Pre-Dodd Frank Whistleblower Denied Reward by Second Circuit.

0

The Second Circuit upheld the Securities and Exchange Commission’s denial of a reward to a pre-Dodd Frank whistleblower yesterday in Stryker v. SEC, No. 13-cv-4404 (2d. Cir. Mar 11, 2015).

The whistleblower provided information to the SEC’s enforcement division between 2004 and 2009. The SEC opened an investigation in 2009 and interviewed him a month later. The SEC settled the enforcement action in November 2010 for $24 million.

Prior to the settlement, on July 21, 2010, Congress passed and President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act. The legislation authorized the whistleblower programs at the SEC and the Commodity Futures Trading Commission.

The whistleblower submitted an application for a reward. In Dodd-Frank, Congress did not explicitly address whether information submitted prior to July 21, 2010 could qualify for an award. However, Rule 21F-4(b)(1)(iv) allows for rewards only when the information is provided for the first time after July 21, 2010. The SEC denied the reward on that basis. The decision was appealed to the Second Circuit.

In denying an award, the Second Circuit deferred to the SEC’s rules. It relied on the language of Dodd-Frank requiring information to be submitted pursuant to the SEC’s rules and regulations, as well as Supreme Court’s opinion in Chevron requiring deference to reasonable agency interpretations of ambiguous statutory language.

The media has referred to individuals submitting tips prior to Dodd-Frank as “zombie” whistleblowers. It looks like these individuals will continue to be the walking dead to the SEC program unless another appellate court chooses to bail them out.

Review of Frequent Appellate Issues in False Claims Act During 2014

0

With only two weeks left in the year, I spent some time yesterday reviewing the appellate decisions in 2014 that were rendered in False Claims Act cases.

The three areas that I saw most frequently were fairly predictable. Each involved an area that would allow the defendant to obtain dismissal of the qui tam lawsuit. These areas were:

  • The First-to-File Rule
  • The Public Disclosure Bar
  • Rule 9(b)

For whistleblowers who are considering their first qui tam lawsuit, these areas of contention are worth examining prior to filing the complaint under seal to allow for an educated decision about whether to proceed. For legal practitioners, it is a useful reminder about the grounds defendants are using to seek dismissal.

The First-to-File Rule

The first-to-file rule is set forth in 31 U.S.C. § 3730(b)(5): “When a person brings an action under this subsection, no person other than the government may intervene or bring a related action based on the facts underlying the pending action.” The four appeals I examined in depth on this issue were all decided in favor of the Defendants.

In brief, the cases turned on whether the essential facts of the fraudulent scheme in the subsequent complaint were laid out to the government in the earlier complaint. Each case turned on a different issue, however:

In U.S. ex rel. Shea v. Cellco Partnership, 748 F.3d 338 (D.C. Cir. 2014), the dismissal of the relator’s first lawsuit under the False Claims Act barred a subsequent lawsuit on the same fraudulent scheme brought by the same relator.

In U.S. ex rel. Wilson v. Bristol-Myers Squibb, Inc., 750 F.3d 111 (1st Cir. 2014), the lawsuit alleging the essential facts of a previously filed claim was barred by the first-to-file rule even though it stated different facts.

In U.S. ex rel. Ven-A-Care v. Baxter Healthcare Corp., Case Nos. 13-1732 & 13-2083, — F.3d —, 2014 WL 6737102 (1st Cir. Dec. 1, 2014), the first qui tam lawsuit alleging evidence of fraud by a specific defendant barred a more detailed, subsequent complaint on the same fraudulent scheme brought by an insider.

In U.S. ex rel. Johnson v. Planned Parenthood of Houston, 570 Fed.Appx. 386 (5th Cir. 2014), allegations in both complaints of altering patient records and billing Medicare programs for services other than those rendered meant the subsequent complaint was subject to the first-to-file bar even though it included fraud on a different program with different facts.

The Public Disclosure Bar

The public disclosure bar was an area of significant appellate litigation in 2014. At least seven cases that I reviewed involved a dispute over whether the case should be dismissed because based on a public disclosure.

The False Claims Act bars qui tam lawsuits based on allegations publicly disclosed via certain methods unless the relator is an original source of the information. 31 U.S.C. § 3730(e)(4)(A). Once there has been a public disclosure, the relator can only qualify as an original source if they voluntarily disclosed their information to the government prior to the public disclosure or they have independent knowledge that materially adds to the publicly disclosed allegations. 31 U.S.C. § 3730(e)(4)(B).

The decisions were roughly split between opinions favoring the relator and the defendant.

In U.S. ex rel. Rostholder v. Omnicare, Inc., 745 F.3d 694, 700(4th Cir. 2014), relator’s claims were not barred by public disclosure doctrine because they were not based upon the public statements and he had sufficient direct and independent knowledge to be an original source.

There were two cases where the publicly available information was not sufficient to be deemed a public disclosure. See U.S. ex rel. Oliver v. Philip Morris USA Inc., 763 F.3d 36, 42-43 (D.C. Cir. 2014)(Government awareness of legal requirements and public disclosure of “innocuous-seeming” facts outside of the FCA specified channels); U.S. ex rel. Heath v. Wisconsin Bell, Inc., 760 F.3d 688, 691-92 (7th Cir. 2014)(posted government contract discovered by corporate auditor).

However, where there was a public disclosure, relators faced a more significant challenge proving that they were an original source. See Maholtra v. Steinberg, 770 F.3d 853, 858-61 (9th Cir. 2014)(Information provided during a deposition taken by the Office of the United States Trustee was a public disclosure); U.S. ex rel. Paulos v. Stryker Corp., 762 F.3d 688, 694-96 (8th Cir. 2014)(relator was not an original source when his information only minimally added to the public reports even though he was among the first to suspect problems); U.S. ex rel. Ahumada v. NISH, 756 F.3d 268, 278 (4th Cir. 2014)(The relator only had direct and independent knowledge sufficient to qualify for original source status against one defendant because he learned the information in the course of his employment from an employee of that particular company and independently confirmed it through his own inquiry.); U.S. ex rel. Kraxberger v. Kansas City Power and Light Co., 756 F.3d 1075, 1080 (8th Cir. 2014)(public disclosure of documents through a FOIA request and the news media barred the relator’s lawsuit)

Heightened Pleading Under Rule 9(b)

Rule 9(b) of the Federal Rules of Civil Procedure requires a plaintiff to plead fraud with particularity in the complaint. “In alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9(b). The defendant in a False Claims Act case will challenge the adequacy of the complaint with respect to this standard on a Rule 12(b)(6) motion to dismiss.

This issue was put before the U.S. Supreme Court in 2014 by a petition for certiorari following United States ex rel. Noah Nathan v. Takeda Pharm. N. Am., Inc., 707 F.3d 451 (4th Cir. 2013). The Department of Justice, however, recommended against granting cert and the Supreme Court declined to hear the case.

Of the four decisions I reviewed in this area, three favored the relator. These three decisions found sufficient indicia of reliability that they did not require the relator to provide a specific example of a false claim submitted to Medicare in the complaint.

In United States ex rel. Foglia v. Renal Ventures Mgmt., 754 F.3d 153, 157-158 (3d Cir. 2014), the Third Circuit required only “particular details of a scheme to submit false claims paired with reliable indicia that lead to a strong inference that claims were actually submitted.”

In U.S. ex rel. Thayer v. Planned Parenthood of the Heartland, 765 F.3d 914 (8th Cir. 2014), a manager with access to their billing system, knowledge of billing practices and personal knowledge of false claim submissions had sufficient indicia of reliability to meet the standard of rule 9(b).

In U.S. ex rel. Mastej v. Health Management Associates, Inc, Case No. 13-11859, —— Fed.Appx. ——, 2014 WL 5471925, *12-14 (11th Cir. Oct. 30, 2014), the relator’s presence in meetings discussing billing for clients was sufficient to state a claim in this case even though no specific examples of claims were submitted. However, the 11th Circuit did not allow the relator to extrapolate false claims beyond the time that he worked at the company.

On the other hand, in United States ex rel. Dunn v. North Memorial Health Care, 739 F.3d 417, 420 (8th Cir. 2014), the relator failed to submit even a single example of a false claim to Medicare for billing and the complaint was dismissed.

Other Areas

Three other areas stood out as I saw multiple opinions addressing the issue, although to a lesser extent than the three posted above.

Intent

The False Claims Act imposes liability only when the defendant acts “knowingly.” In order to meet the intent requirement found in 31 U.S.C. §3729(a), the defendant must have actual knowledge of the information and either act in deliberate ignorance or reckless disregard of the truth or falsity of the information. 31 U.S.C. § 3729(b)(1)(A). No proof of specific intent to defraud is required. 31 U.S.C. § 3729(b)(1)(B).

The decisions in this area were split, with two deciding against the relator because an ambiguous contract or regulation prevented the defendant from having the required scienter. See U.S. Dept. of Transp., ex rel. Arnold v. CMC Engineering, 567 Fed.Appx. 166, 170-71 (3d Cir. 2014)(false claim was not presented “knowingly” because of ambiguity in the contract for an inspectors credentialing requirements); Gonzalez v. Planned Parenthood of Los Angeles, 759 F.3d 1112, 1115 (9th Cir. 2014)(required scienter missing when relator acknowledged unclear definition of cost in billing manual). On the other hand, in Veridyne Corp. v. U.S., 758 F.3d 1371, 1379 (Fed. Cir. 2014), the company possessed intent to defraud the SBA even though the agency in charge of negotiating the contract may have been aware of the false statements.

Is an organization an “arm of the state” or a person under the False Claims Act?

Two different cases saw courts apply a four factor “arm of the state” analysis to determine whether there is sufficient state control to render an organization a part of the state and not a “person” subject to suit under the False Claims Act. See U.S. ex rel. Oberg v. Pennsylvania Higher Educ. Assistance Agency, 745 F.3d 131 (4th Cir. 2014); U.S. ex rel. Lesinski v. South Florida Water Management Dist., 739 F.3d 598, 605 (11th Cir. 2014)(South Florida Water Management District an arm of the state under four factor test and not a proper defendant to a False Claims Act lawsuit. The False Claims Act only applies liability on “any person”. 31 U.S.C. §3729(a)(1).

Discovery

Two cases that I examined involved the issue of privileged documents in discovery.

In re Kellogg Brown & Root, Inc., 756 F.3d 754 (D.C. Cir. 2014), the D.C. Circuit Court reversed the lower court decision requiring KBR to produce documents created during an internal investigation into fraud allegations. The D.C. Circuit clarified that investigative materials were covered by attorney-client privilege if a “significant purpose” of the investigation was to provide or obtain legal advice even if it was not the only purpose. The lower court ordered the documents produced because it was a routine compliance investigation involving non-attorney interviewers.

In Nevada v. J-M Mfg. Co. Inc., 555 Fed.Appx. 782 (10th Cir. 2014), third-party tests paid for by the United States while conducting discovery on the claims in a qui tam action were attorney work-product and not discoverable after the U.S. declined to intervene.

E-Rate Funds Not Protected By False Claims Act, According to Fifth Circuit

0

If you discover fraud in the FCC’s E-rate program, don’t file in the Fifth Circuit. Earlier this month, the Fifth Circuit Court of Appeals held that E-rate funds are not “provided” by the Federal Government and reversed a lower court decision on that basis.

The appellate decision raises serious questions on the viability of qui tam lawsuits in this area going forward. Defendants accused of improperly billing the FCC’s E-rate program have paid nearly $50 million in settlements to the United States Government over the years.

In U.S. ex rel. Shupe v. Cisco Systems, Inc., No. 13-40807 (5th Cir. July 7, 2014)(per curiam), the relator alleged that the telecommunications company presented false claims for payment to the government’s E-Rate program, which is funded out of the Universal Service Fund (“USF”) and administered by the Universal Service Administrative Company (“USAC”).

USAC is an independent, not-for-profit corporation assigned to administer the USF by the FCC. The USF is funded by private corporations at the direction of Congress in the Telecommunications Act of 1996 and does not receive federal funds from the treasury.

The False Claims Act defines a “claim” in relevant part as “any request or demand … for money or property … if the United States Government … provides or has provided any portion of the money or property requested or demanded.” 31 U.S.C. § 3729(b)(2)(A)(ii)(I).

Because treasury money does not fund the USF, and the money is not collected by tax, the Fifth Circuit concluded that the government did not provide any portion of the money paid out because of the false claim. “[T]he Government ‘provides any portion’ of the money requested under §3729(c) when United States Treasury dollars flow to the defrauded entity or if the false claim is submitted to a Government entity.” Shupe, slip op. at 5.

The Court of Appeals explicitly rejected the Government’s argument that funds paid by a corporation at the direction of Congress are government funds protected by the False Claims Act. It also disagreed with the contention that substantial FCC oversight was sufficient to bring the false statements within the False Claims Act even though the money was ultimately disbursed by a private organization.

At the moment, this is a blow to whistleblower actions to protect privately funded programs created by Congress and not administered by a government body. In the case, the United States argued that the FCC would ultimately end up administering the program if the False Claims Act did not apply to it as currently structured. If other courts agree with the Fifth Circuit, the United States will need to restructure the program, and others like it, in order to protect it from fraud.

Tax Court Rules Whistleblower Reward is Ordinary Income

0

Despite arguments from whistleblowers to the contrary, the government continues to demand whistleblowers pay taxes on money awarded under the False Claims Act as ordinary income.

On Monday, the United States Tax Court held in Patrick v. Commissioner, 142 T.C. No. 5 (2014) that a qui tam award does not qualify as capital gains. If the petitioner had been successful, tax liability would have been reduced from the ordinary income tax rate to the lower capital gains rate. The decision reaffirms an earlier opinion on the same issue. See Alderson v. United States, 686 F.3d 791 (9th Cir. 2012).

The Internal Revenue Code treats rewards as ordinary income similar to wages and salaries for the purpose of calculating tax liability. Treas. Reg. §1.61-2(a)(1). An award from a qui tam lawsuit is considered a reward included within gross income. Roco v. Commissioner, 121 T.C. 160, 164 (2003).

Petitioner argued a qui tam award is instead a “gain from the sale or exchange of a capital asset”. 26 U.S.C. § 1222(1), (3). The Tax Court analyzed both whether a “sale or exchange” occurred and whether it is a “capital asset.” It rejected both contentions.

The Tax Court disagreed with the argument that the government purchases information from the relator according to a contractual right established in the False Claims Act. The Petitioner analogized to the transfer of a trade secret which is considered a capital gain. However, the court rejected the notion there is a transfer of rights to the Government.

The Tax Court also declined to find the petitioner had a property right which would constitute a capital asset. Petitioner advanced the contention that relators have a property interest in the information they disclose to the Government. In rejecting the argument, the Court declined to consider the information the property of the relator because they did not demonstrate “a legal right to exclude others from use and enjoyment” of it.

The ruling reinforces the importance of seeking the advice of a qualified accountant or tax lawyer after receiving an award under whistleblower laws.

McEldrew Young helps whistleblowers report fraud and misconduct to the government through the SEC, CFTC and IRS whistleblower programs as well as the False Claims Act. If you would like to speak to Eric L. Young or another attorney at McEldrew Young about becoming a whistleblower, please call 1-800-590-4116 or complete our contact form.

Photo Credit.

Lesson From Fifth Circuit: Don’t Delay Filing Your False Claims Act Lawsuit

0

It may be tempting to report misconduct to the government outside of the formal procedures provided by whistleblower laws. It would be comparatively easy for a whistleblower to send the government a fraud report through a letter, email or hotline without legal representation as soon as they discover it. Two whistleblowers were unfortunately denied a share of the government’s recovery by the Fifth Circuit on Friday in U.S. ex rel. Babalola v. Sharma, No. 13-20182, slip op. (5th Cir. Feb. 14, 2014) because they did.

The relators discovered Medicare and Medicaid fraud at the medical clinics where they were employed. They submitted an anonymous letter to various government agencies detailing the crime in 2007. The Government investigated and the Defendants pleaded guilty to criminal charges in 2010. The Defendants were ordered to pay $43 million to Medicare, Medicaid and private insurers as restitution in 2011. The award was later reduced to $37 million.

During the appeal, the relators filed their qui tam lawsuit under the False Claims Act in November 2011. On a motion for partial summary judgment, the Government sought to deny the relators a share of the proceeds from the criminal prosecution. The District Court agreed with the Government.

The False Claims Act provides for recovery by a relator even if they have previously disclosed the fraud to the government. It requires the dismissal of lawsuits based on publicly disclosed information unless the relator is the “original source” of the information. 31 U.S.C. § 3730(e)(4)(A). An individual is the original source if they “voluntarily disclosed to the Government the information on which allegations or transactions in a claim are based” prior to the public disclosure. 31 U.S.C. § 3730(e)(4)(B). This rule encourages whistleblowers to come forward early and report fraud to the Government.

However, in their specific case, the whistleblowers delayed filing a complaint under the False Claims Act until the Government had already received an award for restitution in the criminal proceedings. When the Department of Justice declined to intervene in their action, the relators sought to have the criminal proceeding considered an “alternate remedy” under § 3730(c)(5).

Section 3730(c)(5) permits the Government to pursue an alternate remedy to the relator’s civil suit under the False Claims Act. “Notwithstanding subsection (b), the Government may elect to pursue its claim through any alternate remedy available to the Government, including any administrative proceeding to determine a civil monetary penalty.” 31 U.S.C. § 3730(c)(5). However, if the Government does pursue an alternate remedy, the relator is entitled to share in the proceeds as if it had been recovered through their False Claims Act lawsuit. “If any such alternate remedy is pursued in another proceeding, the person initiating the action shall have the same rights in such proceeding as such person would have had if the action had continued under this section.” Id.

The Fifth Circuit agreed with the Department of Justice and the District Court. The criminal prosecution was not an alternate remedy because it was filed prior to the qui tam action. The Court of Appeals reasoned, from the text of the statute and the definition of the word alternate, that the qui tam proceeding must exist in order for the government to elect an alternate remedy to it. Babalola, slip op. at 7. As the relators did not file their complaint until after the Government pursued the criminal prosecution, they were not entitled to recover a portion of the proceeds as an alternate remedy.

If, instead of sending the anonymous letter to the government, the whistleblowers had filed a lawsuit under the False Claims Act, they may have been entitled to recover a portion of the funds. See United States v. Bisig, 2005 WL 3532554 (S.D. Ind. Dec. 21, 2005)(criminal prosecution is an alternative remedy under the False Claims Act). As it stands now, the whistleblowers will need to continue their lawsuit under the False Claims Act in order to earn their whistleblower reward.

The concurring opinion by Judge James Dennis points out how this result is at odds with a central goal of the False Claims Act.

Babalola and Adetunmbi could have withheld their information and allowed the fraud to continue while they searched for an authority to represent their interests in a qui tam suit. But they did not — they took the path of the Good Samaritan and without delay provided the government with the evidence needed to purse the defrauders …. For all their efforts, Babalola and Adetunmbi received nothing. Had Babalola and Adetunmbi first filed their qui tam suit before providing their information to the government, then they would have been entitled, under § 3730(d)(1), to an award of between fifteen to thirty percent of the government’s proceeds.

Babalola, slip op. at 15-16 (Dennis, J., concurring).

McEldrew Young represents whistleblowers in litigation under the False Claims Act. If you would like a free, confidential consultation with an attorney regarding a potential claim, please call 1-800-590-4116.

Photo Credit.

Call Now