When former UBS private banker Bradley Birkenfeld asked Stephen Kohn for help in applying to the Internal Revenue Service’s whistle-blower award program in September 2009, he could hardly have been in a deeper legal hole. A month before, Birkenfeld had been sentenced to 40 months in prison—10 months more than prosecutors had recommended—after he pled guilty to conspiring to help a client, Igor Olenicoff, evade U.S. taxes.
Birkenfeld was no one’s idea of an angel. (In their statement of fact, prosecutors said that he once smuggled a client’s diamonds out of the country in a toothpaste tube.) They asserted that after years of helping rich Americans hide their assets at UBS’s private banking unit, Birkenfeld blew the whistle only after he learned that his client was being investigated for tax fraud, and that he himself would be implicated.
But the timing of the highly publicized prosecution—Birkenfeld had just provided information that the IRS and the U.S. Department of Justice both credit with prompting the recovery of $5 billion in unpaid taxes from thousands of offshore accounts, and a $780 million fine against UBS—was a disaster for the IRS’s fledgling whistle-blower program. No whistle-blower in a rewards case, let alone one who the New York Daily News said should be “hailed as a modern-day hero,” had ever been successfully prosecuted. Birkenfeld’s conviction undoubtedly had a chilling effect: IRS whistle-blower submissions, which had been on the rise since the law came into effect in December 2006, plunged by a third from 2009 to 2011. By early this year, “there was almost a panic” about the viability of the program, says Kohn, name partner at Washington, D.C.’s Kohn, Kohn & Colapinto.
To put the IRS program back on the map would take a bold move. And ultimately, the institution did what was necessary: On September 11 the agency awarded Birkenfeld $104 million, one of the largest individual whistle-blower payouts in history.
The award was three years in the making. Far from the public eye, the IRS whistle-blower office had to grapple with the novel legal issues raised by the case, and confront institutional resistance. Could Birkenfeld, as a convicted felon who had participated in the misconduct, be eligible under the law? And if so, how would the award be calculated?
The motivations behind Birkenfeld’s decision to blow the whistle remain murky. Prosecutors asserted during his sentencing hearing that in June 2005, five days before Birkenfeld first contacted his superiors about his concerns, he had learned that IRS agents had raided Olenicoff’s home and seized documents incriminating Birkenfeld. Birkenfeld, in contrast, claimed that he was prompted by an internal UBS memo listing cross-border banking activities that were illegal in the United States—including practices that had been promoted by his superiors.
Birkenfeld resigned from UBS in October 2005, but not before initiating a campaign to alert UBS’s compliance department and in-house counsel to his concerns. When nothing much came of the internal campaign, Birkenfeld said in his plea memorandum, he decided to take his information to government authorities.
According to court documents, during a trip to the U.S. in April 2006, Birkenfeld met with David Schertler, of Washington, D.C., litigation boutique Schertler & Onorato. (The firm declined to comment, citing an ongoing fee dispute with Birkenfeld.) Schertler, a former prosecutor, advised him to seek immunity from criminal prosecution. The IRS’s whistle-blower statute, which affords certain protections, would not be enacted for another eight months; and even then, the new law did not prevent the office from referring a whistle-blower involved in a crime to the Justice Department. Still, in practice, Kohn says, whistle-blowers who have not initiated or directed illegal activities are rarely, if ever, prosecuted.
Schertler told prosecutors what his client had to offer, and requested immunity, but was unsuccessful. Despite the risks, in June 2007 Birkenfeld met with Kevin Downing, head of Justice’s offshore tax fraud crackdown, and a U.S. Department of the Treasury special agent. At the meeting, he handed over reams of internal UBS communications. And at the direction of the new IRS whistle-blower office, his lawyers also gave his whistle-blower claim form to the IRS agent.
What became of that original submission remains unclear. But the IRS whistle-blower office had only just opened its doors. It was so new, Birkenfeld’s attorneys later noted in court documents, that even those in the office were unsure about how the claims process would work.
With Schertler’s help, Birkenfeld’s next stops were the Senate and the Securities and Exchange Commission. In October he testified before the Homeland Security and Government Affairs Committee on Swiss bank practices.
But in May 2008, Birkenfeld was arrested at Boston’s Logan International Airport on a charge that he had helped Olenicoff evade reporting $200 million in assets. According to prosecutors, Birkenfeld had not been up-front about his own involvement in helping Olenicoff hide money. A month later he pled guilty to a single fraud conspiracy count. He was sentenced in August.
By September, Birkenfeld had fired his lawyers at Schertler & Onorato and was at his brother’s home in Boston awaiting incarceration when Kohn flew up for an initial meeting. Kohn wasn’t overly optimistic about Birkenfeld’s chances. Despite the enormous recoveries the IRS had made from his information earlier that year, the IRS hadn’t given out any awards under the program. And no convicted felon had collected an award under any other whistle-blower statute.
Kohn wasn’t a tax expert, so he contacted Dean Zerbe, a tax lawyer whom he knew from Senator Charles Grassley’s office. Grassley, the former Finance Committee chair and a longtime whistle-blower champion, had been the chief author of the IRS’s 2006 whistle-blower law, as well as a driving force in subsequent amendments to the False Claims Act. And Zerbe, who had been Grassley’s senior counsel, had helped draft the law.
The IRS’s existing whistle-blower program had badly needed fixing. Tips were literally being put in a shoebox, recalls Zerbe, who left for private practice in 2008. “They were getting the kind of whistle-blowers we didn’t want to get—the ‘Oh, my aunt didn’t pay her taxes’ tips. Not the big, serious stuff.”
Grassley’s IRS law draws heavily on the False Claims Act. But unlike FCA whistle-blowers, IRS informants can’t file a case on their own; it is up to the IRS to take action on tips. And the award—15–30 percent of any tax recovery—is determined by the IRS only after the related tax proceeds are collected. The award is nonnegotiable.
Kohn and Zerbe filed a new IRS whistle-blower submission that fall. According to Kohn, Birkenfeld’s earlier claim had not been docketed. (The IRS declined to comment on any issues pertaining to the agency raised in this story.)
At the time, the office was experiencing its own difficulties. There was resistance to the new law internally, especially in the office of the chief counsel. (In 2010 former chief counsel Donald Korb, after his move to Sullivan & Cromwell, told the publication Tax Notes that the whistle-blower provision was a “real disaster” for the tax system. “The IRS didn’t ask for these rules,” he said. “They were forced on it by the Congress.”)
Over the next 18 months, Zerbe, Kohn, and Kohn’s colleague David Colapinto submitted reams of evidence to show that Birkenfeld had been responsible for all the money that the IRS had collected from UBS and thousands of U.S. taxpayers under its amnesty program. In parallel, they offered the IRS team the legal foundations the office needed to make a case for Birkenfeld’s eligibility. Zerbe “was able to explain to the IRS the lawmakers’ intentions in drafting the law,” Kohn says.
The facts—Birkenfeld’s own long, voluntary, and well-documented efforts to expose Swiss banking practices in spite of his criminal vulnerability—convinced the whistle-blower office’s director, Steven Whitlock, and his staff that, far from being a bounty hunter, Birkenfeld had the potential to be their star whistle-blower, say Kohn and Zerbe. However, they add, Whitlock also knew that his recommendation would need to be iron-clad. The culture of the IRS is that “they’re going to create a policy, and apply the policy to everyone,” says Kohn. “It all had to be weighed and adjudicated within the agency.”
Zerbe says progress was initially impeded by the narrow focus of lawyers in the chief counsel’s office. “These guys live and breathe the tax code,” says Zerbe. “They were looking for answers to legal questions there. But the answers were in the FCA. The FCA’s provision defining who ‘planned and initiated’ had already been litigated. So one of the things we did was to move their hand down a few shelves from the tax laws to the whistle-blower law.”
There were also bureaucratic obstacles that could have derailed Birkenfeld’s claim. In contrast to the language of the new IRS law, the Internal Revenue Manual, the guide that case managers relied on for evaluating whistle-blower claims, instructed officials to consider disqualifying anyone who knew or should have known that a reported action would lead to noncompliance with the tax code. That appeared likely to exclude almost any participant. In a letter in June to IRS Commissioner Douglas Shulman, the National Whistleblower Center demanded that the manual be revised, arguing that the guidelines flew in the face of the drafters’ intentions as well as settled case law.
Meanwhile, Kohn and Zerbe met with Deputy Commissioner Steven Miller. “I told him, ‘We will sue you if you do not follow [the law]. This is what the law says,’ ” Kohn says.
The time was ripe for such a stance. Political pressure on the IRS was growing. After five years in place, the office had granted only two small awards under the new law. Grassley had repeatedly excoriated the whistle-blower office for the delays, and a critical report had just been issued by the Treasury Department’s inspector general. On June 21, citing the whistle-blower office’s mishandling of claims, Grassley held up two Treasury nominees.
Critically, the whistle-blower program had gained an internal advocate in the IRS deputy commissioner. Miller had begun pushing internally for the program; and on June 20 he wrote a memo to top IRS executives noting the program’s importance and setting a deadline for whistle-blowers to be notified of an award decision.
The internal and external pressures appeared to tip the balance. On August 6 the IRS called Zerbe to inform him that a determination letter was available for pickup: Birkenfeld was offered a take-it-or-leave-it $104 million. Zerbe and Kohn flew to New Hampshire to deliver the letter to Birkenfeld, who had recently been moved to a halfway house.
Kohn and Zerbe say they still don’t know how the IRS came up with the number. Under the IRS’s rules, if they had asked to see the documents upon which the award was determined, the preliminary award would have been withdrawn. “We didn’t open that Pandora’s box,” says Kohn, “but we had seen that they had a system.”
Birkenfeld, who was released in August, is a rich man. His lawyers stand to gain too—though which ones remains unclear. Kohn won’t disclose the terms of his retainer, but whistle-blower counsel typically get a third or more of any award. Meanwhile, Birkenfeld’s previous firm, Schertler & Onorato, asserts that it is owed 12.5 percent of the award under an October 2007 retainer agreement, arguing that its lawyers advised Birkenfeld in bringing the critical information forward. The judge overseeing the dispute has put $13 million of the award in escrow pending its resolution.
But the record-breaking award wasn’t solely about Birkenfeld. “When the lottery goes up above $100 million, that’s really to get millions of people to buy tickets,” says Kohn. “Likewise, it’s the big awards that get your whistle-blowers marching through the door.”