False Claim in the United States

Federal False Claims Act Penalties and Whistleblowers

Note: there is a full entry in this Encyclopedia about the Federal False Claims Act here.

With so much government money sloshing around the economy in 2010, it’s no wonder that False Claims Act cases were suddenly getting a lot more attention. In such litigation, private individuals may be rewarded with extraordinary sums of money for ratting out their own employers for violating the government’s trust. These cases can make attorneys quite rich, as well. One California case, for example, recently a 2010 settlement of nearly $90 million, which included $30 million in attorneys fees.

However this money rarely comes easy. And whistleblowers may not always be motivated by the best of intentions. Some are crass opportunists. Others are extremely disgruntled, if not psychologically unstable employees. And still others are simply trying to immunize themselves from prosecution – since it’s extremely rare for the government to go after whistleblowers who are also bad actors. But in the end it really doesn’t matter who they are or what motivates them – as long as they have the documentation to incriminate the defendant contractors.

False Claims Act Penalties

By Erik Cummins. He is a San Francisco-based freelance writer and a former reporter for the San Francisco Daily Journal (2010)

A decade of spectacular fraud by government contractors in the defense, health care, and financial services industries is generating record recoveries in court—and lots of work for the burgeoning False Claims bar.

Nearly 150 years after President Abraham Lincoln urged Congress to penalize contractors for selling the Union Army bullets filled with sawdust, the so-called Lincoln Law of 1863 is proving a boon to both plaintiffs and defense attorneys. The original statute imposed liability on any person who knowingly submits a false claim to the federal government. Private whistleblowers – called relators – could sue on behalf of the government and collect half the money recovered. The rules were tightened in 1943, when Congress passed a “government-knowledge bar” to prevent whistleblowers from simply restating allegations already made in federal criminal indictments. The knowledge bar, and a lowered share of recoveries, effectively discouraged the statute’s use.

In 1986 Congress again amended the renamed False Claims Act (FCA), making it easier for whistleblowers and their lawyers to remain as parties even if the government joins in the suit. Under the amendments, penalties against contractors can run as high as $10,000 plus three times the amount of the fraud. Whistleblowers can receive from 15 percent to 30 percent of recoveries. And defendants must pay reasonable expenses and attorneys fees for successful relators, who are protected from employer retaliation.

The 1986 amendments produced a small but vibrant qui tam bar – a reference to the Latin phrase for “he who sues for the king as for himself.” By 2009 more than half of the states had passed laws modeled after the federal statute. (California was an early adopter in 1987 (Cal. Gov’t. Code §§ 12650?12656).) When a fraud complaint is filed with federal investigators, states that have some stake in the outcome of the case receive copies of the documents. States with laws that mirror the FCA stand to take in up to half of the government’s total recovery. Thus, many states have been prompted to staff up their anti-fraud divisions. In California, for instance, the state Attorney General’s false claims unit has eleven lawyers working in San Francisco and Sacramento. The team includes state auditors, analysts, and paralegals. A separate unit focuses on health care fraud. Between them, the two units have recovered $1 billion in the past decade.

Robert L. Vogel, a former Department of Justice (DOJ) attorney, says there’s been an explosion of interest in FCA cases. Vogel, now a name partner at Vogel, Slade & Goldstein in Washington, D.C., says that in 2001 40 lawyers attended the first Taxpayers Against Fraud conference there. Last year, he says, he counted more than 200 lawyers at the nonprofit group’s annual event.

Indeed, for fiscal 2009 alone, the DOJ reported $2.4 billion in civil settlements and judgments under the False Claims Act. Of that, $255 million went to whistleblowers. According to DOJ figures reported by Gibson, Dunn & Crutcher, more than a thousand qui tam cases were pending under seal as of December; 985 were health care fraud cases and 205 involved defense procurement – the two most common patterns in FCA actions.

Last year’s financial scandals, revealed on the heels of unprecedented bank bailouts, prompted Congress to further revise the FCA. Though intended primarily to encourage investigations of financial fraud, the Fraud Enforcement and Recovery Act of 2009 (Pub. L. No. 111-29) poured an additional $165 million into detecting and pursuing fraud of all kinds against the federal government. “Wherever government money flows, there is an opportunity for fraud to be committed,” says Larry Raskin, a supervising deputy attorney general in California.

Today, FCA cases are being brought against industries relatively new to government contracting, such as technology, education, construction, energy, and financial services.

Recent amendments to the statute so favor whistleblowers that qui tam lawyers have taken to canvassing contractor employees to serve as relators, much as some plaintiffs attorneys seek representatives for class actions, says Mitchell S. Ettinger, a defense attorney with Skadden, Arps, Slate, Meagher & Flom in Washington, D.C. “No longer is [the whistleblower] a courageous former or current employee,” he says. “Really, it’s the lawyers who can get 50 percent of the recovery.”

Meanwhile, a number of big law firms have jumped in to defend the growing list of targets. “On the defense side, this is a booming industry,” Havian says. “The big firms are almost all into it. Some are specialized more than others, and there are also repeat players, such as Sheppard Mullin Richter & Hampton, Latham & Watkins, and McDermott Will & Emery.”

In some of the more complex cases, big firms also have been hired as co-counsel for the relators. According to Havian, regulars in that role include Day Pitney; Paul, Weiss, Rifkind, Wharton & Garrison; Williams & Connolly; and Irell & Manella. “They see the value of the cases, and they see that the cases involve an awful lot of work,” he says.

Havian recently settled a case that came to his office in 1997. Nora Armenta, a Venezuelan-born purchasing manager in Glendora, had complained to her supervisors that the water valves and fittings her employer was selling to municipal utilities contained too much zinc – which can shorten the life of the waterworks – and too much lead, a big no-no for pipes that transport drinking water. “The company told her to mind her own business,” Havian says. “She felt like she was being harassed.”

Critical to the strength of Armenta’s case was the fact that she had documents detailing the company’s purchases and sales. With that ammunition, Havian filed the case in Los Angeles County Superior Court (State of Calif. ex rel. Nora Armenta v. James Jones Co., No. BC 173487 (Los Angeles Super. Ct., third amended complaint filed August 25, 2004)). Among other claims, the company was alleged to have misrepresented the quality of its valves and fittings to government buyers. Havian says he showed the documents to lawyers at the Los Angeles City Attorney’s office, and they immediately chose to join as intervenors. Eventually, so did more than 50 government agencies, including the Los Angeles Department of Water and Power. The city of Los Angeles estimated that damages – which included digging up and replacing substandard waterworks – would total at least $140 million.

The twelve-year litigation produced two groundbreaking opinions by the state court of appeal, one applying California’s FCA to companies that lie about their products in catalogs (City of Pomona v. Superior Court, 89 Cal. App. 3d 793 (2002)), and the other holding parent companies liable for treble damages if they are aware that their subsidiaries are defrauding the government but fail to stop them (Armenta ex rel. City of Burbank v. Mueller Co., 142 Cal. App. 4th 636 (2006)). The case finally settled last November for nearly $90 million, including $39 million paid to California public agencies and $30 million in attorneys fees.

But a large settlement like that is rarely easy money; qui tam practitioners agree that these cases are challenging to pursue and to defend. In fact, most cases travel a tortuous route that frequently requires many years of litigation and consumes millions of dollars in expenses. Significantly, the nation’s largest qui tam firm is Phillips & Cohen – with just 17 lawyers in three offices. “It doesn’t take very big to be big in this niche,” Havian says.

Cases typically begin when a current or former employee of a government contractor brings allegations of fraud to a private attorney. If the case appears to have merit, the attorney drafts a complaint and serves copies on the U.S. Attorney General’s office. If the government takes an interest, federal attorneys then conduct an investigation, which can take from 60 days to several years. During this time the complaint remains under seal and officially unknown to the defendant (31 U.S.C. § 3730).

Thanks to the 1986 revisions to the FCA, investigators have powerful tools at their command. They can interview company employees, industry experts, and the alleged victims of fraud. Government attorneys may use civil investigative demands to acquire documents, take oral or deposition testimony, and serve interrogatories requiring written response. (See 31 U.S.C. § 3733.) “[T]he government is in the enviable position of being able to conduct investigative discovery prior to any ability of the potential defendant to conduct its own discovery,” an Arent Fox client alert concluded in 2006.

The fact that cases are under seal during the investigation adds intrigue to the proceedings. Companies that divine they are being targeted may have their attorneys begin internal investigations of their own. But they can’t be certain of the government’s suspicions until the case is unsealed.
Allan J. Joseph, a defense attorney with Rogers Joseph O’Donnell in San Francisco, says a contractor’s tip-off to a probe can come in many forms, but typically as requests for documents and audits. “In a potential claim of mischarging, my client could say this is more than just a regular audit,” Joseph says. “You get an idea something is underway.”

After government attorneys finish their investigation, the next step is critical-deciding whether or not to intervene in the case. “The significant part is the intervention decision,” says Nicola T. Hanna, a defense attorney and former prosecutor at the Irvine office of Gibson Dunn. “It’s not the whole game, but it’s obviously a significant part of the game.”

Havian certainly sees it that way. He estimates that when government entities intervene, relators win or successfully settle 95 percent of the cases. If the government doesn’t intervene, he says, about 90 percent of the cases go the other way and are dismissed.

There are no formal guidelines for the proceedings leading up to intervention. Typically, both qui tam and defense attorneys present their findings to government lawyers during full-day sessions that involve numerous binders, white papers, and PowerPoint presentations. Much like presenting a case to a jury, both sides try to persuade the government that the case is either worthy of its intervention or without merit.

Government attorneys can make presentations based on their own investigations, and often they question attorneys who represent the relators and the defendant. “We say, ‘We’ve got these allegations – what do you have to say for yourself?’ ” says Sara Winslow, an assistant U.S. Attorney in San Francisco who handles government fraud cases.
Defense attorneys complain that many of their tactical options have been limited by the latest amendments to the statute, but they can always argue that their clients simply made mistakes, or that any fraud was the work of rogue employees. Another defense is that a contractor’s actions caused no real harm or loss.

Once the government intervenes or declines to, most cases either settle or are withdrawn. “These are very difficult cases to try,” Joseph says. “The statistics aren’t good. Think about how the public feels about defense contractors.”

Settlement inspires its own anxiety for defendants, because the teeth that enforce the FCA can be very, very sharp. “If you have a high-risk case, you want to resolve it as soon as possible,” Joseph says. And if a settlement imposes conditions, he adds, it’s important to make sure they don’t include referral of the client for debarment, or suspension from doing business with the government. Typical settlement agreements can require contractors to set up whistleblower hotlines, provide compliance training, produce regular audit reports, and sign corporate integrity agreements.

“It’s never pleasant to be in a lawsuit with your principal customer,” says Hanna of Gibson Dunn.

So, with all these upsides for plaintiffs, why aren’t even more cases being brought? Relator attorneys note that a lot of money rides on the whistleblowers, who may be psychologically unstable or compromised by participating in the alleged fraud. Relator attorneys typically conduct extensive intake interviews – Phillips & Cohen takes just 1 or 2 cases out of every 100 that come its way, according to Havian. And most of the cases it accepts allege fraud of at least $10 million.

No matter how pure a whistleblower’s motives may be, Havian concedes, they are easy targets for the defense. “They are always impeachable because they are going to get money” if there is a recovery, he says. For that reason, qui tam attorney Vogel says, it’s important to corroborate whistleblower’s allegations with documents and other witnesses. “If you can get them wired by the FBI, you’re in much better shape,” he says.

But the relator’s motivation doesn’t concern Wayne T. Lamprey, a qui tam lawyer with Goodin, MacBride, Squeri, Day & Lamprey in San Francisco. “We all know relators have varying motives,” he says. “There’s always some drama, hoopla, and back-and-forth. Sometimes people’s anger causes them to see things in a worse light. But we rarely proceed on the word or testimony of the relator alone. If you have the evidence, it doesn’t matter if the relator is impeached.”

Potential cases must pass a number of thresholds. First, are the losses big enough to make the effort and expense worthwhile? Second, can the defendant pay a judgment? Third, do the facts clearly show probable fraud? “I’m not talking about mistakes or differences of opinion,” Vogel says. “Are people stealing hand over fist, lying, cheating, and that kind of stuff? Sometimes you realize somebody did something they shouldn’t have, but it didn’t violate the law. And if the government was in on it, then the government is not a victim.”

Prosecuting attorneys have different criteria for the cases they take. Deputy AG Raskin says the state Attorney General’s office doesn’t have a particular dollar threshold (the statutory minimum is $500). “It may be a low dollar amount, but the alleged fraud could be egregious,” he says. “Or the allegations could involve a government contractor that was an ineligible vendor. You can’t turn a blind eye if these are factors.”

Another significant test for a qui tam case is the source of the whistleblower’s information. Qui tam actions may be barred by statute if they are based on publicly disclosed allegations or on transactions in certain specified sources, including administrative reports, audits, and investigations (31 U.S.C. § 3730(e)(4)(A)). Therefore, relators must serve the DOJ with a “disclosure statement” that includes all of the evidence to support the allegations in the complaint. And even a relator who meets those requirements will be left out in the cold if he or she is not the “first to file.”(See 31 U.S.C. 3730(b)(5).)

From the defense perspective, recent revisions to the FCA have tilted the game board. Bryan D. Daly, a Los Angeles attorney with Sheppard Mullin who has defended qui tam cases for two decades, believes the law has become too stringent and its penalties too severe. “The government expects to get a settlement or a payoff as a cost of doing business,” he contends. “There’s an insensitivity among government lawyers in separating the wheat from the chaff.”
“The False Claims Act is a bludgeon against the defendant,” adds David J. Silbert, a defense attorney at Keker & Van Nest in San Francisco. “It’s a terrifying weapon – the damages are eye-popping. It’s often easier to pay millions of dollars in settlement than to fight this.”

Assistant U.S. Attorney Winslow denies that the government is out to get contractors. “Our goal is not to put companies out of business or drive them into bankruptcy,” she says. Winslow also strongly disputes the contention that amendments to the statute unfairly hinder defendants. “Many defendants have resources that far outweigh what the DOJ has,” she says. “Pharmaceutical companies have litigation budgets far larger than ours.”

Still, Skadden Arps’s Ettinger is morose about the evolution of the Lincoln Law over the course of a century and a half. “If I were a CEO of a company, I would think long and hard about doing business with the government,” he says. “It’s dangerous to American business, and it’s not letting up.”

Ettinger might easily be talking about the case against JM Eagle, a major manufacturer of PVC pipe in California, brought in 2006 by Phillips & Cohen (U.S. ex rel. Hendrix v. J-M Mfg. Co., Inc., CV 06-55 (C.D. Cal. filed Jan. 17, 2006)). John Hendrix, a former engineer in the company’s product assurance division, was fired several weeks after he complained about the pipes to his superiors. “This was typical,” Havian says. “If these companies actually listened to their employees, we would rarely see [whistleblowers].”

After four years of investigation, more than 20 lawyers attended the intervention proceeding, including in-house and outside counsel for the defendants, government attorneys, and the relator’s attorneys. The DOJ chose not to intervene – possibly, Havian says, because federal purchases of PVC pipe were small compared with those of the other potential plaintiffs; all told, 22 California cities, 23 water agencies, and four states had joined the case.
Despite the long odds without the federal government, state entities chose to pursue the case anyway. JM Eagle, facing enormous potential damages and the loss of its market-leading share of the PVC pipe business, announced that it would extend its product guarantee from 1 year to 50 years – far beyond industry standards. The guarantee would even cover pipes already in the ground that failed after April 1, 2010. (The case is ongoing.)

Havian reflects that there’s nothing like being in the catbird seat when a firm’s practice area gets hot. “There’s a lot more [government contracting] money sloshing around that can get stolen,” he says. “This [FCA] litigation can only increase in the next five years.”