It all depends on what kind of amounts we’re talking about. If her investment income was still below the taxable threshold – or close enough to not justify an auditor’s time for the minimal returns to be expected from a full audit – they may have elected to ignore her non-compliance as to reporting.
The IRS doesn’t make arrests – as far as I know – for an initial failure to file. If there is evidence that the failure to file may not match the taxpayer’s lifestyle, then they will attempt to reconcile the observed evidence: large bank deposits, stock holdings, paid-off mortgages, expensive cars, boats and other property, with the taxpayer via audit and requests for information (and tax returns, of course). It’s only when they suspect or have direct evidence of “high value” tax evasion, fraud, money laundering or other highly lucrative and illegal activity that they “swoop in and arrest”. And they make a lot of mistakes in doing that, too, so they’re sensitive to the adverse publicity it generates – as much as they want to intimidate people into routine compliance. It’s a balancing act.
As for your mother-in-law not reporting even “somewhat substantial” investment income, they may still determine that the prosecution risk is not worth the expected return. They run actuarial tables, too, and they may have made a cold-blooded decision that “at the end of their lives we don’t want to prosecute these taxpayers – we’ll collect from the estate soon enough, anyway”.
So the question is (it’s a rhetorical question): “How much interest are we talking about?”
It’s also possible, depending on what paid her interest, that the interest was tax-exempt in the first place.