By Erica Orden

The New York attorney general's office on Tuesday said it reached a $40 million settlement with an Alabama investment firm over the failure of members of an investment management company it sponsored to pay millions in New York state taxes.

The firm, Birmingham-based Harbert Management Corp., was the fund sponsor for New York City-based Harbinger Capital Partners, the hedge-fund firm linked with Philip Falcone.

Mr. Falcone isn't accused of wrongdoing in the settlement with the attorney general's office.

The settlement rose out of allegations brought by an unidentified whistleblower, according to Attorney General Eric Schneiderman's office. The whistleblower will receive $8.8 million in reward, according to the office, the largest tax whistleblower recovery ever awarded by the New York attorney general.

"Our investigation uncovered a brazen and deliberate decision to avoid paying millions in taxes owed to New York State," Mr. Schneiderman said in a statement. "Harbert Management made a clear choice to skirt the rules and as a result, ordinary New York taxpayers were left footing the bill."

A spokesman for Harbert said the company "made a commercial decision to settle this legacy issue relating to personal taxes with the NY AG's office in the interest of our investors and in order to avoid protracted and distracting litigation."

The firm and the individuals "adamantly deny that they committed any wrongdoing."

Between 2002 and 2009, the Harbert-sponsored Harbinger fund made Harbinger Capital Partners Offshore Manager its investment manager. Mr. Falcone had been hired as senior managing director of Offshore Manager during that time, with Mr. Falcone and others operating out of Manhattan offices. As a result, members of Offshore Manager were required to pay New York state income tax on the performance fee income earned by Mr. Falcone's trading activity, Mr. Schneiderman said.

During those years, the fund experienced "dramatic growth," according to the settlement, which says that "the peak of Mr. Falcone's investment success was in 2007."

When Offshore Manager's management filed its taxes during several years within this period, however, the entity didn't list its Manhattan office and said it didn't have any income gain, loss or deduction from New York sources, according to Mr. Schneiderman's office.

In 2013, Mr. Falcone reached a civil settlement with the Securities and Exchange Commission that included a five-year ban from the securities industry. Mr. Falcone admitted wrongdoing under the settlement. Regulators hadaccused him of improperly borrowing from one of his hedge funds to pay his taxes, at a time when investors were barred from withdrawing their money.

Write to Erica Orden at erica.orden@wsj.com

(END) Dow Jones Newswires

April 18, 2017 19:23 ET (23:23 GMT)

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