In a recently unsealed qui tam action filed under New York State’s False Claims Act, a former lawyer with Vanguard Group Inc. claims that the company has been evading more than $1 billion in federal taxes and more than $20 million in New York State taxes. State of New York ex rel David Danon v. Vanguard Group, Inc., No. 100711-13 (Sup. Ct, N.Y. Cnty, May 8, 2013).

The complaint alleges that Vanguard has “operated as an illegal tax shelter for nearly forty years,” relying, among other arguments, on contentions that Vanguard did not file income tax returns before 2011, despite “clearly meeting the ‘doing business/nexus’ standard”; on claims that, when Vanguard did begin filing returns, it did not follow New York’s shareholder sourcing rules for apportionment; and on claims that it “violate[d]” New York Tax Law Section 211.5 and Internal Revenue Code Section 482 by providing services to related parties – the Vanguard group of mutual funds – at artificially low prices.

The complaint also alleges that Vanguard “knowingly and fraudulently” failed to pay tax on its $1.5 billion “Contingency Reserve,” violating the principle that income is taxable when it is actually or constructively received or due and payable. The complaint further claims that Vanguard’s failure to include the Contingency Reserve on its “IRS Uncertain Tax Positions Schedule (the ‘Schedule UTP’)” constitutes a “fraudulent effort to conceal” the inaccurate reporting of its Contingency Reserve.

Unlike the situation in State of New York v. Sprint Nextel Corp., 114 A.D. 3d 622, leave to appeal granted (1st Dep’t June 12, 2014), where the State Attorney General took over prosecution of the suit, here the Attorney General, after investigation, has declined to convert the case into a civil enforcement action, so the case is being brought by the whistleblower himself. He has also included conspiracy allegations, and claims that he was retaliated against by having been demoted and discharged by the company. He is seeking between 15 and 30 percent of all funds obtained by state and local governments.

The complaint was originally filed under seal in 2013, and then unsealed this summer and made widely available on the Internet.  After application by Vanguard on August 15, 2014, the court  redacted from the public file certain paragraphs of the complaint, although the publicly available docket file does not specify the protected paragraphs. Vanguard has stated that it denies the allegations and intends to defend itself vigorously.

Additional Insights

This complaint raises many novel and troublesome questions. It is the first large corporate income tax case made public under the New York False Claims Act, and the first to include a retaliation claim. According to press reports, the attorney for Mr. Danon, the whistleblower, has said that New York was chosen as the location for the lawsuit because it is the only jurisdiction in the United States that has a False Claims Act that would cover these claims, raising the question of whether New York’s statute will result in the filing of more such claims here because of such a uniquely wide-reaching statute, and whether it is an appropriate role for the New York courts to hear what may be increasingly dramatic claims of widespread alleged tax violations brought by whistleblowers seeking large recoveries.

While it is difficult to evaluate the merits of most of the lawsuit’s claims without further information, the claim that a New York taxpayer committed fraud by “violating” Tax Law Section 211.5 seems particularly tenuous, since it is a discretionary statute, allowing the Department the discretion to adjust intercompany pricing if it finds that any agreement or understanding between the taxpayer and a related party has resulted in an inaccurate reflection of the taxpayer’s income.  Nothing in Section 211.5 imposes an affirmative obligation on a company to make pricing adjustments, so it is hard to understand how a claim of fraud could be based on “violating” this statute.

In addition, there have been press reports that Mr. Danon has also filed a whistleblower claim with the Securities and Exchange Commission, and that Vanguard has demanded from Mr. Danon’s attorney the return of confidential documents allegedly taken from the company when he was employed there as an attorney. The fact that Mr. Danon is an attorney also raises important issues about whether in-house lawyers can use information they learned from their confidential relationship with their employer-clients to file public claims based on such information, and profitthereby under the provisions of False Claims Acts that allow whistleblowers to receive portions of the monies recovered by the government.