If a long trunk is necessary to be an elephant, then creativity must be the hallmark of a hedge fund. These alternative assets are now placing bets on another alternative asset—tax fraud whistleblower rewards.
Whistleblowers now stand to profit more handsomely from crying foul, thanks to a change in the way the Internal Revenue Service chases down tax cheats. Informants now receive up to 30 percent of the recovered amount, up from the previous maximum reward of 15 percent. But claims can take years to investigate, and some whistleblowers are unable to find new employment. (Unfortunately, the act of whistleblowing may have something to do with that.) And this is where hedge funds come in. Some have begun offering informants upfront payments in exchange for the remainder of the forecasted reward, according to the New York Times.
Such settlements can be risky investments for hedge funds. The IRS does not discuss cases under investigation, so funds must themselves verify the whistleblower’s claims. Even if the accusations check out, the IRS may recover less than the hedge fund anticipated—government investigators may discover some overlooked variable that reduces the amount, for example.
Pricing these settlements is “not really” any different from pricing other alternative assets, said Robert Korajczyk, professor of finance. “The quality of the pricing all revolves around the quality of the information available to the investor.” Uncertainties abound, he said, involving “not only the awards, given the current rules, but the possibility that the rules could change.”