The "'New'" False Claims Act

By John C. Ruhnka and Edward J. GacIn Brief

A Negative Incentive Works Against Positive Incentives

The False Claims Act (FCA) is a Civil War era law primarily enforced by private "bounty hunter" lawsuits against defense contractors, hospitals, medical service providers, research organizations, universities, and anyone who contracts with or seeks reimbursement from the Federal government. The FCA explicitly excludes tax fraud and does not cover waste or mismanagement by the government But aside from these two exceptions, the FCA potentially implicates any organization presenting a false or fraudulent claim for payment to the Federal government or using a false statement or record to conceal, avoid, or decrease an obligation to the Federal government. Private lawsuits on behalf of the government are called qui tam actions, and these lawsuits have mushroomed following 1986 amendments intended to encourage more private enforcement of the FCA, with recoveries to date exceeding $1.45 billion. Unfortunately, the "new" FCA contains significant incentives for employees to cover up or suppress evidence of misbillings or fraud to increase their rewards, which has troubling implications for internal compliance and audit programs by companies doing business with the Federal government, as well as for the role of accountants, auditors, and others who perform audit and compliance functions for both private industry and government.

Fraud in contracting with the government has been a persisting problem in the U.S., and following the outbreak of the Civil War, Congress enacted the Federal False Claims Act of 1863 (FCA) that provided criminal penalties for false claims and overcharging by persons contracting with the Federal government. Because in 1863 there was no Department of Justice, Federal Bureau of Investigation, or Defense Contract Audit Agency to prosecute fraud against the Federal government, President Lincoln recommended to Congress that the act contain "qui tam" or private citizen enforcement provisions. Congress accordingly authorized private citizen "relators" to file civil actions against any party who had presented a false claim for payment to the U.S. government. Since the relators act as "private attorneys general" on behalf of the defrauded government, they need not have suffered any individual injury from the alleged acts and were permitted to prosecute cases to conclusion without government interference. As an incentive to undertake such private enforcement actions, the FCA provided a bounty of 50% of all recovered moneys be paid to private plaintiffs, which included a $2,000 fine for each false claim submitted and doubled damages of all funds out of which the government was defrauded. The 1863 act imposed very few restrictions on qui tam plaintiffs, and even government employees could file qui tam claims. Following the Civil War, the False Claims Act fell into gradual disuse due to restrictive judicial rulings that it was up to judicial discretion how much of the statutory 50% bounty to award private plaintiffs. Because the 1863 act required plaintiffs to bear the entire cost of prosecuting private FCA actions, this produced the risk that a qui tam relator could win his or her suit but realize only a small fraction of the recovery as the reward. Courts also imposed a "clear and convincing evidence" standard of proof for FCA claims and required plaintiffs to show that defendants had actual knowledge of the fraud, which can often be difficult to prove without investigatory powers.

The original FCA did not bar qui tam lawsuits based on information already made public or require a relator produce any new information about an alleged fraudulent practice for the government, which meant that opportunistic qui tam actions based on information already known to the government were possible. Private litigants could copy government criminal FCA indictments verbatim and file them as civil qui tam lawsuits and still be eligible for one-half of the recovery upon their successful prosecution, if they filed their civil action before the government did. Such race to the courthouse scenarios did occur a number of times, in some cases by government employees filing civil qui tam claims against companies who were the subject of government enforcement actions they had found out about in their governmental duties.

The problem of parasitic FCA claims finally came to a head in 1943 in the case of Marcus v. Hess, where a qui tam plaintiff obtained a copy of a Federal criminal indictment of a defense contractor and used information in the criminal indictment to file an FCA civil action against the same defendant. When the Supreme Court ruled that nothing in the FCA barred qui tam actions even if the relator's knowledge of the fraud was solely a product of the government's investigation, Congress reacted by amending the FCA to bar qui tam actions based on evidence or information already in possession of the government when the action was brought. Subsequent judicial interpretations of the 1943 FCA amendments further limited qui tam suits whenever the government already had knowledge of the "essential information" on which the suit was based, even if the qui tam plaintiff had been the original source of the information and the government had subsequently failed to act on it. At that point, the civilian enforcement provisions of the FCA were essentially dead.

Summary of the 1986 Liberalizing Amendments

In 1986, embarrassed by a succession of highly publicized defense contractor overcharging cases, Congress amended the FCA to encourage more private anti-fraud lawsuits. The 1986 amendments significantly enhanced the incentives for private citizens to act as qui tam relators and their share of recoveries from private FCA suits are noted a follows:

• The 1943 prohibition of qui tam suits based on "prior government knowledge" was dropped, so long as the relator was also "an original source" of the information upon which the claim was based.

• The relator's role in FCA suits was expanded; the relator continues to be a party in a qui tam suit even if the government intervenes, and may continue unrestricted participation in the litigation.

• Civil penalties were increased to a minimum $5,000 and maximum $10,000 fine for each violation plus trebled damages on all overcharges to the government (raised from double damages), both of which increased the total recovery in which the private relator shares.

• The private relator's share of qui tam recoveries was increased to a minimum of 25% and up to 30% of the fines and trebled damages, if the government does not intervene in the action, and a minimum of 15% and up to 25% of the recovery in cases where the government intervenes, depending upon the extent to which the plaintiff "substantially contributed to the prosecution of the action."

• Defendants who are found liable or settle qui tam suits have to pay the relator's costs of the suit plus attorneys' fees.

• Whistle-blower protection against firing was provided for the qui tam relator as well as for other employees assisting the relator by testifying, including reinstatement, double back pay, and attorney's fees.

• The burden of proof was reduced from "clear and convincing evidence" to a lower "preponderance of the evidence" standard, and the defendant's "guilty knowledge" requirement was reduced to "knowingly" committing fraud that causes financial loss to the United States--which includes deliberate ignorance of mischarging and reckless disregard of proper accounting practices. Proof of any specific intent to defraud by the defendant is no longer required.

Procedure for Filing a Qui Tam Claim

Under the 1986 FCA amendments, qui tam suits based on allegations or transactions already disclosed in a criminal, civil, or administrative hearing, or Government Accounting Office report, hearing, audit, or investigation, or the news media, are not barred as pre-1986, if the relator is also an original source of the information. "Original source" means an individual has direct and independent knowledge of the information on which the allegations are based (i.e., the relator knew of the alleged fraud from direct involvement with the defendant or independent investigation, rather than through information already in possession of the government). The relator must also have voluntarily provided the information to the government before filing an FCA action based on that information. In practice, the information on the alleged fraud may be disclosed to the government simultaneously with filing a qui tam suit by filing a qui tam complaint with the Federal court in camera (under seal) and filing a written disclosure statement of material evidence and information with the Attorney General of the United States.

The complaint remains under seal for at least 60 days while the Department of Justice has a chance to investigate the claim and decide whether or not to intervene in the civil lawsuit. Since 1986, the Justice Department has intervened in only 225 qui tam claims or about 15% of private FCA filings, leaving private plaintiffs to conduct 85% of such quasi-criminal enforcement actions. If the government intervenes in an FCA action, it retains primary responsibility for prosecuting the action and may dismiss the action after an opportunity for a hearing, or may settle the action with the defendant notwithstanding the objections of a relator. The government may also pursue the same claim through an alternative forum, including an administrative proceeding to determine a civil money penalty, but the qui tam relator retains rights to a share of any settlement--preventing the government from avoiding paying a reward by initiating an independent Federal civil claim.

Impact of the 1986 FCA Amendments

The Congressional sponsors of the 1986 amendments to the FCA hoped to substantially increase private enforcement of the act, and as the exhibit showing the number of qui tam filings following the 1986 amendments indicates, they clearly succeeded. More than 1,550 qui tam actions have been filed since the 1986 amendments, and qui tam claims reported by the Department of Justice have increased 990% from 1987 to 1996.

Qui tam recoveries have increased as well. In July 1996, the Justice Department announced that qui tam recoveries under the FCA amounted to $1.13 billion since the 1986 amendments, and settlements since that date have pushed post-1986 qui tam recoveries over $1.45 billion. Of this amount, private qui tam plaintiffs have been awarded $200 million, or about 18% of the government's recoveries. In qui tam cases where the government has declined to intervene, whistle-blowers' shares can range up to 30%, depending on how critical their information was to achieving a recovery for the government. Qui tam plaintiffs have been awarded $26 million or 28.5% of the total recoveries in those cases. As the much higher bounty totals for the 15% of cases where the DOJ has intervened indicates, the Justice Department tends to intervene only in cases with high potential recoveries, leaving smaller cases to be prosecuted by private plaintiffs.

The subject matter of FCA claims has been changing as well over the past decade, mirroring the changing pattern of Federal government disbursements. Fraud against the Defense Department (DOD) has traditionally accounted for the majority of qui tam claims, but as Exhibit 2 indicates, health-care fraud is rapidly increasing in importance and, by 1996, accounted for more than half of all qui tam cases filed. The increase in health-care fraud claims parallels the rapid growth in Federal disbursements for health care that includes reimbursement programs (Medicare, Medicaid, and civil service health insurance programs) as well as service-delivery programs such as Veterans Administration hospitals, military hospitals, the Bureau of Prisons, and the Indian Health Service. False claims for health care can include billing for nondelivered or unnecessary or unauthorized services, and misrepresentation of services (e.g., billing minor surgical procedures as more expensive operations).

These general categories, in turn, can encompass a multitude of fraudulent contractor practices such as billing for services that do not meet Medicare quality standards, fraud in cost reporting (inclusion of unrelated expenses, failure to disclose supplier relationships, and inflated costs), mislabeling noneligible services as eligible, mislabeling services as being more expensive, and paying kickbacks for patient referrals. Because defense contracting fraud typically involves more money than health-care fraud, the DOD is the contracting agency in 66% of qui tam recoveries in dollar amounts, and Health and Human Services is the contracting agency in about 25% of qui tam recoveries, although the single largest qui tam recovery to date involved a $182 million medical laboratory settlement in 1996.

The FCA is very broad in its reach, and potentially implicates every organization that uses any Federal money. Whistle-blowers have begun to file qui tam suits against universities and nonprofit institutions for including improper items in the overhead rate for Federally-supported research contracts, and in some cases for alleged "scientific misconduct"--not following "proper procedures" in Federally-supported scientific research. This development troubles some critics of the FCA who worry that the "new" FCA has given virtual immunity to disgruntled employees to file paralyzing claims against employers with very few penalties for qui tam suits that later turn out to be unjustified.

Growth in Internal Compliance and Audit Programs

Over the past 20 years, from about the time of the Federal Foreign Corrupt Practices Act of 1977, increasing numbers of Federal regulatory, contracting, and enforcement agencies have made a policy decision to encourage voluntary corporate compliance programs that can supplement, or in some cases even replace, intrusive and inflexible agency monitoring, inspection, and reporting requirements for regulated industries. In some areas, the initiation of voluntary internal audit and compliance programs has been encouraged by governmental incentives. Examples include the 1986 DOD Voluntary Disclosure Program for defense contractors, jointly administered by the Departments of Defense and Justice, which recommends that all defense contractors adopt "a policy of voluntary disclosure as a central part of your corporate integrity program" and suggests that "early voluntary disclosure, coupled with full cooperation and complete access to necessary records, are strong indications of an attitude of contractor integrity even in the wake of potential criminal liability." Once a contractor is admitted into the DOD program, it can expect its eventual liability from self-reported irregularities will be less than FCA-mandated treble damages, an overall settlement will be coordinated with other governmental agencies, and any Federal suspension will be delayed until the disclosure is fully investigated. In 1994, the Office of Inspector General of Health and Human Services instituted a similar voluntary disclosure program for health-care providers.

Other positive incentives for internal corporate audit and compliance programs include 1) the Antitrust Division, which has guaranteed no criminal prosecution of any company that voluntarily reports antitrust violations to the DOJ before the DOJ learns of them and then fully cooperates in any ensuing government investigations and 2) the 1991 Federal Organizational Sentencing Guidelines, which provides substantial mitigation of criminal penalties for organizations that have in place "effective procedures to prevent and detect violations of law."

The reduction in potential criminal fines provided by the Federal Sentencing Guidelines for Organizations is dramatic, since internal compliance programs can prevent aggravating factors that increase criminal fines as well as generate mitigation points, producing resulting fines as much as eight times smaller than for organizations without internal compliance programs.

The DOD has also issued regulations directing government contractors to--

• adopt corporate ethics programs,

• establish internal compliance auditing programs monitored by external or internal auditing,

• provide disciplinary actions and sanctions for violations,

• maintain a "fraud hotline" for the internal reporting of contracting problems to the corporate ethics agency or internal audit department, and

• requiring timely reporting to and cooperation with government investigation agencies.

Accounting and internal audit employees play an important, and often central role in these voluntary compliance programs as well as in government contract costing, accounting, and billing activities.

FCA-Caused Problems for Compliance and Audit Programs

Compliance Programs Can Increase Risk. FCA treble damage provisions can undermine the rationale for internal corporate compliance and voluntary self-reporting programs. Certainly, one very important rationale for internal corporate compliance programs is to reduce potential civil and criminal liability by preventing legal and regulatory violations and, where such violations have already occurred, to reduce potential civil and criminal penalties by promptly investigating and reporting violations for internal or governmental action. But, if information generated by internal compliance and audit functions, information the organization might not otherwise generate except to reduce the occurrence of external liability, can increase the legal liability of the corporation because of the triple damage provisions of the FCA if an employee privy to the internal audit or compliance information files a qui tam suit before the company can voluntarily report the information, this rationale is seriously impaired.

Perverse Incentives. Filing a qui tam action involves high "transaction costs" for a private whistle-blower. The relator is almost sure to destroy any career prospects at his or her present employer, even if the whistle-blower protection provisions of the FCA prevent his or her immediate firing. A reputation as an informant who used inside access and information to charge his or her employer with defrauding the government can also limit future employment opportunities in an industry. Practically speaking, a qui tam relator had better be sure that he or she can comfortably retire on the proceeds of their qui tam suit before they file. Second, if the government does not intervene in a qui tam action, the plaintiff faces the prospect of protracted litigation with a very angry employer who has much deeper pockets than the plaintiff. Further, the plaintiff (or more commonly, plaintiff's counsel under a contingency fee arrangement) must foot its own costs and attorney's fees if they do not achieve a settlement or victory. As a result, there is a very substantial downside to filing a qui tam suit, and a private relator is unlikely to file (and a plaintiff's attorney is unlikely to agree to represent) a qui tam suit involving relatively small damages regardless of the egregiousness of the deception practiced on the government or the seriousness of its eventual impact. Instead, the FCA "bounty hunter" incentives might encourage a potential relator not to notify his or her employer upon first discovering government contracting irregularities, but to wait until a misbilling practice grows to substantial dollar amounts necessary to offset the high transaction costs of a qui tam claim.

Positive vs. Negative Incentives

The 1986 False Claim Act amendments have had the unintended, but nonetheless harmful, result of conflicting with a much larger array of Federal, state, and other regulatory programs that rely on, and encourage voluntary enactment of, corporate self-regulation and compliance programs as a more efficient route to achieving lawful corporate behavior. The problem is that the present patchwork of legislative incentives, regulatory provisions, and Federal agency incentives to encourage lawful corporate conduct were developed piecemeal, and at different times, without regard to cross-linkages. Whenever there are powerful negative incentives and weaker but more diverse positive incentives operating in the same system and intended to achieve the same ends, a danger exists that the negative incentives will cancel out the positive incentives.

The solution, we suggest, is not to abolish qui tam, but rather for Congress to revisit the FCA, as well as other governmental incentives for voluntary corporate reporting and self regulation, to better coordinate these incentives. To give just one example, in the 1991 Federal Sentencing Guidelines for Organizations, Congress gave corporations significant positive incentives for enactment of "effective programs to prevent and detect violations of law" by substantial reductions in fines and penalties if such a program is in place and a violation was reported to the government and the company cooperates with the government in resolution of the issue. Similar positive incentives for voluntary self-regulatory programs and self reporting exist in Justice Department charging guidelines; DOD, HHS, and OSHA rules; and other Federal and state regulatory areas. If this is the case, does it make sense for the FCA to generate strong negative incentives for the use of such internal compliance and self-reporting programs by potentially providing financial incentives for participants in internal corporate compliance programs to cover up or suppress evidence of government misbillings or fraud?

As Judge Patricia Wald observed in a decision for the District of Columbia Circuit interpreting the 1986 FCA amendments, "The history of the FCA qui tam provisions demonstrates repeated congressional efforts to walk a fine line between encouraging whistle-blowing and discouraging opportunistic behavior." It has been 10 years since Congress revised the FCA to increase its use, ample time in which to observe the beneficial results as well as the unanticipated consequences of such changes. In light of the widespread growth of voluntary corporate compliance programs, it may now be appropriate for that line to be redrawn so as not to place at jeopardy companies that enter into such programs in good faith with a view to preventing violations of law and being good corporate citizens.

Prospective FCA modifications should encourage the widespread use of voluntary corporate compliance and internal audit programs to identify contracting problems and potential misbillings early on and provide positive incentives for prompt reporting and cooperative resolution of issues with governmental contracting and regulatory agencies. Given the enormous complexity of many cost allocation and billing issues in government contracting and medical-care fields, what about giving companies a bit more time than the present 30-day window from initial discovery of suspected contracting fraud in which to investigate and voluntarily disclose potential irregularities to qualify for reduced FCA penalties? And what about better incentives for voluntary reporting and cooperative resolution of contract irregularities that the double-damages presently provides for in the FCA--such as waiving the very high minimum statutory fines for each misbilling? If a private qui tam claim was the direct result of information produced by a voluntary corporate compliance or audit program, and absent any evidence of deliberate corporate fraud or cover up, shouldn't a corporation which cooperates fully with the government in investigating and resolving an alleged qui tam claim also be eligible for reductions from the harsh statutory penalties? Should qui tam relators be eligible for full FCA rewards if they violated a specific duty to promptly report information on potential misbillings or intentionally covered up such information to let potential damages grow? In sum, we need more constructive positive incentives for companies and for internal compliance personnel to promptly report and cooperatively resolve contracting problems before civil damages can build up, while at the same time maintaining the prod of private qui tam actions in the event of intentional cover-up by a contractor once significant evidence of contracting fraud has surfaced in a compliance program.

John C. Ruhnka, JD, LLM, is a professor of management at the Graduate School of Business Administration, University of Colorado at Denver. Edward J. Gac, JD, is an associate professor of law and taxation at the Graduate School of Business Administration, University of Colorado at Boulder.