Schneiderman announces $40 million settlement with investment management company

AG Reaches Groundbreaking Settlement With Harbert Management Corporation After Members Of Its Investment Management Company Failed To Pay Millions In New York State Taxes For Several Years

In the largest-ever recovery of its kind, Attorney General Eric T. Schneiderman announced today a $40 million settlement with Alabama-based Harbert Management Corporation and top executives at the firm. Harbert Management was the fund sponsor for Harbinger Capital Partners, a $26 billion hedge fund based in New York City (“Harbinger Fund”). 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.

“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.”

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, which was amended to cover tax claims in 2010 in a bill sponsored by then-State Senator Eric Schneiderman.

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 (“Offshore Manger”) 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, at offices that were located at 555 Madison Avenue in Manhattan.

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 Mr. 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 (“CAO”), 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 CAO received advice from outside accounting professionals that New York tax would be due on the fee income.

The CAO 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 CAO 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 CAO 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.  Finally, 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 this return, Offshore Manager again did not include the 555 Madison Avenue 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 Mr. 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 CAO.  The Office’s investigation into the conduct at issue in this matter continues.

A copy of the settlement can be found here.

Attorney General Schneiderman expressed his thanks to the whistleblower and their attorneys for their vital assistance in bringing this matter to light.

“This case is an extraordinary example of the results that can be achieved on behalf of taxpayers through the public-private partnership provided by the whistleblower laws,” said Neil Getnick of Getnick & Getnick.

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

Assistant Attorney General Justin Wagner of the Taxpayer Protection Bureau led the investigation under the supervision of Deputy Bureau Chief Scott J. Spiegelman.  He was assisted by Legal Support Analyst Bianca M. LaVeglia and former Legal Support Analyst Emilie Schwarz of the Taxpayer Protection Bureau and Forensic Auditor Alex Ozechowski of the Forensic Audit Section, as well as representatives of the State Department of Taxation and Finance, Zal Kumar and Howard Rubin of the New York City Department of Finance, and Gail Rubin and Sabita Krishnan of the New York City Law Department.

The Taxpayer Protection Bureau, led by Bureau Chief Thomas Teige Carroll, is a unit of the Criminal Division, which is led by First Deputy Jason Brown.

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