Alabama based Harbert Management and top executives at the firm will pay $40 million to settle a New York tax whistleblower case.
Harbert Management was the fund sponsor for Harbinger Capital Partners, a $26 billion hedge fund based in New York City.
The settlement resolves whistleblower allegations that members of Harbinger’s investment manager failed to pay millions in New York State tax on performance income for several years.
The case alleges that the defendants evaded New York State and City taxes by shifting income derived from Harbinger from New York to Alabama to avoid New York’s higher tax rates.
The New York Attorney General’s office said that the investigation into the conduct at issue in the matter continues.
The fund was represented by Charles Leeper of Drinker Biddle in New York.
The whistleblower was represented by Neil Getnick of Getnick & Getnick and Jordan Thomas of Labaton Sucharow.
The whistleblower, whose identity remains protected, will receive $8.8 million – or 22 percent of the settlement.
“Our investigation uncovered a brazen and deliberate decision to avoid paying millions in taxes owed to New York State,” said Attorney General Eric 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.”
The settlement is the largest tax-related recovery by the Attorney General’s office, resulting from an action filed under the New York False Claims Act.
Getnick told Corporate Crime Reporter that the case “underscores the efficacy of the New York State’s False Claims Act qui tam approach for pursuing tax fraud by taking full advantage of whistleblowers and their counsel teaming up with the government to achieve successful recoveries.”
“The IRS whistleblower program would benefit from similar partnerships,” Getnick said.
Thomas said that “the tax provisions of the New York False Claims Act allow whistleblowers to bring to light misconduct previously invisible to regulators.”
When businesses operate both inside and out of New York City and State, they must apportion for tax purposes that part of their income derived from or connected with New York.
In 2001, Harbert Management Corporation, an investment management company based in Birmingham, Alabama, sponsored and organized the Harbinger Capital Partners Master Fund I Limited hedge fund, hiring Philip Falcone as its primary investment decision-maker.
Harbinger Capital Partners Offshore Manager LLC served as the investment manager for the Harbinger Fund from 2002 through 2009.
Philip Falcone and the other members of the investment team operated in New York City.
As investment manager, 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 senior executives at Harbert Management Corporation, were required to pay New York State income tax on this performance fee income earned by Falcone’s trading activity in New York.
The first year that Offshore Manager had taxable income of this kind was 2004.
The executives chiefly responsible for tax compliance were Offshore Manager’s chief administrative officer, also a member of Offshore Manager, and its controller.
These two Harbert Management employees lived and worked in Alabama.
In early 2005, during the preparation of tax returns for the 2004 year, the chief administrative officer received advice from outside accounting professionals that New York tax would be due on the fee income.
The chief administrative officer notified other members of Offshore Manager, who would ultimately be paying the tax, of the problem, characterizing this advice as merely “initial.”
Just one week after receiving this advice, the chief administrative officer described the position that no New York tax was due on performance fee income as “unsupportable,” in a document sent to outside accountants seeking a recommendation on the question.
The same day, however, the chief administrative officer sent an email indicating that Offshore Manager “may get aggressive” in taking the position that all of its relevant income was from Alabama.
One week later, Offshore Manager’s controller signed a tax return that apportioned zero percent of its performance fee income to New York State, even though there is no indication that the accountants changed their initial assessment of the about the tax liability, or that there was any written endorsement by other outside professionals.
Instead, 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.
The 2004 return did not mention the existence of its Manhattan office, listing only the Alabama address in response to the return’s instruction to list all places “both in and out of New York State, where the partnership carries on business.”
The return denied any nexus to New York State.
The return answered “no” to the question “[d]id the partnership have any income gain, loss, or deduction derived from New York sources during the tax year?”
In 2006, Offshore Manager filed tax returns for the 2005 tax year that again apportioned zero percent of the performance fee income to New York State.
In the 2005 return, Offshore Manager again did not include the New York address when prompted to list all places where Offshore Manager carried on business.
As it did in the prior year’s return, in this return, Offshore Manager again answered, “no” to the question, “Did the partnership have any income gain, loss, or deduction derived from New York sources during the tax year?” The return also again indicated that Offshore Manager “has no nexus in New York State and has no income derived from New York sources.”
Offshore Manager did not correct these tax filings and did not apportion income to New York, even as the Harbinger Fund became more and more successful, and the New York investment team grew even larger.
Offshore Manager did not file any New York State tax return for the 2006 and 2007 tax years. In its tax returns for the 2008 and 2009 years, Offshore Manager similarly apportioned zero percent of the performance fee income to New York State.
In the return it filed for the 2008 tax year, Offshore Manager again did not identify the New York City office in response to the question seeking it to list all places, both in and out of New York State, where the Offshore Manager carried on business.
When Harbert Management separated from Falcone and Offshore Manager in 2009, Offshore Manager secured written assurances that the Alabama-based members of Offshore Manager, even after the separation, would continue to be responsible for New York State taxes that had not been remitted in the event that their tax position was ever reviewed.
The settlement resolves allegations against HMC and the Alabama-based members of Offshore Manager including the chief administrative officer.