. So delighted to be doing this program today, and we’ve got an extraordinary panel. Sherron Watkins, who was the Vice President of Corporate Development at the Enron Corporation, and famously wrote the letter to then Chairman Kenneth Lay in the summer of 2001, when she warned him about the company’s methods of accounting, that they were improper. In 2002, as many of you remember, she was one of the three women on the cover of Time Magazine named as persons of the year.
Also with us today, John Kostyack, who’s the Executive Director of the National Whistleblower Center, and he’s both an attorney and a nonprofit executive. He’s got a passion for many mission-focused organizations, and worked in conservation, and was the executive director of the Wind Solar Alliance. John, welcome to the show.
John Kostyack: Thank you for inviting me.
Levick: And then another old friend, Bill McGovern, who served as a Hong Kong solicitor is now based in New York as a New York admitted lawyer with the international law firm of Kobre & Kim. His practice focuses on high stakes, cross-border government enforcement and investigations matters. He previously served as a New York prosecutor, during which time he was appointed as a special assistant US Attorney for the Southern District of New York. Bill, welcome to the show.
Bill McGovern: Thank you, Richard. Nice to be here.
Levick: During the pre-show, I think in respect for Bill, we all agreed to do the rest of the program in Cantonese. I think that’s okay with everyone. Sherron, let me open up the first question. I know a huge sigh of relief that we’re not going to speak in Cantonese. I remember the night you and I spoke, probably 2002, I mean, things had unfolded, but they were still really hot and heavy. It was a largely personal conversation, because people forget that the people on the cover of Time magazine are also human beings going through this. How did you have the courage to stand up and become a whistleblower? I know in third grade, when they were all asking us what we wanted to do with the rest of our lives, you didn’t stand up and say, “I want to be a whistleblower.” How did that start?
Sherron Watkins: Well, it really was a knee-jerk reaction to two things. I found the accounting fraud in a way a lot of people do, where it’s a new position, you walk into the room, there’s the elephant in the room, and what’s this doing here? I had discovered the accounting fraud in late July of 2001. Two weeks later, Jeff Skilling, our CEO, quit. It was unexpected. He had been at the company for 10 years striving for the top job, he’d gotten it. January of 2001, eight months later, he’s quitting for no good reason. To me, it was the last little bit that I knew to convince me that this was accounting fraud. These structures had an expiry two years later. He was just getting out in order to be able to say, “Hey, when I left the company, it was in good shape.”
Ken Lay was chairman, stepping back into the CEO role. Truly, I just felt like I was a crew person on the Titanic. I know we’ve hit an iceberg, I know we’ve committed accounting fraud. You’re trying to warn the captain to sound the alarms, form a crisis management team, try to save business lines or cash, come up with a way to disclose this, and just basically warning the captain. The courage part was more, how do you get this horrible bad news to be believed? Just waking up at 2:00 in the morning trying to rehearse what I was going to say. But I fully thought the water pouring into the bottom of the ship was all I needed. This was accounting fraud, look into it. You’re going to discover the same thing. I was shocked that he dismissed me as one long voice, and basically told people, “Don’t go down to the bottom of the ship. Just convinced me we’re unsinkable, convince me that Arthur Andersen, our accounting firm is signed off on these things.” Just various ways of avoiding the inevitable. I went to him because I was optimistic and thought the facts would prevail.
Levick: John, you’ve got a fascinating story as well.
Kostyack: Well, Richard, this interesting, we hear Sherron’s story, and it’s a story that is quite typical among the whistleblowers that we talk with every single day. One is whistleblowers generally have a very keen sense of right and wrong. They also tend to be idealistic, they believe that by speaking up, they can make a difference. Then unfortunately, what is extremely common is retaliation and some variation on circling the wagons, where this news could be used for good. It could actually been used to reform a company to have it clean up its mess and rescue the business. But instead, there’s a defensiveness that takes hold. Usually, the whistleblower is not treating well, because they’re bringing forward news that the company doesn’t want to deal with.
This really was one of the reasons that we at the National Whistleblower Center are so motivated to work on winning legal protection for whistleblowers, because the systems that are in place within companies, time and again, prove to be inadequate to protect whistleblowers. It’s unfortunate. You wish there were different kinds of cultures being set up. But this continues to this day, where companies get news like this, and rather than responding constructively, they push the whistleblower aside, and they find a way to try to cover it up.
Levick: Bill, I know that you’re being uncharacteristically quiet and polite, so we’ll let you go now.
McGovern: Thank you. First of all, I’d just like to say it’s an honor to be on a panel with Sherron and John, both really well-established and passionate leaders in the whistleblower world. I appreciate their work. For me, I think I was drawn to these issues. If I think back to the very beginning of my career as I was trying to reconstruct this before our conversation today, Richard, I was a young assistant district attorney in the Bronx assigned to a unit to investigate police misconduct. Our responsibility was to deal with police officers who were maybe stealing evidence and money and whatnot, or engaged in excessive force and violations.
The key to doing that work that I learned early on is tips. The only way to advance that work as tips. It happens under the cover of night and dark alleys and vacant apartment buildings, and the only way is somebody who was alongside the officer who’s willing to step forward. That stayed with me, the importance of tips to investigators. Then cycling forward, and I mentioned this to Sherron before our meeting today, I joined the SEC about six months before the Enron case broke. I have really strong memories of, again, the importance of the whistleblower contribution to that case, to opening the door to the fraud that happened there. Now in my private practice, where I represent whistleblowers, all these issues are coming together for me.
One thing I’d like to draw out is, we get approached by all kinds of people who have information about corporate fraud, tax fraud. Some of them, there’s sort of two categories. There are many distinctions among them, but one category that I think about is complicit versus non-complicit. Because we’re a criminal defense firm in part, we have a number of people come forward and say, “I did something, but I know something.” That sets you off in one direction in dealing with that information. Then there are others that come to us who have no connection to the wrongful conduct, and are simply as Sherron did, standing up and saying, “There’s water coming into the boat and somebody needs to know about it.” That sets you off down a completely different path. Maybe I’ll pause there, Richard. Those are my thoughts for now.
Elson: Sherron, I’d like to go back to something you said about optimism, and being an optimistic person thinking that there was a way to right the wrongs that you were identifying. 18 years ago or so, what did you discover about the process surrounding the ability to do that, and the sort of support that you had, as you went forward with this? We look at today, 18 years later, we can talk about a lot of the processes that are in place, and the laws that have been put into place, but just tell us a little bit what that was like for you.
Watkins: Well, it’s interesting, because Richard mentioned the time Person of the Year cover, and that was Coleen Rowley from the FBI, Cynthia Cooper from WorldCom, and myself from Enron. They called it the Year of the Whistleblower. We’re all three women. We were the primary breadwinners for our family. We were first born, people of faith, but also we were all three raised in really small towns of like less than 6,000 population. I think when you grow up in that environment, you just overhear your aunts and uncles, or maybe your parents, “Hey, let’s go call the mayor. Did you see somebody dumped trash in that vacant lot off Main Street?” You’re all in this together, you’re reporting something, good stuff happens, it gets corrected. Well, in my younger days, I lived in Manhattan for six years, and I saw plenty of trash on the road. Where are you going to go? The big city, you just feel like a cog in the wheel.
I think all three of us were kind of optimistic, but also a bit naive. I really failed to realize how difficult it is for leaders to have this bad news land in their lap. I did some things that I would now do differently. I was on Ken Lay’s calendar. I identified myself on a Thursday, I was on his calendar for the following Wednesday. I worked my network, and there were people sending me all kinds of information. Like, “Oh, if you’re going to meet Ken Lay about the Raptors, let me send you this Excel spreadsheet. It shows blah, blah, blah, about our CFO at Andy Fastow and his shenanigans. Let me send you this board presentation,” where the board is making decisions about the Raptors, a company that’s, yeah, it’s a related party, but it’s not related. It’s a separate entity legally owned by someone else. That is the smoking gun that shows that the board viewed at all as one company, with Enron’s board making decisions about Andy’s structures.
It was kind of like that old commercial, and this is dating myself where the older kids have a younger brother, Mikey, let Mikey try the cereal. Let Mikey try it. Mikey likes it. He eats up the cereal. Well, it’s like all these people were pushing me information, and then depending upon how Ken Lay reacted, they were either going to join me on the bandwagon that we’ve got problems to correct, or what happened was they all read the tea leaves, Ken Lay did not want to hear this news, and they all went, “Oh, don’t ask me. I’m not an accountant. If Arthur Andersen has signed off on it, I’m sure it’s okay. I don’t know about these things.” Even the accountants in the room were like, “Well, I’m in finance now or treasury now. I haven’t practiced public accounting in over 10 years, so I just wouldn’t know.” They pleaded such ignorance because they saw that Ken Lay did not want to hear this.
Kostyack: Oh, this is a great opportunity for me to talk about some of the work that Sherron and I have done together working to try and advocate before the SEC to keep a strong whistleblower program. Because we have learned so much since that scandal. I think the two key lessons we have learned is we need to protect and incentivize whistle-blowing by creating a channel outside of the usual corporate reporting channels. We now have a confidential reporting mechanism through the SEC, and we now have financial awards for those who contribute to successful prosecutions, all that enables people who are inside of companies, who don’t want to jeopardize their career, to bring forward information, and to deal with crimes and corruption in a confidential anonymous way.
You don’t put yourself at risk of essentially exposing yourself before your entire company. A lot of times these internal email chains, once the company finds out that this is a potential crime underway, it goes right to the in-house counsel, and everything gets put under an umbrella of attorney/client privilege, which protects the company, but not necessarily the whistleblower. We have this now a success formula, and I’m grateful for Sherron’s work to help us continue advocating to protect that mechanism, that reporting mechanism, because if a company wants to create a truly whistleblower friendly situation, they have that ability. But for the many companies that have not yet done that, and are continuing to blackball whistleblowers and treat them badly, we now have an alternative channel. We really recommend people talk to qualified counsel and understand their options before they go down one of these two rounds.
McGovern: John, what I would add to that, in terms of the SEC, is that there has been a complete culture shift within the SEC Enforcement Division in favor of taking in and following up on whistleblower information. As you know, the program was built largely off of the made off miss, we’ll call it, where Harry Markopolos had sent in very specific, very detailed information into the SEC to describe the Madoff Ponzi scheme, which maybe not completely ignored, but were not followed up on. What we have today is a muscular, well-staffed, well-resourced whistleblower office, that I’ll just add a couple of points from my direct dealings with them, when we get a complaint that we think is right for the SEC, we obviously send it in through the automated channel that you need to do to get it in line for consideration. Then we’ll often reach out to contacts at the SEC that we think might have a connection to the information.
Oil and gas issue, maybe the Fort Worth Texas office would be the ones that would be most motivated to take in the complaint. We’ll call them and try to encourage them to take the complaint. What I’ve been so impressed by, and it gets by, I think frankly, better each year, is we need the right level of SEC attorney on this is their willingness to jump on board with you. You don’t get hit with what Sherron got at the company was, when all she had was the company to go to, and the response was, “How do we bury this?” You have incentivized SEC attorney. These are big cases for them, and the way you rise up through the ranks at the SEC is you make the biggest cases, and that’s how you build your reputation. They’re thankful to get the information, and if you can provide it to them in a way that’s easy to digest with evidence or pointers to where there might be other evidence, the whistleblower cases will move out. I’ll get shortly. I’m going to keep talking about SEC and other views, but the IRS program, I found to be somewhat different footing. But let me pause there and see if Sherron or John have anything to offer on the SEC program.
Watkins: Well, I for one, am very, very grateful that the bounty provisions within Dodd-Frank have pumped up the SEC’s Enforcement Division. I quite often discussed the fact that the seeds of what became the bigger fraud at Enron got started in late ’96. It’s arguable whether it was fraud or aggressive accounting, it certainly had I been able to anonymously report to a lawyer, report it to the SEC, I think the SEC would have come in. It was the mark to the model, where you have a hard asset. It’s not a commodity, it’s not liquid, and you’ve decided that you’re treating it like a commodity, and marking it to market, but the market is your model.
Well, the Enron ended up writing up so many assets, that when the market clearly fell, they now needed some other way to justify not writing those things down. That’s when they created these Raptor structures to have like, “Oh, we’ve sold this in the future to a third party. So this isn’t marked to market anymore and marked to the model. It’s based off a transaction that’s going to close in the future.” It was all fraudulent. The seeds were in ’96. I could have reported up to the SEC. They would have come in, slapped in one on the wrist, given them a fine, and I think Enron would have stayed on the tried and true path. They would have pulled back from what they were doing.
Here’s the thing that I always try to make this point. It would have seemed like a minor catch by the SEC. It wouldn’t have been a big deal. But sitting from hindsight from 2002, those two transactions that I was concerned with at ’96 became the much greater fraud that ended up bankrupting the company in 2001. When you stop the small hole in the dam, you never pat yourself on the back that you save the dam from collapsing and the whole community from being flooded and dying. You don’t ever measure the horrible mess. As you say you learned a lot from Madoff. That was a blow up. We learned a lot from these blow ups, like Enron. But I think we’re on the right path, and that’s why I’m so, I guess passionate about protecting those boundary provisions in Dodd-Frank.
Elson: Can you explain a little bit to us what those provisions look like, and what they afford people that take advantage of them?
Watkins: Well, I think John and Bill could discuss that best. John, probably. One of them, to mention a court case that adds a little current wrinkle, but I think if I were a company CEO, I would not like this new wrinkle.
Kostyack: I assume you’re referring to the digital realty case, Sherron.
Kostyack: Yeah, we have some bad court precedent we are working in Congress right now to get reversed because it essentially punishes people who start the process by letting their company know of potential fraud, and then ultimately turn to the SEC. The SEC essentially, excludes you based upon that internal corporate setting. Basically, this court ruling unfairly punishes whistleblowers and excludes them.
Watkins: Wait, if I get this right, me, Sherron, I report internally, “Hey, we can’t do this mark to the model. This isn’t right. I’m trying to get it corrected internally. I don’t get anywhere, and then I report up to the SEC. Yes, the SEC could still come in, slap in on the wrist, but no bounty for me. I’m disqualified. If I am considering whistle-blowing, and I am on my home computer, on my home phone, and I google whistleblower legal advice, all these law firms that have advocacy departments are not going to tell me, “Report to the SEC first. Don’t report internally.” That’s not really what you want. If I’m running a company, I want to be able to have both, report to me. Hopefully, I’ll do the right thing as CEO. But if not, I can report to the SEC and still get legal help and legal support because they have a way of being paid. I think this court case is detrimental to just everybody.
Kostyack: Senator Grassley, a Republican from Iowa, is a champion for whistleblowers in many respects, but he has legislation right now that he is trying to work through the system to get this court ruling reversed. SEC is meeting tomorrow with a series of whistleblower rule changes that potentially could be detrimental. We are working hard to fight them back, and Sherron was with us there at the SEC advocating against some of these changes. I won’t go into all the fine points of those. Let’s talk about the core ideas behind the whistleblower program and SEC. It really is a model for a whistleblower program elsewhere in our government, and we are working right now in Europe to try to expand some of these concepts there. This isn’t just SEC. We’re really talking about a template that’s now been established, that everyone can learn from because it has produced success as measured by monetary sanctions imposed upon people found to have committed fraud and large scale sanctions.
Here’s how the process gets started. Somebody who has information about securities fraud inside of a company has the ability to go to an attorney. The reason why I say attorney as opposed to directly to the SEC is we strongly recommend remaining confidential and anonymous. This is the best way to protect yourself from retaliation. An attorney has an ability to file on behalf of the whistleblower and remove the whistleblower’s name, essentially making the whistleblower anonymous even to the SEC. If the SEC finds the case to be warranting additional investigation, ultimately, they may need to know the name of the whistleblower. But at least at the outset, the attorney can protect the identity of the whistleblower to the greatest extent possible.
They can also advise the whistleblower on major strategic decisions. Well, how do I deal with my company as they inquire about my complaints? How do I deal with the media? Should I talk to the media confidentially? There are a number of very difficult judgments for whistleblowers to make, and we think the ultimate goal is to help the whistleblower achieve justice because they come into this process of seeing something wrong that they want to fix. What’s the best mechanism for achieving success on the ultimate outcome of fixing this corruption and avoiding the trauma that goes along with being exposed and retaliated against, which is substantial, as Sherron can educate us all on. There are ways to do that now, primarily by protecting the confidentiality and anonymity.
If at the end of the process the SEC achieves a successful outcome, usually in terms of monetary sanctions, usually through the administrative process without ever having to go to court, if there’s a criminal case, that goes to the court, and then Justice Department gets involved. But if it remains a civil case, the SEC can resolve the case, secure the sanction, and then as a statutory guarantee, the whistleblower gets a share of those sanctions, between 15 and 30%. The benefit of all this is not just the protection of the whistleblower, which is paramount to us, but is also the precedents that are being set every single day. This sends a message to people inside corporate America that there’s a way to tackle fraud and corruption, and this includes bribery, by the way, as well, without destroying their own lives.
If we can achieve that magic outcome, which is fix these excesses, this crime and corruption without destroying individuals lives of people who are trying to achieve justice, that is our ultimate goal. SEC has proven that it is possible. We are trying to get some of these key concepts over to the IRS, and other key agencies that are doing this kind of work, and also exporting to other countries, especially those that have multinationals operating there, such as Europe.
Levick: I’m curious about the potential rule changes that are being discussed, and I’m just wondering if you can offer any more color, and what the impetus is behind those. Is that a Chairman Clayton initiative, or what do you think that is?
Kostyack: That’s a fair question, Bill. There’s a lot of technical points here, for this audience may not want to get into it. But let me give you two high level examples of problematic changes. Far as motivations go, Chairman Clayton has said all the right things about being supportive of whistleblowers, and not wanting to harm the successful program. There are good friends of the program watching this rulemaking very closely from Congress. I think the impetus behind it is a chamber of commerce, which has had an agenda of undoing whistleblower protections for quite some time now, a long track record, and they’ve never liked some of the key provisions such as the award provisions.
The core problems are one, this notion that we should cap large awards, give the SEC discretion to basically take away some of the largest awards that are coming out of the programs and reduce them based upon some arbitrary consideration that only they would understand. It’s easy to take a shot at those who are getting millions of dollars, potentially, from this program. Why is this whistleblower entitled to that large award? Well, the fundamental answer to that question is, if you want somebody who is a top level executive that was most likely to have access to information about financial accounting fraud, you’re going to need to help them understand there is a lifeline if they were to be exposed, because the long history here is not just losing your job, but losing access to your entire profession. A large award for somebody who’s well-compensated is going to be the incentive that will be needed. We’re fighting hard for that one.
The other is just a technical barrier, but in place of whistleblowers essentially says, if you don’t fill out this specific form called the TCR form, we will disqualify you if you come to us through some other format, which is bizarre to us, considering that other parts of the SEC websites has things like contact SEC and click here. It’s almost punitive and arbitrary. Why would you not want to find any way to get people into the system? All we ask is, if you’ve submitted your information the wrong way, just tell us how to correct it. We’ll fill out your form. Anyway, we are working hard to prevent those changes from going forward. In general, we’ve had nothing but positive relationships with the SEC. This seems to be asked to be kind of strange, and we’re hoping that the noise we are making will make a difference.
Levick: Sherron, let’s go back a little bit in focusing on this issue of awards. What did it feel like being all alone? Let’s take on the Chamber of Commerce argument as well, which is on the other side of the equation, which is are people being incentivized to make these claims?
Watkins: Well, first off, I really don’t buy the Chamber’s argument that people are being incentivized to create mayhem where mayhem doesn’t exist. You go to work because you enjoy working at the company. You like the goods and services, or the camaraderie, the colleagues. You’re wanting thing you’re winning the company to do the right thing. All those people that create a problem, I think the SEC discovers that really quickly, and it doesn’t go anywhere. These law firms that are advocate for whistleblowers, they can see that it’s not a real thing, and it doesn’t go anywhere. But as Bill mentioned, you sure don’t want another Madoff to happen because you didn’t have the right people within the SEC listening to Markopolos.
I can’t work in corporate America. My peers are executives at companies. There’s a lot of hate coming my way weirdly from Arthur Andersen partners’ wives, because Arthur Andersen is no more because of their faulty audits of Enron. I’ve got people that returned my Christmas card, “Take me off your list.” There’s guilty executives, guilty Arthur Andersen people that somehow just feel like I’m to blame for the accounting fraud that Enron did, and Arthur Andersen blessed. It’s weird to go through life with enemies, when you feel like why, just because you pointed out something wrong. Now, I have said over and over again, there was a lot of media attention to my memos to Ken Lay. I was subpoenaed to testify in front of Congress, and I was one of the first people to just open the kimono about things that I thought were wrong at Enron, because there was off balance sheet debt and a few other things that I discussed with Congress.
I have made a living on the lecture circuit, traveled around the globe talking about leadership, ethics, accounting fraud, whistle-blowing. Now, it’s not as lucrative as a corporate job, but also my daughter, who’s now in college felt like she had a stay-at-home mom with a parent giving her undivided attention. I was able to go to most of her sporting events, and plays, and everything else as she grew up. For me, I’m making no complaints about my life, because money’s not everything. But I think for a lot of people, every conference, there’s someone that comes up to me, whose life has been ruined because they tried to stop some behavior at their company, and they were retaliated against, fired, blackballed, their reputation, destroyed.
For a lot of people, they will discuss even maybe getting a false claims award, or some other award 10 years down the road. But they said, “It didn’t do so much for my sons. They’re now grown adults, but in their formative years, they lived in a household that was consumed by fear, lack and insecurity.” This kind of bounty provision, I think does two things. That legal expertise that comes to the whistleblowers aid is helpful, but the emotional support. I happen to be very spiritual, so my home was never filled with fear and insecurity, maybe monetary insecurity, but my daughter never knew of any issues, because I try to walk this earth without too much worry and fear. But that’s just the blessing I have with my very spirit-filled background and faith. I just pity the people that their lives are destroyed, and their children’s lives are impacted and somewhat destroyed based off just trying to tell the truth to the powers that be.
McGovern: Yeah. I just want to echo a little bit of that. If you value using a whistleblower program to root out corporate fraud that wouldn’t otherwise be discovered, because it happens in the shadows, you’ve got to accept that payment, I called it a bounty as sort of a pejorative term, but payment of an award for that work, it has to be part of the equation. Without it, it’s the only way frankly, that lawyers that are commercial lawyers who run a business can get involved. It’s through contingency arrangements that tie to the time of the award, and without that, you won’t have lawyers next to these folks who are in such a desperate moment of their lives, and are holding on to such important information to our corporate lives, frankly. I think the two have to go together. I think it would be really short-sighted for the Chamber of Commerce or the commission to undo that part of the whistleblower program.
Elson: It sounds a little bit, as these processes have gotten really well worked out, that there’s also often the complication that they can get so structured that we run into things that John brought up earlier, that if you don’t fill out a certain form, we’re starting to sound more and more like the IRS here. How do you balance that?
McGovern: Yeah. I don’t mind picking that one up since you mentioned the IRS. When you think about the value of these programs, the value to the SEC program we’ve talked about in uncovering corporate fraud and why that’s good. You’re in the capitalism center, clearly a benefit to capitalism. The IRS program’s mission is different. The IRS whistleblower program is not focused on uncovering fraud. It may uncover fraud in the course of what it does, but its mission is to reclaim tax revenues that were never paid. In the current numbers and their most recent report, there’s a $500 billion tax cap every year. Those are taxes that don’t get paid, revenue that could go into the government that might eliminate the need to raise taxes on people who pay taxes, if you could fill that that hole.
Again, to talk about there’s also an award program in the IRS whistleblower program, very similar if you provide information that is significant and leads to recovery of tax proceeds, you’re entitled to a percentage of the tax proceeds uncovered. The math on that is staggering. In the 12 to about the 15 years the program has really been active, they’ve paid $1 billion in awards to whistleblowers who reported taxpayers who haven’t paid their tax, and they’ve recovered $6 billion in unpaid taxes. It’s a 1:6 ratio of investment in the program through paying the awards, and incentivizing people to come forward with all the risks that Sherron has spoken about, in exchange for $6 billion in tax revenue. It’s still a drop in the bucket of the overall tax gap that they’re trying to close. But the commercial benefit is there to the program.
The issues that I see in the program, and I know John’s organization has been very active in improving the IRS whistleblower program, and I’ll turn it over to him in a moment, because they’ve done great work at prodding that program forward. Also, very hung up on the technicalities of forms is the IRS. But I think more importantly, what I find missing is the incentive structure within the agency. I talked about within the SEC, there’s a built in incentive for SEC attorneys to find the biggest cases and piggyback with the whistleblower, and build a case. It’s beneficial to them within the agency, no question.
IRS, and I don’t know the reason why, again, maybe john has a theory, but my experience with the IRS program is they’re not incentivized in the same way, and they in fact, often take adversarial positions with the whistleblower, which is just bizarre to me. But I described the SEC, where they welcome you and say, “Thank you, and let’s talk, and when can we get together? Give us the documents.” Completely opposite in my experience at the IRS. It’s much more of a bureaucratic, “We’ll move on, and we’re ready to move,” agency rather than what I experienced at the SEC. Some of it is manpower and resources, which is obviously above the individual people you’re dealing with. It’s at the congressional level, and how budgets are allocated, but their headcount is actually shrunk around the whistleblower program, which is a shame.
I’m going to stop in a moment, but the analogy that I use sometimes is if you’re at the bottom of the canyon, and nightfall is coming, and it’s getting cold, and there’s no obvious path out, and there are people around with flashlights and ladders, wouldn’t you want to gravitate toward those people and try to find your way out? Instead, what we have found, and it’s not entirely true across the agency, and I don’t mean to denigrate the agency, and I understand the burdens they’re under and managing revenue collection in the United States, but what I find too often at the bottom of that Canyon is people shuffling around now looking for the ladders and the flashlights, and the canyon remains. I’ll stop there, John, and see if you have anything you’d like to offer on that.
Kostyack: There’s a lot of good stuff there, Bill. Thank you. I would say first of all, to respond to the question I got this whole part of our conversation going, do awards generate frivolous claims? I think the best sources of information on this are the regulators and prosecutors who run these award programs. Every one of them is willing to go out, and regularly goes out into the media and says, “These whistleblowers are the key to our success. We cannot prove these complex crimes without the people on the inside who have the expertise and the information.” If you are somebody who is committing a high level corporate fraud, or engaged in money laundering, or other forms of tax evasion, you’re going to be a fairly sophisticated criminal. There’s no way that the IRS, or the SEC, or any other agencies going to get to the bottom of this without somebody who has close access to this information and expertise on the sophisticated accounting methods that are being used.
We think that that argument has been disproven time and again every single time we get a new annual report from the SEC or IRS, and the people who run these programs saying, “Thank you, whistleblowers, we could not do this without you.” To me, it’s a really a frivolous argument. I’m still waiting for an academic study that the other side can point to that raises legitimate questions about these award programs.
Watkins: Now, hold on, John, if you put that out there, then we’re going to go buy a professor.
Kostyack: I guess there’s an academic for hire ready to go on that one.
Elson: Most of them still are for hire, I think.
Kostyack: Let’s hope not.
Elson: Let’s hope not.
Kostyack: These are successful programs that are bringing forward quality information. About Bill’s point about the IRS, I would agree with the overall assessment is not as successful the SEC. Probably the two big sources of problem are the really intense need for secrecy oftentimes leads them to not communicate with the whistleblowers. This is a real disincentive for whistleblowers to step forward. I just put in information five years ago on this tax crime, and I still haven’t heard back. Well, the other people out there, the potential whistleblowers are hearing that and saying, “Am I really going to take this kind of risk?”
Then, in general, we think that there could be more communication, and Congress could help us with that. We’ve been working on some of those things. But they had the core ideas, they have the confidential submittal process. There are anti-retaliation provisions, and there are awards that are guaranteed by statute. Adjustments are needed, but not wholesale. It is a good idea. There’s new reporting this weekend that came out on the extent of money laundering that’s going on around the world right now. It is out of control, and it’s an outrage really. These are criminals who are finding ways that take the proceeds of their crimes and getting them into legitimate businesses, and the banks are looking the other way. We have a lot of work to do in that space, and the IRS will be essential to that project, as well as regulators, not just in the US and beyond.
I would like to make a plug for the fact that the EU, the European Parliament passed in 2019, a directive that calls upon every member country to pass whistleblower legislation by the end of 2021. Those of us who care a lot about these high level crimes have an enormous opportunity right now to work in Europe to essentially take some of the key lessons we’ve learned here in the States and apply them there. Talking about a powerful one-two punch having European regulators work with the US regulators on some of these challenges. I also want to plant a seed. I think if you look at Enron 2002, if you look at Lehman Brothers in 2009, we have some additional early warning signals that are coming around right now on some big high level corporate frauds.
I think the biggest one we should be worried about is the so called carbon bubble. Many, many companies are right now unprepared for the shift to the new world of climate change, both in terms of their assets being exposed to the impacts of climate change, and their business models being exposed to the rapid move toward decarbonization. We’re talking trillions of dollars at stake. We’re talking central bankers from around the world have formed networks to deal with this problem. This is a gigantic asset bubble that is essentially a financial accounting crime that is not being addressed. How are we going to address it? We think whistleblowers are the only possible way. It’s highly complex. There’s very few prosecutors and regulators that understand this at the level they need to without the help of corporate whistleblowers.
Levick: John, just for a couple points of clarification, and where we go in the last quarter of this conversation, I think you’re referring to the BuzzFeed report that just came out on suspicious activity reports from the banks and trillions of dollars being traced, but not acted upon. For those viewers and listeners who are interested in following it up, and an issue that any other time would be front page news day in day out, almost at the level of Madoff, but hardly made the front page in most American cities. For those of you who don’t know what a newspaper is, they used to exist before they went to birdcages, and they had a front page, and that’s where the key news was.
Let’s talk about this issue you just raised, which is what’s next? Why don’t you start just go a little further, but I’d like to hear from Bill and Sherron on that in terms of what’s next. Because if there is, if there is a change in administrations in November, and you have a Democratic Congress as well, and that’s a big if, but if you do, you have an appetite for review of regulation that one might argue doesn’t exist at the moment.
Kostyack: What I would say, and I do want to hear from my colleagues, I’ll make this brief, there’s so much to be said, is that the scrutiny on large companies is greater than ever right now. With climate change, recent polling showing the number one concern among Democratic voters, people really concerned about the treatment of workers in the era of COVID, the level of concern about corporate behavior, I think, is forcing corporations to reevaluate how they put themselves forward. You saw the Business Roundtable come out with a big statement about stakeholder capitalism. These things are starting to show up now in annual reports of companies in terms of their deep commitment to sustainability and worker fairness and the like, and it’s showing up in financial statements and the like.
The real question that we would ask, and whistleblowers are asking, how much of this is real, and how much of it is PR. I think there is going to be very much scrutiny from the financial regulators and any new administration to get to the bottom of this. On the climate change side, there’s a big push for this notion of stress testing. How ready are companies for this new world? Many very smart people are saying, large corporations are not ready. I do expect rather than just being an academic exercise, I expect that not just in the United States, but around the world, people are going to be much more familiar with financial regulators than they have been in recent years.
Levick: Bill, you want to take the next stab at that?
McGovern: I think one of the areas I see growing is data-driven whistle-blowing, meaning somebody who was not inside of the company and had his or her hands on documents that show misdeeds, and then they carry them out. But the people who, through big data tools, and otherwise detect aberrations in datasets that lead them to conclude that there must be something funny going on. I think probably the best current example that I can think of, it comes out of the False Claims Act world, which focuses on damage to federal or state government programs. There’s a lot of publicly available Medicare and Medicaid data out there, and there are groups of business people/data scientists who have businesses to study, put together the resources and they study this data and find, for example, that a certain procedure is happening at a 10X frequency in a certain zip code. They’re able to tie that to the doctors and draw a conclusion that there’s upcoding of Medicare or Medicaid procedures going on in a particular hospital in a zip code, without ever having stepped foot in it, simply looking at the data. The government has that ability as well. SEC already is a big consumer of big data, so they’re doing their own work. But it’ll be interesting to see what directions whistleblowers can take that in.
The two other forces I see at play, complexity, John mentioned it, the stunning complexity of financial products, and the need to bridge the gap frankly, between an SEC examiner or an IRS level agent, and the complexity, and I think the way to fill that gap are whistleblowers who are willing to step into it. Then last, and also John, piggybacking here again on John, globalization. I think SEC reports from what country they get most of their whistleblower complaints, they do one through 20. China every year is in the top three or four. When I was living in Hong Kong, one of the announcements as whistle-blowing became more popular in the US was an app that Chinese phones had built in that allowed them to report corporate fraud through an app, and it gets delivered to who knows where. There’s thinking globally about these issues, and I think it’ll just drive us to, frankly, better results, better governance, and rooting out more fraud.
Watkins: From my personal perspective, I think the title of this program is about capitalism. I do think it’s a system that does need checks and balances. When Enron collapsed E. J. Dionne from the Washington Post quoted James Madison, that when our country was being formed, Madison said, “If men were angels, no government would be necessary.” E. J. Dionne changed it like if businessmen and capitalists were angels, no regulation would be necessary. We need some regulation. We’ve had monopoly abuse, child labor, worker safety. Whistleblowers become a check and balance on things getting out of whack. I think it keeps the system healthy.
I’m going to get back on my soapbox, that because of Dodd-Frank and the reward program, we now have so many legal advocates for whistleblowers, that they might have started out as advocates towards financial fraud and things going to the SEC, but as we’ve heard, discussed today, it’s now towards the IRS, towards government fraud, their False Claims Act claims, and we do have so much more data available to us. Enron, turns out, was manipulating the California energy market. We had all kinds of tapes that the [inaudible 00:52:26] actually had subpoenaed and made public. Caring retired individuals in California painstakingly listened to all these tapes. This big data idea that there are people out there ready to right wrongs that they aren’t really directly related to, that is actually helped by the fact that you still have this legal community, this large legal community that’s there that understands what to do with this data, and what agency within the government is best to take it to.
I think we’re on the right path to have a healthy system. We don’t want to be a banana republic, we don’t want corruption running rampant, and we’ve lost some checks and balances as industry changed and morphed over time. Part of that is the active shareholder, and people actually taking an interest, an active interest in the company’s sale. Now everyone knows their investment portfolios and mutual funds, and they couldn’t even tell you what they’re invested in. We’ve lost that kind of check and balance, and I’m happy to see new ones come about. I think there’s a lot of indirect benefits to the whistleblower programs that are in place for financial fraud that’s helping other frauds be discovered.
Elson: Sherron, I’d just like to point out that the approach that you’re taking of the checks and balances, where we do want to think about the role of and the relationship between business, maybe civic organizations or scientists out there looking for these data or seeing themselves as a check. Then, of course, the role of government because when we start to drift too far over to our surveillance capitalism, it also can get a little strange, where everyone’s reporting to the Communist Party and the Chinese government. That’s not really where we want to go either. It’s a difficult balance in all three of those. There’s roles, I think, is what you’re saying. I hear me say there’s really important roles for everyone in this. It’s not just the corporations. It shouldn’t just be run internally to keep them on the straight and narrow, right? Ideally, that’s what we’d love. We’d love that, and there are many businesses that do that very successfully their whole careers, and don’t have these problems.
Watkins: I’m certain there are loads of corporations with the right internal reporting mechanisms. Bad news gets delivered to the top, the situation gets rectified, and no one ever hears about it because the company is well-run, and they’re paying attention to those things.
Kostyack: Risk of focusing too much on the bad actors. I have to say my dad was a small business person. He always taught me to play by the rules, and so to me, one of the things that motivates me to do this work is I know there are a lot of honest people out there, and they are being screwed by the cheaters.
Elson: That’s right.
Kostyack: We work a lot on illegal logging and illegal fisheries. You think about all these people out there trying to do that kind of work right, who are getting undercut every single day by those who would violate all the environmental protections, and pay the bribes to get the word out and get the fish out. It is important that it don’t sound like you’re anti-business. That said, I do think we’re at a new phase in this country, especially where the respect for large corporations is on a downward trend. Every day companies need to earn and re-earn their social license, right? They want to operate in our wonderful legal system, which makes capitalism possible by having predictability and making a safe place to park your assets. But you can’t have that for free. You have to be willing to play in a way that is perceived by the policymakers and the public that elects those policymakers as you are playing by a fair set of rules.
When you see, again, I bring up climate change. We’re in the middle of a climate crisis, and we have many companies that are not acting consistently with sustainability of our planet. But I can give other examples too. People now have more access to information than ever before, and they can see through this, they can see the BS, and they want accountability. Companies are going to have to raise their game if they want to continue on that particular social license.
Levick: We only have a couple minutes left, so if we could go in reverse order from the beginning of the show, and start with you, Bill, and if you would, each of you with just a one minute key takeaway that you’d like our audience to take with them today.
McGovern: Coming off of John’s comments, my view representing whistleblowers, two takeaways for me. The importance to our capitalist system to have people who are courageous enough to come forward and provide information that wouldn’t otherwise be available to the government. That’s number one. Then number two, the need for governments to be responsible in accepting and managing that information, protecting the anonymity, if that’s an issue of the whistleblower, and being at least sensitive to the survivability factors that whistleblowers have to go through. That translates, for example, in the IRS program, when you have a 10-year wait from filing to an award, which the average wait now for the largest awards, that really needs to change if whistleblowers are going to come forward and be able to survive the path.
Watkins: I’ll just close with one of Enron’s core values was communication, and their tagline to support communication was a Martin Luther King Jr. quote, that our lives begin to end when we remain silent about things that really matter. Of course, he’s really talking about your soul and your purpose in life. I like to reverse that. Perhaps our lives begin to soar when we do take courage and speak up about things that really matter.
Levick: Sherron Watkins, Bill McGovern, John, I know you got into a lot of these key issues, but we’ve got just about 30 seconds if you want to get the closing thought, and then I’ll turn it over to Christina.
Kostyack: Well, I would just say Sherron represents a much larger community of people, and these are the heroes of our society. We really benefit every single day from the work of whistleblowers, and we should be thanking them, and more importantly, we should be protecting them. We look forward to working with all of you to make sure that that happens.
Elson: Thank you, Richard. Thank you. This has been a great panel. Great informative discussion for our Wake Forest audience. We thank you so much for taking the time to join us today. Wish you all the best in your endeavors. We will definitely be posting some information about how people can reach out to you on our website and on our social media. We look forward to following the recent developments in these whistle-blowing policies as they move forward. I will thank the audience for joining us today. Our next live discussion will be around the role of sports, capitalism, higher education, and the changing market. Please join us for that. I wish everyone a good afternoon. Thank you.
Levick: Thank you so much for joining us today on this special report on the issue of whistle-blowing with my co-host Christina Elson, the Executive Director of the Wake Forest Center for the Study of Capitalism. Thanks for joining us and we’ll see you tomorrow.
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