The New York attorney general on March 2 announced a $105 million New York False Claims Act settlement against an individual hedge fund manager and his firm for alleged tax evasion based on allegations originally brought by a whistleblower, calling it the largest recovery against an individual in the state statute’s 14-year history. This recovery should remind both businesses and individuals that, while the federal False Claims Act specifically excludes tax claims from its purview, a watchful eye should be kept on the steadily growing trend of states permitting such claims under their false claims laws. In fact, the District of Columbia amended its false claims law in January 2021 to mirror New York’s allowance for tax claims.
The issues in allowing tax claims to be pursued under a false claims statute, rather than state department of revenue or tax code enforcement mechanisms, are multifold. First and foremost, such an allowance extends false claims statutes well beyond those businesses that appreciate and commonly undertake false claims risk by doing business with the government or receiving government funds, expanding exposure to a large population of companies and private citizens simply because they are taxpayers. This risk is heightened by the fact that the New York False Claims Act (NYFCA) and DC false claims law contain qui tam provisions allowing whistleblowers to bring and pursue such claims—and to be handsomely rewarded with a portion of any recovery—even if the state or district declines to intervene.
In addition, the complexity and oft-changing nature of tax codes provide fodder for whistleblower allegations that—while more likely to be subject to eventual defeat under false claims statutes’ scienter provisions—create the prospect of an increase in filings and litigation avoidance settlements. The recent NYFCA settlement showcases all of these problems.
In State of New York ex rel. Tooley LLC v. Sandell, et al.,[i] the New York attorney general alleged that Thomas Sandell and his firm failed to pay tens of millions of dollars in state and city taxes on deferred fees for offshore hedge fund investment management services performed in New York City. While these services were performed over a 10-year period ending in 2008, the income was not recognized until 2017 because of amendments to the Internal Revenue Code that changed deferred income allowances.
In the year prior to this recognition, Sandell left New York to live in London, and his firm set up an office in Florida even though it allegedly continued to operate in New York City as its principal place of business. After allegedly conflicting consultations with two different accounting firms, Sandell and his firm did not pay New York state or city taxes on these fees for tax year 2017. Sandell did not admit or deny wrongdoing in settling these claims.
The NYFCA case against Sandell was brought by a limited liability company as a qui tam whistleblower in October 2018. This whistleblower has not been identified beyond its corporate name, joining a growing trend of corporate whistleblowers in false claims law cases that typically may not have the type of inside information that may otherwise go undiscovered, as originally contemplated by the qui tam provisions. The Sandell relator is receiving $22.05 million, which represents 21% of the settlement, and can separately pursue attorney fees and costs against the defendants.
The Sandell settlement explicitly notes that the New York attorney general has an ongoing investigation into other entities involved in the alleged tax evasion conduct, and the agreement includes a cooperation clause.
As noted above, the federal False Claims Act[ii] and several state statutes modeled after it explicitly exclude tax claims from their purview.[iii] However, a growing number of state false claims statutes, including in New York and now the District of Columbia, expressly allow tax claims. In New York, the expansion to the NYFCA was added through amendment in 2010, and is limited to defendants with taxable income or sales over $1 million in the tax year and claimed damages in excess of $350,000.[iv] The District of Columbia’s amendment—signed in January 2021, but under congressional review until March 15, 2021—includes these same limitations.[v] Similar amendments to allow tax claims were introduced in the state legislatures of California and Michigan.[vi]
Meanwhile, the Illinois False Claims Act expressly allows for some tax claims, but excludes those related to income or property tax.[vii] The Indiana and Rhode Island false claims statutes are similar in that they only exclude income tax claims.[viii] Other state false claims statutes are silent about a tax claims exemption.
The significant monetary value of the Sandell settlement is likely to encourage more states to amend their false claims statutes to allow tax claims and more whistleblowers to come forward asserting these claims. Companies and individuals should be aware of the breadth of the state false claims statutes—and any pending amendments—in the states in which they do business. To the extent companies and individuals are doing business in any of these states, take the time to more closely understand your historical tax filing positions and the state’s false claims law statutes of limitations.
Taxpayers and practitioners alike also must understand that, unlike a tax audit by a state department of revenue, in a false claims act case the relator or government must meet a higher burden of proof to substantiate a violation and access treble damages, and must also prove the reckless or intentional state of mind of the taxpayer. Compliance with all laws and a robust compliance program remain critical to protecting companies and individuals from enforcement actions.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact the authors or any of the following Morgan Lewis lawyers:
Meredith S. Auten
John C. Dodds
Lisa C. Dykstra
Rebecca J. Hillyer
Ryan P. McCarthy
Zane David Memeger
John J. Pease, III
Kenneth A. Polite, Jr.
Margaret Erin Rodgers Schmidt
Shevon L. Scarafile
Eric W. Sitarchuk
Douglas W. Baruch
Giovanna M. Cinelli
Scott A. Memmott
Matthew S. Miner
Kenneth J. Nunnenkamp
Amanda B. Robinson
Stephen E. Ruscus
Jennifer M. Wollenberg
Howard J. Young
[i] Index No. 101494/2018 (N.Y. Sup. Ct. N.Y. Cty.).
[ii] See 31 U.S.C. § 3729(d) (“This section does not apply to claims, records, or statements made under the Internal Revenue Code of 1986.”).
[iii] See, e.g., Cal. Gov’t Code § 12651(f) (2018); Iowa Code § 685.2(5) (2011); Md. Code Ann., Gen. Provisions § 8-102(a) (2015); Mass. Gen. Laws Ann. ch. 12, § 5B(d) (2012); Minn. Stat. § 15C.03 (2019); N.C. Gen. Stat. § 1-607(c) (2018); Vt. Stat. Ann. tit. 32, § 631(d) (2015); 2004 Va. Acts ch. 589.
[iv] N.Y. State Fin. Law § 189(4)(a).
[v] D.C. Act A23-0564 (amending D.C. Code § 2-381.02(d)).
[vi] See AB-2570, 2019-2020 Leg. (Cal. 2020); AB-1270, 2019-2020 Leg. (Cal. 2019); S.B. 484, 100th Leg. (Mich. 2019); H.B. 4875, 100th Leg. (Mich. 2019).
[vii] 740 Ill. Comp. Stat. § 175/3(a)(1).
[viii] Ind. Code 5-11-5.5-2 (statute does not apply to “a claim, record, or statement concerning income tax”); R.I. Gen. Laws § 9-1.1-3(c) (“This section does not apply to claims, records, or statements made under the Rhode Island personal income tax law ….”).