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New York Ag Obtains $40 Million Settlement With Investment Management Company For Tax Fraud, Marking Largest Tax Whistleblower Recovery In State History

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  • Posted on: Apr 28 2017

The False Claims Act (“FCA” or the “Act”) prohibits businesses and individuals from defrauding the government by knowingly presenting, or causing to be presented, a false claim for payment or approval. The FCA serves as the foundation upon which the states have structured their false claims act statutes.

Notably, the FCA does not cover tax fraud and securities/commodities fraud. Blowing the whistle on tax fraud is covered by the Tax Relief and Health Care Act of 2006, and blowing the whistle on securities/commodities fraud is covered by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Both acts offer whistleblowers the opportunity to report violations of the tax and securities/commodities laws and receive a reward for helping the government recover the money lost due to fraud or other illegal conduct.

The FCA has proven to be one of the most effective laws to recover money that has been taken from the government through fraud. The Act encourages individuals with knowledge of fraud against the government to come forward by authorizing them to file an action in the name of the government, and by rewarding them with a percentage of any recovery achieved by that lawsuit. A person who brings a successful “qui tam” action can receive between 15% and 30% of the government’s recovery depending upon whether the government intervenes in the action. If the government intervenes, the award generally falls between 15% and 25% of the government’s recovery. If the government declines to intervene and the whistleblower pursues the action alone, the award generally falls between 25% and 30% of the government’s recovery.

The New York False Claims Act

In 2007, New York passed its own false claims act statute (“NYFCA”). The NYFCA largely tracks the language of the federal FCA. In that regard, it imposes liability on a defendant for knowingly presenting false or fraudulent claims for payment/approval and making or using false records or statements material to a false or fraudulent claim. Like the federal FCA, treble damages are available, the knowledge requirement can be satisfied by showing recklessness, and whistleblowers can receive a portion of any recovery obtained by the state.

In 2010, the legislature amended the NYFCA. For relators, the amendments relaxed the pleading requirements. Relators no longer need to allege fraud with particularity. Instead, a complaint will withstand a dismissal motion “if the facts alleged in the complaint, if ultimately proven true, would provide a reasonable indication of one or more violations . . . and if the allegations in the pleading provide adequate notice of the specific nature of the alleged misconduct.” The amendments also simplified the statute of limitations by extending it to 10 years without qualification; previously it had been six years, or three years if the government had actual or constructive knowledge of the violation.

Notably, unlike the FCA, which, as noted, excludes false claims related to tax fraud, the New York amendments include such claims. Under the amended act, individuals and businesses with more than $1 million in net income or sales may be liable for tax fraud if the damages resulting from their improper tax filings amount to at least $350,000.

$40 Million Settlement with Harbert Management Corporation for Tax Violations

On April 18, 2017 (i.e., tax day), New York Attorney General Eric T. Schneiderman announced a $40 million settlement with Alabama-based Harbert Management Corporation (“Harbert Management” or “HMC”) and top executives at the firm in connection with allegations that HMC’s investment firm, Harbinger Capital Partners (“Harbinger Capital”), a $26 billion hedge fund based in New York City, failed to pay millions of dollars in New York State tax on performance income for several years. The settlement resolves claims that were brought by a whistleblower under the NYFCA.

“Our investigation uncovered a brazen and deliberate decision to avoid paying millions in taxes owed to New York State,” said Attorney General Schneiderman. “Harbert Management made a clear choice to skirt the rules and as a result, ordinary New York taxpayers were left footing the bill. On tax day, this sends a forceful reminder to businesses that if they think they can get away with tax evasion in New York, they should think again.”

When businesses operate both inside and out of New York City and New York State, they must apportion for tax purposes the part of their income derived from or connected with New York.  According to Schneiderman, in 2001, Harbert Management sponsored and organized the New York-based Harbinger Capital Partners Master Fund I Limited hedge fund (“Harbinger Fund”), and hired Philip Falcone as its primary investment decision-maker. Harbinger Capital Partners Offshore Manager LLC (“Offshore Manger”) served as the investment manager for the Harbinger Fund from 2002 through 2009.

As investment manager, Offshore Manager earned a performance fee income equal to 20 percent of the Harbinger Fund’s net profits. Offshore Manager’s members, which included several senior executives at Harbert Management, were required to pay New York State income tax on this performance fee income. According to the New York AG, they did not.

Schneiderman noted that in 2005, the individuals at issue were advised by outside accounting professionals that New York tax would be due on the fee income earned during 2004, despite the fact that some of them lived and worked in Alabama. Notwithstanding, Offshore Manager apportioned all performance fee income to the lower-tax state of Alabama, where Harbert Management’s headquarters were located and where back office and support functions for the Harbinger Fund were conducted.

During the ensuing tax years (in particular, 2005, 2008 and 2009), Offshore Manager continued to file returns that failed to report any nexus to, or performance income derived from, activities performed in New York. Not surprisingly, Offshore Manager did not correct any of these tax filings, even as the Harbinger Fund became more successful, and the New York investment team grew larger.

As noted, the settlement resolves claims that were initially brought by a whistleblower. The whistleblower, whose identity remains protected, will receive 22 percent of the settlement ($8.8 million), the largest amount and percentage share ever for a whistleblower in a NYFCA case not involving Medicaid.

A copy of the settlement can be found here.

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