Eric Schneiderman for Attorney General

Schneiderman Settles Largest Whistleblower Tax Case

April 21, 2017

As published by The Buffalo Times on April 17, 2017.

A major Alabama investment group and some of its top executives have agreed to pay New York State $40 million in the largest-ever state settlement of a tax claims case initially brought by a private individual acting as a whistleblower, Attorney General Eric T. Schneiderman said Monday.

The settlement proceeds include $8.8 million that will go to an unnamed whistleblower who first brought the case’s attention to Schneiderman’s office.

Top executives tied to Harbert Management Corp., profited heavily on investments controlled by former billionaire New York City hedge fund executive Philip Falcone, who in 2013 was banned by federal authorities for five years from participating in the securities industry. Falcone was not accused of wrongdoing in the New York tax case.

The investment group from Alabama made money on investments selected by Falcone on troubled securities and companies, including by betting against the subprime mortgage marketplace before the housing meltdown in the last decade.

“Our investigation uncovered a brazen and deliberate decision to avoid paying millions in taxes owed to New York State,’’ Schneiderman said in a statement.

Schneiderman’s office said Harbert Management Corp. sponsored and organized the investment hedge fund, but a lawyer for the group said Monday that none of the income was received by the management company and that the income involved an entity – called Harbinger Capital Offshore Manager, whose members included some top executives at Harbert.

The settlement covers taxes the state says the entity and its investors owed between 2004 and 2009. The $40 million covers taxes owed, penalties and interest on hundreds of millions in income not reported in New York State.

The attorney general is especially close to the law his office employed in the matter: He authored a bill in 2010 when he served as a state senator to expand the state’s whistleblower law to include tax claims.

The case was brought to the Attorney General’s Office by a whistleblower. The whistleblower’s name and how that individual had the information to bring the case was not revealed.

Whistleblowers in such cases are eligible, by state law, to receive between 15 percent and 25 percent of an award either through a settlement agreement or a court decision.

Among the individuals who the settlement papers say owed New York State taxes is Raymond Harbert, chairman and chief executive officer of Harbert Management Corp. Harbert, a major donor to Auburn University, has the business school at the college named after him.

“Harbert Management made a clear choice to skirt the rules in order, and as a result, ordinary New York taxpayers were left footing the bill,’’ Schneiderman said. “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.’’

Charles S. Leeper, a Washington lawyer who represented the respondents, said the individual taxpayers – based on advice from multiple tax professionals – paid taxes in Alabama “where they lived, worked and operated” the group called Offshore Manager.

Leeper said the whistleblower is believed to be “a disgruntled former employee.’’

“The settlement agreement represents the AG’s version of events and as such is one-sided and omits facts and events demonstrating the individual taxpayers’ good faith,’’ Leeper said in an email response about the settlement.

Despite the settlement payments, Leeper stressed that the individuals in the case “adamantly deny they committed any wrongdoing.’’

In announcing the settlement, a copy of which was obtained Monday by The Buffalo News, Schneiderman’s office said an investigation into “other entities” involved in the matter is still ongoing, according to the settlement agreement. Officials declined to elaborate.

The Alabama corporation and 13 individuals or trusts, including Harbert, were sponsors of an investment fund at Harbinger Capital Partners, which was run by Falcone, who made huge profits betting against the subprime mortgage market before the financial meltdown in 2007.

The Birmingham-based investment group, tapping into Falcone’s expertise, put money into “distressed investments,’’ which the agreement defined as companies in financial trouble or undergoing bankruptcy proceedings. In 2007, Falcone doubled the investment group’s holdings, mostly through a “high-profile investment” by shorting the subprime mortgage market.

The action was brought by the undisclosed whistleblower in 2015, alleging the company and individuals made false claims about tax obligations owed to New York. Schneiderman’s office then launched an investigation into the allegations, and found it had civil claims against those involved, according to a copy of the settlement agreement. The agreement was dated April 3 by attorneys in Schneiderman’s office.

The attorney general alleged that the Alabama company and its investors failed to apportion profits they received that were in some way connected to New York.

In the settlement agreement, the respondents in the case said that tax lawyers had been consulted in advance and that New York tax laws pertaining to matter are “ambiguous.’’ The sides agreed to the settlement as a way to avoid a “protracted” litigation.

The investment income was assigned by the investment vehicle – Harbinger Capital Partners Master Fund I Limited hedge fund — to activities performed in Alabama, where income taxes are lower than New York. One memo said that Alabama residents could cut tax obligations one year by 250 percent if no income activities were claimed as occurring in New York State. But New York officials say the investment decisions were directed out of Manhattan at Falcone’s office on Madison Avenue.

The $40 million settlement pertains only to New York State tax obligations. The federal government’s False Claims Act does not pertain to tax matters.