New York Settles Largest-Ever Tax Whistle-Blower Case

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By John Herzfeld

Investment managers for the Harbinger Capital Partners LLC hedge fund have agreed to pay $40 million to resolve a whistle-blower case alleging that they willfully avoided paying New York tax on performance income over six years, state Attorney General Eric T. Schneiderman (D) said.

The settlement is the largest recovery in a tax case brought under the whistle-blower provisions of the state False Claims Act (FCA), Schneiderman said in an April 18 statement. The announcement was timed to coincide with the federal and state tax filing deadline ( New York ex rel. [redacted] v. Harbinger Capital Partners Offshore Manager LLC , N.Y. Sup. Ct., No. 100416/2015, settlement 4/18/17 ).

Members of Harbert Management Co. of Birmingham, Ala., identified as the sponsor of the $26 billion New York-based Harbinger fund, deliberately skirted New York nexus requirements to hide the portion of their income they were obligated to apportion as taxable in the state, Schneiderman alleged.

“This settlement is more than five times larger than the next largest tax FCA settlement to date and suggests that the idea of giving monetary incentives to whistleblowers to report on big-ticket tax violations is coming of age,” Randall M. Fox of the New York law firm Kirby McInerney LLP told Bloomberg BNA.

Fox is a former chief of the Taxpayer Protection Bureau under Schneiderman, who himself as a state senator sponsored the 2010 law applying the state FCA to tax cases. Schneiderman set up the bureau after taking office as attorney general in 2011. It has since recovered about $135 million, with roughly half of the amount from tax-related cases, Fox said.

In a statement, Schneiderman said a probe by his office had found “a brazen and deliberate decision to avoid paying millions in taxes.” He said that Harbert Management had “made a clear choice to skirt the rules and as a result, ordinary New York taxpayers were left footing the bill.”

Wrongdoing Denied

A spokesman for Harbert, in a statement, said the company and the individual taxpayers that joined in the settlement “adamantly deny that they committed any wrongdoing.”

He said that they had “made a commercial decision to settle this legacy issue relating to personal taxes” to protect the interests of the company’s investors and “avoid protracted and distracting litigation.”

The company, he said, “engaged in a constructive dialogue” with Schneiderman’s office and had “presented substantial evidence demonstrating that our filing position was adopted in good faith, and in consultation with leading external tax advisors.”

The state probe, according to Schneiderman, found that investment manager Philip Falcone and other members of the Harbert Management team assigned to the Harbinger fund had run afoul of state apportionment rules for businesses that operate both in and outside of New York.

The Harbert team managed the fund from 2002 to 2009 from a New York city office, under the Harbinger Capital Partners Master Fund I Limited hedge fund and Harbinger Capital Partners Offshore Manager LLC, with Falcone as its primary decisionmaker, the attorney general said.

Partnership Got Aggressive

As investment manager, he said, Offshore Manager earned performance fee income in an amount equal to 20 percent of the Harbinger fund’s net profits. Offshore Manager’s members, which included several Harbert senior executives, owed New York state income tax on the performance fee income earned by Falcone’s trading activity in New York, according to the attorney general.

Schneiderman said a pair of Alabama-based Offshore Manager executives responsible for tax compliance had rejected advice from outside accountants that New York tax would be due on 2004 fee income. One of them, he said, wrote in a 2005 email that the partnership “may get aggressive” in taking the position that all the relevant income was from Alabama, a lower-tax state.

A week later, Offshore Manager’s controller signed a tax return that apportioned zero percent of its performance fee income to New York state, without any indication that the outside tax professionals backed that position, Schneiderman said.

Instead, he said, Offshore Manager apportioned all performance fee income to Alabama, where Harbert Management’s headquarters were located and where back office and support functions for the Harbinger Fund were conducted. The return didn’t mention Offshore Manager’s New York office location and provided only the Alabama address for the partnership’s place of business “both in and out of New York State,” he said.

Probe Continuing

The 2004 return denied any nexus to New York or the existence of any New York income, losses or deductions, Schneiderman said.

Offshore Manager, even as the New York operation grew, took the same positions for 2005, 2008 and 2009, and didn’t file New York returns for 2006 or 2007, he said.

When Harbert Management separated from Falcone and Offshore Manager in 2009, Schneiderman said, Offshore Manager got written assurances that the Alabama-based members would continue to be responsible for New York taxes that hadn’t been remitted if their tax position was ever reviewed.

The settlement resolves allegations against Harbert Management and the Alabama-based members of Offshore Manager, Schneiderman said. The probe is continuing, he said.

Model for Others?

Many tax practitioners have criticized the use of the New York whistle-blower statute in tax cases, but specialists in false claims cases welcomed the development.

Dean Zerbe, a Houston attorney with Zerbe Miller Fingeret Frank & Jadav LLP who helped draft the Internal Revenue Service whistle-blower law in 2006 when he was tax counsel to the chairman of the Senate Finance Committee, said the “important victory” represented by the New York settlement suggests that other states and the federal government should consider applying the false claims model to tax cases.

“The more success we see in New York, the more we should ask why other states aren’t passing similar laws—especially California,” he told Bloomberg BNA in an email.

The New York record, he said, also “begins to raise the question of whether Congress should consider changes at the federal level to make the False Claims Act available for going after big-time tax cheats.”

Relator’s Share: $8.8M

A settlement share of $8.8 million went to the whistle-blower in the case, whose name was redacted in the settlement document filed in state Supreme Court for New York County. His attorneys welcomed the resolution in statements released with Schneiderman’s announcement.

Neil Getnick of Getnick & Getnick LLP in New York called it “an extraordinary example of the results that can be achieved on behalf of taxpayers through the public-private partnership provided by the whistleblower laws.”

Jordan Thomas of Labaton Sucharow LLP in New York said that the tax provisions of the state False Claims Act “allow whistleblowers to bring to light misconduct previously invisible to regulators.”

But the Harbert Management spokesman characterized the whistle-blower as someone “we believe to be a disgruntled former employee.”

He said that none of the income at issue was received by the company and that “based on tax advice from multiple outside professionals, the settling taxpayers paid their full share of tax on all relevant income” to Alabama, “where they lived, worked and operated the Offshore Manager.”

The attorney general’s office, the spokesman continued, “has come to a different conclusion.” The settlement findings represent “the AG’s version of events,” he said, calling the account “one-sided” and saying that it had omitted “important facts and events” showing good faith.

To contact the reporter on this story: John Herzfeld in New York at jherzfeld@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

For More Information

Text of the settlement agreement is at http://src.bna.com/n2O.

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