—

—

The time was ripe for broad bipartisan support for the Fraud Enforcement and Recovery Act (FERA), which passed in both houses of Congress with wide margins. When President Obama signed FERA into law May 20, he framed it, as had key lawmakers, as a bill aimed at fraud by Troubled Assets Relief Program (TARP) and stimulus fund recipients, as well as fraud in the financial and mortgage industries “and related offenses.”

At a time like this, who could argue with that? With trillions of government dollars allocated with the aim of fixing an embattled economy, both public officials and the general public are wary of fraud.

The special inspector general for TARP, Neil Barofsky, announced in his April 21 quarterly report to Congress that his unit had opened 20 investigations into suspected fraud among TARP institutions, noting aspects of TARP “make it inherently vulnerable to fraud, waste, and abuse.” The same day, a Deloitte poll of more than 1,540 “business professionals” revealed that 58.2 percent felt the level of transparency that the Obama administration had promised for the bailout funds was not possible.

Perhaps it's no coincidence that in the same poll, 79.8 percent said they were unfamiliar with the False Claims Act (FCA). Because when it comes to fighting fraud on taxpayer dollars, the FCA with its whistleblower rule is the most important tool in the box.

As bailout and stimulus funds continue flooding the economy with government money, new amendments broaden the FCA and promise to bring about the greatest modifications since the modern act was born in 1986. The FCA defense bar fears the current round will bring about a flood of litigation–as did the Reagan-era amendments.

“I'm 100 percent confident there's going to be a dramatic increase in False Claims actions,” says Robert Rhoad, a Crowell & Moring partner who was lead defense counsel in an FCA case against USA Environmental that was dismissed earlier this year. “Anything that touches government money is at risk.”

Fraud Fighter

As legend has it, sick mules and faulty weaponry led to the 1863 enactment of the FCA, aimed at defense contractors who sold defective goods to the Union Army during the Civil War.

The act made it illegal for government contractors, grantees or other recipients of government funds to improperly receive or fail to repay federal funds. It also included a qui tam, or whistleblower, provision that allowed private citizens to file claims for recovery on the government's behalf and secure a portion of the recovery for their efforts. President Lincoln called the whistleblowers “citizen soldiers”; they are known as “relators” today. The provision was and remains a powerful tool for citizens and a boon to a government that can't be everywhere.

That much remains true–but the FCA has undergone major changes since the Civil War era. Following years of little use, a 1986 overhaul provided for larger penalties and increased the portion of recoveries that goes to whistleblowers. The incentive worked, exponentially increasing FCA litigation–as well as potential recoveries.

After the changes, the statute has recovered for the government more than $21 billion of taxpayer funds. Since the 19th century it had been aimed at defense contractors, but with the Medicaid and Medicare programs, focus shifted toward the health care industry. The Justice Department (DOJ) reported $1.3 billion in FCA recoveries from January through September 2008. Of that, $1.1 billion came from the health care industry, for which seven-, eight- and nine-figure FCA settlements are common. The 2009 numbers are on track to exceed last year's, bolstered by a record-breaking settlement with Eli Lilly in January that yielded $1.4 billion.

The increase in large settlements means whistleblowers walk away with a bigger cut. So the defense bar believes some relators and their trial attorneys take advantage of the system.

Rhoad says the Supreme Court's June 2008 ruling in Allison Engine began to address this. “That case set limits on the scope of the False Claims Act,” he says. “They recognized that it is a very, very dangerous weapon and, if left unchecked, relators can use it for unintended consequences. It's a punitive statute that has the power to destroy any individual, institution or company that's subject to it.”

Several important court rulings of the past few years, culminating in Allison Engine, put limitations on the FCA. The FERA amendments, however, reverse any significant reining-in of the statute. Rhoad believes this was the amendments' ultimate purpose, despite all the talk of battling mortgage fraud.

Backpedaling on Precedent

The Supreme Court justices unanimously ruled in Allison Engine that the FCA requires the plaintiff to prove the defendant directly presented a fraudulent bill or statement to the government with the “specific intent” of defrauding the government.

The case resolved a circuit split and rejected a more liberal 6th Circuit ruling. The amendments reverse the ruling, which imposed a heavy burden on plaintiffs. Now, no clear link of intent between a false claim and approval by the government is required–a provision retroactive to the date of the Allison Engine opinion. And now, merely showing that a government contractor used government funds–somewhere down the line, not necessarily directly–to pay a subcontractor's false claims suffices.

“A huge number of companies provide work on contracts that are reimbursed by federal government dollars,” says Andrew Tulumello, a partner at Gibson, Dunn & Crutcher. “Particularly when you think about the stimulus bill and all of the public works projects underway. … The act reaches even more broadly than just subcontractors on federally funded projects.”

That provision also effectively overturns another important recent FCA case, Totten v. Bombardier. Totten rejected false claims allegations against manufacturers that sold purportedly defective train cars to Amtrak, a corporation that receives money from the government but is not the government or an agency of it. (Chief Justice Roberts wrote the 2004 opinion when he was still a D.C. Circuit judge.)

The amendments may thus open the door to liability for claims that subcontractors (or sub-subcontractors) present to the prime contractors or to government-funded corporations, even if the subcontractor isn't directly presenting the claims to the government.

Now the question is whether any person or company borrowing money from an institution that received TARP or stimulus funds could be considered a subgrantee of the government and liable under the FCA.

“On that question, it probably will depend on the particulars of the program … and I'm sure we will be litigating this issue as we go forward,” says Associate U.S. Attorney General Tom Perrelli. He does foresee certain situations where there may be a basis to go after such entities. In any event, the reach of the amended FCA is broad.

The third significant ruling the amendments reverse is Custer Battles. (Rhoad was lead defense and appellate counsel in that case.) A judge for the Eastern District of Virginia in 2006 overturned a jury verdict finding that a defense contractor in Iraq had defrauded the government because the money at issue was not U.S. money but Iraqi money under control of the U.S.

The FERA amendments extend the FCA to encompass instances where the false claim is made for money the U.S. administers but to which it does not hold title. Further provisions allow actions for “reverse false claims,” or failure to repay overpayments. It also broadens the scope of anti-retaliation rights for relators.

Broad Bearings

“The new amendments contained in the FERA are going to adversely affect anyone: all government contractors and subcontractors; all health care providers; every public and private grantee and subgrantee,” Rhoad says. “It's going to make it far easier for relators to bring cases forward, including meritless cases, and many logical defenses have
been eliminated.”

Echoing some of the court decisions that imposed limitations on the FCA, Rhoad continues, “The False Claims Act was never meant to be an all-purpose fraud statute.”

On that point, Perrelli disagrees. “It's not an all-purpose fraud statute but it is a statute that gives a broad range of recovery when someone engages in fraud that causes them to receive money from the U.S., either directly or indirectly,” he says.

For companies that fall under its widening scope, compliance should become more of a priority than ever. “It's compliance failures and misses that lead to False Claims Act claims,” Tulumello says.

Perrelli, who expects a rise in FCA investigations and litigation as a result of the recent federal lending and spending programs–such increases routinely follow periods of heavy federal spending–makes clear that this administration “has really put a particular emphasis on ensuring we spend taxpayers' money well.”

One backer of that goal is Michael Behn, a former federal prosecutor in fraud cases who now concentrates on civil FCA cases on the plaintiffs' side. He believes FCA enforcement is only going to get stronger under the new administration, noting that both the president and Attorney General Eric Holder have personal experience with such claims and know the statute's effectiveness.

“More resources are going to be devoted,” Behn says. “There [will] be better partnerships with states and whistleblowers, more effective DOJ policies concerning False Claims Act cases and a variety of improvements that have been proposed and will be implemented.”