The Whistleblowing Details: The False Claims Act in Practice

"Now as through this world I ramble
I see lots of funny men,
Some will rob you with a six-gun,
And some with a fountain pen."
- Woody Guthrie¹ 

The civil False Claims Act richly deserves its reputation as the primary workhorse in the fight against fraud in all federal programs. The act takes on the world's second oldest profession “ thievery. Its special weapon is its reward provision, known as "qui tam,"² which allows whistleblowers to file suit on the government's behalf. By permitting this it combines the traditional federal role in law enforcement with an incentive structure similar to private litigation. The act's triple damages and massive penalties make defendants pay dearly for their wrongdoing.

This article will: (1) analyze the liability portion of the act, (2) identify the five most common types of prosecuted cases and give several examples of how the act assists the government in recovering money taken fraudulently by its contractors, (3) analyze the progress and success of the "qui tam" whistleblower provisions since the Act's 1986 amendments, and (4) identify the various states that have adopted similar statutes.

The Act's Liability Provision

The Act prohibits seven different types of conduct, all of which involve submission of false claims to the government.

1. The most common "act" which creates liability is the knowing submission of a false claim.³ For example, seeking reimbursement for goods or services never provided or falsely describing the goods or services that were provided is a section 3729(a)(1) action. (False Claim)
2. Also, a person may not knowingly make or use a false record to obtain a false claim.⁴ Section 3729(a)(2) is aimed at those who supply false documentation in support of a false claim. Examples of false documentation include invoices, results of inspections, safety or performance tests, and evidence of eligibility to contract. (False Record)
3. Conspiracy to defraud the government through false claims is a separate violation.⁵ The elements of this offense are (1) the defendant conspired with one or more persons to get a false claim allowed or paid, (2) one or more conspirators performed an act to effectuate the conspiracy, and (3) as a result of the claim the [government] suffered damages. It's not necessary to show that a false claim was presented to or paid by the government as a result of the conspiracy. Each co-conspirator is jointly and severally liable for the damages and penalties resulting from this violation. (Conspiracy)
4. It is also a violation to knowingly deliver less property than the amount listed on a certificate or receipt.⁶ This section is intended to cover any fraudulent concealment of property resulting in a financial loss to the government. Essentially, it prohibits embezzlement of government property by delivery contractors. (Delivery of Less Property)
5. A person, intending to defraud the government, may not issue a receipt for less than what the government actually receives.⁷ This subsection is aimed primarily against public officials or contractors acting on the government's behalf. It encourages those who receive or make deliveries to the government to verify that the delivery is complete. (False Receipt)
6. Another violation occurs where one knowingly buys government property from a government employee who is not authorized to sell it.⁸ This section reaches those who buy "black market" goods from government employees. (False Purchase)
7. Finally, the "reverse" false claim provision prohibits the knowing use of a false record to decrease an obligation to the government.⁹ This provision is targeted at those who fraudulently reduce the amount they owe to the government.¹⁰ (Reverse False Claim)

The "Delivery of Less Property," "False Receipt," and "False Purchase" provisions are seldom prosecuted because it's much more difficult to misappropriate large amounts of money through these three types of schemes.

Five Most Common Types of Prosecuted Cases

In their attempts to defraud the government, only cunning and ingenuity limit crooked contractors. Thus, all the potential ways the act may be violated have not yet been identified. However, John T. Boese in his book, "Civil False Claims and Qui Tam Actions,"¹¹ identifies the five most common types of cases that are prosecuted: 1) mischarge, 2) fraud in the inducement or false negotiation, 3) false certification of entitlement, 4) substandard product or service, and 5) reverse false claim.

Mischarge Case

This category generally involves two basic situations. First, contractors often submit invoices for goods or services they never deliver or provide. Second, contractors falsely describe, in their invoices, the goods or services they actually provide as being of higher quality than what is actually provided.

A large percentage of Medicare/Medicaid cases usually involve mischarges through fraudulent billing such as: (1) add-ons (billing for tests not ordered or products not provided); (2) up-coding (billing for a more highly reimbursed service or product than the one provided); (3) unbundling (billing separately for groups of services that should have been billed at a single lower composite rate); (4) billing for medically unnecessary services; (5) double billing, (billing twice for the same services provided); and (6) false cost reports by hospitals.

The measure of damages in mischarge cases are generally calculated by answering the following question: What amount did the government pay out, as a consequence of its reliance on the false statements, over and above what it would have paid if the claims had been truthful?

Following are examples of mischarging:

Goods or Services Never Provided

In March 1998, Alliant Techsystems Inc. and Hercules Inc. paid the government $4.5 million to settle allegations they illegally overcharged the Navy for labor not provided. A qui tam suit alleged "that managers at Alliant and Hercules regularly directed their employees to mischarge labor time to a number of military contracts even though management knew the employees did not devote as much time to the contract as was charged to the government."¹² 

Medically Unnecessary Services

Charter Behavioral Health Systems, Inc. agreed to reimburse the government $4.7 million to settle a complaint, which alleged that its patients, a large proportion of which suffered from "debilitating organic brain disorders, such as Alzheimer's Disease and severe dementia," were admitted routinely for "psychiatric treatment" even though they were "utterly incapacitated" and obviously wouldn't benefit from psychiatric services.¹² 

False Cost Reports

Currently, the Columbia/HCA Healthcare Corporation is battling charges that it engaged in, among other frauds, a false cost reporting scheme. A qui tam suit alleges that Columbia prepared a second set of books known as "reserve cost reports" which included certain unallowable costs contained in the cost reports they actually filed with the government to get an inflated reimbursement. The lawsuit alleges that the second set of books was hidden from government auditors and the purpose of the reserve cost reports was to reserve funds to repay the government in the event the unallowable costs were ever discovered.¹⁴ The lawsuit doesn't specify the amount sought. However, analysts have estimated that Columbia may have to pay more than $1 billion to settle all of the various fraud claims currently being investigated, including this cost-reporting case.¹⁵ 

Fraud-in-the-Inducement Case or False Negotiation

This category arises when a contractor, in an attempt to inflate the cost of the contract, makes false statements while negotiating a federal contract (a k a defective pricing) or engages in illegal activity (for example, bid-rigging, bribery or kickback schemes) to secure the contract.

False Negotiation (a k a defective pricing)

Federal contractors are required by law to fully disclose their pricing practices to the government and to provide all discounts to the government that it provides to commercial sector customers. Numerous examples exist in which contractors deceive the government into believing that it's receiving their lowest rate, when in fact, it isn't.

Baker & Taylor, Inc. paid $3 million to settle allegations that it "agreed to provide (the government) with discounts of around 40 percent on trade books, but then failed to provide the full discounts by mis-classifying trade titles into non-trade categories. Meanwhile, Baker & Taylor provided full trade discounts on the same books to retailers."¹⁶ 

The damages in a false negotiation case are equal to the difference between what the government actually paid and the lowest price offered to commercial sector customers.

Kickbacks and Bid Rigging

The federal Anti-Kickback Act, 42 U.S.C. § 1320a-7b(b), prohibits the payment of kickbacks for the purpose of inducing the referral of services that are paid for by federal health programs. Numerous recent civil prosecutions have targeted medical providers. Kickbacks may corrupt medical providers decision making, placing profit above patient welfare. They can lead to grossly inappropriate medical care, including unnecessary hospitalization, surgery, tests, and equipment.¹⁷ 

The general rule for damages in a kickback case are equal to the difference between what the government actually paid less what the government would have paid had the kickback not occurred. However, some courts have increased this amount by the government's loss of reputation, which is, of course, difficult to quantify. Also, other courts have considered the kickback amount in assessing damages.

The damages in a bid-rigging case are equal to the difference between what the government paid and what it would have paid had the bidding been fair, open, and competitive.

False Certification Case

Many federal programs entitle individuals or businesses that meet certain criteria to receive government benefits. One of the most commonly abused entitlements involve federal loan guarantees. In order to qualify for the benefits, the applicant makes false statements in a loan application. The government relies on the false statements and the loan guarantee is granted.

A false loan application to a private bank for a loan that is merely insured by the government is not a "claim" under the False Claims Act. Rather, a falsified loan application ripens into a false claim only if default on the loan occurs and demand for payment on the guarantee is made.

For example, First Union Mortgage Corporation was accused of falsely certifying the eligibility of borrowers for federally insured home mortgages in a complicated scheme. First Union settled for $7 million. The suit alleged that First Union misrepresented to the U.S. federal Housing and Urban Development department (HUD) that borrowers on various properties made their required down payments. The down payments, according to the suit, were shams because the seller, working together with First Union, immediately refunded the down payments at closing. Many of the buyers were "strawbuyers" who qualified for the loans on the seller's behalf and then "flipped" the properties back to him after closing, in violation of HUD regulations. In return, the seller paid the strawbuyers $2,000. The suit charged that First Union employees solicited investors for the properties and assured them that the transactions complied with HUD regulations. Most of the buyers were novice real estate investors culled from "no money down" real estate seminars given by the seller.¹⁸ 

In federal home mortgage insurance cases, if the government wouldn't have insured the loan "but for" the false statements made in the application, the government's damages equal the loan amount (for example, $100,000) plus all costs incurred to maintain, repair and sell the property (for example, $15,000). The government is then entitled to triple the damages ($115,000 * 3 = $345,000). Also, the Act provides for a civil penalty between $5,000 and $10,000 for each false claim. ($345,000 + $10,000 = $355,000). Any amount received from the sale of the property (such as $55,000) is subtracted from a defendant's liability only after the damages have been trebled. Thus, for one claim on a fraudulent home loan, a defendant's total liability would be $300,000 ($355,000 “ $55,000 = $300,000).

In a different type of false certification case, some home oxygen providers agreed to pay the government $5 million to settle allegations that they defrauded Medicare through a complex scheme. The scheme enabled them to provide home oxygen equipment to Medicare beneficiaries who weren't qualified to receive coverage for the equipment. The providers submitted bogus documentation distorting a patient ™s blood oxygen level, for example, in order to collect from Medicare.¹⁹ 

Substandard Product or Service Case

This type of case arises when a contractor dupes the government by providing an inferior or shoddy substitute in place of the originally contracted material. This scheme has been around forever. In fact, substandard product cases provided the impetus for the creation of the False Claims Act signed into law by President Lincoln in 1863. After conducting an extensive investigation of war contractors, the U.S. Congress discovered that when the War Department paid "[f]or sugar it often got sand; for coffee, rye; for leather, something no better than brown paper; for sound horses and mules, spavined beasts and dying donkeys; and for serviceable muskets and pistols, the experimental and failures of sanguine inventors, or the refuse of shops and foreign armories."²⁰ The corrupt contractors fast became "proverbially and notoriously rich."²¹ 

In December 1998, Unisys Corporation "agreed to pay $2.5 million to settle allegations that it supplied refurbished, rather than new, computer materials" to numerous federal agencies. Unisys "admitted to supplying various computer and related components that were re-worked or refurbished" and "did not conform to the contract agreements that required the company to provide new equipment" allowing Unisys to fatten its bottom line.²² 

The measure of damages in substandard product cases is generally the difference between what the government actually paid and what it should have paid for the substandard equipment. If it's determined that the government has no use for the shoddy equipment, then the damages will be equal to the entire contract amount. Otherwise, if the government receives something of value then that value is taken into consideration.

Two other substandard product examples include: (1) a contractor's "failure to test" a product when testing was mandatory under the contract and (2) a health care provider's failure to adhere to standards required by Medicare/Medicaid regulations.²³ 

Failure to Test

In April 1998, a division of AMP Inc. agreed to pay the government $3 million to settle claims that it failed to perform required tests on certain electronic components known as integrated microwave assemblies (IMAs), that it sold to the government. The IMAs were used in the Advanced Self-Protection Jammer system, which enables military aircraft to identify and then jam enemy radar signals.²⁴  

The determinative issue in these cases is whether the failure to test the product sold to the government affected the performance or intrinsic value of the untested product. If the product would have passed anyway, the government is still entitled to the costs it incurred for testing the product itself. However, if testing determines that a product is faulty and fails to meet contract specifications, the full contract amount will be awarded as damages.

Reverse False Claim Case

A "reverse false claim" occurs when a person uses a false record to decrease an obligation to pay the government. These cases are counter-intuitive; since violations of the tax code can ™t be prosecuted under the act, we commonly think only of the government paying out, rather than the government receiving. However, there are a variety of situations where companies trick the government into receiving less money than it rightfully deserves.

For example, federal contractors that harvest timber, coal²⁵, or oil from federal land are required to pay royalties to the federal government. In January 2000, Chevron Corporation agreed to pay $95 million to settle allegations that it underpaid royalties due for oil produced on federal and Indian land leases.²⁶ 

Another common example occurs when companies deceive the post office. Under an honor system, many large "volume-mailers" get postage discounts if they perform certain procedures which save the post office time.²⁷ (Other companies falsify their status as non-profits in order to receive a lower rate of postage.) R.R. Donnelley & Sons Co. agreed to pay $22 million to settle allegations that, for 10 years, it had been skimping on the postage for sending thousands of catalogs, magazines, and other mailings.

Qui Tam Success

Since the act was amended in 1986, more than $3.5 billion has been recovered in whistleblower related cases. In return for filing the cases, in accordance with the statute, the Department of Justice has paid whistleblowers more than $550 million, with additional awards pending.²⁸ 

Almost half of the qui tam recoveries have come in the last 2 ½ years. "It took us 12 years “ to the end of fiscal year 1998 “ to recover $2 billion" in whistleblower cases, and "[w]e have reached the $3 billion mark just 16 months later." reported Acting Assistant Attorney General David Ogden in a Department of Justice press release. "The False Claims Act and its qui tam provisions," he said, "have provided a remarkable return for the taxpayers of this country. The recovery of over $3.5 billion demonstrates that the public-private partnership encouraged by the statute works and is an effective tool in our continuing fight against the fraudulent use of public funds."²⁹ 

More than 3,000 whistleblower suits have been filed since 1986. The number of qui tam suits filed per year has risen from 33 in 1987 to 483 in the last fiscal year.³⁰ The estimated fraud deterrence attributable to the qui tam provisions is $35 billion to $75 billion from 1986 to 1996 and $105 billion to $210 billion from 1996 to 2006.³¹ 

States Follow Suit

It's no great surprise that “ in an effort to duplicate federal success “ California, Illinois, Florida, Louisiana, Texas, Tennessee, and Washington, D.C., have passed legislation that provides a remedy for false claims involving state funds and allows for private qui tam enforcement.³² 

Because, many federal contracts are funded by a combination of state, local, and federal funds. Prosecuting authorities from these sectors may become involved in a False Claims Act investigation. In fact, joint actions under both state and federal law are not uncommon.³³ Liability for contracts with multiple funding sources exists under the Act where "any portion" of the payment sought came from federal funds.³⁴ Consequently, even a false claim to a private entity can generate liability under the Act if the federal government has provided some of the money claimed.

Fraud examiners should follow this fascinating area of fraud prosecution. The act is a powerful and effective legal weapon. The False Claims Act and its qui tam provision fight numerous types of fraud against the government and increasing numbers of states will enact statutes providing for qui tam enforcement. The government, whistleblowers, and their attorneys will continue to use the act to recover increasingly substantial sums taken through fraud. The act's major role in fighting fraud would make President Lincoln proud indeed.

Tod A. Lewis, J.D., CFE, CIA, CGFM, is a litigator at Freed & Weiss in Chicago, Ill. He concentrates on consumer fraud class actions and qui tam actions. His e-mail address is: tod@freedweiss.com.